The Securities and Exchange Commissions civil complaint against Goldman Sachs alleges that it duped a pair of European bank investors in a CDO called Abacus 2007-AC1. Goldman committed fraud, the SEC says, by failing to disclose that it had enlisted hedge fund Paulson & Co. to help design Abacus, and that Paulson was shorting the mortgages he helped select, essentially booby trapping the CDO.
Abacus was structured by Goldman, but as with all CDOs, there was a money manager in the mix. In this case, that manager was ACA Management LLC.
Goldman CEO Lloyd Blankfein surely will continue to come under intense fire in the weeks ahead. Meanwhile, the young Fab Fabrice Tourre sits dead center, the only Goldman employee named in the SECs suit.
But the case also draws attention to buy side money managers, specifically CDO managers.
ACA Management is the asset management division of bond insurer ACA Capital Holdings. At the time the Abacus CDO was structured ACA Management had managed 22 CDOs with $16 billion in underlying assets.
As ACA was part of ACA Capital Holdings, the Abacus deal produced another gig, for ACAs ACA-Financial Guaranty unit to sell protection on one of the tranches.
ACA is no Pimco or Blackrock but it is of decent size and reputation. But one has to wonder whether Goldman would have asked Pimco or Blackrock to collaborate with John Paulson & Co. on building a CDO. After all, Paulson, as early as the first part of 2006, was raising money for a fund that was going to short the daylights out of the housing market.
ACA seemed a bit too eager to please, which is probably why Goldman selected them for the deal. Again, what would Bill Gross have thought if Goldman tried to force him into an arranged marriage with Paulson and his RMBS ideas? Surely he would have bristled.
The SEC paints ACA as a victim in this scheme, but the mere fact that ACA went along with any of Paulsons ideas whatsoever suggests they either had no business doing portfolio selection to begin with or that they looked the other way and did what it was told while Goldman fulfilled its side agenda.
It is one thing for ACA to agree to get in bed with Paulson on constructing the portfolio, but it is another for it to have done so knowing that Paulson intended to short the deal.
The SEC alleges Goldman misled ACA about the intentions of Paulson, and that ACA actually thought Paulson wanted to own the riskiest parts of the Abacus CDO. Goldman strongly disputes this key point, and says it never represented to ACA that Paulson was going to be a long investor. Its my view that ACA likely went along with whatever Goldman and Paulson said because thats what Goldman wanted, and rocking the boat could have jeopardized ACAs CDO management fee and the additional gig, writing protection.
Goldman sold IKB Deutsche Industriesbank AG and ABN Amro on a CDO deal without mentioning even in the fine print the Paulson connection. Goldman contends that as normal business practice, market makers do not disclose the identities of a buyer to a seller and vice versa.
This would not mark the first time that something which had been normal business practice on Wall Street to come back to bite a firm in the hind parts. See the mutual fund/hedge fund late trading/marketing timing scandal.
Goldman perhaps viewed this whole thing as sausage making no one would ever see or learn about.
Maybe Goldman and ACA both thought Paulson would be the big loser, a rationale for the smell test passage of the close intertwining of the hedge fund manager in the process.
Goldmans marketing materials for the deal never mention Paulsons having shorted more than $1 billion of securities, the SEC says, alleging that GS misled investors.
Whether Goldman misled ACA is also at issue. But it is Goldman, not the little known ACA, that's in the SECs cross hairs. Still, an asset manager who allowed a short seller to design a long portfolio deserves some extra scrutiny if not a spot in the money management hall of shame.
The SEC is hanging their hat on a simple issue: the failure to disclose. Goldman is holding up the fact that it lost money on the deal as exhibit A in its case that it didnt create a ticking time bomb. Paulson has issued a statement he did nothing wrong.
My questions right now are not for Fab or Lloyd or for Paulo Pellegrini, Paulsons bespectecled, stylishly Italian right hand man, but for ACA. And they are the oldest ones in the book:
What did you know and when did you know it?