Friday, April 16, 2010

Comment On Goldman Sachs' SEC Complaint

The following is a comment I posted to the Wall Street Journal article, "Goldman Is Charged With Subprime Fraud" by Joe Bel Bruno, Fawn Johnson and Joseph Checkler:
Paulson & Co did not engage in any fraud. Shorting is a legal activity, even when one knows another party is long securities. It is also legal to submit requests of securities to include in a portfolio. There is often a give and take between institutional investors and underwriters about structure, portfolio and pricing so that the underwriting sells and meets the needs of the buyers.

There is no claim in the SEC complaint that the securities in the portfolio were misrepresented or that the portfolio was not as described. Saying that they were mostly from a few states and low fico scores is irrelevant because those were the states with the hottest home markets and all mortgage portfolios were heavy in those mortgages. If it were not the case, only this portfolio would have collapsed, but just about all subprime portfolios from all underwriters from the same time period lost most, if not all their value.

ACA was hired to select the portfolio and was named in the offering documents. The SEC is saying that Paulson influenced ACA's MBS selections and that Goldman should have disclosed Paulson's involvement and his short interest.

Even if ACA was influenced by Paulson, it is unclear Goldman had any duty to inform investors that Paulson & Co was involved or that it t had an effective short interest in those securities. ACA was not forced or coerced to accept Paulson's recommendations and could have objected to specific securities to include in the portfolio or removed itself from the underwriting.

ACA either agreed with Paulson's assessments or was completely negligent is accepting them. ACA and not Goldman may be at fault here but the SEC cannot sue ACA for a bad analysis or for outsourcing the analysis to Paulson.

The SEC will have to show that Goldman intended to defraud investors and set ACA up as a front to hide Paulson's involvement. It does that appear to be the case.

With or without Paulson's involvement, the offering would have lost a lot of its value shortly after issuance due to the collapse of the subprime mortgage and housing markets.

ACA seems to be covering itself and rewriting history to make it appear the subsequent portfolio losses were not due to its poor analytical ability to assess MBS and CDOs.

As often happens, after a risky investment loses a lot of its value, the SEC sues. Lawyers and SEC personnel do no understand risky investments and that risky investments can lose most or all their value without any fraud by the underwriter.

The issue is not that the investments lost most of their value. The issue is Paulson's involvement and whether Goldman had a duty to disclose Paulson's activity with ACA.

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