On The Four Year Anniversary Of The Paulson-ACA Meeting That Conceived Abacus
Four years ago to the day from Saturday, a team of "experts" from ACA Management took the elevators to the 29th floor of 590 Madison, the then address of Paulson & Co., and sat down to discuss the structuring of a CDO. For both firms, this was supposed to be a by the numbers transaction: ACA, which had the financial acumen of any borderline retarded rating agency, was going to provide the wraparound insurance and be the portfolio selection agent in a synthetic CDO, while Paulson & Co. would be the transaction sponsor, and which, through Goldman Sachs, would indicate on various occasions, that it was a beneficially interested party, and represent direct and indirectly that it was long the equity tranche: an indication that it was beneficially inclined for the success of the portfolio. Little did ACA know that Goldman would assist Paulson in lying to investors about the fund's orientation, and the numbers in question would be one billion for Paulson and a comparable loss for everyone else. The CDO in question is of course Abacus, and has since resulted in the biggest ever SEC settlement with an investment bank, pardon, governmentally subsidized hedge fund. And while Goldman may have thought that the settlement put the embarrassing Abacus situation to rest, ACA certainly harbored no such intentions, and on January 6 filed a lawsuit against Goldman seeking monetary and punitive damages. The reason: ACA claims, and has evidence, that despite Lloyd Blankfein's representation to Congress that it was merely making markets, and did in fact nothing illegal, the reality was far different. In fact, as ACA demonstrates in the attached filing, Goldman repeatedly represented that Paulson was long the equity tranche, and neither Goldman nor Paulson did anything to debunk such an assumption. In fact, in solicitation materials Goldman misrepresented outright the economic interest of the transaction sponsor. We are confident that as many other firms that loathed doing their own due diligence (of which ACA is most certainly guilty) realize that Abacus is still a mini goldmine, we will see other such copycat lawsuits, as banks, primarily those out of Europe (and preferably still in business), attempt to collect a few hundred million here and there.
Below we recreate the most damning sections from the ACA lawsuit:
On January 8, 2007, [ACA Management Corp.] met with Paulson at Paulson’s offices in New York City, where they discussed the proposed transaction, including, among other things, the RMBS to be included in the reference portfolio. Paulson did not disclose to ACAM that Paulson intended to short the reference portfolio.
Goldman Sachs knew that Paulson had not disclosed to ACAM that Paulson intended to short the reference portfolio. In an e-mail regarding the “Paulson meeting” later on January 8, 2007, ACAM told a Goldman Sachs representative:
I have no idea how it went – I wouldn’t say that it went poorly, not at all, but I think it didn’t help that we didn’t know exactly how they [Paulson] want to participate in the space. Can you get us some feedback?
Although Goldman Sachs responded to ACAM’s January 8, 2007 e-mail, it did not tell ACAM the truth – that Paulson intended to “participate in the space” by shorting the reference portfolio.
Instead, in an e-mail dated January 10, 2007, Goldman affirmatively misrepresented to ACAM that Paulson would be the equity investor in ABACUS. Specifically, Goldman Sachs misrepresented to ACAM that Paulson would invest in the “%-%” equity tranche of ABACUS’s capital structure and had “pre-committed” to take a “first loss” arising from any defaults in the reference portfolio. In fact, as Goldman Sachs knew, Paulson never intended to take any equity in ABACUS but instead intended to short the ABACUS portfolio.
Goldman Sachs further misrepresented to ACAM that Paulson and ACAM shared a common economic interest by representing that the “compensation structure aligns everyone’s incentives: the Transaction Sponsor [i.e. Paulson], the Portfolio Selection Agent [i.e., ACAM] and Goldman.” In fact, Goldman Sachs knew, the economic interests of Paulson and ACAM in ABACUS were in direct and irreconcilable conflict.
Goldman Sachs knew that it had successfully misled ACAM into believing that Paulson was the equity investor in ABACUS. On January 14, 2007, an ACAM Managing Director sent an e-mail to a Goldman Sachs sales representative, in which ACAM specifically referred to Paulson’s “equity interest” in ABACUS:
I can understand Paulson’s equity perspective but for [ACA] to put our name on something, we have to be sure it enhances our reputation.
Although Goldman Sachs replied to ACAM’s e-mail, Goldman Sachs did not correct ACAM’s manifest understanding that Paulson was to invest in the equity of ABACUS.
Relying on Goldman Sachs’s false representation that Paulson was the equity investor in ABACUS – and thus supposedly shared a common economic interest with ACA – ACA’s Committee approved ACAM’s participation in ABACUS as the “portfolio selection agent.”
Had ACA known that Paulson intended to short the reference portfolio, ACA would not have authorized ACAM to act as the “portfolio selection agent” much less permit Paulson to participate in selecting the reference portfolio as alleged below. Among other things, knowledge of Paulson’s true economic interests would have raised a red flag and caused senior ACA personnel to decline to approve any participation in the transaction.
Just as bad is that Goldman most clearly committed fraud in its marketing materials:
On or about February 26, 2007, Goldman Sachs produces and approved a marketing presentation for ABACUS notes, commonly referred to as a “flip book.” In the flip book, Goldman Sachs represented that the reference portfolio had been selected by a party with an “alignment of economic interest” with the investors. This statement was false.
In fact, as Goldman Sachs knew, Paulson had played a significant role in selecting the reference portfolio, had a huge short position in ABACUS and, therefore, had a direct and irreconcilable conflict of interest with any purchaser of ABACUS notes, including ACA.
And how can any recount of Abacus be complete without a Fab Fab mention. In this particular case, Tourre exposes that fact that Goldman was well aware of the misrepresentation that Paulson was committing with Goldman as an accomplice through his "surreal" email:
On February 2, 2007, Goldman Sachs, Paulson and ACAM representatives met at ACA’s offices to discuss the RMBS to be included in the reference portfolio. While sitting in the meeting, Tourre sent an e-mail to a Goldman Sachs colleague, stating: “I am at this ACA Paulson meeting, this is surreal.” What he meant by “surreal” was that, at the meeting, Paulson proposed RMBS, ostensibly in a good faith effort to select those that it had considered least likely to default, when in fact - as Goldman Sachs was acutely aware and ACAM did not know – Paulson proposed RMBS that it considered most likely to default.
By e-mail dated February 5, 2007, Paulson circulated a “revised portfolio” of 92 RMBS to ACAM and Goldman Sachs. Reinforcing the false impression that Paulson shared ACAM’s economic interest in a strong quality reference portfolio, Paulson explained that it had omitted 6 of the 21 replacement RMBS proposed by ACAM because they were “either too seasoned or have some other characteristics that make them too risky from Paulson’s perspective.” (emphasis supplied). Paulson’s revised portfolio was the final reference portfolio for ABACUS.
In summary, ACA believes that "Goldman Sachs engaged in intentional, willful and malicious misconduct in utter disregard for the severe economic consequences for ACA and other investors in ABACUS, as well as the United States financial markets, evincing a high degree of mural turpitude and wanton dishonesty." And it certainly has the evidence. But at the end of the day, it doesn't matter: in America, a country in which every gross criminal act is met with merely a wristslap, and the grosser the malfeasance, the smaller the relative penalty.
Of course, ACA is not without fault: if the firm actually knew anything about finance, presumably the reason for its business model, it would have conducted its own due diligence instead of relying on the bullish (or bearish) alignment of the portfolio sponsor. After all, it is paid money to represent the portfolio was stable, and received cash to provide the wrap, which it should not have provided had it actually conducted its own analysis on the underlying RMBS.
If anything, this example more vividly than anything presents exactly the key forces in play during the peak of the credit crisis (and certainly since): immense greed (on behalf of the likes of Paulson), criminal laziness and a profound lack of any actual diligence (thank you ACA... and all those addicted to the rating agency model), and of course outright criminal fraud, by none other than Goldman, which from its position as master of the universe and god's only spokesperson on earth, believed it could get away with anything, all the while making hundreds of millions of dollars courtesy of its massive monopolistic scale in the financial "over the counter" industry. None of these have changed in the four years since the original Paulson-ACA meeting. The only addition to the trio: infinite moral hazard, now that none other than the US government is doing all it can to backstop the financial system for a few more months/years until everything comes crumbling down in one final greed, laziness and fraud inspired collapse.
Full ACA filing.
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