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On Friday the SEC made public civil charges of fraud against Goldman Sachs (NYSE:GS) and 31 year old Vice President Fabrice Touree with regard to specific mortgage securities transactions. The complaint involved an investment named Abacus. The complaint charges that Goldman failed to disclose possible conflicts of interest to purchasers of the Abacus package. The SEC allegations pertain to the fact that the firm which selected the securities, ACA Management LLC (“ACA”), picked them from a list prepared by a third party, Paulson & Company, a hedge fund, which was intending to take a short position in opposition to the investment firms to which Abacus was sold (long positions).

The essence of the complaint is that the SEC maintains that those who bought the Abacus product did so with the implication by Goldman that the package had been structured based on a selection process run with the objective of selecting the portfolio with the best chance for success. The SEC maintains that Goldman committed fraud by not disclosing that a party who would take the short position on the portfolio had a significant role in determining which securities would be allowed in the Abacus package.

Just days after the Friday surprise, much more has come to light. Some of the news concerns just how wide a net may be cast in relation to the Abacus events.

Comes the Deluge

There may be other cases coming. Francesco Guerrera, Jean Eaglesham and Ralph Atkins wrote at ft.com:

In February, the Financial Times revealed that the SEC last year sent subpoenas to banks including Bank of America, Merrill Lynch, Barclays, Citigroup, Credit Suisse, Deutsche Bank, Goldman, Morgan Stanley and UBS, seeking information about the marketing of CDOs.

In the same article the authors suggested that things might be getting tougher on both sides of the Atlantic for Goldman. Various stages of political talk and possible investigations have been mention in Germany, the U.K. and the E.U. (European Union). This makes one wonder if there will be a world war on Goldman.

A report by Carrick Mollenkamp, Serena Ng, Gregory Zuckerman and Scott Patterson Monday afternoon in the Wall Street Journal mentions some of the banks mentioned at ft.com but does not indicate knowledge of any specific SEC investigations. The WSJ does enumerate other suits: Pursuit Partners LLP (a hedge fund) is suing USB; Robobank (The Netherlands) is suing Merrill Lynch; and King County, Washington, is suing IKB, which was on the losing side of the Abacus deal. Mike Shedlock (Mish) has a detailed report about the Robobank vs. Merrill Lynch case.

Structured finance consultant Janet Tavakoli, says that what is most surprising about the SEC complaint against Goldman is that it took so long. She feels the SEC is guilty of just not doing its job for years. In an interview on CBS News with Katie Couric (hat tip to Jessie’s Café Americain), Tavakoli said that, if the SEC does its job now, this is the beginning of widespread investigation.

Christine Seib and Martin Waller (TimesOnLine) wrote an article entitled “Goldman Sachs case opens lawsuit floodgates on Wall Street”.

Monday evening Francesco Guerrera Brooke Masters wrote at ft.com that AIG is considering pursuing GS over losses incurred on $6bn of insurance deals on mortgage-backed securities. The securities, on which AIG is said to have lost $2 billion, were part of another Abacus package separate from the one specified in the SEC complaint.

The Blind Side

Goldman contends that the filing of the civil suit by the SEC on Friday took it completely by surprise. This contention comes in spite of the fact that Goldman admits to knowing the SEC was looking into deals such as the Abacus portfolio for as long as 20 months. According to an article by Susanne Craig, Kara Scannel and Gregory Zuckerman in the Wall Street Journal:

Firms typically get a chance to settle such suits, but not in this case, Goldman said. The Wall Street giant said it was alerted to the probe in the summer of 2008 and was warned that it might face a suit in July 2009. It says it then responded in detail to the Securities Exchange Commission's inquiry in September, but heard nothing back from the government until Friday's unveiling of the civil suit. The SEC usually notifies firms ahead of a lawsuit as a courtesy to give them a chance for a last-ditch settlement or to prepare for the public fallout.

Return of Crazy Eddie

Sam E. Antar has labeled the way in which the SEC complaint was delivered constitutes what he calls the “kiss of death”. He further says that Goldman has made a serious error in the way it has defended itself. If the civil case is resolved in favor of the SEC, Antar maintains that Goldman has created language that will be used by future complainants as representation of GS fraud and deception. He particularly criticizes the following words used by Goldman:

...We are disappointed that the SEC would bring this action related to a single transaction in the face of an extensive record which establishes that the accusations are unfounded in law and fact.

Antar is uniquely qualified to speak out on this subject. He is a felon convicted of securities fraud, a result of his activities as CFO of Crazy Eddie. The crazy Eddie fraud case involved criminal charges brought by the SEC (as well as the state of New Jersey) and resulted in the conviction of many executives of the company, members of the Antar family. San E. Antar is now a consultant in dealing with white collar crimes.

For those interested in the Crazy Eddie details, Wikipedia has a good summary of the history.

More to Come from the Abacus Case?

MIT professor and former IMF chief economist Simon Johnson, writes at The Baseline Scenario that John Paulson, whose list of CDSs (credit default swaps) on weak MBSs (mortgage backed securities), should hire a good defense attorney. According to Johnson:

John Paulson was not the trigger man – it was Goldman and its executives who withheld adverse material information from their customers. But if the entire scheme was Mr. Paulson’s idea – if he was in any legal sense the mastermind (obviously he was, but can you prove it beyond a reasonable doubt?) – then we are looking at potential conspiracy to commit fraud. And if he had conversations of any kind and at any time during this period with top Goldman executives, this will become even more interesting - so of course all relevant phone records will now be subpoenaed.

Mr. Paulson should be banned from securities markets for life. If that is not possible under current rules and regulations, those should be changed so they can apply. If that change requires an Act of Congress, so be it.

Other possible infractions in the Abacus case involve concealment by both GS and Tourre of a Wells Notice delivered by the SEC in July 2009. According to YourDictionary.com, a Wells Notice is:

A letter issued by the Securities and Exchange Commission to a company advising the company that the SEC is considering possible civil charges against it. The letter outlines the violations that the SEC is contemplating charging the company with and gives the company the opportunity to argue against the potential action. The SEC considers the company’s response before any action is taken.

There is no mention on the FINRA disclosure document by Tourre dated April 16, 2010 of the Wells Notice in which he was named nine months earlier, according to Zero Hedge. Such disclosure is required within 30 days.

Finally, has anyone seen a corporate disclosure in the fine print from quarterly (or annual filings) by GS in reference to the July 2009 Wells Notice? All investigations, actions or other such events must be disclosed if they could have an effect on financial performance or stock price. Did Goldman really think that the Abacus case had no potential impact? Maybe it was another great misjudgment by financial genius such as the 2007 statements by many notables that the sub-prime problem was contained.

Disclosure: No positions.

Source: Goldman Sachs: How Far Will the Abacus Case Spread?