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Roberto Pfeil / AP Photo The SEC says Goldman duped a German bank. But John Carney uncovers documents that suggest these alleged victims of the scheme should have known what they were getting.
The SEC may have shot itself in the foot when it made a failed German bank a key part of its fraud case against Goldman Sachs.
Yesterday, I reported that IKB Deutsche Industriebank was not the sucker at the table that the SEC depicts in its lawsuit against Goldman. Indeed, its executives were wily and wealthy financiers who employed financial engineering shenanigans to escape the watchful of eye of regulators, shareholders, and auditors.
Now a document exclusively obtained by the Daily Beast demonstrates (view them here) that just a few months before it invested in the derivatives at the center of the SEC's case, the German bank was touting its prowess as a sophisticated investor in those derivatives.
"They weren't consumers, as you or I often think of that term. They were traders."
In other words, IKB were not just sophisticated financial professionals. They were—or claimed to be—sophisticated and experienced when it came to exactly the kind of junky CDOs, dubbed Abacus, they bought from Goldman Sachs.
"Securitisation and CDO investments are an integral part of IKB AG's business model," the document—a marketing brochure for one of IKB's off-balance sheet conduits—claims.
The brochure describes a man named Dr. Thomas Wolwer as the "Senior Portfolio Manager," who has the "responsibility for investing in CDOs both cash and synthetic." His qualifications include working for Dresdner Kleinwort, where he structured and sold various cash and synthetic CDOs. In short, this guy was as experienced in these black financial arts as you can get.
• John Carney: Goldman’s Dirty Customers • Charlie Gasparino: Why Goldman Will Settle The sophistication of IKB will be an important issue in the Goldman case. In general, the securities laws of the United States assume that sophisticated investors can fend for themselves. That's exactly why hedge funds—which only accept money from so-called "accredited investors"—are largely free from regulation. The focus of our securities laws is the protection of ordinary investors and market integrity.
Wharton legal studies professor David Zaring describes the sophistication of the alleged victims in this case as "a fundamental problem for the SEC."
• A Primer on the Goldman Scandal "SEC often describes its mission as one of consumer protection. But the consumers in this case didn't need to be protected. They weren't even consumers, as you or I often think of that term. They were traders," Zaring wrote Thursday on The Conglomerate blog.
In particular, whether or not Goldman Sachs would have had a duty to disclose to the German bank the details of the process under which the Abacus derivatives were created –bundles of putrid subprime mortgages hand-chosen by billionaire hedge fund manager John Paulson, who wanted to bet against them -- may turn on whether IKB had the wherewithal to understand the products absent such disclosure. The 2007 marketing brochure leaves little room for doubt that IKB billed itself to others as having more than enough sophistication.
Perhaps most damaging to the SEC's position: IKB claimed it carefully looked at the CDO pools in which it invested. "CDO pools are examined with a drill down to underlying assets and stress testing of the underlying asset pools," IKB bragged.
"IKB CAM has developed a leading position in the structured finance market through its innovative application of rigorous selection methodologies to the CDO market," the brochure claims in another place.
If they really were performing this kind of investigation, the lack of disclosure from Goldman about Paulson's role should not matter. They would have been fully aware of the contents of the Abacus portfolio, and the motives of those who assembled it would be beside the point.
It is possible, or even probable, that IKB was overstating its level of sophistication—it lost hundreds of millions in the transaction, money that was ultimately covered, most likely, by some byzantine combination of the French bank Calyon and German taxpayers—and the depth of investigation it undertook when making CDO investments. If so, the SEC may still find its case fatally undermined. Because that would indicate that IKB's executives cannot be trusted. No lawyer wants to see a jury wondering whether his star witness was lying back then or lying now.
But that is precisely the dilemma the SEC is faced with. Either the German bank executives were sophisticated and knew what they were investing in when they bought derivatives from Goldman, or they were lying about their sophistication when they bought them.
John Carney is a financial writer and former editor of DealBreaker.com and Clusterstock.com.
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All of them are handling other people's money and so plenty of unsophisticated 'institutional' investors have been hurt by these gamblers. Why is it that Las Vegas is able to ferret out gamblers that are counting cards and signaling and that sort of thing (I don't know but maybe it is even illegal?), but banks are allowed to fix the game, insider trade, hedge their bets? There is no accountability, punishment or fines leveled. No negative consequence whatsoever and this is what needs changing.
When you view it as "all gambling" it doesn't have quite the same meaning. It's only when one group of people doesn't know it's gambling that the problem comes in. After all, what's wrong with gambling? Millions of people do it every day, in Vegas, online, racetracks, sports gambling, Altlantic City, Casinos all over the world? Nicolas Darvas, the famous dancer who made $2 million in the stock market in the 50s, second book was called: "Wall Street, The Other Las Vegas". http://openlibrary.org/b/OL9811137M/Wall_Street_The_Other_Las_Vegas William O'Neil, founder of Investors Business Daily, bases much of his philosophy of buying stocks on Darvas' methods. That's true to this day. You see, it all depends on how you view the stock market.
maspring, This is a classic case of why I say it's more complicated than one might think. My take on this is that even though the German Bank trader lost money on this trade, I doubt very much if he would have thought of it in terms that he got ripped off. He THOUGHT he knew what he was doing, and was merely making a trade. But he ended up getting a fastball he was illequiped to handle. Now that doesn't mean that there was no wrong doing, because had this been an regular unsophisticated investor who was led to believe these were sound investments, well then yes it would be a straight ripoff and worthy of criminal prosecution. But it makes my point that these things are not straightfoward and easily regulated. The reality here (or appears to be from this article) is that it really was a case of buyer beware, and the German trader has no grounds. I've traded in stocks that years later I got a letter inviting me to join a class action suit, and in every time my initial reaction was "that didn't have anything to do with whether I made or lost money in the stock". Why? Because in most cases, I'm just trying to predict the direction of the stock price based on a variety of reasons, over some timeframe. Whatever the reason for the class action usually (not always) doesn't factor in to my thinking. It only does factor in if you are straight investing. If you're trading (or speculating) it doesn't.
It is obvious that the whole banking system needs to be reformed. What we really needed to do first was to reform political contributions.The crooks are paying our crooked politicians to look the other way. A national investment bank should be the answer.Some body needs to figure it out how to make honest bankers out of the crooks that we have now and how to make real public servants out of the bribe takers that we have now. These ethical problems are showing that capitalism and a plutocratic government does not work.It works only for the rich and the crooks. If you look in the dictionary.A socialist republic is good for the average Joe.We have 300 million average Joes in the USA.This means that we need to stop being capitalists and plutocratics. The corporations are running this country we need to stop the crooks.Most of the USA corporations are the equivalent of a psychopathic human being.Corporations are the worst in everything.They are the worst polluters,the worst criminals,liars unethical and crooks. USA bankers = crooks;USA medical doctors/dentists = crooks;USA politicians = crooks;The Republican KKK GOP Party = crooks. All the problems the USA has; is caused by the crooks listed above.
Well everyone knows its ok to steal from drug dealers. Why don't we let the whole rat infested ship sink in the subprime sewer?
From Jesses Cafe today: "Mr. Obama's speech at the Cooper Union today was remarkably unsatisfying. It seemed to be given from weakness, and almost obsequious as the American President politely asked his largest campaign contributors to please stop flouting the law, defrauding the people and their customers, and spending millions per day lobbying the Congress to buy changes in the reform legislation to provide them with the 'right regulators' of their choice and convenient loopholes to render it ineffective. The reform making its way through the Congress is unlikely to be effective given the process in place, despite the political kabuki dance being conducted by the Congress and the Banks. The solution is put simple and effective regulations in the hand of stronger, independent, ad highly capable regulators to bear on the financial services industry, and to understand that the regulations must evolve with a dynamicly evolving business. The idea that you can erect some impregnable and unchanging Maginot line against bank fraud is laughable, a farce. As William K. Black disclosed in his testimony the other day, the regulators always had the power to shut down the frauds, and to resolve the financial crisis without having to give away billions. They lacked the will, and the motivation. You want to wipe that smirk off Lloyd Blankfein's face? Nominate Eliot Spitzer or Elizabeth Warren to be the head of the SEC, or the CFTC, and provide them with a adequate budget and a staff of financial experts and a few experienced prosectors. Even with strong regulations, unless you have capable and motivated regulators, there are always ways to evade the rules, especially if they are complex and provide exceptions. The simpler they are, the stronger the regulations will be, provided they are flexible enough to be amended and expanded efficiently to match the changing and dynamic nature of the industry that they are overseeing. This is not that difficult, and these jokers are not that smart, although part of their con is to paint themselves as the smartest, the best, and practically unstoppable. The root of the US financial crisis is always and everywhere regulatory capture, political cronyism, and fraud. It really is that simple. Barack Obama should to listen to a speech by Nick Clegg of the UK Liberal Democratic Party to hear what a genuine reformer sounds like. Today he sounded like a servant, but not for the public."
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