Via WSJ's DealJournal comes Goldman Sachs's third response, presented here in full, without comment:
Overview:
On Friday, April 16, the US Securities and Exchange Commission brought a civil action against Goldman Sachs in relation to a single transaction in 2007 involving two professional institutional investors, IKB and ACA Capital Management (ACA). We believe the SEC’s allegations to be completely unfounded both in law and fact, and will vigorously contest this action.
The core of the SEC’s case is based on the view that one of our employees misled these two professional investors by failing to disclose the role of another market participant in the transaction, namely Paulson & Co., and that the employee thereby orchestrated the creation of materially defective offering materials for which the firm bears responsibility.
Goldman Sachs would never condone one of its employees misleading anyone, certainly not investors, counterparties or clients. We take our responsibilities as a financial intermediary very seriously and believe that integrity is at the heart of everything that we do.
Were there ever to emerge credible evidence that such behavior indeed occurred here, we would be the first to condemn it and to take all appropriate actions.
This particular transaction has been the subject of SEC examination and review for over eighteen months. Based on all that we have learned, we believe that the firm’s actions were entirely appropriate, and will take all steps necessary to defend the firm and its reputation by making the true facts known.
The SEC does not contend that the two professional institutional investors involved did not know what they were buying, or that the securities included in this privately placed transaction were in any way improper. These institutions were very experienced in the CDO market.
In this private transaction, Goldman Sachs essentially acted as an intermediary, helping to facilitate the investing objectives of two clients. Extensive disclosures as to each of the securities in the reference portfolio, similar to those required by the SEC in public transactions, were contained in the offering documents which provided all the information needed to understand and evaluate the portfolio.
In the process of selecting the reference portfolio, ACA Capital Management, who was both the portfolio selection agent and the overwhelmingly largest investor in the transaction ($951 million, with the other professional investor’s exposure being $150 million), evaluated every security in the reference portfolio using its own proprietary models and methods of analysis. ACA rejected numerous securities suggested by Paulson & Co., including more than half of its initial suggestions, and was paid a fee for its role as portfolio selection agent in analyzing and approving the underlying reference portfolio.
In summary, the SEC’s complaint is an issue of disclosure on a single transaction involving professional investors in a market in which they had extensive experience. Critical points missing from the SEC’s complaint include:
Goldman Sachs Lost Money on the Transaction. The firm lost more than $90 million arising from this transaction. Our fee was $15 million. We certainly did not wish to structure an investment that was designed to lose money.
Objective Disclosure Was Provided. The transaction at issue involved a static portfolio of securities, and was marketed solely to sophisticated financial institutions. IKB, a large German Bank and leading CDO market participant and ACA Capital Management, the two investors, were provided extensive information about those securities and knew the associated risks. Among the most sophisticated mortgage investors in the world, they understood that a synthetic CDO transaction requires a short interest for every corresponding long position.
Goldman Sachs Never Represented to ACA That Paulson Was Going To Be A Long Investor. The SEC’s complaint in part accuses the firm of potential fraud because it didn’t disclose to one party of the transaction the identity of the party on the other side. As normal business practice, market makers do not disclose the identities of a buyer to a seller and vice versa. Goldman Sachs never represented to ACA that Paulson was to be a long investor.
ACA, the Largest Investor, Selected and Approved the Portfolio. The portfolio of mortgage backed securities was selected by an independent and experienced portfolio selection agent after a series of discussions, including with IKB and Paulson & Co. ACA had an obligation and, as by far the largest investor, every incentive to select appropriate securities.
In 2006, Paulson & Co. indicated its interest in positioning itself for a decline in housing prices. The firm structured a synthetic CDO through which Paulson could benefit from a decline in the value of the underlying reference securities. Those on the other side of the transaction, IKB and ACA Capital Management, the portfolio selection agent, could benefit from an increase in the value of the securities. ACA had a long established track record as a CDO manager. As of May 31, 2007, ACA was managing 26 outstanding CDOs with underlying portfolios consisting of $17.5 billion of assets.
IKB, ACA and Paulson all provided their input regarding the composition of the underlying securities. ACA ultimately and independently approved the selection of 90 Residential Mortgage Backed Securities (RMBS), which it stood behind as the portfolio selection agent and the largest investor in the transaction.
The offering documents for the transaction included every underlying reference mortgage security.
The offering documents for each of these RMBS in turn disclosed detailed information concerning the mortgages held by the trust that issued the RMBS.
Any investor losses resulted from the massive decline of the broader subprime mortgage market, not because of which particular securities ended up in the reference portfolio or how they were selected.
The transaction was not created as a way for Goldman Sachs to short the subprime market. To the contrary, Goldman Sachs retained a substantial long position in the transaction and lost money as a result.
Questions and Answers
Who were the investors in this transaction?
The investors in the transaction were ACA Capital Management, a well-recognized collateral manager and investor in CDOs, and IKB, then believed to be one of the most highly-sophisticated CDO investors in the world.
The investors in the transaction were ACA Capital Management, a well-recognized collateral manager and investor in CDOs, and IKB, then believed to be one of the most highly-sophisticated CDO investors in the world.
What is a synthetic CDO?
A synthetic CDO has characteristics much like that of a futures contract, requiring two counterparties to take different views on the forward direction of a market or particular financial product, one short and one long. A CDO is a debt security collateralized by debt obligations, including mortgage-backed securities in many instances. These securities are packaged and held by a special purpose vehicle (SPV), which issues notes that entitle their holders to payments derived from the underlying assets. In a synthetic CDO, the SPV does not own the portfolio of actual fixed income assets that govern the investors’ rights to payment, but rather enters into CDSs that reference the performance of a portfolio. The SPV does hold some separate collateral securities which it uses to meet its payment obligations.
A synthetic CDO has characteristics much like that of a futures contract, requiring two counterparties to take different views on the forward direction of a market or particular financial product, one short and one long. A CDO is a debt security collateralized by debt obligations, including mortgage-backed securities in many instances. These securities are packaged and held by a special purpose vehicle (SPV), which issues notes that entitle their holders to payments derived from the underlying assets. In a synthetic CDO, the SPV does not own the portfolio of actual fixed income assets that govern the investors’ rights to payment, but rather enters into CDSs that reference the performance of a portfolio. The SPV does hold some separate collateral securities which it uses to meet its payment obligations.
What are the implications of this SEC action for the overall CDO market?
The SEC complaint is related to a single transaction in 2007 and involves a highly particularized set of alleged facts. It would not appear to have broad ramifications for the CDO market generally.
The SEC complaint is related to a single transaction in 2007 and involves a highly particularized set of alleged facts. It would not appear to have broad ramifications for the CDO market generally.
Who selected the securities that ended up in this particular portfolio?
ACA had the sole right and responsibility to select the portfolio and it in fact did so. As part of the process, ACA received input from other transaction participants. ACA had served as portfolio selection agent or collateral manager for numerous other transactions, and no doubt was accustomed to an interactive selection process. ACA used its own expertise and models in scrutinizing and approving the referenced securities. ACA subjected the securities proposed for inclusion in the portfolio to its own proprietary models and analysis.
ACA had the sole right and responsibility to select the portfolio and it in fact did so. As part of the process, ACA received input from other transaction participants. ACA had served as portfolio selection agent or collateral manager for numerous other transactions, and no doubt was accustomed to an interactive selection process. ACA used its own expertise and models in scrutinizing and approving the referenced securities. ACA subjected the securities proposed for inclusion in the portfolio to its own proprietary models and analysis.
What is the firm’s role in facilitating such transactions?
Goldman Sachs acts as a market intermediary through which its clients can take long or short positions on the reference securities. Goldman Sachs will often assume the opposite side of a client’s position to complete a transaction. As fully disclosed to investors in the offering materials in this transaction, the firm can then hold or sell that position to increase, reduce or eliminate its own exposures.
Did investors have adequate disclosure?
Extensive, objective disclosures were contained in the offering documents. Investors had all the information they needed to understand and evaluate the reference securities.
Goldman Sachs acts as a market intermediary through which its clients can take long or short positions on the reference securities. Goldman Sachs will often assume the opposite side of a client’s position to complete a transaction. As fully disclosed to investors in the offering materials in this transaction, the firm can then hold or sell that position to increase, reduce or eliminate its own exposures.
Did investors have adequate disclosure?
Extensive, objective disclosures were contained in the offering documents. Investors had all the information they needed to understand and evaluate the reference securities.
What was the role of ABN Amro / RBS in this transaction?
ABN intermediated a $909 million credit default swap referencing the portfolio between Goldman Sachs and ACA. ABN assumed the credit risk that ACA might not be able to pay if its obligations under the credit default swap came due. When the portfolio suffered writedowns, ACA ultimately was not able to pay the amount due on the credit default swap, and ABN made payment.
ABN intermediated a $909 million credit default swap referencing the portfolio between Goldman Sachs and ACA. ABN assumed the credit risk that ACA might not be able to pay if its obligations under the credit default swap came due. When the portfolio suffered writedowns, ACA ultimately was not able to pay the amount due on the credit default swap, and ABN made payment.
-KD
15 comments:
ok, now i'll comment in the comments: the key is near the end:
"Did investors have adequate disclosure?
Extensive, objective disclosures were contained in the offering documents. Investors had all the information they needed to understand and evaluate the reference securities."
i agree with that statement 100%. but, the problem for GS is that it may not be relevant. it's like my previous post - it's the difference between the TRUTH and THE WHOLE TRUTH.
investors absolutely had everything they needed to understand and evaluate the reference securities - and this is why I believe that additional disclosures wouldn't have changed the outcome (while additional or better evaluation by the buyers would have) - and yet THAT"S NOT THE POINT OF THE SUIT.
the outcome may very well have been the same, but GS can still be guilty of failure to disclose.
Summarizing Goldman's defense: ACA and IKB were asleep at the wheel, or awake and playing golf with Goldman VP's and not giving shit. Very true. And in an environment where only a few bonds here and there go bad, would suffice. ACA probably deserve's a lawsuit from anyone who invested with them, IKB as well.
KD, I'm seeing the light a little on your "defense" for lack of a better term, of Goldman.
But I just don't see any way that Goldman gets around this fact - legal or not: Paulson helped select the issue, and was a primary counter-party in the synthetic. Goldman didn't disclose it, or made it seem as if he was a co-investor with ACA.
Maybe they didn't "have too", or maybe ACA "selected" or maybe this or maybe that.....
It just keeps gnawing at me that that simple connection isn't gonna sit well with the public/media, not ever.
I don't know if you remember what actually convicted Enron in the public eye - But it was the tape of two traders laughing about running up electric bills on "Granny". Just two traders actually just having a conversation, trading, nothing illegal.
Should an internal email such as that emerge from this investigation(and I assure you many exist), Goldman will get hurt. They have to do everything right from here out. The are on dangerous ground.....
Final point:
This suit is a moral indictment of Wall Street, and is NOT about the technical disclosure aspects of a CDO arrangement - and Goldman isn't addressing what people actually want to hear them address.
Their intent.
That's what people want to know, what was your intent, sir?
KD - good coverage
Scharfy said:
> But I just don't see any way
> that Goldman gets around this
> fact - legal or not: Paulson
> helped select the issue, and was
> a primary counter-party in the
> synthetic. Goldman didn't
> disclose it, or made it seem as
> if he was a co-investor with ACA.
But this was a synthetic CDO built on a hand crafted pool of MBSs (i.e. it was not following an existing ABX index or something similar).
So... everyone on both sides who gave it literally 1 minute of thought must have realized that the deal was being put together to be most advantageous to whomever was structuring it, in the minds of that entity (whether or not they were right).
It is likely always the case with a synthetic not tracking an existing asset/index that one of the primary parties helped select the assets.
This isn't like a corporate bond that trades in the secondary market. To have this deal in the first place, someone had to want it created...
That is and always will be the case with a synthetic that doesn't track an existing index/asset.
Just because that wasn't spelled out doesn't mean it wasn't obvious to people who traded literally billions of dollars of these things, and had been themselves involved in the selection process on this and other deals for their own benefit (even if their models were so screwed up, ACA did select the pools that they believed would net them the most profit).
GS denies ever telling ACA that Paulson was going long the deal. If they did, that's a problem (further compounded by their statements to the contrary over the last 4 days), and I'm sure that the SEC and ACA will seek to prove otherwise if that was in fact the case.
However, if ACA just assumed Paulson (who at the time was viewed generally as the patsy on these fabulous AAA deals) was long and never asked him, then it is even more ridiculous for ACA (talk about lack of DD, to not even ask the question if it was material to them).
-PeterPeter
This is a politically inspired pile of stuff, and nothing more.
Doesn't even rise to the Martha Stewart level.
Innocent on all counts.
I want to know what the 1% of the securities in the portfolio that weren't downgraded were doing in there. Somebody effed up there.
@PeterPeter
Thanx for the response.
Hypothetical?
Morgan Stanley designs an ETF to mimic gold mining stock's sector performance, and markets it to investors as such. Later we learn that only the crappiest managed mines were selected- and not by Morgan Stanley, but by a notorious gold bear.
Then Gold prices tank and most mining stocks get hurt, and our ETF gets destroyed.
One could say to the investors: Hey the stocks in the prospectus were the stocks you bought - the end.
One could say: Hey I just thought I was buying a gold mining proxy - I should have done more homework.
One could say: Fraud!! These stocks were picked by HEDGE FUND X, who is short gold, I should have been told!!
A lot of ranges of potential responses here, but to me - Goldman doesn't come off as an honest broker here. But my opinion isn't fully formed...
It seems to me that the logic used to say that IKB+ACA were misled could be used to say any on the short side of other non-failing CDOs were misled as well. Take the case where Paulson really was on the long side and invested along with ACA/IKB. Someone would still have to be on the short side of the transaction.
If default rates failed to rise, would the short have a right to claim that they were defrauded? Could I as the short claim to not know the portfolio was constructed with securities possesing solid credit and thereby misled?
scharfy - as you know, ETFs marketed to retail investors are totally different, but, while we're going with your analogy:
"One could say: Hey I just thought I was buying a gold mining proxy - I should have done more homework."
yes. exactly. and you can also say "i'll never ever buy another morgan stanley product again." that's your prerogative if you feel they f'd you.
if you did your research on the components of the ETF, it doesn't matter who picked them. they are what they are, regardless of who picked them.
Soon the Boy Scouts will be sued for failing to help sophisticated investors cross the street.
fayvren - rapier logic. Of course, if their glass ball told the CDO would not fail, and they failed to disclose that glass-ball prediction, then by all means, call out the firing squad. It's now a capital offense to not disclose fortune telling results, or the notions of people who believe in fortune telling.
"Jean Dixon, and the people who believe her, are betting on failure."
"Well crap, it's doomed. Might as well stop the earth from rotating. Everything about the future is now known."
Essentially GS is being charged with failing to divulge the contents of the fortune cookie, or the outcome of the ouija-board test.
oh by the way, Scharfy, it's not that i'm "defending" Goldman, it's just that people use the term FRAUD here like it's capitol murder - but it's more like jaywalking... or maybe breaking & entering.. .or perhaps fencing stolen goods (hehehhe)... and i'll say again: it wouldn't have changed the outcome.
this was released today, from GS's September response to the SEC:
"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."
in other words, ACA had worked on the Magnetar deal in which the long equity investor held short positions in other tranches. Also, ACA SAT DOWN WITH PAULSON! they had ample opportunity to ask him anything they wanted.
none of this makes Goldman any technically less guilty of Fraud
KD, yes, ACA sat down with Paulson, but the complaint raises some interesting issues about that sit-down and whether the Paulson folks were forthcoming about where they stood... Allegedly, the ACA folks were frustrated and confused by the ambiguity of the John Paulson & Co. responses.
@scharfy:
Really liked your observation that GS is skirting the fundamental issue of intent. As KD has very ably alluded to, the requisite legal intent (or "corporate scienter") required to tag a company with securities fraud is much narrower than laypersons know. People expecting this case to be a vindication of Main Street in the war against Wall Street are going to be disappointed.
Transor - sure, maybe. so what though?
"Allegedly, the ACA folks were frustrated and confused by the ambiguity of the John Paulson & Co. responses."
then walk away! don't do the f'n trade! this point needs to be driven home with a sledgehammer.
regardless of GS's guilt - ACA had AMPLE opportunity to get the information they needed. and again, they picked the portfolio.
@KD:
You already answered your own question at 11:21 am yesterday: because that's not the point of the suit. The point is material misrepresentation by Goldman of what Paulson's involvement was.
sorry transor Z - I misunderstood your point. yes - my comment is independent of GS's guilt or lack thereof. I was addressing the "victim" status of ACA, which I think i've clearly expressed: they are not victims.
i was responding to your point about ACA's confusion. that's their own problem - even if GS is guilty. ACA has no one to blame but themselves - EVEN if GS is guilty.
i mean - they SAT DOWN with paulson!
i'm so sick of debating this... all i can think of is "history repeats itself because no one was listening the first time"... the lesson we should be listening to is that idiot money managers will continue to be idiot money managers until someone holds them accountable.
I know this is very serious stuff but I have to take a shot at levity. The Jon Stewart piece showing a grinning Cramer in a black and white photo as captain of the Titanic, complete with Titanic life ring in the background, is fall on the floor, howl at the moon, funny.
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