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Musings On An ABACUS

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The following post is by Dealbreaker reader and commenter Infinite Guest.

Whether they could have avoided it, I don’t know--today's Securities and Exchange Commission acts like a wounded animal--the management of Goldman, Sachs & Co. made a strategic error by failing to cultivate a closer relationship with the new regime. That much is evident from the fact that the suit came as a surprise. Chairman Schapiro is quite capable of partnering with industry: Had Goldman done better, earlier, there might never have been a lawsuit. Popular wisdom says that Goldman should settle. I disagree. Although both parties understand that cooperation beats enmity, the SEC chose not to cooperate; and now, Goldman’s best strategy is to respond in kind.

A settlement would reward the SEC’s transparent attempt to obtain, through extortion, a victory it cannot hope to gain by enforcing the law. The burden is on the SEC to prove that Goldman’s failure to advertise Mr. Paulson’s interest in the Abacus deal was a material omission, or else to prove not only that Mr. Tourre lied to ACA about Paulson’s position, but also that it mattered, and that Goldman is liable. If the case goes to trial, Judge Barbara Jones will not allow theatrics and badgering to compensate for a weak case. She will insist on having the facts. The facts, as far as we have seen, show that Goldman did nothing illegal. For the edification of those who fret that they did something unethical, a full airing of the facts would suffice to demonstrate that Goldman behaved at all times according to the best ethics in the business of institutional derivatives sales.

Goldman is in a bad position. Settling the case does nothing to mitigate the flood of legal actions against them. If anything, a settlement encourages further action. Settling the case does nothing to clear the blot that the SEC has smeared on their name. Fighting carries the risk of losing the case, and supposedly carries additional headline risk with each passing day. While the risk of losing is real, especially before a jury, it is at this point remote, therefore inferior to the likely costs of settlement, in dollar terms and in terms of subsequent risks. The marginal headline risk, too, has been vastly overstated. Goldman is constantly in the news these days. The worst headlines to come will happen only periodically, at times that Goldman can anticipate: for instance, when they file a motion to dismiss; when that motion is denied; when a court date is set; whenever another firm files an amicus brief; and every day during the trial. Goldman can effectively get ahead of all of those headlines. In the meantime, they are well-advised to continue denying the allegations, delaying the prosecution, and defending the firm’s reputation.

Since the suit was filed, management has done an outstanding job presenting its side of the story internally, to clients, shareholders and the public. Goldman has secured multiple enviable endorsements from popular, credible public figures. They have wisely agreed to discuss a settlement with the SEC, in case they can somehow find any common ground: perhaps a $15 million disgorgement and a promise to make future CDOs more transparent, without the admission of any wrongdoing, would be reasonable in exchange for freedom from criminal prosecution. Some kind of settlement, even now, would be worthwhile, albeit distasteful, if it rewards Goldman for cooperating. Judge Jones, unlike some of her peers, has shown a conspicuous willingness to reward cooperation.

Mr. Tourre, who is in an even worse position than his employer, is the wildcard. Mr. Tourre’s e-mails to his girlfriends were clearly a frolic, wholly unrelated to Goldman's business. His weakness for Belgian jokes, his graphic metaphors, his narcissism and the rest are no crime, and certainly nothing for which his employer can be held to account. Even if evidence suggests that Mr. Tourre may have told ACA Mr. Paulson wanted to buy some of Abacus, all is not lost. In order to implicate the firm, the SEC has to prove that Mr. Tourre was lying, they have to prove that his lie helped induce ACA to participate, and they have to prove that his managers knew, or should have known. Paolo Pelligrini, who told ACA that Paulson wanted to take a short position, is on record as having wanted buying the equity tranche--as a hedge. Mr. Pellegrini's buying interest is not inconsistent with Mr. Tourre's remarks, nor does it obviously indicate anything material in context. Nevertheless, Mr. Tourre's strong motivation to settle is self-evident. The SEC named him, and only him, for a reason. They are counting on him to put his own self-interest above his employer's. They're using him as a lever. It is incumbent upon the Goldman to take good care of Mr. Tourre, to keep a close eye on him, to make a clear commitment to him contingent upon his continuing loyalty, and to ensure he understands that he has no better choice.