SEC started investigating Abacus in 2008

By Felix Salmon
April 19, 2010

Talk about Goldman not disclosing material information. I’m not talking about Abacus here, I’m talking about the fact that Goldman knew as far back as last September that the SEC was on the warpath with respect to Abacus, and gave no hint to shareholders that there might be legal trouble afoot.

The WSJ has got its hands on — but, unforgivably, has not posted online — a letter that Goldman Sachs sent to the SEC in September, claiming that the Paulson’s involvement in Abacus was not material. (This, incidentally, should help keep quiet anybody who credits the press in general or the NYT in particular with being central to this story: the SEC was clearly on the case long before the press was.) In fact, the SEC probe dates back all the way to August 2008:

Goldman said it first heard from the SEC about the investigation in August 2008, when it received a subpoena requesting documents related to the transaction…

In July 2009, Goldman and Mr. Tourre received so-called Wells notices from the SEC. Such notices are a formal warning that regulators intend to file civil charges.

The letter clearly wasn’t very convincing, and Goldman surely knew it.

Goldman argued that the facts about Paulson weren’t material. In the response, reviewed by The Wall Street Journal, Goldman asserted that hedge-fund manager John Paulson, today a famed figure on Wall Street, was nearly unknown when the securities were sold in early 2007, and participants were unlikely to have cared about his role.

This is just silly. Paulson’s involvement was material not because who he is, but because a person with enormous control over the contents of the CDO was exerting that control with the express intention of making them as toxic and failure-prone as possible. Goldman isn’t stupid, so they surely understood what the SEC was driving at, and also understood that their response was weak.

It’s the job of Goldman’s lawyers, of course, to fight these SEC charges aggressively. But when they got the Wells notice in July, they surely realized that there was a significant chance charges would arrive at some point. And so they had a duty to reveal that fact to shareholders.

Add this to the lawsuits likely facing Goldman, then: suits from shareholders who suffered a massive loss on their holdings Friday, and who will claim, reasonably enough, that Goldman should have told them about the Wells notice and its discussions with the SEC.

On the other hand, Goldman might have assumed that all SEC lawyers were utterly toothless, at least if the one dug up by the WSJ is any indication:

“This isn’t mom and pop getting taken advantage of,” said Peter Henning, a professor at Wayne State University Law School and a former SEC enforcement lawyer. These clients “might not have known about Paulson, but they had to have known that these securities were extremely risky.”

Yeah, this is the kind of person that the SEC hired as an enforcement lawyer: someone who seems to think that a small state bank in Germany “had to have known” that the CDO was extremely risky, even when it carried a triple-A credit rating. In fact, given the modest yield pick-up that the tranches offered, I think it’s pretty obvious that the investors can’t have known that the securities were extremely risky. If they had, then they wouldn’t have bought them.

In any case, the more we learn about this case, the worse it looks for Goldman. Even if they go to trial and win, they surely face multiple lawsuits. If they settle, they’ll get more. And if they go to trial and lose, then that could be extremely harmful indeed to their franchise.

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