Below are my reactions to the US Securities and Exchange Commission fraud suit that began yesterday against “Fabulous Fab” Fabrice Tourre, a Vice President at Goldman Sachs for structured products.
From what I gather in the press, the Feds are suing Fabulous Fab for the following reasons:
- He sent embarrassing emails to his girlfriend revealing anxiety about the performance of his markets.
- He did not fully disclose his and Goldman’s simultaneous role as broker between one client – John Paulson & Co – who wanted to short mortgage derivatives, and another client ACA Financial Guaranty Corp – who wanted to go long mortgage derivatives.
- He’s French.[1]
Listening to the news last night I realized that people might actually think Fab is to blame here. That is a travesty. The SEC’s suit is a joke, albeit a really unfunny one if you’re Fab.
Fab is no more to blame for investors’ losses in a CDO known as the Abacus 2007-AC1 than any broker who sold you shares in any publicly traded stock in the year 2007 which subsequently halved in value by the end of 2008.
The SEC prosecution appears to rest primarily on the idea that Goldman brought together clients with opposite views of the mortgage derivative market, and then didn’t tell all sides of the trade who everyone was.
Factor #1
What?!! You mean to tell me Goldman brought together clients with opposite views on the market?
One of the disappointing aspects of William Cohan’s Money and Power: How Goldman Sachs Came to Rule the World is Cohan’s seeming misunderstanding of how a broker-dealer works. Cohan seems shocked, as the SEC attorneys in the Fab trial want the jury to be shocked, that Goldman could match up clients with diametrically opposed views on the mortgage derivative market.
Hey guys? Let me give you pro tip: That’s how a broker-dealer works.
It’s the job of a broker to find willing buyers and willing sellers, all day long, to take diametrically opposed views on the future direction of securities and markets. It’s also the broker’s job to generally protect and make anonymous the counterparties to a trade.
[NB: Cohan clearly does know how a broker-dealer works and he has an excellent review of the Fab case here on Bloomberg. My jab at him is about his book in which he doesn’t clarify just how ridiculous Sen. Carl Levin, and by extension the SEC’s theory is, on potential conflicts of interest within a broker-dealer]
So the fact that Paulson and ACA had different views on mortgages means that Goldman did its job. The fact that Goldman didn’t overly advertise the central role of Paulson in the CDO structuring is not evidence of a crime.
The level of expected disclosure in CDO structuring will be a combination of
1. law, and
2. informally agreed-to market standards.
I spent enough time around the persnickety legal compliance folks at Goldman to have confidence that Fab’s team complied with the letter of the law over counterparty disclosure, or what is called in the business ‘name give-up.’
Some types of trades require it, some types of trades forbid it, and some types of trades will rely on market standards to determine the correct level of disclosure.
At the moment of structuring the Abacus CDO it’s less clear to me, from a distance, whether Fab’s team reached a less formal level of ‘market standard’ when it came to disclosing Paulson’s role. But market standard is a kind of nebulous concept for which I can’t believe Fab can be found guilty by the SEC
Factor #2
Why go after Fab and not bigger fish? Because he’s the only one against whom you could find embarrassing emails to his girlfriend? (Give him a break. He’s French.)
Fab was a relative nobody. Like Greg Smith (of Muppets fame), or like me, Vice Presidents are in charge of very little at a Wall Street firm. From his ill-advised emails we gather he was an over-worked, under-sexed, anxious, and narcissistic guy, but what 31 year-old on Wall Street isn’t all of those things? If that’s a crime, then lock ‘em all up.
I’m not a fan of the Eliot Spitzer- trademarked prosecution-and-trial by embarrassing email.[2] That appears to be why Goldman settled for $550 million with the SEC a year ago, because of Fab’s anxious, flirty emails to his girlfriend.[3] Goldman, as is typical in these situations, did not admit guilt, they just paid the money in order to move on.
I’m not saying the SEC shouldn’t bother to prosecute bad actors even if they are low on the totem pole, but I am saying two things:
1. Fab was a small cog in a big machine doing exactly what he was paid by his bosses to do, and
2. There’s nothing bad about what he did except try to sell squirrely investments to willing, professional, sophisticated buyers. And that’s his job! CDOs are squirrely. Everybody knows that. CDOs, we used to say on the desk, are “sold, not bought.” Meaning, once you’ve placed them in a client’s portfolio, pray they never ask to sell them back to you. You do not want to buy them back. They’re too squirrely.
Factor #3
ACA was no innocent victim
ACA was not an ‘innocent victim’ of mean, nasty brokers tricking them into buying destined-to-soon-fail derivatives. These were highly compensated, professional, CDO investors. ACA charged their customers millions of dollars in fees, and collectively paid themselves millions of dollars in compensation, to provide their “unique insight” into buying complex financial products.
As Michael Lewis pointed out before in The Big Short, if any fraud or crime was being perpetuated, it was by ACA on their own customers, for pretending they knew how to separate the profitable from the unprofitable, the gold from the dross, the good from the garbage. If you can’t do that, you’re just tricking your own customers. If you lose money buying a terrible product in the way ACA did, you should only blame yourself.
Factor #4
But ACA was on the wrong side of John Paulson without knowing it. Paulson’s a genius! It’s so unfair!
John Paulson in 2007 was not John Paulson. He was just another contrarian hedge fund guy taking a swing at the overly frothy mortgage and housing market. Everybody who had done this type of trade previously – betting big against mortgage credit and housing in the run-up – from 2001 to 2007 – had lost their shirt, as the market moved against them.
Everybody who took Paulson’s side of the trade before things broke in 2007 was an idiot and a money loser. What’s obvious now in retrospect was not obvious then. The ACAs of the world – buying the stupid, illiquid, highly-levered subprime, garbage CDOs – had made much more money in the previous years than the John Paulsons of the world.
That’s why Paulson was so damned successful. Because there were only a few Paulsons around to take the other side of the mortgage derivative trade in 2007.
Being on the short-side, like Paulson dared to be, appeared to be for suckers.
ACA must have been laughing all the way to the bank.
If Fab is guilty, then I’m the big bad wolf.
Bloomberg News wrote that
U.S. District Judge Katherine Forrest, who will oversee the trial in Manhattan, summed up the SEC’s allegations this way in a June 4 opinion: “Tourre handed Little Red Riding Hood an invitation to grandmother’s house while concealing the fact that it was written by the Big Bad Wolf.
The SEC’s version of the case is so absurd it’s hard for me to believe they’re pursuing it. It’s a fairy tale.
[1] In my opinion, this is the only valid reason of the three.
[2] For more on this, as well as a great primer on why Spitzer should never, ever, be elected dog-catcher, I recommend this blast-from-the-past article.
[3] Broker-dealers always, always, always settle with regulators because the cost of fighting regulators in court is that you’re out of business.
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