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May 14, 2013


Timeo Goldman et dona ferentes

When it comes to CDOs –beware of gifts from Goldman
There is one lesson to be learned in the CDO debacle. To paraphrase Laocoon, who attempted to warn the Trojans of the giant horse left behind by the Greeks in the Aeneid: “Timeo Danaos et dona ferentes.” I would say: “Timeo Goldman et dona ferentes” which means “I fear Goldman even when bearing gifts.”
By Edward Manfredonia
July 13th, 2010

[Policing Wall Street]

I Fear Goldman….When Bearing Gifts

On June 10, 2010 it was reported that the Securities and Exchange Commission was investigating Goldman Sachs for its involvement in creating and marketing a second Collateralized Debt Obligation, Hudson Mezzanine. 

But the SEC leaked that there would be no charges of fraud as the SEC had already civilly charged Goldman with fraud in the marketing and sale of another CDO, Timberwolf. Hudson Mezzanine tracked a series of Collateralized Mortgage Obligations. This CDO was created by Goldman to hedge the risk of its inventory of CMOs, which the firm held in its proprietary account. 

So let’s examine the record of e-mails concerning Hudson Mezzanine that have been made public. On October 30, 2006 Peter L. Ostrem, a Goldman manager, sent an e-mail to approximately 25 company employees, including Darryl K. Herrick. The subject of this e-mail was titled: “Great Job in Hudson Mezzanine.” The e-mail read: “Wednesday of last week we price Hudson Mezzanine SP CDO, a static $2.0 billion structured product CDO backed by $1.2 billion of the ABX Index (an index of subprime mortgages) and $800 mm (million) of other RMBS subprime securities (residential mortgage backed securities). Goldman was the sole buyer of protection on the entire $2.0 billion of assets….Darryl Herrick led a core team that executed this deal…”

Later the e-mail message read: “Goldman is currently mandated on $40+ billion of additional CDOs and CLOs (Collateralized Loan Obligations) for the next 12 months. Increasing velocity on debt and equity placement of our upcoming transactions will be the key to our success in 2007. Let’s do it again.”

Do what again? Sell toxic CDOs to Goldman’s clients- that what. So it seems that Goldman was once again ahead of the curve. But was the firm legally ahead of the curve? Was the Hudson CDO on the up and up? On Thursday, October 11, 2006 Tetsuya Ishikawa sent this e-mail message to Herrick: “You may want to ask Sarah about this when she’s there tomorrow and Friday. She said: ‘AIB are too smart to buy this kind of junk’ to jess and now getting radio silence.”

Herrick replied in an e-mail message to Ishikawa: “Very Interesting.”

So is Goldman liable for knowingly buying protection against Hudson? The facts of the situation are very similar to 1970 when Goldman Sachs sold Penn Central Commercial Paper to its clients and did not disclose material facts to the purchasers as I have shown in previous columns. The following cases involved Penn Central Commercial Paper.

For illumination, let’s review more earlier cases. Franklin Savings Bank v. Gustave Levy, Goldman Sachs, et al, 551 F.2d 521, United States Court of Appeals of the Second Circuit, dated March 9, 1977. On page 525 referring to the Securities Act of 1933 the Court stated: 

“Section 12(2) imposes liability upon: Any person who (2) offers to sell or sells a security… by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact…”

On page 527 the Court stated: “We have held that where a broker-dealer makes a representation as to the quality of the security he sells, he implicitly represents that he has an adequate basis in fact for the opinion he renders.” The Franklin Case was used as precedent in another case, Alton Box Board Company v Goldman Sachs and Company, 560 F2d 916, decided August 10, 1977, United States Court of Appeals for the Eighth Circuit. 

On page 923 the Court stated:  “If Goldman Sachs failed to exercise reasonable professional care assembling and evaluating the financial data, particularly in view of the worsening condition of Penn Central, then its representation that the paper was credit worthy was untrue in fact and misleading no matter how honestly but mistakenly held…. it in fact makes the dealer responsible to Franklin if it is unable to shoulder the burden of establishing that it was not reasonable for it to have determined on March 16, 1970 that the quality of the paper it was purveying was less than that represented.”

Furthermore, on page 924 the Court continued: “Under the circumstances the record makes it clear that Goldman Sachs did not, as a matter of law, shoulder its burden of proving that it was reasonable for it to have determined, on March 31, 1970, that the Penn Central Notes it purveyed were creditworthy and of high quality. In fact the record shows it assumed no burden at all. Therefore, we are led to the conclusion that Goldman Sachs representation that the Penn Central Notes were creditworthy was misleading, and Goldman Sachs thereby violated Section 12 (2) of the Securities Act of 1933.”

In the recent matter I opened this column with, the circumstances are even more damning. Goldman created a CDO with the purpose of lessening its risk. Goldman then bought protection against this CDO- with the express purpose of hedging the risk of its inventory. And Goldman never informed its customer that it had created Hudson Mezzanine CDO to lessen Goldman’s risk. The Hudson Mezzanine CDO was worthless. Goldman earned $2 billion by cheating its clients. 

And this is where Section 12(2) of the Securities Act of 1933 is applicable.
So why has the SEC not charged Goldman with fraud in a civil case? Because the SEC has always protected Goldman Sachs, under the buddy system on Wall Street.

There is one lesson to be learned in the CDO debacle. To paraphrase Laocoon, who attempted to warn the Trojans of the giant horse left behind by the Greeks in the Aeneid: “Timeo Danaos et dona ferentes.”  I would say: “Timeo Goldman et dona ferentes” which means “I fear Goldman even when bearing gifts.”

Especially when bearing gifts.

Manfredonia was a Wall Street trader who was later blacklisted for exposing corruption

“Speaking Truth To Empower.”


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