On Wall Street, names of things are meaningless. Hedge fund managers like “Fortress” or “Citadel” may think they are branding themselves as sturdy but Steve Cohen would have a mountain of money under management and an ex seeking to destroy him whether he named his operation SAC Capital or CSA Advisors or ACS Management.
Or ABACUS. Or ACA.
IKB Deutsche Industriesbank AG, the German bank that bought slices of a CDO called “ABACUS-2007 AC1″ would not have gotten its lederhosen in a bunge over the CDO’s actual name.
However, they would have had questions about who would select and manage the RMBS in the CDO.
In the case of ABACUS, the CDO would involve ACA Management LLC, the small, unknown asset management division of bond insurer ACA Capital Holdings.
At the time the CDO was constructed and peddled, ACA Management was decent sized, not a PIMCO or BlackRock, big CDO managers, but ACA had managed 22 CDOs with $16 billion in underlying assets.
ACA would have been happy to secure a 23rd gig. So pleased that it would have worked with GS on the ABACUS CDO even if it had been named ABACAB or ABBA or YABBA DABBO DOO so long as it got a fee.
As ACA was part of ACA Capital Holdings, this deal produced another gig: ACA’s ACA-Financial Guaranty unit sold protection on one of the tranches. This was a most joyous synergy, indeed. Boat rocking would be frowned upon.
ACA even would have even been fine working with one of GS’s hedge fund clients in selecting the subprime RMBS that went into the deal, so long as GS asked it to, even if that client was Paulson & Co. But as early as the first part of 2006 Paulson was raising money for a fund that was going to short the living snot out of the housing market.
I’m thinking that some other larger CDO managers, however, would not have been happy to work with JP & Co. on GS’s instructions; that’s just not how they roll, and this inconvenience is possibly why GS selected ACA for the deal in the first place; ACA had a good enough reputation, served as a third party portfolio selection agent (of course GS could be trusted, but to avoid the appearance of a conflict, a third party made the deal that much more kosher) though if GS tried to push ACA to involve P & Co., and to take into consideration his ideas for RMBS, might ACA bristle? Or would ACA look the other way while GS crammed its side agenda down its throat?
ACA was fine to consult with P & Co. on constructing the portfolio. But it would seem unlikely that it would have done so knowing that P & Co. intended to short the living snot out of the deal.
Maybe they did know, and like Omar from “The Wire” just thought, “it’s all in the game.”
The SEC alleges GS misled ACA about the intentions of P & Co., and that ACA actually thought JP & Co. wanted to own the riskiest parts of the ABACUS CDO.
But it would have been easy for ACA, if it wanted to know, to find out that P & Co. was drumming up business for a new fund, specifically to short the mortgage market. Likely ACA went along with whatever GS and P & Co. said to do, just to earn the CDO management fee.
That still doesn’t necessarily get GS off the hook for selling IKB and ABN Amro a CDO deal without mentioning even in fine print the involvement of P & Co.
GS perhaps purely viewed this as sausage making no one would ever know about, standard operating procedure, two sides, two views, a nice, neat hedge with fees coming in here and there. Might GS have been blind to its envelope push, never thinking of the insanity in the mortgage markets that would ensue? At the time, GS would have seen someone losing and someone winning and GS in the middle getting a cut. Maybe GS thought P & Co. would be the big loser, a convenient rationale for taking the step of so closely intertwining the fund manager in the selection process. Imagine if the Bills allowed Dolphins’ Bill Parcells to consult on their draftâ€¦. Buffalo could end up taking a Div 3 punter in the first round.
GS’s marketing materials for the deal never mention P & Co.’s having shorted more than $1 billion of securities, the SEC says. Like many foul ups on The Street it is coming down to a disclosure issue.
GS misled investors, the SEC says.
GS, which prides itself on doing right by its clients, has issued a lengthy power point explaining the seemingly suspicious investment vehicle it created was business as usual, totally above board.
They are in a tense, can’t blink situation not unlike the one facing the big fat lady who was standing in a grocery checkout line when a ham fell out of her dress. She could have tearfully come clean and explained she had not eaten in a long time, as hard as that would have been to believe. Instead, and of course, the fat, ham-pilfering lady automatically blurted: “That’s not my ham!”
The GS statement:
The Goldman Sachs Group, Inc. (NYSE: GS) said today: We are disappointed that the SEC would bring this action related to a single transaction in the face of an extensive record which establishes that the accusations are unfounded in law and fact.
We want to emphasize the following four critical points which were missing from the SEC’s complaint.
â€˘ Goldman Sachs Lost Money On The Transaction. Goldman Sachs, itself, lost more than $90 million. Our fee was $15 million. We were subject to losses and we did not structure a portfolio that was designed to lose money.
â€˘ Extensive Disclosure Was Provided. IKB, a large German Bank and sophisticated CDO market participant and ACA Capital Management, the two investors, were provided extensive information about the underlying mortgage securities. The risk associated with the securities was known to these investors, who were among the most sophisticated mortgage investors in the world. These investors also understood that a synthetic CDO transaction necessarily included both a long and short side.
â€˘ ACA, the Largest Investor, Selected The Portfolio. The portfolio of mortgage backed securities in this investment was selected by an independent and experienced portfolio selection agent after a series of discussions, including with Paulson & Co., which were entirely typical of these types of transactions. ACA had the largest exposure to the transaction, investing $951 million. It had an obligation and every incentive to select appropriate securities.
â€˘ Goldman Sachs Never Represented to ACA That Paulson Was Going To Be A Long Investor. The SEC’s complaint accuses the firm of fraud because it didn’t disclose to one party of the transaction who was on the other side of that transaction. As normal business practice, market makers do not disclose the identities of a buyer to a seller and vice versa. Goldman Sachs never represented to ACA that Paulson was going to be a long investor.
In 2006, Paulson & Co. indicated its interest in positioning itself for a decline in housing prices. The firm structured a synthetic CDO through which Paulson benefitted from a decline in the value of the underlying securities. Those on the other side of the transaction, IKB and ACA Capital Management, the portfolio selection agent, would benefit from an increase in the value of the securities. ACA had a long established track record as a CDO manager, having 26 separate transactions before the transaction. Goldman Sachs retained a significant residual long risk position in the transaction.
IKB, ACA and Paulson all provided their input regarding the composition of the underlying securities. ACA ultimately and independently approved the selection of 90 Residential Mortgage Backed Securities, which it stood behind as the portfolio selection agent and the largest investor in the transaction.
The offering documents for the transaction included every underlying mortgage security. The offering documents for each of these RMBS in turn disclosed the various categories of information required by the SEC, including detailed information concerning the mortgages held by the trust that issued the RMBS. Any investor losses result from the overall negative performance of the entire sector, not because of which particular securities ended in the reference portfolio or how they were selected.
The transaction was not created as a way for Goldman Sachs to short the subprime market. To the contrary, Goldman Sachs’s substantial long position in the transaction lost money for the firm.