U.S. Accuses Goldman Sachs of Fraud in Mortgage Deal

[Cees Binkhorst]

REPLY TO: D66 at nic.surfnet.nl

Round ONE has started.
Three players, SEC against primary target Goldman Sachs and secondary
target John A. Paulson.

Mr. Paulson made a fortune 'overnight' and it is now known that he did
that with the aid of Goldman Sachs.

What a wonderful company it is: who are other beneficiaries?

Well a Mr. John de Mol and John van den Ende, who sold their company
Endemol to a Spanish telephone company. The director/buyer was
eventually sacked and Goldman Sachs miraculously ended up as part owner
of that company Endemol.
Both John's ended up as billionaires and are still doing business with
Endemol/Goldman Sachs. Everybody happy, untill now.

Groet / Cees

April 16, 2010
U.S. Accuses Goldman Sachs of Fraud in Mortgage Deal
http://www.nytimes.com/2010/04/17/business/17goldman.html
By LOUISE STORY and GRETCHEN MORGENSON

Goldman Sachs, which emerged relatively unscathed from the financial
crisis, was accused of securities fraud in a civil suit filed Friday by
the Securities and Exchange Commission, which claims the bank created
and sold a mortgage investment that was secretly devised to fail.

The move marks the first time that regulators have taken action against
a Wall Street deal that helped investors capitalize on the collapse of
the housing market. Goldman itself profited by betting against the very
mortgage investments that it sold to its customers.

The suit also named Fabrice Tourre, a vice president at Goldman who
helped create and sell the investment.

In a statement, Goldman called the S.E.C. accusations “completely
unfounded in law and fact” and said the firm would “vigorously contest
them and defend the firm and its reputation.”

The instrument in the S.E.C. case, called Abacus 2007-AC1, was one of 25
deals that Goldman created so the bank and select clients could bet
against the housing market. Those deals, which were the subject of an
article in The New York Times in December, initially protected Goldman
from losses when the mortgage market disintegrated and later yielded
profits for the bank.

As the Abacus deal plunged in value, Goldman and a prominent hedge fund
made money on their negative bets, while European investors like IKB and
ABN Amro lost more than $1 billion, the S.E.C. said.

According to the complaint, Goldman created Abacus 2007-AC1 in February
2007, at the request of John A. Paulson, a prominent hedge fund manager
who earned an estimated $3.7 billion in 2007 by correctly wagering that
the housing bubble would burst.

Goldman let Mr. Paulson select mortgage bonds that he wanted to bet
against — the ones he believed were most likely to lose value — and
packaged those bonds into Abacus 2007-AC1, according to the S.E.C.
complaint. Goldman then sold the Abacus deal to investors like foreign
banks, pension funds, insurance companies and other hedge funds.

But the deck was stacked against the Abacus investors, the complaint
contends, because the investment was filled with bonds chosen by Mr.
Paulson, who is not named in the suit, as likely to default. Goldman
told investors in Abacus marketing materials reviewed by The Times that
the bonds would be chosen by an independent manager.

“The product was new and complex, but the deception and conflicts are
old and simple,” Robert Khuzami, the director of the S.E.C.’s division
of enforcement, said in a statement. “Goldman wrongly permitted a client
that was betting against the mortgage market to heavily influence which
mortgage securities to include in an investment portfolio, while telling
other investors that the securities were selected by an independent,
objective third party.”

The complaint heralds the return of a more aggressive S.E.C. The case
may help the agency recover from some initial mishaps, and signals that
the agency is tracing the mortgage pipeline all the way from the
companies like Countrywide that originated home loans to the raucous
trading floors that dominate Wall Street’s profit machine.

In the half-hour after the suit was announced, Goldman Sachs’s stock
fell by more than 10 percent. It closed at $160.70, down almost 13
percent from the day before. Investors sold off other bank stocks, as
well, as rumors swirled about which other firms might become embroiled
in the S.E.C.’s investigation.

In recent months, Goldman has repeatedly defended its actions in the
mortgage market, including its own bets against it. In a letter
published last week in Goldman’s annual report, the bank rebutted
criticism that it had created, and sold to its clients, mortgage-linked
securities that it had little confidence in.

“We certainly did not know the future of the residential housing market
in the first half of 2007 anymore than we can predict the future of
markets today,” Goldman wrote. “We also did not know whether the value
of the instruments we sold would increase or decrease.”

The letter continued: “Although Goldman Sachs held various positions in
residential mortgage-related products in 2007, our short positions were
not a ‘bet against our clients.’ ” Instead, the trades were used to
hedge other trading positions, the bank said.

In a statement provided in December to The Times as it prepared the
article on the Abacus deals, Goldman said that it had sold the
instruments to sophisticated investors and that these securities “were
popular with many investors prior to the financial crisis because they
gave investors the ability to work with banks to design tailored
securities which met their particular criteria, whether it be ratings,
leverage or other aspects of the transaction.”

Goldman was one of many Wall Street firms that created complex mortgage
securities — known as synthetic collateralized debt obligations — as the
housing wave was cresting. At the time, traders like Mr. Paulson, as
well as those within Goldman, were looking for ways to short the
overheated market.

Such investments consisted of insurance-like policies written on
mortgage bonds. If the mortgage market held up and those bonds did well,
investors who bought Abacus notes would have made money from the
insurance premiums paid by investors like Mr. Paulson, who were negative
on housing and had bought insurance on mortgage bonds. Instead, defaults
spread and the bonds plunged, generating billion of dollars in losses
for Abacus investors and billions in profits for Mr. Paulson.

For months, S.E.C. officials have been examining mortgage bundles like
Abacus that were created across Wall Street. The commission has been
interviewing people who structured Goldman mortgage deals about Abacus
and other, similar instruments. The S.E.C. advised Goldman that it was
likely to face a civil suit in the matter, sending the bank what is
known as a Wells notice.

The S.E.C. focused on only one Abacus deal in its complaint, but Mr.
Khuzami said in a conference call that the commission continues to look
at the rest. All told there were $10.9 billion of Abacus investments sold.

Mr. Tourre was one of Goldman’s top workers running the Abacus deal,
peddling the investment to investors across Europe. Raised in France,
Mr. Tourre moved to the United States in 2000 to earn his master’s in
operations at Stanford. The next year, he began working at Goldman,
according to his profile in LinkedIn.

He rose to prominence working on the Abacus deals under a trader named
Jonathan M. Egol. Now a managing director at Goldman, Mr. Egol is not
being named in the S.E.C. suit.

Goldman structured the Abacus deals with a sharp eye on the credit
ratings assigned to the mortgage bonds associated with the instrument,
the S.E.C. said. In the Abacus deal in the S.E.C. complaint, Mr. Paulson
pinpointed those mortgage bonds that he believed carried higher ratings
than the underlying loans deserved. Goldman placed insurance on those
bonds — called credit-default swaps — inside Abacus, allowing Mr.
Paulson to short them while clients on the other side of the trade
wagered that they would not fail.

But when Goldman sold shares in Abacus to investors, the bank and Mr.
Tourre only disclosed the ratings of those bonds and did not disclose
that Mr. Paulson was on the other side, betting those ratings were wrong.

Mr. Tourre at one point complained to an investor who was buying shares
in Abacus that he was having trouble persuading Moody’s to give the deal
the rating he desired, according to the investor’s notes, which were
provided to The Times by a colleague who asked for anonymity because he
was not authorized to release them.

In seven of Goldman’s Abacus deals, the bank went to the American
International Group for insurance on the bonds. Those deals have led to
billions of dollars in losses at A.I.G., which was the subject of an
$180 billion taxpayer rescue. The Abacus deal in the S.E.C. complaint
was not one of them.

That deal was managed by ACA Management, a part of ACA Capital Holdings,
which changed its name in 2008 to Manifold Capital Holdings.

Goldman told investors the mortgage bond portfolio would be “selected by
ACA Management,” according to the deal’s marketing documents, which were
given to The Times by an Abacus investor.In that flip-book, it says that
Goldman may have long or short positions in the bonds. It does not
mention Mr. Paulson or say that Goldman was in fact short.

ACA was not named in the case. That firm was led to believe that Mr.
Paulson was positive on mortgages, not negative, and so it did not see a
problem with his involvement, the S.E.C. said. Mr. Tourre was aware of
ACA’s misconception, the S.E.C. said. In February 2007, Mr. Tourre met
with both ACA and Mr. Paulson, and he sent an e-mail message to a
Goldman colleague acknowledging the awkwardness of the situation. “This
is surreal,” Mr. Tourre wrote.

Nine days later, a Goldman colleague wrote Mr. Tourre and said, “The
C.D.O. biz is dead. We don’t have a lot of time left.”

The Abacus deals deteriorated rapidly when the housing market hit
trouble. For instance, in the Abacus deal in the S.E.C. complaint, 83
percent of the mortgage bonds underlying it were downgraded by rating
agencies just six months later, and 99 percent had been downgraded by
early 2008, according to the S.E.C.

It takes time for such mortgage investments to pay out for investors who
short them, like Mr. Paulson. Each deal is structured differently, but
generally, the bonds underlying the investment must deteriorate to a
certain point before short-sellers get paid. By the end of 2007, Mr.
Paulson’s credit hedge fund was up 590 percent.

Mr. Paulson’s firm, Paulson & Company, is paid a management fee and 20
percent of the annual profits that its funds generate, according to a
Paulson investor document from late 2008 titled “Navigating Through the
Crisis.”

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