Category Archives: CDOs, Collateralized Debt Obligations

Goldman Sachs is facing yet another lawsuit involving toxic synthetic collateralized debt obligations (CDOs). Australian hedge fund manager Basis Capital’s Yield Alpha Fund claims it was defrauded by Goldman when it purchased $78 million of the Timberwolf CDOs in June 2007 and that Goldman knew at the time of the sale the securities were destined to fail as the mortgage market began to decline.

Basis Capital is seeking more than $1 billion in damages.

The lawsuit comes on the heels of another fraud lawsuit against Goldman Sachs. In April, the Securities and Exchange Commission (SEC) filed a civil suit against Goldman in connection to the sale of a synthetic CDO known as Abacus. As reported June 9 by the Wall Street Journal, Goldman and the SEC are reportedly working to settle that case, which could cost Goldman between $500 million and $1 billion in fines.

Emails will likely play a central role in the Basis Capital case. According to complaint, one email from a former Goldman executive describes the $1 billion Timberwolf CDO as “one s—-y deal.”

Basis Capital was forced to liquidate the Basis Yield Alpha Fund in late 2007 after sustaining heavy losses betting on the subprime mortgage market, including buying instruments like Timberwolf.

“Goldman was pressuring investors to take the risk of toxic securities off its books with knowingly false sales pitches,” said Eric L. Lewis of Baach Robinson & Lewis PLLC, Basis Yield Alpha Fund’s lead counsel, in the Wall Street Journal article. “Goldman should be called to account for its deception of BYAFM and other investors who were misled.”

Citigroup and Morgan Stanley appear to be taking a lead from Goldman Sachs when it comes to collateralized debt obligations (CDOs). As reported in a May 21 article by Bloomberg, Citigroup is the focus of several inquiries for allegedly selling a series of mortgage-linked securities – known as the Jackson Segregated Portfolio – to investors without disclosing the fact that Morgan Stanley helped shape the investments while also betting they would fail.

According to the Bloomberg article, marketing documents for the products – which were underwritten by Citigroup in 2006 – failed to provide information on the entity responsible for selecting the underlying mortgage bonds. Sources close to the deal contend that the entity was a Morgan Stanley unit. Six of the seven series of Jackson bonds later defaulted, costing investors more than $150 million of losses, according to Bloomberg data.

So far, Citigroup hasn’t been publicly accused of any violations tied to the Jackson deals.

In a similar situation last month, the Securities and Exchange Commission (SEC) accused Goldman Sachs of misleading investors by failing to disclose that the hedge fund, Paulson & Company, had a role in picking securities it then bet against.

As in the Goldman Sachs case, the Jackson Segregated investments involved a synthetic CDO. Derivatives linked to mortgage bonds were pooled together, packaged into new bonds and then sold investors. On the other end of the Jackson derivatives was a “short” investor. Profits were made when the underlying bonds failed.

“To get the deals done, most underwriters of synthetic CDOs initially took the short positions, sometimes with a plan to sell them off later. When Citigroup set up Jackson, it arranged with Morgan Stanley to take over the short positions once the deal closed . . . Citigroup allowed the firm to help select the bonds linked to the derivatives because Morgan Stanley would have a stake in the performance of the securities,” the Bloomberg article reports

Investments deals involving CDOs have come back to haunt Morgan Stanley. Federal prosecutors apparently are investigating whether the investment bank intentionally misled investors about various synthetic collateralized debt obligations that it helped design and sometimes bet against. The story was first reported by the Wall Street Journal on May 11.

According to the story, Morgan Stanley marketed and sold the CDOs in question to investors and then subsequently placed bets that their value would fall. Among other things, investigators want to know whether the bank disclosed certain facts to investors, as well as its role in the deals themselves.

In April, the Securities and Exchange Commission (SEC) charged another investment firm – Goldman Sachs – with fraud in connection to sales of synthetic CDOs.

According to the SEC’s complaint, Goldman Sachs failed to tell investors certain details regarding the financial products, including the fact that a major hedge fund not only selected the securities held by the CDO but also bet against them to fail.

Meanwhile, the probe into Morgan Stanley’s CDO is at a preliminary stage.

Already facing a fraud lawsuit by the Securities and Exchange Commission (SEC) related to collateralized debt obligations (CDOs), Goldman Sachs says additional CDO lawsuits over its mortgage-trading activities are likely in the coming months.

“We anticipate that additional putative shareholder derivative actions and other litigation may be filed, and regulatory and other investigations and actions commenced against us with respect to offering of CDOs,” Goldman Sachs said in its 10-Q filing with the SEC on May 10.

The SEC’s lawsuit against Goldman accuses the investment bank and Vice President Fabrice Tourre of misleading investors about a mortgage-linked security and the role the hedge fund, Paulson & Co., played in selecting and then betting against the investment.

Following the SEC’s lawsuit, Goldman Sachs stock fell 22%.

Last month, current and former Goldman Sachs executives, including CEO Lloyd Blankfein and Tourre, faced intense grilling by the Senate’s Permanent Subcommittee on Investigations. Members of the committee subsequently released potentially damaging e-mails that showed various Goldman Sachs employees questioning the securities at the heart of the SEC’s lawsuit and referring to them as “junk.”

Goldman also warned in its 10Q filing that any settlement with the SEC could affect its business operations, including potentially hindering its core broker/dealer activities, as well as its ability to advise mutual funds.

Goldman Sachs, looking to unload toxic securities connected to the U.S. housing market, stepped up its efforts to sell those products to clients in 2006 and 2007, according to newly disclosed internal emails. The emails, some of which were from Goldman Sachs CEO Lloyd Blankfein, show that Goldman’s employees discussed how to “arm” its salespeople to get rids of the bonds that the company deemed too risky to keep.

The emails were released publicly on April 27 by Senator Carl Levin. Levin heads the Senate’s Permanent Subcommittee on Investigations, which is conducting a hearing about Goldman’s role in the financial crisis. Earlier this month, the Securities and Exchange Commission (SEC) filed fraud charges against Goldman and one of its employees, Fabrice Tourre.

Goldman continues to deny that it did anything wrong when it created a synthetic collateralized loan obligation that caused about $1 billion in losses while undertaking other transactions that allowed the company to profit when the housing market collapsed.

During the Senate hearing, Senator Levin said that Goldman had advertised itself as having a responsibility to its clients, “yet the evidence shows that Goldman repeatedly put its own interests and profits ahead of the interests of its clients.” Levin further stated that Goldman had crossed “ethical lines” in selling collateralized debt obligations to clients while standing to gain from their losses.

The “Fabulous Fabrice Tourre,” as he refers to himself in an e-mail cited in an April 16 securities fraud lawsuit filed by the Securities and Exchange Commission, is reportedly set to rake in a massive bonus courtesy of his employer Goldman Sachs.

An April 18 story in the Guardian first reported the bonus news, which is set to be announced on April 20 by Goldman Sachs CEO Lloyd Blankfein as part of the first-quarter 2010 financial results for the bank.

News of Tourre’s potential bonus comes on the heels of the SEC’s lawsuit against the VP and Goldman Sachs over claims involving a package of collateralized debt obligations – called Abacus 2007-AC1 – that regulators contend was designed to fail. According to the civil complaint, Tourre knew that the hedge fund, Paulson and Company, had helped select the assets backing Abacus while at the same time betting on it fail.

The SEC further alleges that Tourre misled a collateral manager, ACA Management, about Paulson’s role.

“Marketing materials for Abacus 2007-AC1 were false and misleading because they represented that ACA selected the reference portfolio while omitting any mention that Paulson, a party with economic interests adverse to CDO investors, played a significant role in the selection of the reference portfolio,” the complaint reads.

The SEC’s complaint also includes potentially damning e-mails from Tourre about Abacus. One of those e-mails states the following:

“Only potential survivor, the fabulous Fab standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstrosities!!!”

According to an April 19 article in the Wall Street Journal, Tourre received a paycheck of more than $2 million in 2007. The compensation was reportedly due in part to the success of the CDO at the center of the SEC’s lawsuit. Meanwhile, Tourre apparently has taken an “indefinite vacation” but remains employed at Goldman Sachs.

The fraud lawsuit involving Fabrice Tourre and Goldman Sachs may be just the tip of the iceberg for Wall Street. On April 16, the SEC accused Tourre, a VP at Goldman Sachs, and the bank of creating and selling high-risk collateralized debt obligations tied to mortgages without disclosing to investors the role of a hedge that helped picked the underlying securities and then bet against them to fail.

A number of analysts now say the probe may prompt additional investigations in CDOs at other Wall Street firms.

“This is probably just the tip of the iceberg,” said Chizu Nakajima, director of the Centre for Financial Regulation and Crime at Cass Business School in London, in an April 19 article in Investment News. “As far as other financial institutions are concerned, they are obviously very worried. If the SEC’s action is actually successful, it could well open up the gates to other litigation worldwide.”

Besides Goldman Sachs, at least 20 banks arranged more than $400 billion CDO deals in 2007 – the same time that the U.S. housing market began to collapse. Citigroup was the leader of those deals, followed by Merrill Lynch and Deutsche Bank, according to the Investment News story.

The New York Post reported this morning that the SEC is now investigating transactions structured by other big players in the CDO market, including Deutsche Bank, UBS and Merrill Lynch.

A recent lawsuit against Fabrice Tourre may be emblematic of public sentiment regarding Wall Street. The Securities and Exchange Commission (SEC) filed a civil lawsuit against Tourre and his employer, Goldman Sachs, on April 16, accusing the duo of defrauding investors by misstating and omitting key facts about a financial product tied to mortgage-related investments.

The focus of the lawsuit is on a collateralized debt obligation that Tourre created. The performance of that CDO, called Abacus, was linked to the performance of the housing market. When the housing market tanked, so, too, did Abacus. The SEC isn’t focused on that aspect, however. Its lawsuit concerns a hedge fund, Paulson & Co., which selected the losing assets that went into Abacus and then bet against them. Goldman never revealed Paulson’s role to investors, according to the SEC.

Meanwhile, another company became involved in the deal – ACA Management. Allegedly, Goldman and Tourre convinced ACA that Paulson was investing in Abacus, instead of betting against it.

The SEC’s complaint accuses Tourre as the person principally responsible for ABACUS 2007-AC1. Tourre structured the transaction, prepared the marketing materials, and communicated directly with investors, the SEC says. Tourre also allegedly knew of Paulson & Co.’s undisclosed short interest and role in the collateral selection process.

In addition, Tourre is charged with misleading 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 the interests of ACA. In reality, however, their interests were sharply conflicting.

In the end, Paulson paid Goldman $15 million for putting Abacus together. Investors lost more than $1 billion, while Paulson made a profit of $1 billion, the SEC says.

The name Fabrice Tourre probably wasn’t widely recognized – until now. The Securities and Exchange Commission (SEC) filed a civil lawsuit against the Goldman Sachs broker and his employer last week for their connection to a complex financial product – known as Abacus 2007-AC1 – that was filled with equally complex and high-risk synthetic collateralized debt obligations (CDOs).

According to the SEC’s 22-page complaint, Goldman and Tourre are alleged to have knowing deceived investors when they marketed and sold Abacus. In addition, the SEC says Goldman failed to disclose that one of its clients, Paulson & Co., actually helped choose the risky securities that were packaged into Abacus. Moreover, Goldman did not disclose that Paulson, one of the world’s largest hedge funds, had bet that the value of the securities would fall, the SEC says.

Tourre was the mastermind behind the creation of Abacus, and agreed to the deal with Paulson in April 2007, the SEC claims. Regulators allege, however, that Tourre knew the market in mortgage-backed securities was about to be hit well before April 2007.

The SEC’s April 16 lawsuit against Goldman Sachs and Tourre contains a number of potentially incriminating e-mails from Tourre, one of which reads as follows:

“More and more leverage in the system. Only potential survivor, the fabulous Fab[rice Tourre]… standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstrosities!!!”

Tourre, 31, currently resides in London as executive director of Goldman Sachs International. He’s apparently worked for Goldman since 2001.

French trader Fabrice Tourre and his employer, Goldman Sachs, are being sued by the Securities and Exchange Commission (SEC) for allegedly devising a package of highly risky credit default swaps (CDS) and then betting against the investments – and their clients – to fail. The deals produced massive losses for investors but big profits for Tourre and, ultimately, for Goldman Sachs.

The SEC filed its civil lawsuit on April 16, and the move seems to confirm what many people have long believed: The world of Wall Street is indeed rigged, and investors are the ones who wind up on the losing end.

“The SEC suit against Goldman, if proven true, will confirm to people their suspicions about the total selfishness of these financial institutions,” said Steve Fraser, a Wall Street historian, in an April 18 article in the New York Times. “There’s nothing more damaging than that. This is way beyond recklessness. This is way beyond incompetence. This is cynical, selfish exploiting.”

Tourre is the only Goldman Sachs employee named in the SEC’s complaint. As for the deals Tourre created, they consisted of collateralized debt obligations (CDOs), which were contingent on the performance of risky mortgage-related securities. Those details, however, were never disclosed to investors, according to the SEC.

In the SEC’s complaint, Tourre is accused of structuring the CDO, called ABACUS 2007-AC1, with input from the hedge fund Paulson & Co. The CDO itself held some of the riskiest assets around, a key fact that allegedly was never stated in any marketing materials related to ABACUS or by Tourre when he sold the investments to investors. Regulators say Paulson then bet against the CDO. Again, investors in the CDO were never told about Paulson’s role or intentions.

When the housing market began to spiral out of control in 2007 and 2008, ABACUS felt the pain. In an e-mail that Tourre sent to a friend on Jan. 23, 2007, he states the following:

“More and more leverage in the system, The whole building is about to collapse anytime now…Only potential survivor, the fabulous Fab[rice Tourre]…standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities!!!”

Another e-mail from Tourre – this one dated Feb. 11, 2007 – reads as follows:

“The CDO biz is dead we don’t have a lot of time left.”

And neither did investors as it turns out. When the housing market collapsed, investors in ABACUS 2007 AC1 suffered losses of more than $1 billion, according to the SEC. Paulson, meanwhile, made a profit of about $1 billion. And Goldman Sachs? It was paid about $15 million for structuring the bonds and selling them to investors.