Goldman Sachs ABACUS Securities Enforcement Case: The Conflict Left Out of the Sales Pitch

Goldman Sachs agreed to pay $550 million in the ABACUS securities enforcement case to resolve Securities and Exchange Commission allegations that it concealed a short seller’s role in selecting a mortgage-linked investment’s reference portfolio. Investors saw a portfolio presented as the work of an experienced manager. Inside the transaction, the Commission alleged, a hedge fund betting against that portfolio helped decide what went into it.

This page follows ABACUS 2007-AC1 through the selection emails, investor disclosures and Goldman acknowledgment. Our page on structured products and CDO fraud explains the broader mechanics. Here, the revealing comparison is between the deal participants’ own descriptions of the same transaction.

What Did the SEC Allege About ABACUS?

The Securities and Exchange Commission alleged that Goldman marketed ABACUS without disclosing hedge fund Paulson & Co. Inc.’s influence over the reference portfolio or its financial interest in the portfolio’s decline. The Commission’s complaint named Goldman, Sachs & Co., the group’s principal U.S. broker-dealer, and a vice president responsible for structuring and marketing the transaction. The Commission’s Structured and New Products Unit conducted the investigation.

ABACUS was a synthetic collateralized debt obligation tied to subprime residential mortgage-backed securities. The complaint explains that a synthetic CDO takes exposure through credit default swaps referencing securities, rather than owning the reference portfolio itself. A protection buyer pays premiums, and the protection seller owes a payment if a referenced obligation experiences a credit event. Paulson & Co. wanted protection against mortgage securities it expected to deteriorate.

According to the complaint, Goldman presented ACA Management LLC as the portfolio selection agent in the term sheet, sales presentation and offering memorandum. The sales presentation described ACA’s experience and assured investors that the selector’s economic interests aligned with theirs. It omitted the hedge fund’s role and opposing financial interest. For an investor relying on the manager’s judgment, who influenced that judgment was part of what was being sold.

How the Short Seller Shaped the Portfolio

The Commission described portfolio selection as a series of proposals, revisions and approvals involving Goldman, ACA and Paulson & Co. The hedge fund allegedly favored Triple-B-rated mortgage securities with adjustable-rate loans, lower borrower credit scores and concentrations in states that had experienced rapid house-price appreciation. It wanted the portfolio to include those securities or others with similar characteristics.

The complaint alleged that Goldman sent ACA the hedge fund’s proposed list, ACA recommended a revised selection, and ACA later sought the hedge fund’s approval of replacements. It described a February 2007 email in which Paulson & Co. deleted eight securities ACA had recommended. Further discussions, according to the complaint, produced an agreed reference portfolio of mortgage-backed securities.

The Commission quoted Goldman’s internal approval memorandum to show why ACA’s participation would help sell the investment. The memorandum gave the marketing rationale:

The complaint alleged that the sales presentation devoted extensive space to ACA’s strategy, expertise and staff biographies while omitting Paulson & Co.’s involvement. The biographies made the cut. The conflict did not.

ACA Believed the Hedge Fund Was Investing Alongside It

The Commission also alleged that Goldman led ACA to believe Paulson & Co. would invest in the transaction’s equity, putting the hedge fund on the same side as investors. Equity sits at the bottom of the capital structure and takes losses first. Someone holding that position wants the portfolio to perform, while someone buying protection can benefit when it deteriorates.

The complaint traced ACA’s alleged misunderstanding to its own approval documents. It described ACA’s committee memorandum and handwritten meeting notes as identifying the hedge fund as an equity investor. By contrast, it quoted Goldman’s internal memorandum describing an order for the hedge fund to buy protection on layers of ABACUS. In the Commission’s account, the documents assigned opposite interests to the same participant.

The complaint alleged that ACA had asked Goldman to clarify the hedge fund’s role, then continued to believe it would hold equity through the transaction. A structuring or sales employee may have seen what the other participant believed, who received that information and how the role was described afterward.

Who Carried the ABACUS Exposure?

The complaint placed different businesses on different sides of the transaction. Goldman structured and marketed it, Paulson & Co. bought protection, and ACA Management served as the named selector. IKB, a German commercial bank, bought notes.

According to the Commission, IKB had told Goldman it wanted an independent collateral manager with expertise in the U.S. housing market. Goldman sent IKB materials identifying ACA as the selector without describing the hedge fund’s participation. The complaint alleged that IKB would not have invested had it known the hedge fund helped select the portfolio while intending to bet against it.

The complaint alleged that ABN AMRO took on risk through swap contracts while also receiving marketing materials that omitted the hedge fund’s role and adverse interest. It described Royal Bank of Scotland paying Goldman to unwind ABN AMRO’s position, with most of that money subsequently going to Paulson & Co. An employee looking at the protection contracts would see financial obligations that a portfolio-selection label alone could never explain.

The Fee, the Losses and the Opposite Bet

The Commission alleged that Paulson & Co. paid Goldman approximately $15 million to structure and market ABACUS, which closed on April 26, 2007. The complaint also quoted a message from the head of Goldman’s structured product correlation trading desk showing how the desk viewed the market before the deal closed:

According to the complaint, by October 24, 2007, 83% of the portfolio’s mortgage-backed securities had been downgraded and 17% were on negative watch. By January 29, 2008, 99% had been downgraded. The Commission alleged investor losses of over $1 billion and approximately $1 billion in profit for Paulson & Co. from its opposite swap positions.

Goldman’s settlement exceeded its alleged structuring fee, while the hedge fund’s alleged profit exceeded the settlement. The investors’ losses were on the other side of that bet.

What Did Goldman Acknowledge in the ABACUS Settlement?

Goldman acknowledged that its ABACUS marketing materials contained incomplete information. In the SEC’s July 15, 2010 settlement announcement, the company identified the missing disclosure in its own words:

The announced agreement allocated $250 million for harmed investors through a Fair Fund distribution and $300 million for the U.S. Treasury. We see an expensive way to acknowledge what Goldman called a mistake in the sales pitch.

The agreement also required changes to Goldman’s review and approval of certain mortgage-securities offerings. The Commission specified responsibilities for legal and compliance personnel reviewing written marketing materials, along with additional employee education and training. The same records that carried the alleged omission were the focus of the required review changes.

What Evidence Can Show a Hidden CDO Selection Conflict?

For an offering like ABACUS, useful securities fraud evidence connects the investor’s version of the deal to the selection decisions and economic positions behind it. The Commission’s complaint shows those connections in concrete documents: portfolio emails, marketing materials, committee memoranda and swap arrangements. We work with insiders to understand what their own part of that chain reveals.

A portfolio analyst may know why a bond entered or left the proposed list. A salesperson may know which presentation a buyer received and what the buyer had asked about the selector. A person involved in approval or compliance may know whether the internal description of a participant’s position reached the disclosure review. In the ABACUS allegations, those accounts could be compared against documents describing the same hedge fund as a protection buyer inside Goldman and an equity investor inside ACA.

The distinction between an allegation and a company acknowledgment also matters when we assess what an insider can add. In ABACUS, the complaint laid out the selection history and communications, while Goldman’s acknowledgment addressed the incomplete marketing disclosure. Someone who knows how the materials were prepared can explain the decisions behind the wording.

We assess whether your deal knowledge could support an SEC whistleblower award and work through which program fits your information with you. For fraud against the government, a whistleblower case under the False Claims Act can pay 15% to 30% of what the government recovers.

You Saw How the Portfolio Was Chosen

If you worked on selection, structuring, sales or review and know what the investor materials left out, talk with our whistleblower experts about the deal you saw. We build your strongest securities whistleblower case around your knowledge of the decisions and bring in securities fraud whistleblower lawyers who understand structured offerings. You have a partner from the first conversation through the pursuit of your case.