The weekend produced a veritable Eyjafjallajökull ash cloud of blogging and bloviating on the SEC’s filing on Friday against Goldman Sachs and its structured products trader Fabrice Tourre. Here’s the best we’ve read.
Getting shorty in CDOs
First — the key SEC charge is that Tourre allowed John Paulson to pre-select bonds in a proposed CDO and then to short them, without informing its other investors, ACA Capital included.
In a stand-out post, Steve Waldman questions the role of shorting in CDOs overall, arguing that CDOs are more akin to securities than derivatives, in terms of disclosure:
Investors in Goldman’s deal reasonably thought that they were buying a portfolio that had been carefully selected by a reputable manager whose sole interest lay in optimizing the performance of the CDO. They no more thought they were trading “against” short investors than investors in IBM or Treasury bonds do. In violation of these reasonable expectations, Goldman arranged that a party whose interests were diametrically opposed to those of investors would have significant influence over the selection of the portfolio. Goldman misrepresented that party’s role to the manager and failed to disclose the conflict of interest to investors. That’s inexcusable. Was it illegal? I don’t know, and I don’t care.
In a separate post, Steve mulls a more abstract view of whether Goldman did indeed act as a ’secret agent’ for one client to the disadvantage of another.
And was that pragmatic, let alone legal?After reading the filing, Bond Girl is cutting:
Seriously, why the hell would anyone want to be a client of Goldman Sachs after reading this?
Why would you work with a firm where employees mock the transactions they are arranging for you to purchase in emails?
Why would you work with a firm that would let someone that it knows is going to have a short position in the investment – because it helped them attain it – help structure that investment for you?
Why would you work with a firm that sees your multi-million-dollar business relationship as nothing more than collateral damage in its ultimate pursuit of fees?
This is not what investment bankers do. This is what backstabbing sociopaths do.
ACA and due diligence
Meanwhile, Henry Blodget and Felix Salmon squared off over whether Paulson’s prior involvement did indeed materially affect ACA’s position — or whether a ’sophisticated investor’ should have known better. Quite the ding-dong, this.
Blodget argues that there is a difference between control and influence:
Paulson did NOT have control over which securities were selected for the CDO.
This is critical. It’s also a fact that is clearly visible in the evidence the SEC provided.
The firm that DID have control over which securities were selected, ACA, was a highly sophisticated firm that analyzed securities like this for a living. It had FULL CONTROL over which securities were included in the CDO. We know this because, of the 123 bonds that Paulson proposed for the CDO, ACA only included 55 of them. In other words, ACA dinged more than half of the bonds Paulson wanted in the CDO, presumably because they did not meet ACA’s quality hurdle.
Now, did Paulson influence which securities ACA selected? Yes, he probably did. But any time someone says or does anything with respect to a security, there are lots of things that influence decisions.
Salmon calls this argument ‘pathetically unconvincing’:
Let’s remember here that in the end there were 90 securities in the CDO. Of those 90, it seems that 55 were chosen by Paulson. In other words, more than 60% of the securities in the CDO were picked, essentially, out of a stacked deck. It didn’t matter which securities ACA chose; Paulson had come up with his longlist of 123 securities precisely because all of them were particularly toxic. That’s a material fact which, if ACA had known it, would surely have sufficed to get them to exit the deal entirely.
Paul Kedrosky has the original flipbook for the ill-starred CDO, for reference.
Pivoting from that flipbook, Erik Gerding of The Conglomerate zeroes in on the SEC’s case over disclosure:
My guess is that a reasonable investor would indeed want to know that Paulson was involved in selecting the deck. What’s the support for this beyond the SEC’s Complaint? Look at the “flipbook” for the transaction provided to investors by Goldman…
It goes on at length of why ACA is a good collateral manager for the CDO. On p. 27, it includes a bullet point “Alignment of Economic Interest.” The SEC complaint zooms in on this little nugget (see Complaint Para. 38). (Note to law students: bullet points in “powerpoint” style are not only bad devices to communicate ideas, they have some itty bitty securities law problems when used to market securities. If you can’t formulate something in a complete sentence, try again.) Nowhere does the flipbook mention that the Paulson hedge fund was involved in selecting the collateral for the CDO.
But it’s far from a slam dunk, he notes. Still, Salmon has raised a wider set of questions about the Abacus deal — so this aspect will no doubt run and run as a point of bloggy contention.
(from FT, Apr 19 2010)