goldman sachs fraud in plain english
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* GOLDMAN SACHS/SEC Criminal Complaint for Fraud* Action
SEC charges Goldman Sachs & Co. and Fabrice Tourre with securities fraud.
SUMMARY: The SEC claims the defendants committed crimes in the following way:
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Goldman Sachs (GS&Co) and one of its employees, Fabrice Tourre (Tourre), lied and hid
facts regarding a synthetic collateralized debt obligation (CDO) when marketing it to
investors. [When you borrow money to buy a home, your house becomes collateral. Collateral issomething of value attached to the debt, to encourage you to make your payments. You give the lender
the right to take it if you dont. You have created a collateralized debt. CDOs are financial packages one
bank sells to another containing several collateralized debts. The value is in the interest rates paid by the
borrowers and the value of the collateral. A synthetic collateralized debt obligation means the investor
doesnt invest in the collateral/debt itself, but rather its performance.] This particular synthetic
CDO, named ABACUS 2007-AC1, was made up of residential subprime loans. It was
designed by GS&Co and offered to investors in early 2007 when the market was
beginning to decline. Synthetic CDOs are largely responsible for the current financial
crisis in the US because losses were magnified when the housing market declined.
All the marketing materials put out by GS&Co for this CDO stated that an impartial third
party, ACA Management (ACA), was behind it and had experience analyzing credit risk in
these deals. They failed to point out to potential investors, however, that a large hedge
fund, Paulson & Co. Inc. (Paulson), had a significant role in the selection process, and
had conflicting interests. Once Paulson helped to select the portfolio, Paulson enteredinto credit default swaps (CDS) with GS&Co. [Simply put, a CDS is like an insurance policy on aloan, promising to pay if the borrower defaults. Neither the buyer nor seller of the CDS actually owns the
loan. Theyre on the outside of the deal, betting on whether it will succeed or not.] Paulson made
money if the loans failed. For this reason, Paulson had incentive to choose riskier
packages for the portfolio. Paulson benefitted tremendously if the investors lost money.
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GS&Co created a transaction at Paulsons request. In this transaction, Paulson
influenced the selection of the finance package to benefit Paulson. GS&Co never told
investors that Paulson was involved in the selection process or had a conflicting interest.
Tourre was primarily responsible for ABACUS 2007-AC1.
1. He arranged the transaction, prepared the marketing materials andcommunicated directly with investors.
2. He was completely aware of Paulsons involvement in the selection process andconflicting credit default swaps.
3. He led ACA to believe Paulson invested $200 Million into ABACUS 2007-AC1.4. He led ACA to believe Paulsons interests in the selection process were the same
as ACAs, when in fact they were sharply opposing.
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APRIL 26, 2007: The deal closed. Paulson paid GS&Co $15 Million for structuring and
marketing ABACUS 2007-AC1.
OCTOBER 24, 2007: 83% of the loans were downgraded and 17% were on negativewatch.
JANUARY 29, 2008: 99% of the entire loan portfolio was downgraded. As a result, the
investors lost over $1 Billion. Paulson profited by $1 Billion.
GS&Co and employee Tourre violated the following:
1. Section 17(a) of the Securities Act of 19332. Section 10(b) of the Exchange Act of 19343.
Exchange Act Rule 10b-5
The SEC asks the Court to stop the defendants from their actions; to give up profits
made in this crime, with interest; to require them to pay fines and make their victims
whole.
This is the correct court to hear these charges. All of the crimes occurred here.
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GS&Co is part of the Goldman Sachs Group, Inc., a global investment firm in NYC.
GS&Co structured and marketed ABACUS 2007-ACT1.
Facts on Fabrice Tourre, age 31:
a) Registered representative with GS&Cob) Responsible for marketing the CDOc) Vice President of the structured product correlation trading desk at the time of
these crimes
d) Currently works in London as Executive Director, Goldman Sachs International
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GS&Co created a structured product correlation trading desk in late 2004 to early 2005.
One of the products was ABACUS 2007-AC1, a CDO involving mortgages. GS&Co
competed on the open market in selling this product.
On March 12, 2007 a company memo to the Goldman Sachs Mortgage Capital
Committee (MCC) stated, the ability to structure and execute complicated transactions
to meet multiple clients needs and objectives is key for our franchise. Executing thistransaction and others like it helps position Goldman to compete more aggressively in
the growing market for synthetics written on structured products.
Paulson began in 1994. Starting in 2006, Paulson created two funds known as Paulson
Credit Opportunity Funds, which made money on the declining real estate market by
buying protection through credit default swaps on subprime mortgages.
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At the same time, GS&Co realized the struggling real estate market was beginning topresent a problem when trying to market CDOs backed by mortgages.
JANUARY 23, 2007: Tourre wrote an email to a friend that said, More and more
leverage in the system. The whole building is about to collapse anytime nowOnly
potential survivor, the fabulous Fab [himself]standing in the middle of all these
complex, highly leveraged, exotic trades he created without necessarily understanding
all of the implications of those monstrosities!
FEBRUARY 11, 2007: The head of the GS&Co structured product correlation trading desk
sent an email to Tourre stating, The CDO biz is dead, we dont have a lot of time left.
GS&Co and Tourre knew it would be near impossible to get anyone to invest in the
portfolio if they knew Paulson played such a big role in the selection process. They also
knew if they brought in an independent third-party management company with
experience, and claimed they controlled the selection, no one would question it.
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GS&Co knew that at least one significant investor, IKB Deutsche Industriebank AG (IKB),
wouldnt invest if GS&Co didnt use a collateral manager to select the portfolio.
GS&Co decided to seek a collateral manager to play a role in Paulsons proposedtransaction. Internal correspondence shows that GS&Co knew very few collateral
managers would agree to the selection Paulson wanted, and risk putting their name on a
weak portfolio.
JANUARY 2007: GS&Co asked ACA to serve as the Portfolio Selection Agent for a CDO
sponsored by Paulson. ACA had managed CDOs many times for a fee. The previous year
ACA closed 22 CDO transactions with attached portfolios worth $15.7 Billion in assets.
FEBRUARY 7, 2007: Tourre sent an internal email stating, One thing that we need to
make sure ACA understands is that we want their name on this transaction. This is a
transaction for which they are acting as portfolio selection agent. This will be important
that we can use ACAs branding to help distribute the bonds.
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MARCH 12, 2007: A GS&Co company memo described the marketing advantages of
ACAs brand name and credibility. The memo said (quotes):
1. We expect the strong brand-name of ACA as well as our market-leading positionin synthetic CDOs of structured products to result in a successful offering.
2. We expect that the role of ACA as Portfolio Selection Agent will broaden theinvestor base for this and future ABACUS offerings.
3. We intend to target suitable structured product investors who have previouslyparticipated in ACA-managed cashflow CDO transactions or who have previously
participated in prior ABACUS transactions.
4.
We expect to leverage ACAs credibility and franchise to help distribute thi sTransaction.
Between late 2006 and early 2007, Paulson identified over 100 bonds it thought would
soon fail. Paulson favored selections that included a large amount of adjustable rate
mortgages with low FICO scores in states that recently experienced strong price
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increases. Paulson told GS&Co that it wanted this portfolio to include those types of
mortgages.
JANUARY 8, 2007: Tourre met with both Paulson and ACA representatives at Paulsons
NYC office to talk about the proposed transaction.
JANUARY 9, 2007: GS&Co sent an email to ACA entitled, Paulson Portfolio. Attached
was a list of 123 bonds.
On the same day, ACA performed an overlap analysis of the list and found it
previously purchased 62 of them at the same or lower ratings.
GS&Co told ACA that Tourre was very excited by the initial portfolio feedback.
JANUARY 10, 2007: Tourre sent an email to ACA entitled, Transaction Summary. It
said, We wanted to summarize ACAs proposed role a Portfolio Selection Agent for the
transaction that would be sponsored by Paulson (the Transaction Sponsor). It also
said, Starting portfolio would be ideally what the Transaction Sponsor shared, but there
is flexibility around the names.
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JANUARY 22, 2007: ACA sent an email to Tourre and others at GS&Co entitled, Paulson
Portfolio 1-22-10.xls. It said, Attached please find a worksheet with 86 subprime
mortgage positions that we would recommend taking exposure to synthetically. Of the
123 names that were originally submitted to us for review, we have included only 55.
JANUARY 27, 2007: ACA met with a Paulson rep in Jackson Hole, Wyoming and
discussed the proposed transaction and portfolio.
JANUARY 28, 2007: ACA summarized the meeting in an email to Tourre. Tourre
returned the email, This is confirming my initial impression that Paulson wanted to
proceed with you subject to agreement on portfolio and compensation structure.
FEBRUARY 2, 2007: Paulson, Tourre and ACA met at ACAs offices in NYC to discuss the
portfolio. ACA didnt know yet that Paulson intended to enter the portfolio selected
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into credit default swaps, with GS&Co participation. Both Tourre and GS&Co, of course,
were aware that Paulsons plan was unfavorable to investors.
During the meeting, Tourre sent an email to another GS&Co employee stating, I am in
this ACA-Paulson meeting. This is surreal. Later the same day, ACA emailed Paulson,Tourre and others at GS&Co a list of 82 mortgage portfolios that Paulson and ACA
agreed on. Also attached was another list of 21 replacements. ACA wanted Paulsons
approval of the list, asking, Let me know if these work for you at the Baa2 level.
FEBRUARY 5, 2007: Paulson sent an email to ACA and copied Tourre, deleting 8 bonds
and stating that Tourre agreed 92 bonds were enough.
The same day and internal ACA email asked, Attached is the revised portfolio that
Paulson would like us to commit to all names are at the Baa2 level. The final portfolio
will have between 80 and these 92 names. Are we okay to say yes on this portfolio?
The ACA internal response was, Looks good to me. Did Paulson give a reason why they
kicked out all the Wells Fargo deals? Wells Fargo was generally seen as a higher quality
subprime loan originator.
FEBRUARY 26, 2007: Paulson and ACA agreed on a portfolio of ABACUS 2007-AC1.
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GS&Cos marketing materials for ABACUS 2007-AC1 were false and misleading. They
made it look as if ACA chose the portfolio and never mentioned anything about
Paulsons significant role in the selection process.
MARKETING MATERIALS
Example No. 1:
FEBRUARY 26, 2007: GS&Co finalized a 9-page term sheet for ABACUS 2007-AC1 anddescribed ACA as the Portfolio Selection Agent. Then, in bold, at the top of the first
page it stated that the portfolio had been Selected by ACA. There was no mention of
Paulson, its role in the selection process or financial interests in the transaction.
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MARKETING MATERIALS
Example No. 2:
FEBRUARY 26, 2007: GS&Co finalized a 65-page flip book for ABACUS 2007-AC1 and, on
the front page, stated that the portfolio had been, Selected by ACA Management, LLC.Inside the book was a 28-page overview of ACA describing its business strategy,
philosophy, staff, expertise, track record and credit selection process. It had a 7-page
section giving the bio for ACA officers and employees. Investors were assured they had
the same economic interests as the investors. Again, there was no mention of Paulson,
its role in the selection process or financial interests in the transaction.
Tourre was primarily responsible for preparing the term sheet and flip book.
MARCH 12, 2007: Goldman Sachs MMC, which included senior-level management of
GS&Co, approved the ABACUS 2007-AC1 and expected to earn $15-$20 Million.
MARKETING MATERIALS
Example No. 3:
APRIL 26, 2007: GS&Co finalized a 178-page offering memo for ABACUS 2007-AC1. The
cover described ACA as Portfolio Selection Agent. The Transaction Overview,
Summary and Portfolio Selection Agent sections all pointed to ACE as the party that
selected the portfolio. There was no mention of Paulson, its role in the selection process
or financial interests in the transaction.
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Tourre reviewed the Summary section before it was sent to potential investors.
Although the marketing materials never mentioned Paulson, its role in the selection
process or financial interests in the transaction, internal communication at GS&Co
clearly did.
MARCH 12, 2007: An MCC memo went out describing the transaction. It stated,
Goldman is effectively working an order for Paulson to buy protection on specific layers
of the ABACUS 2007-AC1 capital structure.
GS&Co also misled ACA into believing Paulson shared an interest in the success of
ABACUS 2007-AC1 because it would be investing in its equity. The equity portion is at
the bottom of the financial structure and therefore the first to experience losses if a
portfolio underperforms. Equity investors have more of an interest in seeing it succeed.
As of early 2007, ACA had participated in many CDO transactions handled in this way
with other hedge fund companies.
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If ACA had been aware that Paulson was going to enter into a credit default swap ACA
would have been reluctant to allow Paulson to have an influential role in the portfolio
selection because it would risk ACAs reputation as an endorser of the portfolio. In fact,its unlikely ACA would have served as the portfolio selection agent at all. Tourre and
GS&Co were responsible for ACAs misinterpretation of the situation.
JANUARY 8, 2007: Tourre attended a meeting in Paulsons NYC office with reps from
Paulson and ACA to discuss the proposed transaction. ACA didnt understand Paulsons
financial interest, and asked GS&Co to clarify. Later that day, ACA sent an email to a
GS&Co sales rep entitled, Paulson meeting. It said:
I have no idea how it went. I wouldnt say it went poorly, not at all. But I think it didnt
help that we didnt know exactly how they want to participate in the space. Can you get
us some feedback?
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JANUARY 10, 2007: Tourre emailed ACA a Transaction Summary that described
Paulson as the Transaction Sponsor, and mentioned a Contemplated Capital
structure, with a 0%-9% tranche [portion] at the bottom of the capital structure. ACA
reasonably believed this referred to the size of the equity investment Paulson
supposedly was making. In fact, GS&Co never intended to market it this way.
JANUARY 12, 2007: Tourre spoke to ACA on the phone about the transaction.
JANUARY 14, 2007: ACA sent an email to the GS&Co sales rep asking questions about
the transaction and Paulsons role. The email, entitled Call with Tourre on Friday,
said:
I certainly hope I didnt come across to antagonistic on the call with Fabrice last week,
but the structure looks difficult from a debt investor perspective. I can understand
Paulsons equity perspective but for us to put our name on something, we have to be
sure it enhances our reputation.
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JANUARY 16, 2007: The GS&Co sales rep forwarded the ACA email to Tourre. As of that
date, Tourre had to have known that ACA was led to believe Paulson intended to invest
in the equity of ABACUS 2007-AC1.
Based on Tourres January 10, 2007 Transaction Summary, phone calls and continuing
communication with Tourre and others at GS&Co, ACA believed throughout the
transaction that Paulson would be an equity investor in ABACUS 2007-AC1.
FEBRUARY 12, 2007: ACAs Commitments Committee wrote a memo approving the
participation as the ABACUS portfolio selection agent, and described Paulsons role as:
The hedge fund equity investor wanted to invest in the 0% -9% tranche of a staticmezzanine ABS CDO backed 100% by subprime residential mortgage securities.
Handwritten notes from the meeting reflect discussion of portfolio selection work with
the equity investor.
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IKB is a commercial bank in Dusseldorf, Germany, specializing in lending to small and
medium-sized companies. Starting in 2002 IKB was involved in the purchase of
securitized assets made up of consumer credit risks backed by mid and subprime
mortgages. IKBs former subsidiary, IKB Credit Asset Management GmbH, advisedvarious entities in a commercial venture known as the Rhineland programme conduit.
In February, March and April 2007, GS&Co sent IKB copies of the ABACUS 2007-AC1 term
sheet, flip book and offering memo, all claiming ACA Management selected the
portfolio. This was a lie. IKB was never told of Paulsons role in the selection process or
sharply conflicting interests.
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FEBRUARY 15, 2007: The first marketing materials were distributed when GS&Co
emailed a preliminary term sheet and portfolio to the GS&Co sales rep covering IKB.
Tourre knew these materials would be given to IKB.
FEBRUARY 19, 2007: GS&Co sales rep forwarded the emailed marketing materials to
IKB, saying, Attached are details of the ACA trade we spoke about with Fabrice in which
you thought the AAAs would be interesting.
Tourre maintained contact with IKB in an effort to close the deal.
MARCH 6, 2007: Tourre sent an email to the GS&Co internal sales rep for IKB, saying,
This is a portfolio selected by ACA He also later described the portfolio in an internal
email as being, selected by ACA/Paulson.
APRIL 26, 2007: ABACUS 2007-AC1 closed.
IKB bought $50 Million worth of Class A-1 notes in the deal at face value. The notes paid
a variable rate equal to LIBOR [London Interbank Offered Rate] plus 85 basis points, and
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Moodys as well as Standard & Poor rated them highly.
IKB also bought $100 Million worth of Class A-2 notes at face value. These notes also
paid a rate equal to LIBOR plus 110 basis points, and both Moodys and Standard & Poor
rated them highly.
It was important to IKB that an experienced, independent third-party with interests in
line with investors, select the portfolio. IKB would never have invested if it had known
Paulsons role and plan.
Months later, ABACUS 2007-AC1s notes were nearly worthless. IKB lost almost all of
the $150 Million invested.
Most all of the money went to Paulson, through GS&Co transactions.
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ACAs parent company, ACA Capital Holdings, Inc. (ACA Capital), gave financial guaranty
insurance on several finance products through its wholly-owned subsidiary, ACA
Financial Guaranty Corporation.
MAY 31, 2007: ACA Capital protected and therefore assumed a large amount of the risk
($909 Million) associated with ABACUS 2007-AC1 in exchange for premium payments
plus 50 basis points per year.
ACA Capital was unaware of Paulsons intentions in the transaction, and most likely
would not have taken the risk if it had known.
The ACA Capital protection transaction was handled by ABN AMRO Bank N.V. (ABN),
one of the largest banks in Europe at the time. ABN did this with the expectation of
receiving 17 points per year as premium payments. Therefore, if ACA Capital defaulted,
ABN would have to step in and assume the risk.
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GS&Co sent ABN the marketing materials for ABACUS 2007-AC1, all claiming ACA
selected the portfolio. There was no mention of Paulsons role and conflicting financial
interest.
Tourre also emailed ABN saying ACA had selected the portfolio.
At the end of 2007, ACA Capital experienced severe financial problems. By early 2008, it
settled $69 Billion in debt, $26 Billion of which was related to the subprime mortgagemarket.
ACA Capital no longer accepts new business.
In late 2007, ABN was acquired by a group of banks including the Royal Bank of Scotland
(RBS).
AUGUST 7, 2008: RBS paid GS&Co $840,909,090 on behalf of ABN. GS&Co then paid
most of the money to Paulson.
FIRST CLAIM: Everything in paragraphs 1-66 above supports this First Claim.
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GS&Co and Tourre violated Section 17(a)(1), (2), (3) of the Exchange [error: Securities] Act.[Generally, using interstate commerce or other devices to defraud; to omit material facts; to operate a
business that defrauds]
Goldman and Tourre:
(a)Schemed to defraud others(b)Profited by lying or leaving out material facts(c) Operated a fraudulent business transaction to deceive buyers of securities
GS&Co and Tourre misrepresented marketing materials for ABACUS 2007-AC1 by
claiming the portfolio was selected by ACA. They didnt disclose the role played by
Paulson, a hedge fund with opposing interests to IKB, ACA Capital, and ABN. They also
led ACA to believe Paulson invested in ABACUS 2007-AC1.
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GS&Co and Tourre misrepresented marketing materials for ABACUS 2007-AC1 by
claiming the portfolio was selected by ACA. They didnt disclose the role played by
Paulson, a hedge fund with opposing interests to IKB, ACA Capital, and ABN. They also
led ACA to believe Paulson invested in ABACUS 2007-AC1.
The Commission asks the Court to enter a judgment that:
GS&Co and Tourre each violated securities laws and a Commission rule described here;
Permanently stop the defendants from committing these crimes.
Order the defendants to give up all profits made from this crime, with interest.
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Make them pay penalties.
Make them payback the investors.
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