SEC v. Goldman Sachs ABACUS

SEC v. Goldman Sachs & Co, civ 3229 (S.D. of NY 2010) was a civil court case in front of the United States District Court for the Southern District of New York brought by the U.S. Securities and Exchange Commission against Goldman Sachs (GS&Co) and Fabrice Tourre an employee of GS&Co relating to the ABACUS 2007-AC1 CDO. The court found against the defendant which resulted in the largest fine in the SEC history at the time of $550m.

The court had accused GS&Co and Fabrice of omission and misstating information regarding their synthetic collateralized debt obligation (CDO) ABACUS 2007-AC1, tied to subprime residential mortgage-backed securities. ABACUS 2007-AC1 was one of the many synthetic CDOs that contributed to the 2007–2008 financial crisis. Goldman admitted guilt and accepted that their marketing materials provided "incomplete information".

History

The SEC filed the case with the United States District Court for the Southern District of New York on April 16th, 2010 against GS&Co and Fabrice Tourre an employee of GS&Co. The court accused GS&Co and Fabrice of omission and misstating information regarding their synthetic collateralized debt obligation. The synthetic CDO in question was ABACUS 2007-AC1, tied to subprime residential mortgage-backed securities. The SEC accused GS&Co of misrepresenting the role ACA Managment LLC ("ACA") played in selecting the CDO's reference portfolio.

Background on involved parties

• Goldman, Sachs & Co.: A prominent leader in the global financial services sector. Founded in 1869, the firm's main headquarters are in New York, NY and they have offices globally. Goldman is the second largest investment bank in the world and they are known for their wealth management services and proprietary trading. They "aspire to be the world's most exceptional financial institution, united by our shared values of partnership, client service, integrity and excellence."
• SEC: The Securities and Exchange Commission (SEC) oversees securities exchanges, securities brokers and dealers, investment advisors, and mutual funds to promote fair dealing, the disclosure of important market information, and to prevent fraud.
• Paulson & Co.: An investment banking firm that specializes in small to mid-cap markets. It was founded in July 1994 and is based in New York, NY, it's an employee-owned fund. Paulson &Co. was run by Mr. John Alfred Paulson until the company in 2020 became private and focused on managing family money.
• ACA Management LLC: It is the asset managing division of the bond insurer ACA Capital Holdings. At the time of this event, ACA managed 22 CDOs with $16 billion in underlying assets. Not much information can be found on the actual company, but ACA had another subdivision called ACA Financial Guaranty which benefited from their involvement in the deal. They were able to sell protection on the transaction. The SEC paints ACA as a victim that Goldman took advantage of.
• IKB Deutsche Industriebank (IKB): A bank that is based in Dusseldorf, Germany, specializing in loans to small and medium-sized companies for more than 90 years. They were bailed out financially in 2007 due to the losses sustained from the ABACUS deal. IKB was found guilty in the ABACUS deal according to the SEC.

The event

GS&Co's marketing materials for the CDO included the term sheet, flip book and an offering memorandum all stated ACA selected the reference portfolio. ACA is a third-party company which specializes in analyzing credit risk in residential mortgage-backed securities("RMBS"). Paulson & Co. Inc. ("Paulson") was in reality the company behind the portfolios selection process. Paulson is a large hedge fund that had economic interest's that were the polar opposite of ABACUS 2007-AC1 CDO investors' interest.

Paulson elected to short the RMBS portfolio it curated through credit default swap ("CDS") agreements with GS&Co, defectively protecting themselves against the capital structure of the ABACUS. Paulsons' interest in shorting the portfolio meant they had motive to select RMBS that would experience credit events and ultimately fail. GS&Co. failed to disclose to their investors Paulsons' true interest's and the involvement the fund played in regard to the RMBS portfolio in any of their marketing material.

Touree, an employee of GS&Co in their NYC office was the main architect of the ABACUS CDO according to the SEC. Tourre was the point of contact for investors in regard to the CDO and was responsible for curating the marketing materials which misinformed investors. It is believed he was aware of Paulsons' desire to short and their role in regard to the RMBS portfolio. In addition, it is believed Touree explicitly informed ACA that Paulson invested about $200 million into ABACUS which implies that Paulson was taking on a long position. Touree also allegedly informed ACA that Paulsons investment interests directly aligned with ACAs'.

The deal was finalized on April 26, 2007; GS&Co. profited $15 million from Paulson for preparing and adverting the ABACUS 2007-AC1 CDO. October 24th, 2007, 6 months after the deal was closed, 83% of the RMBS in the portfolio were downgraded and 17% of the RMBS were on negative watch. Shortly after in January, 99% of the portfolio had been downgraded. This resulted in investors losing over $1 billion, while Paulsons' short position garnered them a $1 billion dollars in profit.

Outcome

GS&Co and Tourre were found guilty of violating Section 17(a) of the Securities Act 15 U.S.C. 77q(a) and 78j(b), Section 10(b) of the Securities Exchange Act and Exchange Act rule 10b-5, 17 C.F.R. 240.10b-5. T The SEC fined Goldman $550 million, the largest fine in the SEC history at the time. $250 million of the fine was paid out to the investors who lost money on the deal, while the remaining $300 million went to the US Treasury. Goldman admitted guilt and accepted that their marketing materials provided "incomplete information". The SEC viewed ACA as a victim in the deal, stating they were misled by Goldman. Resulting in no repercussions for them legally. Although ACA was able to benefit from the partnership.

Impact

Once news of the settlement between the SEC and Goldman broke, the Dow was able to come back from its 100-point loss, netting only a 7-point fall. In addition, Goldman's shares went up roughly $6, to close out the market at $145.22 despite rules being passed indicating unprecedented change and regulation of Wall Street. Although the market made a recovery, Wall Street's integrity was brought into question, and rules and regulations increased.