SEC Charges Goldman Sachs With Fraud; Was Matt Taibbi Right About The 'Giant Vampire Squid'?

On Friday, April 16, the U.S. Securities and Exchange Commission charged Goldman Sachs & Co. with fraud relating to transactions the firm - dubbed the ‘giant vampire squid’ in an article by Matt Taibbi last year - structured, tied to the housing market. According to the SEC’s press release:
 

The SEC alleges that Goldman Sachs structured and marketed a synthetic collateralized debt obligation (CDO) that hinged on the performance of subprime residential mortgage-backed securities (RMBS). Goldman Sachs failed to disclose to investors vital information about the CDO, in particular the role that a major hedge fund” –disclosed elsewhere in the SEC press release as Paulson & Co. – “played in the portfolio selection process and the fact that the hedge fund had taken a short position against the CDO…

...The SEC alleges that one of the world's largest hedge funds, Paulson & Co., paid Goldman Sachs to structure a transaction in which Paulson & Co. could take short positions against mortgage securities chosen by Paulson & Co. based on a belief that the securities would experience credit events.

SEC Enforcement Director Robert Khuzami added:
 

"The product was new and complex but the deception and conflicts are old and simple. 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."

Kenneth Lench, Chief of the SEC's Structured and New Products Unit, SEC Enforcement Division, noted:
 

“The SEC continues to investigate the practices of investment banks and others involved in the securitization of complex financial products tied to the U.S. housing market as it was beginning to show signs of distress."

Was Taibbi Right?
In light of the above news, I wonder if Rolling Stone writer Matt Taibbi feels vindicated now, having faced substantial criticism of his article published on July 9, 2009, entitled: “The Great American Bubble Machine - From tech stocks to high gas prices, Goldman Sachs has engineered every major market manipulation since the Great Depression - and they're about to do it again.”

My recollection of the discussions in the blogosphere and twitterverse at the time Taibbi's article was first published last year (including commentary by former WSJ reporter Heidi Moore, and articles in the Columbia Journalism Review, among others, come to mind) were that Taibbi seemed to be 'reaching' his conclusions about Goldman, without sufficient 'evidence.' With 20-20 hindsight in light of today's announcement, there will likely still be varying views about Taibbi's article, but there may be a shift overall in how it is now perceived.

Goldman’s Response to the SEC
In response to the SEC charges, Goldman Sachs initially issued a one sentence press release on the day the SEC announced the charges (one sentence, not including the introduction and tagline), in which the firm stated: "The SEC’s charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation."

UPDATE: Later in the day, Goldman issued a lengthier press release, stating: "We want to emphasize the following four critical points which were missing from the SEC’s complaint.

• Goldman Sachs Lost Money On The Transaction.  Goldman Sachs, itself, lost more than $90 million.  Our fee was $15 million.  We were subject to losses and we did not structure a portfolio that was designed to lose money.

• Extensive Disclosure Was Provided.  IKB, a large German Bank and sophisticated CDO market participant and ACA Capital Management, the two investors, were provided extensive information about the underlying mortgage securities.  The risk associated with the securities was known to these investors, who were among the most sophisticated mortgage investors in the world. These investors also understood that a synthetic CDO transaction necessarily included both a long and short side.

 ACA, the Largest Investor, Selected The Portfolio.  The portfolio of mortgage backed securities in this investment was selected by an independent and experienced portfolio selection agent after a series of discussions, including with Paulson & Co., which were entirely typical of these types of transactions.  ACA had the largest exposure to the transaction, investing $951 million.  It had an obligation and every incentive to select appropriate securities. 

• Goldman Sachs Never Represented to ACA That Paulson Was Going To Be A Long Investor.  The SEC’s complaint accuses the firm of fraud because it didn’t disclose to one party of the transaction who was on the other side of that transaction.  As normal business practice, market makers do not disclose the identities of a buyer to a seller and vice versa. Goldman Sachs never represented to ACA that Paulson was going to be a long investor." Read more in Goldman's press release, "Goldman Sachs Makes Further Comments on SEC Complaint."

Read here to find "My Two Cents on Goldman Sachs and Mark-to-Market Accounting."

 

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FEI Financial Reporting Blog provides highlights from SEC, PCAOB, FASB, IASB, and other regulatory news, including reporting under Sarbanes-Oxley Sect 404. It is written by Edith Orenstein, Director of Technical Policy Analysis at FEI

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