SEC v Goldman - Who Wins and Why? Part 2

This Post continues the analysis of SEC v Goldman from Part 1.

Goldman is publicly making all these arguments: we didn't tell anyone Paulson was a long: we had an obligation to keep his role confidential not to disclose the fact that he was going short; even if ACA thought Paulson was going long, it wasn't material because ACA still had the responsibility to assess the proposed referenced securities based on the data about the securities – not the source of any recommendation.

Goldman is making at least one other major argument.  Goldman itself took a long position, and a  loss, on the transaction.  This suggests that even if Paulson was stacking the deck on the short side with Fab's help and ACA's rubber stamp, Goldman, at least at some level, didn't understand what was going on.  Why bet on black if you've rigged the game to come up red?  One possible explanation – Fab was eager to get his deal done.  By letting ACA's Laura Schwartz think that Paulson was on the same team, everyone stayed a little cozier and things moved along just a little more smoothly.  Fab gets a bigger bonus and who gets hurt?  It's not like the reference securities are going to crash or anything, right?.  Sorry, Fab.   If that's what happened, then some of the Goldman higher ups were  plenty surprised when they first saw the e-mail quoted above.  The Goldman employees may be rallying around Lloyd Blankfein, but  Fab's indefinite leave could be permanent.    It will be interesting to see if Laura Schwartz defends ACA's selection process or concedes that it was swayed by Paulson and goes after Goldman.

One last question.  Why didn't ACA and IKB and ABN banks, the other big losers, sue even before the SEC?  After all, they took most of the loss.   ACA was in a position to know the facts, including any misrepresentation about Paulson's role.  ACA was also in a position to be embarrassed by the publicity surrounding any suit.  Even if it was fooled by Fab, it doesn't look very diligent if it selected reference securities just because Paulson recommended them, and it would not want to highlight this in a suit.  IKB and ABN had their hands full with their own bailouts, and had less data than ACA.  IKB and ABN probably will file claims now, then sit back and let the SEC do all the work.

So, Goldman is stuck defending a transaction that seems to have produced no real economic benefit to society – not directly relevant to the fraud claim, but not great PR when regulatory reform is afoot.  Goldman is stuck defending fabulous Fab and his e-mail, even though though it would like to strand Fab on an episode of Lost.  Goldman is stuck defending the proposition that fooling ACA about Paulson's role did not matter, so long as ACA did its job.

The fact that Goldman is stuck defending some unpleasant positions does not mean that it will, or should, lose the case.  Normally a tenable, but ugly, defense, suggests settlement.  Here, Goldman will not accept a resolution that includes culpability for fraud – even if the SEC imposed sanctions are palatable, the damage to its reputation, not to mention problems with broker/dealer licenses and qualification to participate in underwriting government securities,  won't be.  Unless.......maybe, at some point if and when the SEC is feeling shaky about its case, Goldman can hang Fab out to dry and cut a settlement deal in which the firm accepts failure to supervise but not culpability for fraud.

At trial, the synthetic CDO  will look like a big unpleasant con game to a jury.  Fabulous Fab is a French investment banker who writes e-mails depicting himself as a survivor standing tall in the wreckage of the mortgage securities market.  This will probably not endear him to a group of twelve grumpy retirees like me  who will be whining constantly about how crazy the whole business is and acting as if the trial is a major imposition, while secretly loving it.  So Goldman loses?  Not so fast.  Synthetic CDO's are complicated and confusing, but, at least for now,  the single, simple salient fact most likely to sway a jury is ringing clearly and loudly as a church bell on Sunday morning – who rigs a game to come up red, then bets on black?