The case against Goldman – fact or fiction

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Blogger and author Barry Ritholtz (The Big Picture) separates fact from fiction in the allegations of fraud made by the SEC against Goldman Sachs in an interview with Dylan Ratigan.

Barry tells me his post 10 Things You Don’t Know (or were misinformed) About the GS Case is turning out to be the most popular article he had ever written. His list follows below, with the video interview at the end.

1.  This is a weak case: Actually, no — it’s a very strong case. Based upon what is in the SEC complaint, parts of the case are a slam dunk. The claim Paulson & Co. were long $200 million dollars when they were actually short is a material misrepresentation — that’s Rule 10b-5, and it’s a no brainer. The rest is gravy.

2.  Robert Khuzami is a bad ass, no-nonsense, thorough, awardwinning prosecutor:  This guy is the real deal — he busted terrorist rings, broke up the mob, took down security frauds. He is now the director of SEC enforcement. He is fearless, and was awarded the Attorney General’s Exceptional Service Award (1996), for “extraordinary courage and voluntary risk of life in performing an act resulting in direct benefits to the Department of Justice or the nation”.

When you prosecute mass murderers who use guns and bombs and threaten your life, and you kick their asses anyway, you ain’t afraid of a group of billionaire bankers and their spreadsheets. He is the shit. My advice to anyone on Wall Street in his crosshairs: if you are indicted in a case by Khuzami, do yourself a big favor: ettle.

3.  Goldman lost $90 million dollars, hence, they are innocent:  This is a civil, not a criminal case. Hence, any mens rea — guilty mind — does not matter. Did they or did they not violate the letter of the law? That is all that matters, regardless of what they were thinking — or their P&L.

4.  ACA is a victim in this case: Not exactly, it was an active participant in ratings gaming. Look at the back and forth between Paulson’s selection and ACA’s management. 55 items in the synthetic CDO were added and removed. Why?

What ACA was doing was gaming the ratings agencies for their investment grade, Triple AAA ratings approval. Their expertise (if you can call it that) was knowing exactly how much junk they could include in the CDO to raise yield, yet still get investment grade from Moody’s or S&P. They are hardly an innocent party in this.

5.  This was only one incident: The market sure as hell doesn’t think so — it whacked 15% off of Goldman’s market cap. The aggressive SEC posture, the huge reaction from Goldie, and the short-term market verdict all suggest there is more coming.

If it were only this one case, and there was nothing else worrisome behind it, GS would have written a check and quietly settled this. Their reaction (some say over-reaction) belies that theory. I suspect this is a tip of the iceberg, with lots more problematic synthetics behind it.

And not just at GS. I suspect the kids over at Deutsche Bank, Merrill and Morgan are working furiously to review their various CDOs deals.

6.  The timing of this case is suspect: More coincidental, really. The Wells notice (notification from the SEC that they intend to recommend enforcement) was over eight months ago. The White House is not involved in the timing of the suit itself, it is a lower-level staff decision.

7.  This is a complex case:  Again, no. Parts of it are a little more sophisticated than others, but this is a simple case of fraud/misrepresentation. The most difficult part of this case is likely to turn on what is a “material omission.” Paulson’s role in selecting mortgages may or may not be material — that is an issue of fact for a jury to determine.  But complex? Not even close.

8.  The case looks thin: What we see in the complaint is the bare minimum the prosecutor has to reveal to make his case. What you don’t see are all the emails, depositions, interrogations, phone taps, etc. that the prosecutor knows about and GS does not. During the litigation discovery process, this material slowly gets turned over (some is held back if there are other pending investigations into GS).

Going back to who the prosecutor in this case is: his legal reputation is he is a very thorough, very precise, meticulous litigator. If he decided to recommend bringing a case against the biggest, baddest investment house on Wall Street, I assure you he has a major arsenal of additional evidence you don’t know about. Yet.

Typically, at a certain point the lawyers will tell their client the evidence is overwhelming and advise settling. That is around 6-12 months after the suit has begun.

9.  This case is political: I keep hearing that phrase due to the SEC party vote. It is incorrect. What that means is the case is not political, it means it has been politicized as a defense tactic. There is a huge difference between the two.

10.  I’m not a lawyer, but . . . Then you should not be ignorantly commenting on securities litigation. Why don’t you pour yourself a tall glass of STF up and go sit quietly in the corner.

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Source: The Dylan Ratigan Show, April 27, 2010.

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