This morning, the SEC filed securities-fraud charges against Goldman Sachs and a vice-president at the company, London-based Fabrice Tourre. In the complaint, they allege that in 2007, Tourre allowed hedge-funder John Paulson to structure a collateralized debt obligation called Abacus, made up of crappy subprime-mortgages securities he handpicked himself, and that the firm then turned around and marketed Abacus to its clients, without mentioning that Paulson had created the CDO specifically in order to buy credit-default insurance against it.
To aid in the deception, the suit alleges, Goldman brought in a firm called ACA Management, an independent company of the sort that firms hire to select assets for CDOs, and told them that Paulson was helping pick the securities because he was investing in the CDO, rather than betting against it. From the complaint:
Tourre allegedly knew of Paulson & Co.’s undisclosed short interest and role in the collateral selection process. In addition, he misled ACA into believing that Paulson & Co. invested approximately $200 million in the equity of ABACUS, indicating that Paulson & Co.’s interests in the collateral selection process were closely aligned with ACA’s interests. In reality, however, their interests were sharply conflicting.
And today, he came to Washington to testify before Congress. Most importantly, Tourre stated “I deny–categorically–the SEC’s allegation. And I will defend myself in court against this false claim.”
It seems unlikely Goldman Sachs will suffer much as a result of this inquiry. Sen. John McCain (R-AZ) put it simply, “I don’t know if Goldman Sachs has done anything illegal, [but] from the reading of these emails … there’s no doubt their behavior was unethical, and the American people will render a judgment as well as the courts.”
Henry Blodget seconds the sentiment, arguing that Goldman will have to pay a fine and walk away completely intact. He has a slightly less rosy forecast for Fabulous Fab:
Fabrice Tourre will be placed on administrative leave or fired (a.k.a., thrown under the bus). He will then spend the next couple of years testifying in this and other follow-on civil lawsuits. The SEC will probably demand a cash settlement from him, too, and boot him out of the industry. Based on our scan of the allegations, Tourre was involved in every aspect of the structuring and marketing of the CDO in question. The complaint includes snippets of communications in which Tourre describes the CDO one way internally and another way externally. Again, this is not proof of fraud, but, at least as represented by the SEC, it looks bad. Tourre will likely want to fight the charges, especially if he thinks they’re b.s., but it will be too risky and expensive for him to do so, so he’ll likely settle. Having made such public allegations, the SEC will make sure that any settlement produces an appropriately tough-looking headline (thus the fine and industry dismissal)
Now, there’s a lot to dislike about Fabrice Tourre. He openly gloated about the future misery of others. He was something of a womanizer. He threw giant parties. He’s well-educated and foreign. All in all, he is a perfect fall guy. This is not to absolve him of responsibility (he certainly seems to have his fair share of it), but there are some problems with focusing our collective ire on him, and more generally short sellers.
For one, as David Brooks pointed out yesterday, the problems that led to the financial crisis ran much deeper than individual bad apples such as Tourre, and stringing up a couple individuals may satisfy the mob, but it hardly will fix wider structural problems.
More to the point, the much-maligned short sellers provide an important market service, in that, as Michael Lewis and David Eichhorn put it in January, they are, “the only market players who have a financial incentive to expose fraud and abuse.” And while Goldman Sachs’ error appears to basically be shorting something that they were selling to customers (implying quite convincingly that they knew the product they were fobbing off on their clients was a loser), short sellers in general are a useful bulwark against the excesses of the market.
For more on the story, and if you’re especially masochistic, you can download the 900 pages of exhibits from today’s hearing.