Fabulous Fab Tourre is on his way to trial in the SEC's securities-fraud lawsuit over the Abacus synthetic CDO he built at Goldman Sachs for John Paulson, and Andrew Ross Sorkin has a column today about all the things that the SEC doesn't want him to be allowed to say to the jury. You should read it, it's enraging, though who you get enraged at is entirely up to you.1 But I'll give you a quick and tendentious summary, which is:
- The SEC's main argument is that Fab deceived ACA, the "portfolio selection agent" on the Abacus deal, and
- ACA were sort of stupid scumbags, and
- the SEC understandably doesn't want the jury to find that out.
Right? The SEC's suit accuses Tourre of two things:
- he deceived the investors in Abacus into thinking that ACA, an experienced collateral manager or whatever, had picked the reference portfolio, whereas actually Paulson did and ACA rubber-stamped it; and
- he deceived ACA (the collateral manager and insurer of Abacus) into thinking that John Paulson, who effectively picked Abacus's reference portfolio, was long Abacus and thus wanted to pick the best possible reference portfolio, whereas he was actually using Abacus to get short the underlying mortgages.
The first thing - deceiving investors about ACA's role - seems kinda bad, but also hard to pin on Tourre. Here's the complaint:
On or about April 26, 2007, GS&Co finalized a 178-page offering memorandum for ABACUS 2007-AC1. The cover page of the offering memorandum included a description of ACA as "Portfolio Selection Agent." The Transaction Overview, Summary and Portfolio Selection Agent sections of the memorandum all represented that the reference portfolio of RMBS had been selected by ACA. This document contained no mention of Paulson, its economic interests in the transaction, or its role in selecting the reference portfolio.
Tourre reviewed portions of the offering memorandum, including the Summary section, before it was sent to potential investors.
Got it? Goldman's lawyers wrote the allegedly fraudulent OM, and Tourre looked at it. That might constitute fraud but it's sort of rough if it does.
On the other hand, the charge that Tourre deceived ACA about Paulson's role is meatier. He was the primary contact with ACA, and the SEC's claim is that he lied to them, directly, in person, by phone, and over email, about Paulson's interest in the Abacus capital structure. That might be fraud, and it might even be Fabrice Tourre's fraud.
The problem for the SEC is that ACA is so terrible. ACA, you'll recall, recently lost its own lawsuit against Goldman over Abacus. And as we discussed then, that's as it should be, because ACA was totally in on whatever scam Goldman was or was not running. ACA knew it was being hired to pretend to select the portfolio, and cheerfully let Goldman tell Abacus investors that it had picked the reference portfolio. But it hadn't. As ACA said itself, it was "the pro forma portfolio selection agent for ABACUS" and "agreed to and relied upon a portfolio largely selected by Paulson." But the offering memorandum made much of ACA's expertise, alignment of interests, and hard work in selecting a portfolio. All false! Probably not Fab Tourre's fault! Probably more ACA's fault than Fab's!
So at the end of the day you could have sympathy for the investors ripped off by Abacus, but it's hard to blame Fabrice Tourre for their losses. And you can blame Fabrice Tourre for ACA's losses on Abacus, but you can't really have much sympathy for ACA: ACA knew with certainty that Goldman was lying about who picked the underlying mortgages; they just couldn't figure out what that meant. They weren't victims of Goldman; they were co-conspirators, albeit dumb ones. The SEC does not entirely disagree.2 But that leaves them without much of a sympathetic case.
And they - and Tourre's lawyers - know it. So, for instance, Tourre's lawyers want to introduce evidence that everyone knew that John Paulson was shorting mortgages, so ACA can't really have been that deceived by Tourre's representations that he was the equity investor in Abacus.3 The SEC disagrees. Sorkin:
The S.E.C., for example, has sought to block any mention of news reports that Mr. Paulson was betting against the subprime mortgage market. The defense argues that the news reports are necessary to demonstrate that the institutional investors, who arguably read the news as part of their jobs, were not duped into thinking that Mr. Paulson was betting that the value of Abacus would rise, undercutting the S.E.C.’s contention that the investors were misled victims.
“News articles about Paulson’s purported macro investment strategy of shorting the subprime housing market are not relevant,” the S.E.C. wrote. “Such articles are irrelevant, prejudicial and confusing. With respect to most or all of them, there is no evidence that they were read by the employees of ACA Management.”
Hahaha well of course not! Why would they have made any effort to understand the transaction that they were investing in, or the counterparty they were trading with? Tourre might argue that any reasonable investor in the RMBS CDO space, negotiating an RMBS CDO deal with John Paulson, would be aware of John Paulson's widely publicized strategy of shorting RMBS. The SEC's argument is that ACA was not a reasonable investor. You can see why they don't want to have that fight in front of a jury.
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1.I'm suspicious of prosecutorial power so I'm outraged that the SEC would want to prevent him from arguing his innocence and explaining the context of his actions to a jury. Here, on the other hand, is a man who is very angry at Sorkin, possibly for reasons!
2.As Sorkin points out:
One of the biggest issues is this: ACA, which the S.E.C. has portrayed as a victim of Mr. Tourre’s fraud, was not considered a victim when the government divided the $550 million Goldman Sachs settlement that had been set up to repay victims. The government excluded ACA completely from the list of investors that were paid from the Goldman settlement. How can ACA be a victim for the purpose of Mr. Tourre’s case, but not be for the purpose of the recompense? The S.E.C. says the victim list from the fund is irrelevant. Payments are “entirely discretionary and involve policy judgments that do not necessarily reflect any decision about whether a particular entity or institution was actually victimized as a result of a defendant’s fraud,” the S.E.C. said in a legal brief.
3.He could have been long $1 of equity and short $10 of senior, and so telling ACA that he was long the equity wouldn't necessarily be false - and whether it was fraudulent would depend on whether "everyone knew" that he was also short the senior. In any case he actually seems not to have bought the equity, though as the New York court pointed out that was made clear in the OM so ACA really should have known that.