Tag: Goldman Sachs

SEC Brings a Pay-to-Play Action

The Securities and Exchange Commission filed a “pay-to-play” case against Goldman Sachs and one of its former investment bankers, Neil M.M. Morrison. The SEC alleges that Goldman and Morrison made undisclosed campaign contributions to then-Massachusetts state treasurer Timothy P. Cahill while he was a candidate for governor.

The case was brought under the Municipal Securities Rule on pay-to-play: MSRB Rule G-37. The SEC’s investment adviser/private fund rule on pay to play, Rule 206(4)-5, is based closely on that MSRB rule.

The SEC’s order found that Goldman Sachs did not disclose any of the contributions on MSRB forms and did not  keep records of the contributions in violation of MSRB rules.

Goldman Sachs agreed to settle the charges by paying $7,558,942 in disgorgement, $670,033 in prejudgment interest, and a $3.75 million penalty. This is the largest fine ever imposed by the SEC for Municipal Securities Rulemaking Board pay-to-play violations. The SEC’s case against Morrison continues.

According to the SEC’s order against Goldman Sachs, Morrison worked in the firm’s Boston office and solicited underwriting business from the Massachusetts treasurer’s office beginning in July 2008. Morrison was substantially engaged in working on Cahill’s political campaigns. Before joining Goldman Sachs, between January 2003 and June 2007, Morrison was employed by the Massachusetts Treasurer’s Office, which included positions as the first deputy treasurer, chief of staff and assistant treasurer, reporting directly to Cahill.

Morrison participated extensively in Cahill’s gubernatorial campaign, often during working hours from his Goldman Sachs office, and used Goldman Sachs resources (such as phones, e-mail and office space). The SEC claims that Morrison’s use of Goldman Sachs work time and resources for campaign activities constituted valuable in-kind campaign contributions to Cahill that were attributable to Goldman Sachs and disqualified the firm from engaging in municipal underwriting business with certain Massachusetts municipal issuers for two years after the contributions.

While Morrison was an employee and working on the Cahill campaign, Goldman Sachs participated in 30 prohibited underwritings with Massachusetts issuers and earned more than $7.5 million in underwriting fees.

According to the complaint, this seems like an egregious violation of the pay-to-play rules. It does highlight that items beyond cash contributions could be considered a “contribution” under the pay-to-play rule.

We would not consider a donation of time by an individual to be a contribution, provided the adviser has not solicited the individual’s efforts and the adviser’s resources, such as office space and telephones, are not used….

A covered associate’s donation of his or her time generally would not be viewed as a contribution if such volunteering were to occur during non-work hours, if the covered associate were using vacation time, or if the adviser is not otherwise paying the employee’s salary

Sec Release IA-3403 page 46 and footnote 157 (.pdf)

From a compliance perspective, the question is how to value the use of time in the office, email, and phone usage. I suppose you can add up long distance charges. For employees you can use their hourly rate to determine time spent.  For Morrison, it appears that even using a very conservative measurement  of his time and the Goldman resources, the value would be many times in excess of the $250 limit under the MSRB rule. (The SEC limit is $350 if you can vote for the person.)

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Revisiting the Fabulous Fab

Last summer, Fabrice Tourre didn’t turn around fast enough to see the bus coming at him. Goldman Sachs had given him a big push and put him in the front and center of their big bet on a crash in the residential mortgage securities market.

Tourre ended up as the Fabulous Fab after giving himself that nickname in a series of colorful emails. In one he wrote, “The whole building is about to collapse anytime now,” according to the complaint. “Only potential survivor, the fabulous Fab.”

I still use Tourre as part of my records management policy and education.

The Fabulous Fab Rule: Don’t write emails so provocative that they wind up reproduced on the front page of the Wall Street Journal.

What has happened to Tourre and his colleagues at Goldman Sachs?

Goldman settled the matter for $550 million, with $250 million going to investors and $300 million going to the SEC.

Louise Story and Gretchen Morgenson of the New York Times took another look at the Goldman mortgage desk and the prosecutions against it: S.E.C. Case Stands Out Because It Stands Alone.

According to the article, the SEC looked at Jonathan M. Egol who worked closely with the Fabulous Fab. “But Mr. Egol, now a managing director at the bank, was not named in the case, in part because he was more discreet in his e-mails than Mr. Tourre was, so there was less evidence against him, according to a person with knowledge of the S.E.C.’s case.” That just seems to reinforce the Fabulous Fab Rule.

Also, the story points out that Torre’s trading desk was using a shared email account or listserv to share the messages with the larger group.

The story about the Fabulous Fab Rule gets worse. The New York Times obtained additional information from a lost laptop.

[The information was] provided to The New York Times by Nancy Cohen, an artist and filmmaker in New York also known as Nancy Koan, who says she found the materials in a laptop she had been given by a friend in 2006.  The friend told her he had happened upon the laptop discarded in a garbage area in a downtown apartment building. E-mail messages for Mr. Tourre continued streaming into the device, but Ms. Cohen said she had ignored them until she heard Mr. Tourre’s name in news reports about the S.E.C. case.  She then provided the material to The Times.

That just makes the nightmare worse. An employee is sending out provocative emails, they are going to mass distribution list, and an unsecured laptop is getting the messages.

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Facebook, Capital and Liquidity

There have been many stories written about the Goldman Sachs investment in Facebook. On one hand, there is the chatter about the investment placing the valuation at $50 billion. On the other, there hand there is the talk about how this affects a possible IPO by Facebook.

There are two main reasons for an public offering of stock: liquidity and capital.

If you need capital, a public offering of common stock is merely one of many ways to raise capital. The benefit of this option is that the capital does not need to be repaid. A bank loan, a bond offering, venture capital or private capital will generally need to be repaid at some point. Each source of capital has a price and repayment terms that you need to align with the company’s needs and business plan.

It sounds like Facebook has ready access to capital in many forms. So an initial public offering may not be the best or the cheapest source of capital.

The liquidity of public stock is useful for rewarding employees and cashing out earlier sources of capital. Employee stock is great, but in a private company is very illiquid. It does you very little good to be a millionaire on paper if you can’t access the wealth. Early round investors, like venture capital funds, want to be cashed out at some point. They need to return capital to their investors. It sounds like some of the private trading of Facebook stock is being done by employees and early investors.

The third reason for a public offering stock was the reason faced by Google. Once you have more than 499 investors, you need to start making reports public. So you may as well get the benefits of liquidity in the stock.

The cash from a public offering does not need to repaid, but there are costs to the capital. That means complying with Sarbanes-Oxley. The CEO and CFO has potential criminal liability for false reporting. The board of directors will now need to include independent directors. The company will be subject to shareholder lawsuits. There are lots of costs.

To me it sounds like Facebook and Goldman have come up with an ingenious solution to the address the capital needs for Facebook and to avoid a public offering of stock. I assume the Goldman investment and its new fund will be used to provide some capital for expansion and growth. I also suspect that some of it will be used to cash out early investors, purchase employee stock, and repurchase stock that has been privately traded. Gobbling up the stock would be an opportunity to keep the number of investors well below the 499 trigger point. Early investors may take their money and run.

Assuming Goldman can provide $2 billion and charge its investors a 4% fee for investing, they have already made $80 million on their $450 million investment.

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That’s a $h!#ty Policy

On the front page of today’s Wall Street Journal is story about one of the fallouts from Goldman Sachs’ recent problems with the SEC: George Carlin Never Would’ve Cut It at the New Goldman Sachs.

One of the most sensational bits of Goldman Sachs fiasco was an email from a Goldman executive “[B]oy that, timberwolf was one $h!#ty deal.” Apparently, Goldman thinks the solution is to ban profanity in electronic messages.

Of course, everyone needs to pay closer attention to what is written down in email. They are often reviewed and taken out of context during litigation. Saying it was “$h!#ty deal” is more sensational than saying it was a “bad deal.”

Monitoring language in email has been part of financial service compliance for years. The SEC requires that compliance monitor for improper activity and advice. It will be easy enough to have the monitoring program also search for George Carlin’s “Seven Words You Can Never Say on Television” and their variants.

The big problem will be false positives once you start getting into the variants. That means frontline employees and deal flow will be get emails bounced back or blocked. Inevitably, compliance will get the blame for messing up a deal.

The other problem is enforcement. The first line of enforcement will probably be to block messages from being sent with profanity in them. That works as long as you can eliminate false positives. The alternative is to notify compliance when a message has profanity. Compliance can then keep track of the number of messages and report back to management for discipline.

“Employee A had 354 message with “$h!#ty”, 1,567 with F@(k, and 456 with this word which I don’t know but sounds dirty.”

Sounds like a $h!#ty policy and $h!#ty role for the compliance department.

Goldman Settles; Fabulous Fab is Left on His Own

Goldman Sachs settled with the Securities and Exchange Commission. That’s not a surprise. Goldman did not want to litigate this action. It wanted it to go away.

As a shareholder in Goldman, I wanted it to go away. It seems others did also. GS stock price opened at $138.50 on Thursday morning. It opened at $151.47 this morning. That’s a 10% increase based on the settlement. The stock has been down 21% since the SEC filed its complaint.

Goldman is going pay $550 million, with $250 million going to investors and $300 million going to the SEC. The dollar amount is not a surprise. I assumed the top dollar amount was the $1 billion lost by investors. I think the time it took between the filing of the action and the settlement was largely focused on how much Goldman was going to pay to make this ugly incident go away.

That is a big dollar amount. As SEC enforcement director Robert Khuzami points out, it’s the biggest SEC fine against a Wall Street firm. There have been bigger fines in other industries.

According to Footnoted, Goldman has $27 billion is cash and short term securities. It’s big dollar number, but Goldman can find that much the cash by looking under the cushions on its couch.

Unfortunately for Goldman VP Fabrice Tourre, he is not included in the settlement. The SEC is continuing its litigation against him. Fabulous Fab has a Monday deadline to respond to the SEC complaint. Fab still works at Goldman but is on paid leave.

He is trying to clear his name. Goldman just paid to get theirs back.

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What About the Rating Agencies?

There has been lots of criticism aimed at Goldman Sachs over the Abacus 2007-AC1 deal. They help set up a CDO so their client, Paulson & Company, could make a bet on a downturn in the residential real estate market. To make that bet, they allowed Paulson to influence the securities that went into the CDO. Most of them turned out to be dreck and the CDO ended up tanking. Paulson made money from his short position and the investors in the CDO lost more than $1 billion.

Who Was the Client?

Paulson & Company hired Goldman Sachs and paid them $15 million for the structuring of the Ababcus 2001-AC1 CDO. So they were clearly a client.

The purchasers of the CDO were clients of Goldman Sachs. Since they were purchasing securities from Goldman Sachs as a broker-dealer, they were not owed a fiduciary duty by Goldman Sachs. That is one of the current differences between the law governing investment advisers and broker-dealers. Goldman made a statement in the materials that they do not have a fiduciary obligation to the investors.

Goldman Sachs had a split loyalty that is common with Wall Street transactions.

Disclosure

In selling securities you are required to disclose all material information and risks in a prospectus for the security and deliver that prospectus to purchasers.

Goldman claims that its Abacus investors had all the information needed to evaluate risks for themselves in the prospectus.

The SEC is claiming that Goldman should have disclosed that Paulson influenced the selection of securities placed in the CDO and that they were engaged by Paulson to build the CDO so Paulson could take a short position against it.

Illegal or Unethical?

Obviously, the SEC is taking the position that Goldman acted illegally. Personally, I’m not sure it was illegal. If it turns out that they said Paulson was long on the CDO, when he was actually short, then they are in trouble.

Lots of people are arguing that they acted unethically. That is a stronger argument. Goldman may not have been required to disclose Paulson’s role in the transaction, but they probable should have disclosed it.

I prefer to use the very technical term “yechy.” Goldman looks very bad. As a company, they seek to have a better reputation than this.

They should not have structured the transaction this way. They should settle this case, chalk it up as a mistake and act better. (I own some stock in Goldman Sachs that I bought when the price dropped because of these accusations.)

What about the Rating Agencies?

Even with all the dreck in this CDO, the rating agencies still gave a AAA rating to the $480 million Class A, AA to the $60 million Class B, AA- to the $100 million Class C, and A to the $60 million Class D.

Clearly one of the factors in the sub-prime market was the failure of the rating agencies. They were giving AAA ratings to collections of dreck.

S&P defines the AAA rating for structured finance as “judged to be of the highest quality, with minimal credit risk.”

Maybe this chart is better explanation of the ratings:

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Subprime Lending Settlement in Massachusetts

Attorney General Martha Coakley

Massachusetts Attorney General Martha Coakley’s Office announced that it has reached a settlement agreement with Goldman Sachs & Co stemming from the office’s investigation of subprime lending and securitization markets. The Attorney General’s Office has been investigating the role of investment banks in the origination and securitization of subprime loans in Massachusetts.

The Attorney General’s Office began its investigation into the securitization of subprime loans in December 2007, investigating whether securitizers may have:

  • facilitated the origination of “unfair” loans under Massachusetts law;
  • failed to ascertain whether loans purchased from originators complied with the originators’ stated underwriting guidelines;
  • failed to take sufficient steps to avoid placing problem loans in securitization pools;
  • been aware of allegedly unfair or problem loans;
  • failed to correct inaccurate information in securitization trustee reports concerning repurchases of loans; and
  • failed to make available to potential investors certain information concerning allegedly unfair or problem loans, including information obtained during loan diligence and the pre-securitization process, as well as information concerning their practices in making repurchase claims relating to loans both in and out of securitizations.

The settlement didn’t involve court action and Goldman didn’t acknowledge wrongdoing.

Under the agreement, Goldman will restructure loans for borrowers whose loans it holds. The Attorney General said there are about 714 of those borrowers. Goldman’s borrowers with first mortgages could see their principal reduced 25% to 35%, and those with second mortgages held  could see principal reduced 50% or more. Reducing those loan amounts will cost Goldman $50 million. It has also agreed to have its subsidiary, Litton Loan Servicing LP, help qualified borrowers who are in trouble on their loans to avoid foreclosure. Goldman will also pay the state $10 million. Delinquent borrowers will be required to make a “reasonable monthly payment” while trying to sell or refinance their homes.

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