Why Goldman Sachs May Get Off Lightly on Fraud Charges

Chris Lee

Apparently, Goldman Sachs has been putting together questionable deals for some time before getting caught up on fraud charges that were recently exposed by the Securities and Exchange Commission or SEC.

Also, many people regard the current SEC investment fraud charges against Goldman, as well as the possible criminal charges that may be filed after an ongoing Department of Justice investigation, as potentially serious for the U.S. investment bank and its reputation.

Nevertheless, the likelihood that Goldman Sachs gets off for a fine or a minor slap on the wrist actually seem fairly good, especially given the amount of ex-Goldman employees working at high levels within the present Obama administration.

A list of present and former Treasury, Federal Reserve, Securities and Exchange Commission or SEC, and the Commodities Futures Trading Commission or CFTC officials virtually reads like a who’s who of former Goldman Sachs executives and former employees. These include former Goldman CEO, Henry Paulson and Robert Rubin, both former U.S. Treasury Secretaries.

Obama himself received almost one million dollars from Goldman Sachs employees for his 2008 Presidential campaign, and Goldman is now deploying twelve high powered politicos from its government affairs office for damage control in this situation.

While the price of Goldman Sach’s stock price has fallen around 20% since the SEC announced it would file a civil suit on April 16th, the stock is still trading at the rather inflated price of roughly $150 a share, around twice what it was in 2008. One also wonders just how many shares Goldman’s insiders had already sold before the lawsuit news came out.

Why Goldman Sachs is being Charged

The nature of the SEC’s charges stem from Goldman Sach’s failure to disclose vital information to its clients about a Collateralized Debt Obligation or CDO, specifically the Abacus 2007 – AC1 CDO, which it sold to its clients in 2007.

According to the SEC’s complaint, the key disclosure that Goldman failed to make was in reference to the hedge fund Paulson and Co. which Goldman received input from to structure the deal. The SEC claims that the “aid” which Goldman received from Paulson and Co. was never disclosed by Goldman Sachs to the clients it sold the CDO to.

Not only did Goldman hide the fact that Paulson and Co. selected the Residential Mortgage-Backed Securities or RMBSs which would make up the CDO, they also failed to disclose that Paulson had bet against the portfolio of securities it had selected by buying a type of insurance-like protection on certain layers of the ABACUS 2007-AC1 capital structure.

The protection was in the form of Credit Default Swaps or CDSs which Paulson and Co. had entered into with Goldman Sachs. The SEC’s complaint states:

“Given its financial short interest, Paulson had an economic incentive to choose RMBS that it expected to experience credit events in the near future. Goldman Sachs and Company did not disclose Paulson’s adverse economic interests or its role in the portfolio selection process in the term sheet, flip book, offering memorandum or other marketing materials provided to investors.”

“Fabulous” Fabrice Tourre – Goldman’s Once-Golden Boy

Apparently behind this elaborate plot was Goldman Sachs’ 31-year-old self-described “fabulous” Fabrice Tourre, a French-born registered representative and Goldman Vice President who now works for the bank’s London office. At the time, Tourre was responsible for the structured product correlation desk at Goldman’s New York headquarters.

For his part in the deal, Tourre prepared the marketing material for the deal and was fully aware of Paulson and Co.’s undisclosed short interest in the CDO selection process.

The SEC claims Tourre also misled ACA Capital Holdings, who was the third party that recommended the CDO, by informing them that Paulson and Co. had invested $200 million in a long position in the CDO. Nevertheless, Tourre denies this claim.

By way of evidence, Tourre sent a rather incriminating e-mail in January of 2007 to a friend that was originally written in French. The translated version states:

“…more and more leverage in the system, The whole building is about to collapse anytime now…Only 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!!!”

Goldman’s Investors Speak Out in Its Defense

Goldman’s stock price has lost over $20 billion in value since the SEC announced it would file civil charges that were later compounded by the announcement of an ongoing criminal investigation by the U.S. Department of Justice’s New York office.

Nevertheless, a number of high-powered investors such as Warren Buffet have come to the major investment bank’s defense. Buffet initially commented “I do not see a problem,” to CNBC on May 3rd in relation to the Abacus deal that was the source of the SEC’s fraud allegations.

Goldman claims that its clients were experienced investors and knew what they were getting into. Still, concerns now arise over other investment banks involved in similar deals, like Bank of America-owned Merrill Lynch, and the effect it will have on the U.S. stock market as a whole.

As of this writing, Goldman Sachs’ stock price has recovered 3% from its post-announcement lows to almost $150 per share which is still double the price the shares traded at during the 2008 financial crisis. Around that time, Warren Buffet invested $5 billion in the bank.

Perhaps Buffet does not want to see a problem with the fraud charges since he seems to be talking his book. As the old saying goes, “There are none so blind as those who do not wish to see.”

In addition, many people believe the timing of the charges were politically motivated, since they came virtually on the eve of legislation being introduced by the Obama administration for financial reform affecting Wall Street.

Nevertheless, a crime is a crime, no matter whether the criminal wears an expensive suit and tie or a pair of Levis. Letting Goldman off easy would send a clear signal that cronyism is alive and well in the Obama Administration.

It would therefore not be surprising to learn that the beleaguered investment bank was hoping that its not what you do but who you know and whose campaign you contributed to that will buy you influence in high places in Washington D.C.

Chris Lee

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