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Trading Opinions/In the News: Understanding the Goldman Case

with 4 comments

If you are having trouble following or understanding the SEC’s case against Goldman Sachs, read this post.

We at Vault are passionate about reading and supporting each other’s work and making sure that the information we share with you is meaningful. Witness the following e-mail exchange between Vault’s Finance Editor Derek Loosvelt and Vault’s Director of Technology Sean Carrington regarding Sean’s post, Why the Goldman Sachs Case is a Witch Hunt.  Read Sean’s piece first.

Derek: Hi Sean,
I read your blog post and wondered if you might have oversimplified some of the facts to the point of misrepresenting them. I was thinking about posting a reply to your position but wanted to ask you a few things before I did so I better understand your position before I do.

Here’s what you wrote:
“So the SEC is suing Goldman because the company made money by selling the securities to the public, then made money in their own account when the bubble burst. In the complaint, the SEC contends that even though Goldman knew there was going to be trouble, they kept selling these toxic bonds to the public.”

In fact, the SEC is not contending anything about whether “Goldman knew there was going to trouble” but is contending that Goldman acted fraudulently when they did not let investors know that a client of theirs, John Paulson, had handpicked the securities to be bundled — securities which Paulson was then able to bet against. (Below I’ve included some info cut and pasted from the SEC site).

If you could perhaps clarify what you meant in the above, that might be helpful.  And as for analysts and traders not riding in the same elevators, I have no idea what that has to do with this. If anything. Maybe I am missing something. So, if you could explain that, that would be helpful to me as well.

Here’s the complaint from the SEC site (

The SEC alleges that Goldman Sachs structured and marketed a synthetic collateralized debt obligation (CDO) that hinged on the performance of subprime residential mortgage-backed securities (RMBS). Goldman Sachs failed to disclose to investors vital information about the CDO, in particular the role that a major hedge fund played in the portfolio selection process and
the fact that the hedge fund had taken a short position against the CDO.

The SEC alleges that one of the world’s largest hedge funds, Paulson & Co., paid Goldman Sachs to structure a transaction in which Paulson & Co. couldtake short positions against mortgage securities chosen by Paulson & Co. based on a belief that the securities would experience credit events.

The SEC’s complaint alleges that after participating in the portfolio selection, Paulson & Co. effectively shorted the RMBS portfolio it helped select by entering into credit default swaps (CDS) with Goldman Sachs to buy protection on specific layers of the ABACUS capital structure. Given that
financial short interest, Paulson & Co. had an economic incentive to select RMBS that it expected to experience credit events in the near future. Goldman Sachs did not disclose Paulson & Co.’s short position or its role in the collateral selection process in the term sheet, flip book, offering
memorandum, or other marketing materials provided to investors.

Sean: Paulson & Co is a hedge fund. They are not a member of the exchange and as such they cannot place trades on their own behalf. Goldman placed trades for Paulson. The SEC did not assume that Paulson had any responsibility to convince the Goldman Analysts that the trades should no longer be sold to the public and that is why Paulson wasn’t named in the complaint.  The two traders who also placed said trades for the Goldman house account were the only two persons named individually in the complaint.

The point of contention is if the traders notified Sr. Management of their position and if Sr. Management agreed with said position. If they did, then in theory, they should have been obligated to pull the plug on the other side of the business.  The problem with that assertion however, is no Sr. Management was named in the complaint and the two traders named had no way of communicating their concerns to the analysts.  (Not to mention the obvious fact, that they were forbidden to do so even if they wanted to).

Derek: Have you read the SEC complaint?

Sean: Yes. Why don’t you explain to me where you think the named individuals should be charged? Or where you think my logic falls down.

Derek: It seems to me, and I haven’t read anything to the contrary (SEC complaint, WSJ, NYTimes, etc.), that the issue is one of “material disclosure” –Did Goldman have a legal right to disclose to investors of the CDO in question that one of its clients picked the securities that were packaged and
then short-sold them?

Is that wrong?

Sean: Fabrice Tourre is the only individual charged specifically in the complaint & I understand him to be a trader on the wholesale side of the house working on the CDO desk. He & Paulson worked together structuring the trades that made so much money. If that is the case then he obviously has no disclosure obligation to the firm’s retail clients.

Now with that said, one of two things may be happening here:
1. It’s entirely possible that my understanding of his role at Goldman is not correct but I’m fairly certain, that is what he did.

2. The SEC may be squeezing him in order to find out who he notified and when in order to work their way up the chain the same way the justice department did with the Enron boys a decade ago.

Derek: My understanding is Fab Fab was charged because he’s the one who arranged the CDO. And yes, per your no. 2, I bet you’re right about that. And already, it seems to be working:

Sean: I just read that article and his role seems to be as I suspected. Traders at that level don’t just buy and sell securities. They structure deals that hopefully, make the firm a lot of money. That’s their job, it’s how they are evaluated and it is what their bonus is based on.

Obviously, at the exact same time, other traders both inside and outside Goldman were structuring deals betting that CDO’s and REIT’s would continue to rise. If they weren’t there wouldn’t have been such losses at places like Bear Stearns & Mother Merrill. Fab Fab won, other traders/bankers lost. That’s not criminal. It’s the American way.

Here’s the key: No one has a crystal ball and knows what will happen in the future. We do our analysis & make predictions. Sometimes they we’re right & sometimes we’re wrong. Fabrice Tourrie was betting that the CDO market would drop while others INSIDE HIS OWN COMPANY thought he was dead wrong. Those facts are not in dispute. Now assume for a moment that he was in fact wrong. What would have happened?

His house account & Paulson’s hedge fund would have lost a few million dollars & life would have gone on. There would be no SEC action & no one would care. But because he happened to have been right & made money when others were losing, now it’s criminal. And somehow he was obligated to have convinced everyone else at Goldman & all Goldman’s clients that the sky was about to fall and they should abandon ship? It’s total nonsense.

More of Vault’s take on the SEC vs. Goldman Sachs:
Goldman Sachs Accused of Fraud: God’s Work or the Devil’s Business?
Goldman & the SEC: living a material world


Written by Linda Petock

April 19, 2010 at 1:17 pm

4 Responses

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  1. While Sean may be correct about motives, his argument is a non sequitur in regard to the SEC complaint itself (i.e., the stated merits of the case). When Sean says the following:

    “The point of contention is if the traders notified Sr. Management of their position and if Sr. Management agreed with said position. If they did, then in theory, they should have been obligated to pull the plug on the other side of the business.”

    … he is incorrect in regard to the SEC complaint itself.

    The SEC claim has nothing to do with Fabs role as a trader. The two claims are against “GS&Co and Tourre” in in their “offer or sale of securities or securities-based swap agreements” (p 68) and again “in connection with the purchase or sale of securities or securities-based swap agreements”

    The issue does no turn on (i) GS net view of mortgages or (ii) Fab’s role as trader. The claim is against the primaries at GS who offered the securities and the nature of their DISCLOSURE responsibilities

    David Harper

    April 19, 2010 at 1:51 pm

  2. Quoted from the following article:

    “Blankfein, whose company is facing civil fraud charges from theSecurities and Exchange Commission over one of its subprime deals, declined to give ground. He denied that Goldman made massive “short,” or negative, bets on subprime mortgage securities. Further, he said, Goldman had no obligation to divulge its short bets in its role as a market maker for sophisticated institutional investors. “The investors we’re dealing with … know what they want to acquire,” Blankfein said. If they raise questions about a deal, he said, “then the salesman owes them an honest answer.”

    That is the truth & it’s the reason why these senators won’t be able to move toward throwing anyone in jail. Think about this for a second… If one salesman in a General Motors showroom, thinks that the Honda Civic is a better car than the Chevrolet Cobolt, and advises one of his clients to buy the Civic, is that now “the official GM position” and is GM obligated to tell every potential buyer what this one salesman thinks??? This whole thing is PR posturing. Total nonsense!

    Sean Carrington

    April 28, 2010 at 9:22 am

  3. If I, a low level employee at a major mortgage lender, was able to grasp and understand that these “high risk loans” that were being underwritten, approved & sometimes even sent for EXCEPTIONS outside the posted guidelines were paying big bucks on the back end to the brokers, to the company and to the investors….the boys on wall street knew EXACTLY what they were doing. The bigger the risk, the better the payout. It wasn’t dumb luck on the traders part.

    Sally Long

    April 28, 2010 at 12:19 pm

  4. This reminds me of another deal in which Jack Pennybaker & Co. asked General Monstrosity to place some faulty brake pads into one of the crapmobile manufacturers’ new synthetic model A’s, so Pennybaker & Co. could bet a few of their Palm Beach Island mansions on the synthetic model A’s crashing and burning. General Monstrosity gladly and quickly agreed to the deal, and then hit the pavement (in one of their more solidly built vehicles with real working parts) and found several silly and naïve Europeans to take the other side of Pennybaker’s
    bet. Since General Monstrosity believed they did not legally have to tell the stupid Euros about Pennybaker’s faulty brake pads, they kept the info to themselves (what the hell, they thought, let the stupid Euros crash into their own trees). The deal, of course, was a success. The crash did happen and the Euros did burn and Pennybaker, as planned, pocketed a cool billion bucks. (General Monstrosity
    pocketed some duckets, too, for setting up the genius shady deal.) Some time later, after cars were crashing all over the place, a couple of bumbling
    cops from the District of Clowns — who had it out for General Monstrosity because GM had been weaseling
    around the coppers’ flimsy laws for years, pretending to be doing God’s work when in fact they were simply fattening up their already fat-as-heck bellies — found out about the
    genius shady deal (not to be confused with GM’s genius sh!tty deals) and they said, wait a minute, something sounds fishy here. After some light investigation into the foul smell, the bumbling cops served General Monstrosity papers claiming that the crapmobile manufacturer did violate one of the coppers’ flimsy laws by not divulging the information about the faulty brake pads. This resulted in the CEO (chief evil officer) of Pennybaker & Co. to take a trip to Maui while things settled down. Meanwhile, General Monstrosity, knowing it couldn’t and wouldn’t go down for something as business as usual and on the up and up as a few faulty brake pads, decided to hang out to dry a pompous young idiot from one of their assembly lines in Omaha with a name that no one can pronounce, not even the coppers.

    The last I checked, the case was still pending.

    C’est vrai, et oui, total nonsense aussi.

    Joseph S.

    April 29, 2010 at 1:28 pm

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