Well, the SEC
complaint against Goldman Sachs has thwarted my resolve to refrain from
blogging until classes end in a few days in the hopes of actually getting some work
done. And, of course, I can’t stand to be the only person in the blawgosphere
with nothing to say on the issue, especially when I’ve spent a good chunk of my
career teaching and researching disclosure duties (see, for example, this empirical
study with Kathy Zeiler on the duty to disclose at common law).
Let me say at the outset that, perhaps unsurprisingly, the bulk of the media coverage in my opinion misses the primary issue in the case, which has – or should have -- nothing to do with the fact that a major client was shorting the deal (which is inherent in the synthetic CDO structure), that the client was speculating rather than hedging (an obvious possibility, especially by 2007), or even that the client was Paulson or any other well-known bear. Sure, this latter fact seems relevant now, with the benefit of hindsight. But, as Larry Ribstein points out, in early 2007 much of the market was still betting against Paulson’s view that CDOs were underpriced relative to their risks.
Instead, the real question, as already noted by Erik Gerding, is whether Goldman’s failure to disclose to investors that Paulson, based on his analysis of which securities were likely to be downgraded, had been involved in picking the specific securities comprising the CDO portfolio, and, in fact, had been allowed to veto the inclusion of particular issues. It seems to me that the SEC’s case in this regard is not a slam-dunk, nor is Goldman’s defense of it. In other words, it looks to me to be a rather hard case, whose outcome will depend on the ultimate resolution of several underlying questions.
Was Goldman’s failure to disclose this information to investors a material omission? I think that’s a real possibility. The Abacus flipbook contains by my count 29 pages (nearly half the content of the 66 page flipbook) of disclosure on ACA as Portfolio Selection Agent, including information on ACA’s business strategy, investment philosophy, senior management team, asset management organization chart, and the ACA-ABS credit selection process and criteria, with a good deal of emphasis on ACA’s prior experience as a portfolio selection agent. Nowhere is Paulson’s role in the selection process mentioned. It’s plausible that a reasonable investor, even a sophisticated one, could have taken this information to suggest that ACA exercised independent judgment, expertise, and diligence in selecting the CDO portfolio.
The next question is whether any countervailing disclosures might reasonably have quelled that false impression. Jeff Lipshaw correctly notes that the Abacus flipbook contains disclaimers and risk factors, which prominently note the following:
·Goldman Sachs may, by virtue of its status as an underwriter, advisor or otherwise, possess or have access to non-publicly available information relating to the Reference Obligations, the Reference Entities and/or other obligations of the Reference Entities and has not undertaken, and does not intend, to disclose, such status or non-public information in connection with the Transaction. Accordingly, this presentation may not contain all information that would be material to the evaluation of the merits and risks of purchasing the Notes.
· . . . Goldman Sachs is currently and may be from time to time in the future an active participant on both sides of the market and have long or short positions in, or buy and sell, securities, commodities, futures, options or other derivatives identical or related to those mentioned herein. Goldman Sachs may have potential conflicts of interest due to present or future relationships between Goldman Sachs and any Collateral, the issuer thereof, any Reference Entity or any obligation of any Reference Entity.
·Goldman Sachs & Co. will act as the initial purchaser for all classes of Notes, and affiliates of Goldman Sachs & Co. will act as the Protection Buyer, the Basis Swap Counterparty, the Collateral Put Provider and the Collateral Disposal Agent.
Are these disclaimers sufficiently specific to overcome any duty to disclose the involvement of Paulson that might have been created by Section II of the flipbook? Though that’s a possibility, I think the answer is probably “no.” These are quite generalized boilerplate that are probably not sufficient to negate any false impression, if indeed there was one, created by the remainder of the flipbook disclosures on ACA. Perhaps the Offering Circular (I have not seen it – the SEC complaint says that it is 178 pages) contains a more detailed disclosure, though I suspect not -- Goldman made no reference to it in its press release defending its conduct in the Abacus matter.
Erik’s excellent post does raise other hurdles to the SEC case, some of which are serious, including the role of ACA (I may post more on this later) and potential difficulties with damages and causation. In any event, the case will be a fun one for us blawgers, which is mostly what matters, I suppose.
Above Image: Brendan McDermid/Reuters
The Goldman Sachs global headquarters in Manhattan.
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