The SEC’s suit against Goldman Sachs (GS) is phrased simply, but it doesn’t answer several interesting questions. By way of background, Scarecrow provided a description of the suit with links here, and I did more detailed description here. You can read the complaint here, and those interested in the details of the offering can read the flip book, a description of the proposed deal prepared by Goldman Sachs, here. This post has descriptions of some of the more important terms.
- Exactly who bought securities of ABACUS 2007-ACI?
The flip book says that ABACUS 2007-ACI planned to issue six tranches of securities. It relates only to four classes of Notes, which it calls the A, B, C, and D Notes. It does not say who is buying the Super Senior note, a debt tranche, or the “First Loss”, or equity, tranche. The Super Senior Note was $1.1 billion, and Goldman Sachs kept it on its books. The first loss tranche was $200 million. P. 15 (references are to the .pdf page, not the page in the flip book).
The Complaint says that IKB bought $50 million of A-1 Notes and $100 million of A-2 Notes. Neither of these classes is described in the flip book, so they are either subdivisions of the A Notes, or the A-2 Notes are B Notes as described in the flip book. The structure calls for a total of $900 million in A through D Notes. The deal closed. Who bought the other A through D Notes?
Maybe they weren’t sold at all. GS filed a Submission with the SEC (.pdf) arguing that the SEC should not file suit. It identifies only one other purchaser, ACA, in the amount of $42 million. ACA is the independent CDO manager hired to pick the reference portfolio for ABACUS 2007-ACI. As of now, it looks like there weren’t other note purchasers.
- Who owned the equity tranche?
On April 20, GS held its regular analysts call, in which senior staff discuss the earnings report. GS claims that it did not own the equity tranche. This strongly suggests that there was another investor, or it may be that the equity tranche was not required in the final form of the deal. We would need the final offering materials, which I couldn’t find.
- Who bought the Credit Default Swaps issued by ABACUS 2007-ACI?
This is a question that was nagging at me. At first I thought it was Paulson & Co., Inc. the hedge fund that sought out Goldman Sachs to set up the deal. However, in the Submission, GS says it bought a $192 million CDS from ABACUS 2007-ACI, as protection on the ABACUS 2007-ACI reference portfolio. I can’t find any other reference to CDSs issued by ABACUS 20007-ACI.
- What did Paulson & Co., Inc, purchase?
According to the Submission, GS sold to PCI the $192 million CDS it bought from ABACUS 2007-ACI. GS also bought a $909 million CDS from ABN-AMRO and ACA protecting the top part of the Super Senior tranche, and sold that to PCI. GS says it was on the hook for the remaining part of the Super Senior tranche, which appears to be $100 million. In the investor call, GS said it lost $83 million on the retained long position and more in related parts of the transaction, for a total of over $100 million.
On the analyst call, GS Chief Counsel Greg Palm called ACA the largest investor in ABACUS 2007-ACI. He must have meant to include the $909 million CDS as an investment, otherwise he misspoke.
- How did GS wind up holding a long position in this deal?
Gretchen Morgenson of the New York Times reported that in December 2006, GS decided to reduce its exposure to the house mortgage market. GS apparently tried to sell its entire position, but could not get out. On the analyst call, GS explained this by saying it was like keeping some skin in the game. Sure.
- How did GS explain to ACA that it should consult with PCI about the reference portfolio?
The first questioner on the analyst call tried to get an answer to this question. Palm waffled, and didn’t answer. He did say that GS arranged the meeting, but he refused to explain the reason GS gave ACA for the meeting.
- Is it relevant that either IKB or ACA possibly could have figured out the role of PCI?
No. The burden is on GS to make adequate disclosure, and the possibility that the cheated person could or should have figured it out is not relevant in an SEC action. One of the questions on the analyst call raised this issue, and Palm didn’t explain why it was wrong. He did deny that PCI’s involvement was material.
- Should ACA have been able to figure out PCI’s role?
It is possible that ACA should or could have figured out that PCI’s involvement in the selection of the reference portfolio meant that PCI intended to short the deal. Since they were together, ACA could easily have asked PCI.
On the other hand, in the flip book, there is an equity tranche, and the SEC alleges that ACA thought PCI was buying it. The only CDS purchaser shown in the flip book is GS, and ACA might easily have assumed that PCI had no other involvement.
- Could IKB have figured out the role of PCI?
Based on what we now know, there is no way IKB could have figured it out. The only short IKB knew about was GS, because it was shown as the CDS purchaser in the flip book. IKB insisted that GS appoint an independent CDO manager. Little did IKB know that by inserting PCI into that independent relationship, GS put the fox in the henhouse.
IKB was fully justified in relying on ACA, both because it was in the flip book as an independent party, and because ultimately, whether IKB knew it or not, ACA’s interests were aligned with IKB’s.
- How did GS lose $100 million?
GS refused to explain on the analyst call. I can’t figure out the answer with the information available.