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Goldman Sachs, The SEC and Media Perception

April 19th, 2010
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04.19.2010 original publish date
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04.21.2010 update 3
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Goldman Sachs, The SEC and Media Perception

original article written by Net Advisor

On Friday, 04-16-2010, the Securities and Exchange Commission (SEC) filed charges against Goldman Sachs for allegedly “making materially misleading statements and omissions” aka misleading investors over certain investments in sub-prime mortgage related securities.

After reading the headlines last Friday and watching and listening to the news aired all day long, I found some interesting points that few cared to report and some (many) painted a different picture from this impression I got from Friday’s news.

The headlines gave me the impression that GS committed fraud according to the SEC, and that GS mislead investors causing them about $1 Billion in losses. That is what I heard and read over and over, and made PDF copies of certain media websites. I would have linked the sites, however later even that same day some changed their headlines.

From Yahoo Finance: 04.16.2010 @ 10:25 AM
SEC Charges Goldman with Fraud, Says Investors Lost $1 Billion

Headline Changed: From Yahoo Finance: 04.16.2010 @ 12:31 PM
Goldman Charged With Fraud Over Paulson CDO Trade

From ABC News: 04.16.2010 @ 10:45 AM
” SEC Charges Goldman Sachs With Fraud Costing Investors $1 Billion”
PDF File: 2010-04-16 SEC Charges Goldman Sachs With Fraud Costing Investors $1 Billion (ABC)

Not as Dramatic, but Headline Changed: From ABC News: 04.19.2010 @2:10 AM
“SEC Accuses Goldman Sachs of Defrauding Investors”
PDF File: 2010-04-19 SEC Accuses Goldman Sachs of Defrauding Investors

There are other media who did the same; I am not picking on Yahoo or ABC. They are good media companies. I am just pointing out what I observed and recorded.

That was basically the news I read all day on the SEC filing. Truthful, partially true, or a bit misleading as I saw it, helped send GS’s stock down $23.57 a share or 12.79% on 04-16-2010. In terms of market value, Goldman Sachs lost $12 billion worth of their stock in a single day (Source: Business Insider, chart).

Let’s take a look at the facts in the case, and examine who was involved that we know of, a little history, and examine whether there are any other motives that might exist in this case.

How This GS Story Can Be Misleading
First, some basic financial definitions.

When you hear the term “Investor,” who do you think of? I am going to make the assumption that most people reading this will say when I hear about investors losing money, they think of themselves; or they think of ‘Main Street America’ who has investments in mutual funds, stocks, bonds, etc; and or those who might have a 401(k) or other retirement plan, or they know someone who invests money in the market.

Not a single U.S. citizen lost ANY money from this SEC complaint, except for perhaps Goldman Sachs.

Goldman Sachs stated the following:

“Goldman Sachs, itself, lost more than $90 million. Our fee was $15 million. We were subject to losses and we did not structure a portfolio that was designed to lose money.”

— Source: Goldman Sachs

So with the exemption of GS who stated they lost money on the deal in question, and since there were no American investors who lost a single dime from this alleged fraud complaint by the SEC, who were these “investors” anyway?

Let’s define one more word as public media perception might lead one way as to its meaning.

So when you hear or read headlines that say “Investors Lost $1 Billion,” do you think that was probably a lot of people, or just a few people? When I hear this as a headline, I think of a lot of people where involved who lost money, don’t you? So how many investors lost money in this deal in question?

There were TWO investors who apparently lost money in this deal. How many? Two. Yes, that is correct, there were only (2) investors who lost money. There were not 50,000 investors, not 3,000 investors, not 400 investors, not even 100 investors, just 2 investors lost money.

Again this goes back to my issues with headlines such as, “Investors lose $1 Billion.” It could have been read like this, and it would be correct:

“Two Investors Lost $1 Billion on Goldman Deal.”

Now do you bother to read past the media headline? Tie in the word fraud, Goldman Sachs and the SEC and you got a whip saw headline guaranteed to impact markets.

Now that you know there were just two investors, and they lost $1 billion, you probably can safely assume that they are not mom and pop investors. Who do you think they are? Bill Gates, or Warren Buffet comes to my mind. Who did you think of? We’ll, it wasn’t Gates, Buffett, or some wealthy person. I am going to guess that anyone reading this who is an everyday normal person, and most professionals are still not going to be able to guess who are the two investors who lost money? Remember, no Americans lost any money from this Goldman deal, except by admission, Goldman lost money on their own investment.

So if they aren’t typical or American investors at all, it’s probably really just a couple really rich people and who cares if they lose money they got so much of it anyway, right? They are rich; they know what they are doing, correct?

Actually, there were no individuals who lost any money either. No Americans, no foreign citizens, no individual fortunes were lost. OK, so who were these investors?

Who Lost the $1 Billion?

1. ABN Amro, a major Dutch bank reportedly lost $841 million.
2. IKB Deutsche Industriebank AG, a German commercial bank reportedly lost $150 million.

— Source: CBS News

So now we can recast the headline to a more accurate description:
“Two Giant Foreign Banks Lose $1 Billion in Goldman Deal. SEC Charges Goldman for Fraud, Claiming Goldman Mislead Them.”

Now do you care about the loss? Do you feel sorry for them? We’ll this more accurate headline does not sell the sizzle to the public compared with “Investors lose $1 Billion. SEC Charges Goldman Sachs with Fraud.”

With the samples of headlines verses one that is more precise, that’s is a huge difference in public perception. It may or may not be accurate, but I would argue those kinds of headlines are misleading.

Now that you know that this SEC case is over two foreign banks that invested with Goldman, and has nothing to do with any U.S. investors losing any money. Do you really care about billion-dollar sophisticated foreign banks? Wait, the SEC says, Goldman “mislead” these two foreign banks on this Goldman deal.

Did Goldman Really Dup these Two foreign Banks?
According to Goldman Sachs, “IKB, a large German Bank…and ACA Capital Management (were) the two investors… (and said investors) were provided extensive information about the underlying mortgage securities.”

Now, most people who are familiar with formal financial language won’t call a bank an “investor.” They are generally referred to as “institutions.” Even the Federal Deposit Insurance Corporation (FDIC) doesn’t call banks “investors,” it also refers to them as “Institutions.” (source: FDIC)

Were these two foreign institutions that lost money naive and unsophisticated?
No, actually, both firms meet the SEC’s definition of “Accredited Investors” under the Securities Act of 1933, Regulation D, Rule 501.

“The federal securities laws define the term accredited investor in Rule 501 of Regulation D as:

1. a bank, insurance company, registered investment company, business development company, or small business investment company;…”

— Source: SEC

Further, Goldman Sachs stated that the German bank IKB is a “sophisticated CDO market participant.” Based on what we know now, one could arguably reason to say that these two foreign banks were not “unsophisticated investors” by any means.

If there were unsophisticated (unqualified) investors in this particular Goldman deal, then the SEC would have a slam dunk case against Goldman for violating (at least) Rule 501 of Regulation D of the 1933 SEC Act. But this was not the case.

What are CDO’s?
CDO is an acronym for Collateralized Debt Obligations, which basically are securities that are bundled together and backed by underline assets, in this case Sub-prime Mortgage loans.

Now this definition can get really complex, as CDO’s can have what are called “tranches.” Think of a tranches like branches of a tree. Some tree branches are strong and some are weak right? CDO tranches can have some (branches) that have high credit ratings, all the way down to low or no credit ratings which are generally considered to be of the highest risk in exchange for a potential bigger pay off.

Remember the basics of investing.
Low Risk = Low Reward, with a better chance of keeping most of your principle.
High Risk = High Reward, but you could lose a lot or all of your money.

The odds are, that weak branches of a tree fall before thicker branches. So does the risk with tranches in theory. High risk tranches are more likely to fail before lower risk tranches. In theory, high credit risk will fail more often than low credit risk.

Thus these German and Dutch banks not only invested in these highly complex derivatives, they are known experts and actively are involved in these complex securities on a regular basis. This was not the first time they were involved in CDOs. They just bought at the top of the market. See even the big boys screw up. AIG, Wachovia, Lehman Brothers, Washington Mutual, General Motors, Bear Sterns, etc. What? Foreign banks can’t make bad investment decisions?

So the SEC says these (two) investors were “mislead.” Please, these are professional, highly sophisticated mega billion-dollar banks, not the amateur hour.

According to Goldman Sachs,

“The risk associated with the securities was known to these investors, who were among the most sophisticated mortgage investors in the world. These investors also understood that a synthetic CDO transaction necessarily included both a long and short side.”

I am not here to argue the case for one side or defend another. I am just trying to cover the story more factually and more accurately, and point out that not too many people are willing to call it like it is, and try to explain it in non-technical terms as best as I can.

The Basics of Trading
When it comes to buying and selling anything, you always have two parties: A buyer and a seller. This is true with stocks, and all securities. When you buy, someone else is selling to you; when you sell, someone if buying from you.

Thus, when investing, as in this Goldman case, you have two groups who are on opposite sides of a trade. One long (betting that the portfolio will increase in value, and profit on that move), and one short (betting that the portfolio will decrease in value, and profit on that move).

  1. The German and Dutch banks went long. Goldman Sachs also went long. (Remember, Goldman lost $90 million).
  2. Paulson & Company went short.

All parties in the deal are sophisticated, wealthy intuitions with access to all the talent they are willing to pay for.

As a former compliance officer in the securities brokerage and hedge fund industry, firms have a fiduciary duty of keeping their client information and positions secret. Hedge funds in general don’t disclose their positions because they are concerned that other bigger funds could trade the other side and wipe them out, or they could figure out their unique trading models and risk losing their competitive advantage.

On 04-19-2010, Business Week reported via Bloomberg news that “Goldman Sachs ‘Had Duty’ to Keep Paulson Bets Secret.” The funny part of this article is that it seems that the media is still saying GS mislead or deceived investors. Again, why not just say there were 2 giant foreign banks, and those were the investors?

Is Hedge Fund King Paulson then the Bad Guy?
He was the guy who made 100% of the profits from investing in the correct direction, betting that sub-prime and housing market would tank.

Apparently, at least so far, the SEC isn’t suing Paulson at all. Paulson made his second conference call to his hedge fund investors and this was reported by the Wall Street Journal that:


  • “He (Paulson) made no misrepresentations about his intentions.
  • He didn’t structure the Abacus investment vehicle (in question).
  • The $15 million he paid Goldman was a standard 1% trade commission.
  • The SEC suit will not affect his strategy.” (Republished Source: Forbes)

American Tax Payers Defending Billion-Dollar Foreign Banks
You don’t see that headline anywhere. You should ask why not? It’s the truth isn’t it? Yes. So why not say that? Good question.

The SEC’s case, regardless of its merit, is really defending two giant sophisticated foreign banks who made bad investments, and U.S. tax payers are paying for this.

If these foreign banks thought they were duped, why not have them spend some of their own money and file the lawsuit themselves. As a matter of jurisdiction were these deals even signed in the USA, or were they signed in foreign countries? A small side issue but a technical one. Courts can be all about technicalities such as, what the meaning of “is” is? (Source: BBC News)

Remember, President Clinton in re: Monica Lewinski?

“It depends on what the meaning of the word ‘is’ is.”

I am not a legal expert, just have worked with them in my career, and paying attention to reports such as the above, suggests how technical courts can get.

In the SEC-Goldman case, it all might come down to the meaning of the word “selected.” (Source: Business Week)

“Goldman SEC Case May Hinge on Meaning of ‘Selected.’”

So law can come down to interpretation of very technical matters. The question is whether Goldman mislead the long group about the investments, including themselves? Only a court of law having jurisdiction over the matter will make the decision whether anyone was misled, not the SEC, not Goldman, and not the media.

Ignoring the Signs
Now, you don’t have to work for Goldman, the foreign banks such as IKB, ACA, or anyone else to figure out that there were problems developing in the mortgage market in 2006. The signs were there, and just got bigger and bigger, but most people ignored them. I have discussed this repeatedly on a professional level, and began raising concerns when the FED began raising interest rates starting in spring 2004. I began discussing this to the general public on Yahoo! Answers under my profile name “Net Advisor” back in Oct/Nov 2007: (Post 1) (Post 2). In these said Posts 1 & 2, I named specific U.S. banks, investment banks, and other institutions whom I saw were at financial risk at that time.

In 2006, Paulson & Co. – a large hedge fund also figured out that the real estate market was in trouble. What Paulson did is tried to figure out a way to short sub-prime. A brilliant idea. I had no idea this could be done, or else I would have done it too.

Setting aside the argument for or against the parties in the said lawsuit, I think it was a pretty bad idea to be going long when there were growing red flags about the mortgage market especially in 2006 and 2007. My final red flag for the mortgage market fall was when Bear Sterns announced in June 2007 that two giant ($800 million) hedge funds collapsed. They were not just any hedge funds, they were long and leveraged sub-prime hedge funds, invested in the CDO market, sound familiar?

This was a global news event back in 2007 – before the stock market tanked. How more obvious of a red flag did these banks need? The question I propose to the two institutional foreign banks who lost money is this:

If the big boys… excuse me, “fat cats” couldn’t figure out their neighbor, Bear Sterns’ $800 million sub-prime CDO funds just got totally wiped out in June 2007, why did the German and Dutch banks continue to stay long in the same type of investments for another year?

Is Politics Involved in the SEC Case vs. Goldman?

According to Bloomberg, “the U.S. Securities and Exchange Commission split 3-2 along party lines to approve an enforcement case against Goldman Sachs.” Thus, three Democrats voted for, and two Republicans voted against filing charged verses Goldman Sachs.

The Excuse
The market also had been looking for an excuse to sell, and it got one, and interestingly, the SEC came out with this lawsuit during market hours, not pre-market, not after the market was closed, it choose to do so during market hours, and that created a “panic sell” in Goldman’s stock, and the banking index and the stock market in general, all of which sold off. Even technology stocks, which have nothing to do with exotic mortgages, fell on 04-16-2010.

On top of this, to magnify the move, the SEC came out with this suit on a options expiration day, and also two days before GS released its earnings on Tue 04-20-2010.

The SEC had been taking a lot of bad public relations (PR) for its handling or lack thereof in the Bernie Madoff Ponzi scheme. (source: Reuters)

Goldman Sachs and “Wall Street” generally have been the target for the Obama Administration since he came to Office referring them as, “fat cats” (Example: article 1, article 2).

Coincidentally, the Obama administration has been looking for leverage to push his financial reform agenda, and the timing of this release is also quite interesting.

Goldman Sachs was also Obama’s single largest campaign contributor, donating about $994,000 to Obama’s 2008 Presidential Campaign. (source: Reuters)

With regard to the SEC suit, Goldman Sachs stated:

“The SEC’s charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation.”

Read more on Goldman’s initial defense.

Keep in mind that this is a civil case, not a criminal case. Thus if the SEC is victorious, they will collect huge fines, and maybe a few people will get fired who, and IF, they committed any securities violations. If you want to go beyond headlines, and really read the actual news, I encourage everyone to read the actual court documents filed by the SEC; then read the response court document filed by Goldman Sachs, and you might have a different perspective than a sizzling headline. I posted both arguments by each opposing parties because I don’t want to “mislead” you.


Court Documents:
SEC v. Goldman Sachs (22 pages PDF)
Goldman Sachs in response to said SEC allegations (49 pages PDF)

I have never worked, been a consultant for, nor have been paid by Goldman Sachs. But if someone is looking for help, I have collected over 1,000 files just on banking and finance from 2006-2010 thus far, and over 900 files on real estate from 2005-2010 thus far. I have more. I have been studying the issues.

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