Recent Revelations Concerning The SEC v. Goldman Sachs RE: ACA

I first, and most recently, wrote about the SEC's civil suit against Goldman Sachs on the day after the former filed its suit, on Friday of last week.

Since that time, various news organizations have been scurrying about, interviewing, or attempting to interview, major players in the several years-old case.

Paola Pellegrini, then with Paulson's hedge fund, Laura Schwartz, then with ACA, and Fabrice Tourre, the Goldman employee most involved with the Abacus deal, were all spotlighted in the Wall Street Journal yesterday.

The most revealing information that has appeared in the public domain since last Friday has been attributed to Pellegrini. His alleged contentions seem to directly contradict several assertions in the SEC's case.

Specifically, it appears that Pellegrini says that ACA knew that Paulson's firm was involved in the deal. ACA also apparently exercised considerable discretion in rejecting some of Paulson's suggested inclusions, substituting other mortgages which, it later developed, actually reduced the quality of the resulting CDO.

What's losing credibility, though, is at least one of the SEC's two charges against Goldman- that it hid Paulson's involvement from ACA.

On CNBC this morning, several people debated whether Goldman would, if it could, settle this case. The preponderance of opinion was that it would not, since it needs to refute the SEC's charges in court, in order to emerge free of taint of actual illegal behavior. I would agree.

In my prior post, I emphasized that even if Goldman didn't engage in illegal activities, this case may finally convince many institutions to be wary of dealing with Goldman, having evidence that you simply cannot trust the firm to view any counterparty as a 'valued client' whom the firm won't treat roughly when given the opportunity.

To me, reviewing the additional information of the past week, the SEC's case appears much weaker than it did when first announced.

Yesterday's Wall Street Journal's column by Holman Jenkins, Jr., made a convincing case that this suit is the SEC's attempt to accomplish a largely political task, i.e., fight for and win a larger role in financial regulation under the currently-proposed so-called 'reform' bill. Others allege that the SEC is attempting to fill the media with stories about the SEC that don't focus on its decision to leave Allen Stanford alone years ago. In short, the high profile Goldman case is meant to focus public attention on the agency and a major financial sector vendor. Perhaps even curry favor with Congressional Democrats for delivering a convenient victim in time to drive passage of the legislation. Jenkins wrote,

"The need for villains frequently (not always) conflicts with the need for understanding. The SEC certainly understands the need for a rapid route to rehabilitation for itself if it hopes for a share of the power and budget up for grabs in the Senate debate over financial reform. If you don't think this played a role in the suit it sprang on Goldman last week, we have a CDO to sell you."

Jenkins also argued persuasively that much about the Abacus case involves a latent public and regulatory distaste for those who profit on the short side of transactions. Though necessary and helpful to real, free markets, short-side activity carries a stigma, since the profit comes from the destruction of someone else's financial value. He also contended in his column,

"Goldman will have to decide for itself if its business model can be defended in the court of public opinion. But let's admit there's an implicit long bias to the SEC's case. Nobody would give a hoot if Mr. Paulson were the party who lost money. The SEC would never have gone on its hunt for something, anything, to hang a fraud case on."

I think it's fair to say that dealings between a complicated, multi-business financial giant like Goldman and institutional counterparties is very different than from, say, GE's jet engine business and an airline.

There are lots of rules governing how the execution of trades in financial markets are to be performed which, generally, lend a bias against the legality of too much coziness between parties in the business. For example, a firm having securities underwritten by a firm like Goldman must understand that Goldman couldn't hide material information about the firm when selling the securities to its customers.

Years ago, Frank Quattrone, then of CSFB, was accused of illegal behavior resulting from alleged ties between IPO allocations and other business activities.

My point is that employees at institutions dealing with major market-making, trading firms, including the now-commercial banks such as Goldman Sachs and Morgan Stanley, are wise to view any solicitations to buy securities cautiously.

One natural reaction of a potential buyer could, and should be,

"If it's such a great deal, why are letting me in, and not keeping it all for yourself?"

There are some valid answers, such as selling a sufficient amount of a security to ensure a liquid market for future trading and valuation. But the core of the question is germane, especially to a firm like Goldman, which has so many different businesses in the financial sector. Its GSAM asset management group could well provide a sufficient appetite for many choice Goldman underwriting products.

From this perspective, it's simply ludicrous that the SEC would claim that Goldman failed to tell potential buyers of the CDOs who had been involved in their creation. All of the sophisticated investors with whom they dealt, former SEC legal personnel's opinions notwithstanding, had both the savvy and opportunity, as Holman Jenkins noted in his column, to ask for sufficient information prior to their purchase of the CDOs from Goldman.

If it were truly important to an institutional investor to know the provenance of the entire Abacus deal, and Goldman refused to disclose it, well, I would expect such an investor to refrain from buying the CDOs.

At no time does it appear that any Goldman employee put a gun to any institutional investor's head to force her/him to buy any of the Abacus deal.

At this point, I'm guessing that Goldman is eager to get to trial, in order to publicly dimantle the SEC's case. Short of that, a withdrawal of the suit by the agency would be the next best remedy.

Failing the disclosure of some truly illegal, explicit misrepresentation of the Abacus deal by Goldman personnel, though, it's looking less likely that the SEC complaint has merit in the context the world of sophisticated institutional investors.