The SEC’s civil fraud suit against Goldman Sachs and Goldman employee Fabrice Tourre, filed yesterday in federal court in New York, alleges the defendants made “materially misleading statements and omissions in connection with a synthetic collateralized debt obligation (“CDO”) GS&Co structured and marketed to investors.” The structured-investment’s value was tied to performance of a portfolio of subprime mortgages selected, according to Goldman’s marketing materials, by ACA Management. According to the Complaint Goldman failed to disclose to investors that hedge fund Paulson & Co., Inc. “played a significant role in the portfolio selection process” while maintaining “economic interests directly adverse to investors”–in other words, while shorting the portfolio. The SEC alleges Paulson entered into credit-default swaps with Goldman on specific tranches of the CDO. According to the complaint Tourre was responsible for structuring the investment, knew of Paulson’s undisclosed short interest, knew Paulson’s role in selecting the portfolio, and misled ACA that Paulson had a $200 million equity stake in the deal. Goldman earned $15 million in fees for structuring the investment. Six months after the April 2007 closing 83% of the portfolio’s mortgages had been downgraded; by January 2008 downgrades stood at 99%. The SEC alleges investors lost over $1 billion in the deal, while Paulson made over $1 billion. Goldman called the complaint’s allegations “completely unfounded” and claims its long position lost over $100 million.
The 22-page complaint crisply describes structured securities, synthetic CDOs, compromising internal correspondence, and this entertaining email from Tourre to a friend three months before the deal closed:
“More and more leverage in the system, The whole building is about to collapse anytime now. . . Only potential survivor, the fabulous Fab[rice Tourre]…standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities!!!”
In another email before the deal closed Fabulous Fab wrote “the cdo biz is dead we don’t have a lot of time left.” All together the complaint paints an ugly picture, but that’s what complaints do.
Why is Paulson not a defendant? Because Paulson did not communicate anything to investors. Investor disclosure, not deal structure, is the heart of the alleged fraud.