Goldman’s defense

By Felix Salmon
April 20, 2010
Goldman's earnings call this morning was how guarded they were. For a company which has happily been talking to the press and leaking the letters it sent to the SEC, no one on the call seemed to want to talk candidly about the SEC lawsuit, the Abacus deal, or anything related to them: once the formal statement was over -- which added nothing substantial to the press releases we've already seen -- the Q&A elicited very little in the way of useful information.

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The thing which struck me most about Goldman’s earnings call this morning was how guarded they were. For a company which has happily been talking to the press and leaking the letters it sent to the SEC, no one on the call seemed to want to talk candidly about the SEC lawsuit, the Abacus deal, or anything related to them: once the formal statement was over — which added nothing substantial to the press releases we’ve already seen — the Q&A elicited very little in the way of useful information.

Goldman would clearly love everybody to remain focused on its own talking points, some of which do have some substance to them. This was an isolated deal, they said, and we lost money on it — over $100 million, all told. Our interests were aligned with those of the investors, and the investors ended up losing money not because of the specific securities which were chosen by Paulson, but because the entire market tanked.

Goldman made no mention of the fact that the deal was a particularly bad one — the odds were always stacked against the investors. And the Q&A started off badly, with stonewalling and non-answers. Glenn Schorr of UBS had a great first question, asking how Paulson was characterized when they were introduced, by Goldman, to ACA. No answer. Similar non-answers came to other good questions: has Goldman received any other Wells notices? Is the SEC sniffing over any other securitizations? Why did Goldman retain that slim super-senior slice of the deal?

Other questions served to open holes in Goldman’s legal defense. You’re making a big deal out of the fact that ACA rejected half of Paulson’s proposed bonds, said one — does that imply that if they hadn’t rejected any of the proposed bonds at all, disclosure would have been warranted? Again, no answer.

Indeed, the one question which was answered on the call only served to raise more questions of its own. Goldman said that they did not hold on to the equity tranche of the deal, which raises the obvious question: who owned ABACUS 2007-AC1, and whatever happened to the famous 0-9% equity tranche? If the bonds in the deal had all performed perfectly, where would the excess profits have gone?

But there was also a hint, in this call, of a very aggressive and high-risk possible Goldman defense to the SEC accusations. The SEC says that Goldman misled ACA into believing that Paulson was long. But Goldman’s GC, Greg Palm, said quite explicitly on the call that putting any deal like this together involves negotiating back and forth between the short side and the long side. Goldman has repeated ad nauseam that ACA knew there had to be a short side. It has also said repeatedly that disclosing Paulson’s involvement wouldn’t have made any difference to the outcome of the deal. And here’s Goldman’s letter to the SEC:

The Staff has pointed to two ambiguous statements contained in an e-mail from Goldman Sachs that it contends caused ACA to infer that Paulson would be an equity investor. As an initial matter, it is difficult to reconcile such an inference with the Staff’s theory that Paulson tried to influence ACA to select dozens of riskier Baa2-rated securities, which would have raised questions about Paulson’s true economic interests for any sophisticated market participant.

All of this is pointing towards, if not quite stating, the conclusion that ACA did know — all along — that Paulson was short. Sometimes, it’s in one’s best interests to pretend not to have known something you actually did know at the time.

Which doesn’t answer the question of why Paulson’s involvement wasn’t disclosed. Maybe it’s an IKB thing — remember that IKB wouldn’t do a deal with Goldman directly, wanted an independent CDO manager running the deal, and would have got scared if it knew that a short-seller had had a major role in picking its components. Or maybe Goldman’s being honest when they say that as a matter of principle they simply never disclosed the involvement of participants on either the long or the short sides of the deal. But in any case if Goldman can show that ACA knew that Paulson was short, a massive plank of the SEC case then starts crumbling.

If this goes to trial, expect a lot of interest when ACA executives come onto the stand.

Update: Mark Gimein seems to be thinking along the same lines as Goldman, and sees in the SEC complaint an implication “that ACA knew very well that their goals and Paulson’s could be opposed”.

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