SEC says Goldman CDO fraud lawsuit ‘tough’

LONDON – The US Securities and Exchange Commission’s (SEC) collateralised debt obligation (CDO) fraud lawsuit against Goldman Sachs had been “from our perspective a pretty straightforward case”, according to Scott Friestad, deputy director of the SEC’s enforcement division. But since the civil case’s launch and its exhaustive legal and media coverage he said “it’s going to be tough”. Friestad was speaking at the SEC regulation outside the US conference on June 10 in London.

“We’re prepared to litigate tough cases and we’re not going to wait around and try to settle on a case that we want to pursue,” said Friestad. “The message is out there and people should pay close attention when we say the train is leaving the station. That is better [as an approach] as it will speed things up. There is a unanimous view within the Commission that getting cases done quickly is an extremely high priority. Long delays diminish the impact, so there’s a commitment to speeding enforcement action up from beginning to end and bring cases more quickly. The Goldman case is a good example of that.”

The SEC accused Goldman on April 16 of behaving fraudulently in its representations to investors about the role of hedge fund Paulson in the selection of underlying mortgage-backed securities for the bank’s Abacus 20007 AC-1 CDO. The bank structured the product and marketed it to investors in 2007 after the fund had allegedly played a role in selecting the securities, which the fund went on to short in the context of the deteriorating conditions in the US subprime mortgage industry.

Media attention has focused on the possibility that Goldman could settle, to head off reputational costs as well as the threat a negative legal judgement could represent to the investment firm turned bank holding company’s business model. Speculation on the strength of SEC’s faith in whether it can achieve success in the case has highlighted a reported split in the SEC vote by commissioners on the enforcement action.

“The vote is one issue worth mentioning. It is reported the Commission vote on this matter was three to two,” said Linda Thomsen, a partner at legal firm Davis Polk, speaking at the same event. “If you assume that is the case, then it is rare the Commission splits on an enforcement issue. They do from time to time, and they surely do on regulatory and rule-making. Generally speaking on enforcement they make unanimous decisions.”

The reputational cost to the SEC should the case fail could also be significant. Thomsen said: “It [remains] to be seen how much this [enforcement] policy will continue if cases are lost. If in the eyes of the court somebody was not liable and is innocent in the eyes of the law, and yet suffered a 13% stock drop in one day [as Goldman experienced], that will affect things and it will affect the agency’s reputation for fairness and its own future enforcement policy.”

“We have a good track record in court,” said Friestad. “We win about 90% of the cases that we bring – but the losses do stick out.”