Goldman Eye

Since last Friday's surprising announcement by the SEC that it is bring a civil suit against Goldman Sachs over the misrepresentation of a synthetic CDO named "Abacus" I have received many questions concerning the survivability of Goldman. I believe that questioning the viability of the most profitable investment bank on Wall Street due to such questionable charges is a bit of an overreaction.

The SEC is charging that Goldman Sachs misrepresented how it structured a synthetic CDO and did not properly disclose who was the other side of the transaction. First let's be clear what a synthetic CDO is. A synthetic CDO is a pool of bets, it this case CDS, on assets, such as subprime mortgages, which are not owned by any of the involved parties.


In the case of Abacus noted hedge fund manager, John Paulson wished to take a negative bet on subprime mortgages and asked Goldman Sachs to structure a CDO based on CDS referencing subprime mortgages. Goldman asked structure ABA to assemble the CDO. It was agreed that Paulson would choose the collateral, but that ABA could reject collateral it deemed unfit. Using these guidelines a structure was created. Goldman then marketed Abacus to counterparties it believed would be interested going long exposure to subprime mortgages. Now the SEC claims that because Goldman did not disclose the other side was Paulson and that Paulson had a say as to what collateral would be referenced, buyers of Abacus were not treated fairly.

Truthfully, deals in which a counterparty asks an investment bank to create a security or structure and the investment bank markets the other side of the transaction to counterparties or customers is very common place and not wrong, neither legally nor morally. With every trade, there are counterparties who have contrary opinions. That is inherently necessary. Also, counterparties are often anonymous.


Goldman is being used as the whipping boy for making money on many of these kinds of deals (although it claims to have lost money on Abacus) and to satisfy a political agenda.


I am not a Goldman apologist, but Goldman did not market Abacus to unsophisticated retail investors. These were very sophisticated speculators who made a bet and lost. The SEC is looking to repair its tarnished reputation from years of missing warning signs on two Ponzi schemes (Madoff and Stanford), not to mention lax oversight. This also plays well to with the Obama administration which is looking to revamp Wall Street. By all means, go after those who are truly guilty of fraud, but to say that Goldman took advantage of innocent investors is disingenuous.

Notice that this is a civil suit. It appears as though the SEC has no evidence that Goldman acted in a criminal manner The case is weak based on merits, but even a politically driven outcome is unlikely to be more than a speed bump for GS.