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Committee's Decision Key in SEC vs Goldman

Source: WSJ

Posted on 20 Apr 2010

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According to people familiar with the matter, the 2007 mortgage deal that set off controversy at Goldman Sachs Group Inc. was quickly approved by a group of roughly a dozen senior executives in a routine meeting in a drab conference room.

That group of senior-level executives -- which included those helping to manage Goldman's mortgage, credit and legal operations -- has surfaced as an important participant in the Securities and Exchange Commission's securities-fraud case against Goldman, which has rocked the firm and Wall Street.

The Goldman group that approved the deal was led by Daniel Sparks, Goldman's mortgage chief, according to people familiar with the matter. Mr. Sparks, who left the firm two years ago, referred questions about the case to the firm.

In a civil lawsuit filed on Friday, the SEC accused Goldman and a young mortgage trader of misleading investors by not notifying them of the role of hedge-fund investor John Paulson, who was dubious about the housing boom, in selecting what went into the mortgage deal, which later cratered.

But the decision by the group of executives—Goldman's "Mortgage Capital Committee"—indicates that the involvement in the deal went far higher than Fabrice Tourre, the young trader accused of fraud, according to the complaint. Goldman and Mr. Tourre are fighting the charges.

The SEC complaint doesn't name any of the members of the mortgage committee at the time. But it alleges that a memorandum by the committee the day it approved the deal shows it had full knowledge of Mr. Paulson's role in selecting the deal's investments. The March 12, 2007, memo by the committee said: "Goldman is effectively working an order for Paulson to buy protection on specific layers of the [deal's] capital structure."

Goldman says it made the proper disclosures and has noted that it lost $90 million on the deal, despite having pocketed a $15 million fee from Paulson for arranging it.

"The core of the SEC's case is the allegation that one employee misled two professional investors by failing to disclose the role of another market participant in a transaction," said Goldman CEO Lloyd Blankfein said in a recent message to employees. The firm "assumed risk in the deal, and we lost money, just like the other two long investors," he added.

But Goldman invested the money only because sales of the deal didn't play out as planned, forcing Goldman to step up with its own money, people familiar with the matter say.

The SEC didn't respond to requests for comment on why it didn't include members of the Mortgage Capital Committee in its lawsuit. A Paulson spokesman declined to comment.

The deal, dubbed "Abacus," has proven controversial because it was sold to investors bullish on the housing market—but created to allow a key client to bet on a housing downturn. At least one other bank, Bear Stearns Cos., turned down working with Mr. Paulson on such a deal, according to people close to the matter. A senior Bear Stearns trader met with the Paulson team in 2007 but turned down the idea, these people said, believing it wasn't proper to sell to investors a deal prompted by another investor who was betting against the securities.

Other committee members in 2007 included Kevin Gasvoda, who was in charge of issuing new mortgage-securities products, and Peter Aberg, an investment banker at the firm who advised the mortgage group on some acquisitions it made during that period, say people familiar with the matter.

Jonathan Sobel, who ran the mortgage group before Mr. Sparks did and maintained an office there even after he stepped down, also was a member, these people say.

Rounding out the panel were representatives from the legal, credit and compliance departments, which assisted the mortgage unit in its day-to-day business, these people added.

It wasn't clear whether Messrs. Gasvoda and Aberg, who didn't respond to requests for comment, were at the meeting where Abacus was approved. Mr. Sobel, whose presence also couldn't be determined, couldn't be reached.

The committee's job was to vet potential new products and transactions, being wary of deals that exposed Goldman to too much risk, say people familiar with its workings. With the mortgage market primed for a meltdown, there was much to discuss at any given meeting.

Some, like the mortgage deal in the SEC complaint—which according to the SEC complaint lost investors $1 billion—were so small that the discussion about them wasn't even memorable, a person familiar with the matter recalls. It was approved the same day it was presented to the group, the SEC complaint suggests.

More significant deals that risked greater amounts of Goldman's own capital were the subject of more detailed discussion, people familiar with the matter say.

Those bigger deals at times were vetted by the firm's overall capital committee—a panel that was overseen by Chief Financial Officer David Viniar and Chief Administrative Officer Edward Forst, according to people who were there at the time—for further analysis. The Abacus deal didn't rise to that level, according to one of those people.

The March day in 2007 during which Abacus was approved was a chaotic time for Goldman's 400-person mortgage division, with numerous transactions—some with conflicting objectives—being undertaken each day, according to people who were there at the time.

The market for "subprime" mortgage loans, those held by higher-risk borrowers, had begun to slide. Some of Goldman's subprime-mortgage traders had taken a markedly bearish position that would lead to nearly $4 billion in gross profits for the year, according to people who were familiar with the firm's finances at the time.

But Goldman also held sizable bullish, or long, positions in pools of mortgage bonds called collateralized bond obligations, or CDOs that Mr. Sparks wanted to sell, say people who were there at the time.

CDOs typically were backed by bundles of mortgage bonds and other assets, including complex derivatives based on the bonds' performance.

Goldman's mortgage group had hedge-fund clients to serve, and at least one of them—the New York hedge fund Paulson & Co.—was in the market for a new type of CDO that would enable it to pile on additional short, or bearish, bets on subprime loans.

So when Paulson's sales contact at Goldman conveyed their interest to the mortgage division, Mr. Tourre and others scrambled to accommodate it, says a person who was there at the time.

Abacus was presented to Goldman's mortgage-capital committee on March 12, 2007, according to the SEC complaint. It was approved the same day, according to someone who was there at the time, after an unmemorable discussion.