Opinion

Alison Frankel

Is this the inside info that triggered Goldman’s MBS ‘big short’?

Alison Frankel
Jul 9, 2014 22:12 UTC

It is an axiom of the financial crisis that Goldman Sachs realized before any of the other big banks that the mortgage-backed securities market was going to implode in 2007. Goldman dumped MBS and shorted the market, turning a profit in its mortgage department when every other major financial institution suffered record losses.

So what tipped Goldman to start off-loading its MBS exposure at the end of 2006? In a new brief in its securities fraud case against the bank, the Federal Housing Finance Agency has an intriguing theory.

According to the conservator for Fannie Mae and Freddie Mac, Goldman received a report on December 10, 2006 from the CEO of Senderra, a subprime mortgage lender partially owned by Goldman. Goldman had taken a stake in Senderra — a relatively small mortgage originator — to stay informed about the state of the mortgage market, according to FHFA.

In the December 10 emailed report, Senderra CEO Brad Bradley supplied grim market intelligence. “Credit quality has risen to become the major crisis in the non-prime industry,” he wrote to Kevin Gasvoda, the head of Goldman’s whole loan trading desk. “We are seeing unprecedented defaults and fraud in the market, inflated appraisals, inflated income and occupancy fraud.”

Gasvoda forwarded the proprietary report to other Goldman executives, along with what he called a “very telling” follow-up email from Senderra that warned of “irrational” mortgage originators chasing “any loan which smells of quality.”

Can banks force clients to litigate, not arbitrate?

Alison Frankel
Apr 3, 2014 20:38 UTC

If you are a customer of a big bank — let’s say a merchant unhappy about the fees you’re being charged to process credit card transactions — good luck trying to bring claims in federal court when you’re subject to an arbitration provision. As you probably recall, in last term’s opinion in American Express v. Italian Colors, the U.S. Supreme Court continued its genuflection at the altar of the Federal Arbitration Act, holding definitively that if you’ve signed an agreement requiring you to arbitrate your claims, you’re stuck with it even if you can’t afford to vindicate your statutory rights via individual arbitration.

But what if you’re a bank customer who wants to go to arbitration — and, in a weird role-reversal, the bank is insisting that you must instead bring a federal district court suit? Will courts show the same deference to arbitration when a plaintiff, rather than a defendant, is invoking the right to arbitrate and not litigate?

On Friday, the 2nd Circuit Court of Appeals will hear a rare tandem argument in two cases that present the question of whether bank clients have the right to arbitrate their claims even though they’ve signed contracts with forum selection clauses directing disputes to federal court. Believe it or not, the 2nd Circuit will be the third federal appellate court to answer this question, which has divided its predecessors. In January 2013, the 4th Circuit ruled that a UBS client may proceed to arbitration, but on Friday, the 9th Circuit held that a Goldman Sachs customer who agreed to a nearly identical forum selection clause must sue in federal court. To add to the confusion, the 9th Circuit panel was split, which led the majority to call the case “a close question.”

2nd Circuit squelches Title VII exception to mandatory arbitration

Alison Frankel
Mar 21, 2013 21:03 UTC

The 2nd Circuit Court of Appeals has been known on occasion to buck the judicial trend of deference to arbitration and champion plaintiffs’ rights to class action litigation. But not if the only justification for classwide litigation is a phantom statutory right. In a notably short and emphatic decision issued Thursday in a closely watched sex discrimination case against Goldman Sachs, a three-judge appellate panel reversed a lower-court ruling that former Goldman managing director Lisa Parisi may pursue a class action despite the mandatory arbitration clause in her employment contract. The appeals court agreed with just about every argument by Goldman’s lawyers at Sullivan & Cromwell, ruling that the bank’s arbitration clause does not preclude Parisi’s statutory rights under Title VII of the Civil Rights Act because she has no private cause of action to claim that her employer engaged in a pattern or practice of discrimination.

A contrary ruling by the 2nd Circuit would have punched a huge hole in employment agreements mandating individual arbitration. Instead, the appeals court acknowledged that employers can curtail class actions against them, even when they’re accused of violating employees’ civil rights.

The 2nd Circuit panel (Judges Barrington ParkerReena Raggi and Gerard Lynch) said that U.S. Magistrate Judge James Francis and U.S. District Judge Leonard Sand erred when they found that Parisi could not vindicate her Title VII rights without classwide litigation. Parisi’s trial lawyers at Outten & Golden had persuaded the lower courts that she could only prove Goldman’s supposed pattern or practice of discrimination – and thus assure her statutory civil rights – through a class action, because her employment agreement prohibited classwide arbitration. But the 2nd Circuit sided with Goldman. As an initial matter, the opinion said, the Civil Rights Act of 1991 contains specific language endorsing arbitration as a vehicle for resolving discrimination claims, and courts have “consistently found” that civil rights claims can be subject to arbitration. Moreover, the court said, the pattern-or-practice method of proof is intended to enable the government to enforce Title VII on behalf of employees, not to give private plaintiffs a freestanding cause of action. And since Parisi has no statutory right to pursue a pattern-or-practice class action, the 2nd Circuit held, she cannot rely on that right to invalidate the mandatory arbitration clause in her employment contract.

Will Goldman learn its lesson from El Paso shareholder settlement?

Alison Frankel
Sep 11, 2012 15:43 UTC

Late Friday, Kinder Morgan announced a $110 million settlement with El Paso Corp shareholders who asserted that Kinder’s $21.1 billion acquisition of El Paso was tainted by Goldman Sachs’s involvement on both sides of the deal. You remember the case: As Chancellor Leo Strine of Delaware Chancery Court detailed in a scathing opinion in March, Goldman served as a financial adviser to El Paso even though it simultaneously held a $4 billion investment (a 19 percent ownership stake) at Kinder Morgan. Strine refused to enjoin a shareholder vote on the merger but encouraged plaintiffs’ lawyers to press on with claims for money damages, finding “a reasonable likelihood of success in proving that the merger was tainted by disloyalty.”

The settlement certainly reflects Strine’s skeptical view of the sale process. The $110 million from El Paso is as good a recovery for shareholders as we’ve seen in an M&A breach-of-fiduciary-duty suit, topping last year’s settlement in another celebrated conflict-of-interest case — against Del Monte and Barclays — by more than $20 million. (The recently upheld $2 billion judgment in the Southern Peru Copper case is a bit different, since it involved alleged self-dealing by a controlling shareholder.)

But what about Goldman Sachs? Strine’s ruling in March sent mixed messages about Goldman’s potential liability. The chancellor heaped scorn upon Goldman for refusing to be bothered with such trifles as conflicts of interest, calling the bank’s behavior “furtive” and “troubling,” and citing an email from Morgan Stanley, a co-adviser to El Paso, that described Goldman as “shameless.” Strine also said, however, that shareholder lawyers at Bernstein Litowitz Berger & GrossmannGrant & Eisenhofer and Labaton Sucharow would have a tough time making out an aiding-and-abetting case against Goldman. Nevertheless, the plaintiffs were clearly determined not to settle the case without some contribution by Goldman Sachs. In the final settlement, that contribution came in the form of Goldman Sachs waiving payments from El Paso: a $20 million advisory fee and indemnity for Goldman’s legal costs. In essence, that means Goldman is funding upwards of $20 million of the settlement, since you can bet that its lawyers at Sullivan & Cromwell charged in excess of $1 million on the case. (A Goldman Sachs spokesman declined to comment, and Goldman counsel John Hardiman of S&C did not return my call.)

In Gupta case, U.S. must disclose Blankfein deposition prep

Alison Frankel
Mar 28, 2012 14:19 UTC

Jed Rakoff has bounced back quite nicely, thank you, from his appellate smackdown in the Securities and Exchange Commission’s collateralized debt obligation case against Citigroup. In the unlikely event you’ve forgotten, earlier this month the 2nd Circuit Court of Appeals stayed the SEC’s case before Rakoff, finding a strong likelihood that the government and Citi would prevail in their argument that the judge overstepped his bounds when he rejected their proposed $285 million settlement. Despite the notably critical language in the three-judge panel’s per curiam ruling in the Citi case, Rakoff, a U.S. Senior District Judge in federal court in Manhattan, seems undaunted in his determination to hold the SEC accountable. On Tuesday, he ruled that the agency must disclose documents used to prepare Goldman CEO Lloyd Blankfein for his deposition in the Rajat Gupta insider trading case.

Rakoff’s 10-page ruling, issued on the same day that he said the government can use wiretap evidence in the parallel Gupta criminal case, rejects the SEC’s argument that work-product privilege protects its preparation of Blankfein. The judge pointed to a 1993 case from the 2nd Circuit, In re Steinhardt Partners, and a 2003 ruling from the same appeals court, In re Grand Jury Subpoenas, in holding that the government waived its privilege claim when it voluntarily shared materials with Blankfein, a third-party witness. Rakoff said that Blankfein doesn’t have a “common interest” with the government in the Gupta case, so disclosures to him amount to “‘deliberate, affirmative, and selective’ use of work product [that] waives the SEC’s ability to now assert the privilege against the defendants.”

Here’s the fascinating backstory. At Blankfein’s deposition on Feb. 24, Gupta’s lawyers at Kramer Levin Naftalis & Frankel asked him standard questions about how he prepared to testify. Blankfein, according to Kramer Levin’s March 1 brief, revealed that on two occasions leading up to the deposition, he met with SEC lawyers, an agent from the Federal Bureau of Investigation, and prosecutors from the Manhattan U.S. Attorney’s office. At those two sessions, he said, prosecutors asked him 75 percent of the prep questions; the SEC asked the other 25 percent of the questions. Blankfein’s own lawyers at Sullivan & Cromwell, according to Kramer Levin, didn’t ask him questions at the two prep sessions with government lawyers. Blankfein also disclosed that government lawyers showed him 10 or 12 documents in advance of his deposition testimony.

Forget Greg Smith. For Goldman exposé, read Hudson CDO ruling

Alison Frankel
Mar 22, 2012 21:41 UTC

Goldman’s sweep for internal emails containing client insults like “muppet,” a scoop by my Reuters colleague Lauren LaCapra, got lots of well-deserved snark as the bank’s latest too-little-too-late response to Greg Smith’s “Why I Am Leaving Goldman Sachs” op-ed. In case you’re just returning from a vacation in Antarctica, which is pretty much the only way you could have avoided the financial world’s equivalent of Kim Kardashian’s divorce, Smith, a London-based Goldman executive director, said he was sick and tired of the bank’s callous treatment of its clients. “It’s purely about how we can make the most possible money off of them,” Smith wrote in the New York Times. “If you were an alien from Mars and sat in on one of these meetings, you would believe that a client’s success or progress was not part of the thought process at all.”

Why Smith’s piece was considered a revelation is mystifying, given Goldman’s starring role in last April’s 635-page Senate report on Wall Street and the financial crisis. We all know about the Securities and Exchange Commission scrutiny of the Abacus deal, in which Goldman permitted hedge fund manager John Paulson to pick underlying mortgages that doomed the collateralized debt obligation it was hawking to clients, and the famous “one shitty deal” otherwise known as the Timberwolf mortgage-backed CDO. As the Senate report explains, both were part of Goldman’s institutional effort to secretly reverse its own long position in residential mortgage-backed securities even as it marketed MBS investments to clients.

That’s the campaign U.S. District Judge Victor Marrero of federal court in Manhattan detailed in a 64-page ruling Wednesday that greenlights most securities and common law fraud claims by investors in two other rigged-to-fail CDOs, Hudson 1 and Hudson 2. (Here’s Jon Stempel’s Reuters story on the ruling.) Marrero’s decision doesn’t have the freewheeling rhetorical flair (or 1980s pop references) of Delaware Chancellor Leo Strine‘s much-discussed opinion on Goldman’s conflicts in Kinder Morgan’s proposed acquisition of El Paso Corporation, but in a way it’s a much more devastating ruling. Marrero portrays a sweeping, months-long effort, initiated by Goldman CFO David Viniar, to shed the bank’s exposure to subprime mortgages in mortgage-backed securities — and simultaneously to take advantage of clients who were slower to perceive the looming MBS market collapse.

Tortured opinion is Strine’s surrender in El Paso case

Alison Frankel
Mar 1, 2012 21:47 UTC

Chancellor Leo Strine of Delaware Chancery Court is thoroughly sick of what he perceives as Goldman Sachs’ disregard for the M&A rules everyone else plays by. His 34-page decision Wednesday in a shareholder challenge to Kinder Morgan’s $21.1 billion acquisition of El Paso Corp is filled with scorn for Goldman’s eagerness to remain an adviser to longtime client El Paso even though Goldman held a $4 billion stake and two board seats at Kinder Morgan. Writing four months after he took Goldman to task for manipulating valuations in the Southern Peru Copper case, Strine used words like “tainted,” “furtive,” and “troubling” to describe the investment bank’s continuing influence on El Paso CEO Douglas Foshee, even after it was supposed to be walled off from the Kinder deal.

“This behavior,” Strine wrote, “makes it difficult to conclude that the [El Paso] board’s less-than-aggressive negotiating strategy and its failure to test Kinder Morgan’s bid actively in the market through even a quiet, soft market check were not compromised by the conflicting financial incentives of these key players.”

That’s tough talk, and Strine supplied some juicy details about Goldman’s conduct to back it. For one thing, the chancellor wrote, Goldman’s lead El Paso banker, Steve Daniel, didn’t inform El Paso that he personally had a $340,000 investment in Kinder Morgan. According to Strine, Goldman and El Paso also structured the fee arrangement for Morgan Stanley — the financial adviser the board engaged for the Kinder Morgan negotiations in order to wall off Goldman — so that Morgan Stanley was only paid if El Paso agreed to the acquisition. And Goldman chairman Lloyd Blankfein, Strine wrote, made a really peculiar call to El Paso CEO Foshee to assure Goldman’s continued role as an El Paso adviser. Strine quoted from the “obsequious” draft script Steve Daniel prepared for Blankfein: “Hello Doug — it’s been a long time since we have had the chance to visit/[I] wanted to reach out and say thank you for everything from [Goldman] …./You have been very good to [Goldman] in having us help on all kinds of transactions over the years …./And of course I was very pleased you reached out to us on this most recent matter [the Kinder Morgan proposal].”

SEC loses again: Agency judge clears State Street execs

Alison Frankel
Oct 31, 2011 21:06 UTC

Back when former Goldman Sachs director Rajat Gupta’s most pressing problem was the Securities and Exchange Commission’s civil case against him, his defense scored a small victory when the SEC agreed to drop an administrative proceeding against him and brought civil charges in federal court instead. Gupta’s lawyer, Gary Naftalis of Kramer Levin Naftalis & Frankel, had fought to have Gupta’s case heard by a federal judge, rather than an SEC administrative law judge, because the rules of evidence in administrative proceedings favor the agency. Among other things, the SEC can admit hearsay evidence, and defendants don’t have the same rights to depose opposing witnesses. Although the SEC can’t seek the same penalties in administrative proceedings as it can in federal court, they can be an effective way for the agency to make a statement about improper conduct.

Except when the defendants win.

On Friday, the SEC’s chief administrative law judge, Brenda Murray, entered a painstaking 58-page decision that cleared former State Street executives John Flannery and James Hopkins on all of the SEC’s sprawling allegations that they misled investors about the mortgage-backed securities holdings in State Street bond funds. Murray found that the agency failed to show at trial that Flannery and Hopkins violated any securities laws in communicating with investors about the funds’ subprime MBS holdings. She went out of her way to describe the former State Street execs as candid, believable witnesses who were frustrated to be on trial.

Murray’s ruling is yet another courtroom rebuke to the SEC, which in the last few years has seen several high-profile trials end in victory for defendants. Most notably, in 2009 a San Francisco federal judge dismissed stock options backdating charges against Broadcom executives; and in 2010 a Manhattan federal judge exonerated two traders in a landmark SEC case alleging insider trading in credit-default swaps. The State Street loss is perhaps an even bigger black eye for the SEC, given that the loss came in an administrative proceeding, the agency’s home turf.

$1.3bn Grupo ruling is Strine v. Goldman, ex-Wachtell partner

Alison Frankel
Oct 17, 2011 22:00 UTC

Grupo Mexico’s lead lawyer, Alan Stone of Milbank, Tweed, Hadley & McCloy, told me Monday that the company was “shocked” by Chancellor Leo Strine’s 106-page Oct. 14 ruling that the company owes $1.26 billion to the shareholders of Southern Peru Copper Company — the second-biggest shareholder derivative award in history.

It is a pretty shocking ruling. Strine found that Grupo Mexico, which at the time owned more than 50 percent of the shares of Southern Peru, basically forced the publicly-traded company to overpay, in stock, for Minera, Grupo’s privately-held Mexican mining company. In reaching that conclusion, the Chancellor managed to do three remarkable things: He rejected the judgment of Goldman Sachs, which advised Southern Peru on the deal; he questioned decisions by former Wachtell, Lipton, Rosen & Katz partner Harold Handelsman, who represented a minority owner of Southern Peru that was eager to cash out its stake; and he concluded that a special board committee of investment bankers conducted a tainted analysis. From the lead judge in a court that’s best known for making it almost impossible to prosecute a shareholder derivative suit successfully, this is a ruling every securities and corporate lawyer should read. (Plus, it’s written in Strine’s usual fluent, engaging style.)

Don’t cry too hard for Grupo Mexico (if you happen to be the sort of person who cries for corporate defendants found liable of breaching their duty to shareholders). Not only is it planning to appeal, according to Milbank’s Stone, but it now owns about 80 percent of the shares of Southern Peru, so even if it loses on appeal and has to pay up, it’s basically moving money from one pocket of Grupo Mexico’s fat wallet to another.

Decoding Lloyd Blankfein’s retention of Reid Weingarten

Alison Frankel
Aug 23, 2011 18:34 UTC
The market assumed the worst Monday after Reuters’ great scoop on Goldman Sachs CEO Lloyd Blankfein bringing in Reid Weingarten of Steptoe & Johnson to represent him in the Justice Department’s investigation of the bank. Goldman’s share price fell almost 5 percent on the fear that Weingarten’s entrance signals that DOJ is getting serious about its follow-up to the April 2011 Senate subcommittee report on the financial crisis. In one sense, that’s reading way too much into the mere fact that Blankfein has brought in his own lawyer. It’s standard operating procedure for corporate executives at companies under investigation to have separate counsel. Consider the example of other alleged villains of the financial meltdown. Richard Fuld of Lehman, Joseph Cassano of AIG, Angelo Mozilo and David Sambol of Countrywide, John Thain of Merrill Lynch, Kenneth Lewis of Bank of America: they all have their own lawyers, and none of them have faced any criminal charges. Only Mozilo and Sambol even had to answer to the SEC.
Lawyers who represent corporations — Sullivan & Cromwell, in Goldman’s case — have a duty to the company. And though CEOs and other high-ranking executives often think their interests are exactly the same as the corporation’s, lawyers have to anticipate a divergence between what’s good for the company and what’s good for its leaders. A company under investigation might be best served by cooperating with prosecutors and turning over (for instance) its lawyers’ interview notes; execs may have conflicting interests. Even if they don’t, lawyers are supposed to avoid even the appearance of a conflict, so as soon as it’s clear that investigators are interested even in just interviewing an individual executive, white-collar defense lawyers will typically advise bringing in separate counsel.

A couple of cases from the last few years drove home that lesson. Proskauer Rose represented Allen Stanford’s Stanford Financial as the Ponzi scheme collapsed. Proskauer partner Thomas Sjoblom was in the room with Stanford Financial’s chief investment officer, Laura Pendergest-Holt, when she was interviewed by the SEC in 2009. Sjoblom told the SEC that he was representing the company, not Pendergest-Holt. But she ended up indicted for lying to investigators and obstructing justice based on that SEC interview. Pendergest-Holt turned around and sued Sjoblom and Proskauer, asserting that she was never told the firm wasn’t representing her. Sjoblom subsequently resigned from Proskauer. (Proskauer’s spokesman didn’t return my call.)

In another case, Irell & Manella represented Broadcom in an internal investigation of its stock options backdating practices. As part of that investigation, Irell lawyers interviewed Broadcom CFO William Ruehle. Irell was simultaneously representing Ruehle in two securities suits, and, he later said that he believed Irell was his counsel. But it wasn’t: when Broadcom decided to cooperate with prosecutors, Irell turned over its notes of the Ruehle interview. Ruehle was indicted and (among other things) blamed Irell for misleading him. The trial judge in Ruehle’s case, Cormac Carney, blasted Irell for breaching its duty to Ruehle, though the U.S. Court of Appeals for the Ninth Circuit later cleared the firm of wrongdoing. (Judge Carney eventually tossed charges against Ruehle for other reasons.)

So Sullivan & Cromwell and Blankfein are both better off now that the CEO’s interests are protected by another lawyer, even if Blankfein only brought in counsel for an interview with DOJ investigators. In that regard, we shouldn’t assume that Weingarten’s entrance necessarily bodes ill for Goldman or Blankfein. Goldman told Reuters Monday that this is entirely routine: “As is common in such situations, Mr. Blankfein and other individuals who were expected to be interviewed in connection with the Justice Department’s inquiry into certain matters raised in the PSI report hired counsel at the outset,” the bank said.

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