It’s been a busy week for the SEC. On Wednesday, the regulatory agency took a small, but important first step toward shining light on the very dark, very unregulated world of high frequency trading. And now come charges of civil fraud levied at Goldman Sachs. Talk about a double whammy. In the old days, the SEC would’ve put its feet up and called it a week after the high-frequency trading action. But following it up two days later by charging the biggest, baddest bank in the world with $1 billion of fraud? Who does the SEC think it is? The country’s financial watch dog? Let’s hope so.
We may be witnessing the first real signs of a newly empowered SEC under chair Mary Schapiro. She’s been in the job for over a year, and while critics have been on her for a slow start and giving Wall Street a pass, it must be noted that she’s had her work cut out for her. As Congress gears up to pass financial reform, Schapiro finally seems to have started to turn the SEC back toward its stated purpose of regulating, rather than enabling, Wall Street. This has required a complete about-face, and all the metaphors of turning around the Titanic apply here. Remember, this is an institution that over the last decade completely whiffed on some of the biggest cases of fraud in the country’s history: Madoff, Enron, and Worldcom, not to mention helping sow the seeds of the financial crisis through lax regulation. Under her three Bush-appointed predecessors, Harvey Pitt, William Donaldson, and Christopher Cox, (the guy McCain wanted fired in ’08) the SEC was basically the fox guarding the henhouse, ceding authority to the financial institutions it was supposed to be regulating.
Judging by the details of the charges -- which contain emails from Goldman employees, including the “Fabulous” Fabrice Toure, a 31 year-old Goldman VP allegedly most responsible for the fraud -- this took some serious sleuthing by SEC investigators. It also sheds light into the role Goldman played in helping hedge fund billionaire John Paulson make so much money off the crash.
According to the SEC, Paulson went to Goldman in early 2007 and said that he wanted to bet against (short) a portfolio of subprime mortgages. Goldman essentially said sure, no problem. First it created the CDO, dubbed ABACUS 2007-AC1, and then found some suckers (counterparties) to buy the thing, all the while (and here’s the basis for the SEC's charge) allegedly touting that Paulson had invested $200 million in it, when in actuality he’d bet the other way. Those suckers turned out to be German bank IKB and Dutch bank ABN AMRO, which is entirely owned by the Dutch government. The deal closed in April 2007, and within a year ABACUS had gone kablowey, costing IKB $140 million, and ABN AMRO $890 million. Goldman meanwhile made $15 million in fees from Paulson for structuring and marketing ABACUS, and Paulson made a cool $1billion off the credit default swaps he bought on ABACUS. Paulson responded by saying he is not the subject of the SEC's complaint, made no misrepresentations and is not the subject of any charges. For its part, Goldman calls the charges “completely unfounded” and has vowed to fight them. It’ll be interesting to see how the SEC stands up to a full-on defense from Goldman on this.
The charges certainly took the market by surprise. But more importantly this may be the first shot fired in the SEC’s war against the kind of financial practices that helped bring on the crisis. Judging by the words of an SEC official, who tells NEWSWEEK that agency is investigating the CDO structuring and marketing practices of “a number of Wall Street firms.” It would appear so.