The testimony of former Paulson & Company executive Paolo Pellegrini has undercut the SEC case against Goldman Sachs (NYSE:GS), according to Jeff Cox at CNBC.com. Steve Liesman (an economics commentator for CNBC) has a video accessible in the Cox article. Gregory Zuckerman and Serena NG, in The Wall Street Journal, express the same opinion as Cox.
For those not familiar with the details of the case, a summary is provided as a Note at the end of this article.
Yesterday Andrew Butter suggested a view which might be used to argue that the case against GS might not be significantly affected by the Pellegrini information. Andrew's article indicates that Paulson & Company did not improve their bearish position through the Abacus issuance. The effect of the synthetic construction was, according to Andrew, designed to transfer a Goldman Sachs obligation to pay Paulson should the underlying securities lose money. The parties ending up with that obligation (actually most but not all) were ACA Management and IKB Bank (Germany).
The question that remains: Just what was the disclosure responsibility of GS?
Goldman represented themselves as the sponsor and marketer of the Abacus CDO. These activities are those of an intermediary. However, Goldman also had a material position in the trade, according to Andrew Butter's argument. This makes GS also a principal in the transaction. Did they disclose this? Were they required to disclose this?
If an intermediary also has a material position there is a potential conflict of interest. If disclosure of such relationships is not required, it should be.
It is interesting that Goldman has maintained that one of their points of defense is that they lost $90 million on the Abacus deal in question. If the original exposure of the CDSs Goldman had written was $1 billion and they transfer $910 million of that exposure to IKB bank and ACA Management, they might argue that the $90 million they ended up paying directly was a loss on the deal.
Paying $90 million instead of $1 billion is actually a gain of $910 million. It will be interesting if this case is presented that way in court by the SEC.
And, finally, if Andrew Butter's analysis is correct, why did Paulson & Company pay $15 million to Goldman for structuring the Abacus offering? There must be more to the story because Paulson had nothing to gain in this scenario.
This case must go to court. It is a case of discovery of the arcane world of layered financial derivatives. Just what legal boundaries are there on such processes? Some of those boundaries, or lack of boundaries, will be defined in this case, but not if a pre-trial settlement is reached.
Note: For those who have not been following this story closely, here are the details of the players in this case:
- Goldman Sachs, who was the sponsor and was responsible for the marketing of a package of synthetic CDOs (consolidated debt obligation) composed of CDSs (credit default swaps) on a number of MBSs (mortgage backed securities) based on sub-prime mortgages. The specific securitiy package in the SEC complaint was named Abacus-2007-Ac1. The SEC has filed a civil complaint against GS centered on the Abacus CDO package. Read the full complaint here.
- ACA Management LLC, who was named as participant in the Abacus project, but was not named as a target of the SEC complaint. Goldman represented that ACA was responsible for selecting the particular CDSs included in the synthetic CDOs in the Abacus offering.
- John Paulson & Company was also named by the SEC complaint but was not a target of the complaint. Paulson's role was (1) the purported requestor of the Abacus package who paid $15 million for its construction and (2) the source of a list of CDSs that were the candidates for incorporation into Abacus. ACA selected CDSs from the Paulson list.
The civil complaint by the SEC against Goldman Sachs filed last Friday has been summarized by many including early articles by Felix Salmon and this author. Since last Friday morning both of these authors have posted several more reports on the subject and others have published more than 160 articles on GS over the five days. In the three weeks before the scandal broke an average of ten articles per week referenced GS. To access the full list of SA articles referencing Goldman just enter GS in the Seeking Alpha search query window.
Disclosure: No positions