On April 16, 2010, the Securities and Exchange Commission (SEC) filed a complaint against Goldman, Sachs & Co. and one of its employees alleging that they made materially misleading statements and omissions in connection with ABACUS 2007- AC1, a synthetic collateralized debt obligation (CDO), that Goldman structured and marketed to investors and that was sponsored by Paulson & Co. Inc. Paulson became famous for making a fortune betting that subprime mortgage assets would default.
According the SEC, the marketing materials for ABACUS 2007-AC1 – including the term sheet, flip book and offering memorandum for the CDO – all represented that the reference portfolio of Residential Mortgage-Backed Securities (RMBS) underlying the CDO was selected by ACA Management LLC (ACA), a third-party with experience analyzing credit risk in RMBS. But Goldman did not disclosed in the marketing materials that Paulson played a significant role in the portfolio selection process even though it had economic interests directly adverse to investors in the ABACUS 2007-AC1 CDO.
The complaint explains how Paulson participated in the selection of the reference portfolio, and then Paulson effectively shorted the RMBS portfolio it helped select by entering into credit default swaps (CDS) with Goldman. Paulson used the CDS to buy protection (i.e., Paulson gets paid if a “credit event” or, generally speaking, a default occurs) on specific tranches of the ABACUS 2007-AC1 capital structure. Therefore, Paulson had an economic incentive to choose RMBS that it expected to experience credit events in the near future. Neither Paulson’s involvement in the selection process, nor Paulson’s adverse economic interests, were disclosed in any of the marketing materials distributed to investors.
The SEC claims that the Goldman employee was principally responsible for ABACUS 2007-AC1; that he devised the transaction, prepared the marketing materials and communicated directly with investors; that he knew of Paulson’s undisclosed short interest and its role in the collateral selection process; and that he also misled ACA into believing that Paulson invested approximately $200 million in the equity of ABACUS 2007-AC1 (a long position) and, accordingly, that Paulson’s interests in the collateral section process were aligned with ACA’s. Goldman knew, however, that Paulson’s interests were the opposite of the investors’ interests.
The deal closed on April 26, 2007. Paulson paid Goldman approximately $15 million for structuring and marketing ABACUS 2007-AC1. By October 24, 2007, 83% of the RMBS in the ABACUS 2007-AC1 portfolio had been downgraded and 17% were on negative watch. By January 29, 2008, 99% of the portfolio had been downgraded. As a result, investors in the ABACUS 2007-AC1 CDO lost over $1 billion. Paulson’s opposite CDS positions yielded a profit of approximately $1 billion for Paulson.
If you have questions about CDOs, an investment that was made in ABACUS 2007-AC1, or would like to discuss this SEC action, contact Jeffrey Wittenberg at (877) 352-2010. Jeffrey Wittenberg has in-depth experience with asset-backed securities offerings.