Tuesday, April 20, 2010

[Abacus] The experience of Laura Schwartz

by Tracy Alloway

Laura Schwartz is a name that appears in Goldman Sachs’ defence documents — the bank’s counter-arguments against the SEC’s allegations of civil fraud in its Abacus CDO — and the pitch-book for the deal.

From 2004 to 2007 she was head of ACA Capital’s CDO Asset Management business, earning a salary of $275,000 in 2006, according to Bloomberg data. ACA was at the time a monoline insurer and CDO manager — running some 26 deals, worth $17.5bn, by May 2007.

In early 2007 Schwartz began working with Goldman Sachs on the Abacus 2007-AC1 deal, a $2bn synthetic CDO, referencing subprime mortgages. ACA’s role was to act as selection agent for the portfolio of securities the CDO would reference, but it was also an investor in the deal.

Part of the SEC complaint against Goldman alleges that one of the bank’s employees — Fabrice Tourre — misled investors into believing that hedge fund Paulson & Co was buying Abacus’ equity.

The equity tranche is the riskiest portion of a CDO, so being an investor in the tranche might suggest one had some confidence in the deal’s performance. The idea is that by believing that Paulson was going long Abacus, the CDO would be more marketable to the investors; ACA and German bank IKB.

The following is gleaned from Part I of Goldman’s defence documents:

* Laura Schwartz of ACA’s January 8, 2007 e-mail to Gail Kreitman in which she wrote “I have no idea how [the Paulson meeting] went – I wouldn’t say it went poorly, not at all, but I think it didn’t help that we didn’t know exactly how they want to participate in the space. Can you give us some feedback?” (GS MBS-E-003499710);

* Fabrice Tourre’s January 10, 2007 e-mail to Ms. Schwartz containing the “Transaction Summary” in which he stated that the transaction was “sponsored by Paulson” and included the line: “[0] – [9]%: pre-committed first loss,” (GS MBS E-003504901) which the Staff stated described the equity tranche; and

* Ms. Kreitman’s e-mail exchanges with Ms. Schwartz on January 14 and 28, 2007 in which Ms. Kreitman did not correct Ms. Schwartz’s apparent misunderstanding that Paulson was an equity investor (GS MBS-E-007980762; GS MBS-E-007992234).8

Goldman’s defence centres around a few things. For a start, the banks says that, under confidentiality requirements, it could not have disclosed Paulson’s role in the deal even if it wanted to. Furthermore, the bank never intended for ACA to infer that Paulson was investing in the equity tranche.

When it comes to those e-mails, the bank says that it doesn’t know what Tourre meant by “[0] – [9]%: pre-committed first loss,” and “sponsor” doesn’t necessarily mean equity investor. Meanwhile, Kreitman’s communiques were largely irrelevant, Goldman says, as she was simply the bank’s relationship manager for ACA, and did not participate directly in the creation of Abacus.

One of the over-arching themes of Goldman’s defence, however, is that it was not actually materially important for ACA to know that Paulson was or was not the equity investor. Thus it was under no obligation to disclose the position.

And here’s where things get really interesting.

From the defence document:

Similarly, the fact that ACA may have perceived Paulson to be an equity investor is of no moment. As a threshold matter, the interests of an equity investor would not necessarily be aligned with those of ACA or other noteholders, and holders of equity may also hold other long or short positions that offset or exceed their equity exposure. Indeed, Laura Schwartz of ACA understood this from her work on a transaction that closed in December 2006 in which Magnetar, a hedge fund that bought equity and took short positions in mezzanine-level debt, participated. (See GS MBS-E-007992234 (“Magnetar-like equity investor”).) Certainly, ACA could have questioned Paulson about its interests if it that information were significant to it.

Chicago-based hedge fund Magnetar is another name that has been hurled into prominence in recent months.

ProPublica ran a very detailed series about how the hedge fund created subprime CDOs to short in the years before the financial crisis. The Magnetar Trade, according to ProPublica, involved investing in the equity tranche, and then shorting its own position.

ProPublica also said some people have alleged that the hedge fund also helped stuff the CDOs with riskier mortgages — an allegation Magnetar strenuously denies. The hedge fund says it was arbitraging between the different layers of securities and was “net long”, rather than engineering a short.

Magnetar closed at least 26 subprime deals in 2006 and 2007, according to ProPublica.

Schwartz’s work was on ACA Aquarius 2006-1, a $2bn CDO which closed in September 2006.

Her name and biography appear in the prospectus for the deal, and ACA is listed as CDO manager — a similar role to the one it had on Goldman’s Abacus 2007 project.

Thus it looks like, in one sense, Schwartz’s experience on the construction of Abacus could well lie at the heart of a legal battle between Goldman and the SEC. Proving whether ACA was misled into believing Paulson was a long investor in the deal will no doubt involve her perspective.

In another sense, Schwartz’s overall experience as a CDO manager, including her role in Magnetar’s Aquarius CDO, could act as a litmus test for the sophistication of Abacus investors — something Goldman refers to in its defence documents over and over again:

Like other transactions of this type, all participants were highly sophisticated institutions that were knowledgeable about subprime securitization products and had both the resources and the expertise to perform due diligence, demand any information that was important to them, analyze the portfolio, form their own market views and negotiate forcefully at arm‟s length.

As for Schwartz, she appears to have left ACA in late 2007 — shortly before the firm divested itself of its CDO business.

(from FT, Apr 20 2010)

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