SEC Charges Goldman Sachs With Fraud in Structuring and Marketing of CDO Tied to Subprime Mortgages
APR 16, 2010 | REPUBLISHED BY LIT: MAR 22, 2022
FOR IMMEDIATE RELEASE
2010-59
Washington, D.C., April 16, 2010 — The Securities and Exchange Commission today charged Goldman, Sachs & Co. and one of its vice presidents for defrauding investors by misstating and omitting key facts about a financial product tied to subprime mortgages as the U.S. housing market was beginning to falter.
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 played in the portfolio selection process and the fact that the hedge fund had taken a short position against the CDO.
“The product was new and complex but the deception and conflicts are old and simple,”
said Robert Khuzami, Director of the Division of Enforcement.
“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, added,
“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.”
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.
According to the SEC’s complaint, filed in U.S. District Court for the Southern District of New York, the marketing materials for the CDO known as ABACUS 2007-AC1 (ABACUS) all represented that the RMBS portfolio underlying the CDO was selected by ACA Management LLC (ACA), a third party with expertise in analyzing credit risk in RMBS. The SEC alleges that undisclosed in the marketing materials and unbeknownst to investors, the Paulson & Co. hedge fund, which was poised to benefit if the RMBS defaulted, played a significant role in selecting which RMBS should make up the portfolio.
The SEC’s complaint alleges that after participating in the portfolio selection, Paulson & Co. effectively shorted the RMBS portfolio it helped select by entering into credit default swaps (CDS) with Goldman Sachs to buy protection on specific layers of the ABACUS capital structure.
Given that financial short interest, Paulson & Co. had an economic incentive to select RMBS that it expected to experience credit events in the near future.
Goldman Sachs did not disclose Paulson & Co.’s short position or its role in the collateral selection process in the term sheet, flip book, offering memorandum, or other marketing materials provided to investors.
The SEC alleges that Goldman Sachs Vice President Fabrice Tourre was principally responsible for ABACUS 2007-AC1.
Tourre structured the transaction, prepared the marketing materials, and communicated directly with investors. Tourre allegedly knew of Paulson & Co.’s undisclosed short interest and role in the collateral selection process.
In addition, he misled ACA into believing that Paulson & Co. invested approximately $200 million in the equity of ABACUS, indicating that Paulson & Co.’s interests in the collateral selection process were closely aligned with ACA’s interests.
In reality, however, their interests were sharply conflicting.
According to the SEC’s complaint, the deal closed on April 26, 2007, and Paulson & Co. paid Goldman Sachs approximately $15 million for structuring and marketing ABACUS.
By Oct. 24, 2007, 83 percent of the RMBS in the ABACUS portfolio had been downgraded and 17 percent were on negative watch.
By Jan. 29, 2008, 99 percent of the portfolio had been downgraded.
Investors in the liabilities of ABACUS are alleged to have lost more than $1 billion.
The SEC’s complaint charges Goldman Sachs and Tourre with violations of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Exchange Act Rule 10b-5. The Commission seeks injunctive relief, disgorgement of profits, prejudgment interest, and financial penalties.
# # #
For more information about this enforcement action, contact:
Lorin L. Reisner
Deputy Director, SEC Enforcement Division
(202) 551-4787
Kenneth R. Lench
Chief, Structured and New Products Unit, SEC Enforcement Division
(202) 551-4938
Reid A. Muoio
Deputy Chief, Structured and New Products Unit, SEC Enforcement Division
(202) 551-4488
Goldman Mortgage Trader Convicted of Fraud Pursuing New Career in Academia
Fabrice Tourre still spends his days doing obscure bond math, but far from the trading pits
JUL 2, 2018 | REPUBLISHED BY LIT: MAR 22, 2022
Fabrice Tourre testified on Capitol Hill in Washington in 2010.
PHOTO: CHARLES DHARAPAK/ASSOCIATED PRESS
A decade after the financial crisis, The Wall Street Journal has checked in on dozens of the bankers, government officials, chief executives, hedge-fund managers and others who left a mark on that period to find out what they are doing now.
Today, we spotlight former AIG executive Joseph Cassano and ex- Goldman Sachs GS trader Fabrice Tourre.
Fabrice Tourre was one of the few on Wall Street prosecuted for building and selling the complex mortgage bonds that blew up when real-estate prices crashed. The former Goldman Sachs Group Inc. trader still spends his days doing obscure bond math, but far from the trading pits.
Mr. Tourre received a Ph.D. in economics from the University of Chicago after the financial crisis and is conducting postdoctoral research at Northwestern University.
He has studied how markets price risk in debt securities and was a teaching assistant in a course on asset pricing for Professor George Constantinides at the University of Chicago.
“The reason I picked him up was because he was the top student when I taught the course the previous year,”
Prof. Constantinides said.
“As a TA, you want to be empathetic and help the students, and he did that very well.”
Nicknamed “fabulous Fab” at Goldman, Mr. Tourre was convicted by a federal jury in 2013 for defrauding investors in a derivative tied to subprime mortgages called Abacus 2007-AC1.
He was ordered to pay about $825,000.
Goldman settled with the Securities and Exchange Commission for $550 million in 2010,
but Mr. Tourre battled the regulator in a trial that exposed the mix of hubris and doubt felt by many traders before the crisis.
The case uncovered an email by Mr. Tourre, then 27 years old, to a friend asking
“what if we created a ’thing’, which had no purpose, which is absolutely conceptual and highly theoretical and nobody knows how to price?”
He bragged in another email,
“The whole building is about to collapse anytime now…the only potential survivor, the fabulous Fab.”
Mr. Tourre declined to comment for this article.
Sec. & Exch. Comm’n v. Tourre, 10 Civ. 3229 (KBF) (S.D.N.Y. Jan. 7, 2014)
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Discussion Slides
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by Gary Painter, Xi Yang and and Ninghua Zhong; discussion given at the AEA Conference, AREUEA session in January 2021
World Financial Cycles,
by Yan Bai, Pat Kehoe and Fabrizio Perri; discussion given at the NBER Summer Institute, International Asset Pricing session in July 2019
Expected Currency Depreciation Upon Sovereign Default,
by Pasqualle Della Corte, Ella Dias-Saraiva-Patelli and Alexandre Jeanneret; discussion given at the Canadian Derivatives Institute’s conference on derivatives in September 2018
Term Structures of Credit Spreads with Dynamic Debt Issuance and Incomplete Information,
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Disclaimer
Prior to starting my graduate studies at the University of Chicago, I was an employee of Goldman Sachs from July 2001 until I resigned to begin my doctorate in September 2011. In April 2010, the Securities and Exchange Commission filed a civil law suit against Goldman Sachs and against me, for allegedly making materially misleading statements and omissions in connection with a synthetic CDO transaction named ABACUS 2007-AC1, a complex financial product sold to two large institutional investors in 2007.
While Goldman Sachs decided in July 2010 to settle those charges by neither admitting nor denying wrongdoing, I declined a similar offer to settle and instead continued to dispute those claims. In August 2013, after a three-week civil trial, I was found liable by a jury, and was ordered to pay approximately $850,000, consisting of a combination of a fine, disgorgements and prejudgment interest.
I have fully paid these penalties and there is no other legal consequence to this verdict.
In June 2014, while my lawyers assured me that there were strong grounds on which to appeal, I decided not to pursue a lengthy appeal process which, if successful, would have led to a retrial of the entire case.
Instead, I decided to move forward, close this difficult chapter of my life, and fully focus on my academic work, with the ultimate goal to make meaningful contributions to my field.
