Sunday, September 4, 2011


negative view of RMBS securities was based primarily on his view that moderating home prices
would cause subprime mortgage defaults and was not dependent upon the quality of the
subprime loans.1299
In the fall of 2005, Mr. Lippmann said that he approached his supervisor Richard
D’Albert, Global Head of the Structured Products Group, for permission to enter into CDS
agreements to short RMBS securities totaling $1 billion.1300 He said that he explained at the time
that a cost benefit analysis favored a short RMBS position, because the bank would pay a
relatively small amount of CDS premiums per year in exchange for a potentially huge payout.
Mr. Lippmann said that he estimated at the time that, when the costs were compared to the
potential payout if the BBB securities defaulted, the proposed short position offered a potential
payout ratio of 8 to 1.
Mr. Lippmann also developed a presentation supporting his position entitled, “Shorting
Home Equity Mezzanine Tranches.” It made the following points:
“Over 50% of outstanding subprime mortgages are located in MSAs [metropolitan
statistical areas] with double digit 5 year average of annual home price growth rates.
There is a strong negative correlation between home price appreciation and loss
Default of subprime mortgages are also strongly negatively correlated with home
price growth rates.
1296 Subcommittee interview of Greg Lippmann (10/18/2010). When asked if the position was a proprietary
investment by the bank, Mr. Lippmann told the Subcommittee that it was. Id. Deutsche Bank acknowledges in a
20-F filing with the U.S. Securities and Exchange Commission that it conducts proprietary trading, in addition to
trading activity that facilitates customer business. Deutsche Bank stated that it trades for its own account (i.e., uses
its capital) to exploit market opportunities. See Deutsche Bank Aktiengesellschaft’s Form 20-F filed with the
Securities and Exchange Commission on March 26, 2008, at 24.
1297 Subcommittee interview of Greg Lippmann (10/18/2010).
1298 Subcommittee interview of Greg Lippmann (10/18/2010).
1299 Id.
1300 Id.
Nearly $440 billion subprime mortgages will experience payment shocks in the next 3
Products that may be riskier than traditional home equity/subprime mortgages have
become popular.” 1301
Mr. Lippmann told the Subcommittee that Mr. D’Albert approved his taking the short
position in or around November 2005, but said the trade was so big and controversial that Mr.
Lippmann also had to get the approval of Rajeev Misra, Global Head of Credit Trading,
Securitization and Commodities, who was based in London.1302 Mr. Lippmann said that, in or
around November 2005, Mr. Misra reluctantly gave his approval for the short position, even
though Mr. Misra believed mortgage related securities would continue to increase in value over
Building the Short Position. Mr. Lippmann told the Subcommittee that he used some
existing short positions that had been undertaken as hedges to begin building his position.1303 He
said that, throughout 2006, he gradually accumulated a larger short position, which eventually
reached $2 billion. According to Mr. Lippmann, Deutsche Bank senior management reluctantly
went along.1304 He told the Subcommittee that, at one point in 2006, Boaz Weinstein, who
reported to Mr. Misra, told him that the carrying costs of his position, which required the bank to
pay insurance-like premiums to support the $2 billion short position, had become so large that he
had to find a way to pay for them. According to Mr. Lippmann, the bank’s senior management
asked him to persuade them that he was right by demonstrating that others were willing to
“short” the market as well. Mr. Lippmann told the Subcommittee he was then motivated to
convince his clients that they ought to short the mortgage market, arrange the shorts for them,
and make enough in fees from those transactions to pay for the costs of his multi-billion-dollar
Mr. Lippmann told the Subcommittee that he spent much of 2006 pitching his clients to
short the mortgage market. He said that he often made presentations to prospective clients
sharing with them his “strategy on how to cash in on a slowing housing market.”1306 He said
that, in early 2006, he expended approximately 200 hours trying to convince AIG to short single
name RMBS, but was unsuccessful. He told the Subcommittee that he also believed that his
presentations helped convince AIG to stop buying RMBS and CDO securities and stop selling
CDS protection for those deals. In an August 2006 email, Mr. Lippmann wrote: “In 05 for a
time, we sold EVERY single one to AIG. They stepped out of the market in March of 06 after
speaking with me and our research people (and I don’t doubt other dealers).”1307
1301 9/2005 “Shorting Home Equity Mezzanine Tranches, A Strategy to Cash in on a Slowing Housing Market,”
Mr. Lippmann
1302 Subcommittee interview of Greg Lippmann (10/18/2010).
1303 Id.
1304 Id.
1305 Id.
1306 Id.
1307 8/26/2006 email from Greg Lippmann to Richard Axilrod at Moore Capital, DBSI_PSI_EMAIL01618236.
told the Subcommittee that Mr. Lamont, who co-led Deutsche Bank’s CDO Group, was not
pleased that Mr. Lippmann had convinced AIG, a very large purchaser of long interest in RMBS
and CDO securities, to stop buying them.
The documents indicate that Mr. Lippmann and his trading team were aware at the time
that the CDO Trading Desk was expected to promote rather than discourage client interest in
purchasing Deutsche Bank’s CDO securities. One of Mr. Lippmann’s top traders, Rocky Kurita,
put it this way in mid-2005: “[W]e have to make money. Customer happiness is a secondary
goal but we cannot lose sight of the trading desk[’]s other role of supporting new issue and the
customer franchise.”1308 In a 2007 email to a client, Mr. Lippmann wrote: “[P]lease please do
not forward these emails outside of your firm. … I do not want to be blamed by the new issue
people for destroying their business.”1309
Although Mr. Lippmann was unsuccessful in convincing AIG to short RMBS and CDO
securities, he did convince some of his other clients, usually hedge funds, to undertake such
shorts, primarily by purchasing single name CDS contracts referencing specific RMBS
securities. Those trades generated substantial sums for the ABS Correlation Trading Desk which
acted as a market maker in the CDS market for those clients. Mr. Lippmann told the
Subcommittee that the shorts executed by his clients ultimately generated about $200 million in
revenues for his desk in 2006.1310
Defending the Short. According to Mr. Lippmann, in December 2006, he met in
London with a senior bank official, Anshu Jain, Head of Global Markets at Deutsche Bank, and
suggested that Deutsche Bank’s long positions in mortgage related securities created too much
exposure for the bank and should be reduced.1311 Mr. Lippmann recommended that the bank
hedge its risk using his short strategy. His suggestion was not acted upon, but as the market
grew more volatile in late 2006 and early 2007, Mr. Lippmann’s short position began to gain in
value and caught the attention of senior management at the bank.
Mr. Lippmann told the Subcommittee that, in January 2007, he met with Mr. Jain, Mr.
Misra, and Mr. D’Albert at a hotel in Lisbon, where all three again challenged him to defend his
short position by noting that it had required him to pay out $20 million in CDS premiums during
2006.1312 Mr. Lippmann told the Subcommittee that he countered by pointing out, while he had
paid out $20 million, his desk made $200 million from trading in RMBS and CDO shorts for his
clients. He said that the three concluded he could keep his short position.1313
1308 5/12/2005 email from Rocky Kurita to Greg Lippmann, DBSI_PSI_EMAIL00054826.
According to Mr.
Lippmann, in February 2007, Mr. Jain met with him again to discuss whether or not to keep his
short position, because it had gained in value and Deutsche Bank could cash in the position and
1309 2/1/2007 email from Greg Lippmann to Wyck Brown at Braddock Financial, DBSI_PSI_EMAIL01969867.
1310 Subcommittee interview of Greg Lippmann (10/18/2010).
1311 Subcommittee interview of Greg Lippmann (10/18/2010).
1312 Subcommittee interview of Greg Lippmann (10/18/2010).
1313 Subcommittee interview of Greg Lippmann (10/18/2010).
take the profits at that time. Mr. Lippmann said that the result of the meeting was that, once
again, his position was left in place.
While defending his position within the bank, Mr. Lippmann continued to speak with his
outside clients about his negative views of the market, continued to make presentations to
potential clients about shorting the market,1314 and continued to execute shorts for them, while
building his desk’s proprietary short position.
According to Mr. Lippmann, in late February or early March 2007, as the ABX Index
showed subprime RMBS securities losing value and subprime mortgages continued incurring
delinquencies at record rates, an ad hoc meeting of Deutsche Bank’s executive committee took
place in London to discuss the bank’s risk exposure in mortgage related securities. According to
Mr. Lippmann, he happened to be in London at the time and was invited to attend. He estimated
that ten to twelve persons were at the meeting in person, and another two to four persons
participated by telephone. He said that, at the meeting, Deutsche Bank executives discussed
whether the recent market volatility reflected short term or longer term trends and whether the
bank should make any changes in its holdings.1315 At that time, Mr. Lippmann held the only
large short position on behalf of the bank, then about $4 to 5 billion in size.1316 In contrast, the
Deutsche Bank mortgage group held $102 billion in long RMBS and CDO securities, and
Winchester Capital, Deutsche Bank’s hedge fund affiliate, held a net long position of $8.9
billion.1317 Mr. Lippmann told the Subcommittee that he was the only person at the meeting who
argued for the bank to increase its short position.1318
At the time of the London meeting, Mr. Lippmann’s position was showing a significant
profit. Mr. Misra brought up the alternative of cashing in his position while RMBS prices were
down, because he thought prices were in a short term dip and the profits might disappear later
on. Mr. Lippmann contended that the bank should not only keep his short position, but increase
it, but more senior voices disagreed with him. He told the Subcommittee that the decision at the
end of the meeting was for all parties to keep their positions unchanged, including Mr.
Cashing In the Short. In July 2007, the major credit rating agencies began issuing
downgrades of RMBS and CDO securities, in particular those that incorporated or referenced
subprime mortgages. The value of those securities began to plummet. By the end of the summer
of 2007, Deutsche Bank initiated efforts to sell off the long positions held by Winchester Capital
and other Deutsche Bank entities, reflecting a shift in the bank’s strategy, but its sales force had
1314 See, e.g., 2/2007 presentation, “Shorting Home Equity Mezzanine Tranches,” prepared by Mr. Lippmann,
1315 Subcommittee interview of Greg Lippmann (10/18/2010).
1316 2/23/2007 email from Greg Lippmann to Anshu Jain, DBSI_PSI_EMAIL02383117-18.
1317 3/2/2011 letter from Deutsche Bank’s counsel to the Subcommittee, PSI-DeutscheBank-31-0004-06.
1318 Subcommittee interview of Greg Lippmann (10/18/2010).
1319 Id.
difficulty due to the lack of customers willing to buy long.1320 During 2007 and 2008, at the
direction of senior management, Mr. Lippmann gradually cashed in his short position, obtaining
a total return of about $1.5 billion, which Mr. Lippmann told the Subcommittee he believes was
the largest profit obtained from a single position in Deutsche Bank history.1321
Despite the gain from Mr. Lippmann’s short position, Deutsche Bank told the
Subcommittee that, overall in 2007, it had a long position in mortgage related holdings, with a
face value of about $128 billion and a market value of more than $25 billion. Deutsche Bank
told the Subcommittee that, despite the size of these holdings and their declining value, it lost
only about $4.5 billion on those mortgage related holdings for the year.1322 Deutsche Bank also
filed a 2007 annual report with the SEC claiming a 2007 profit of €7.2 billion.1323 When asked
why its large long position in mortgage holdings did not lose more value, Deutsche Bank told the
Subcommittee that it had placed large hedges, using U.S. Treasury bonds, which reduced its
(4) The “CDO Machine”
From 2006 to 2007, Mr. Lippmann repeatedly cautioned his colleagues and clients that
the mortgage market was headed for a downfall, convinced a number of his clients to short
RMBS and CDO securities, and built his $5 billion short position on behalf of Deutsche Bank.
Meanwhile, the “CDO machine,” as he described it, continued issuing new CDO securities
through the end of 2007. The reasons for this continuing CDO activity, despite a deteriorating
mortgage market and waning investor interest, are key to understanding how these complex, high
risk, structured finance products ended up in multiple financial portfolios throughout the U.S.
financial system.
Mr. Lippmann was frequently asked why, given his negative views, the CDO market was
continuing to operate. He pointed to investment bank fees, prestige, and pressure to preserve the
CDO jobs involved. In August 2006, for example, Mr. Lippmann wrote:
1320 Subcommittee interview of Jordan Milman (10/22/2010). Mr. Milman, one of Mr. Lippmann’s top traders,
stated that the market first weakened in February 2007, stabilized until June or July 2007, and then it was a “one
way train” down from then through 2008. Id.
1321 Subcommittee interview of Greg Lippmann (10/18/2010). See Net Revenues from ABS Products Backed by
U.S. Residential Mortgages, DB_PSI_C00000003.
1322 According to a chart prepared by Deutsche Bank for the Subcommittee, in 2007 and 2008, its RMBS holdings
lost about $3.4 billion; the CDO Group lost about $1.0 billion; Winchester Capital lost about $1.1 billion; and two
other trading desks lost nearly $650 million. These losses were offset by the $1.5 billion gain from the bank’s short
position, for total mortgage related losses of about $4.5 billion. Net Revenues from ABS Products Backed by U.S.
Residential Mortgages, DB_PSI_C00000003.
1323 Deutsche Bank stated in its annual report filed with the SEC that it ended 2007 in the black, due to gains in other
areas of the bank, including its Corporate and Investment Bank which reported a pre-tax profit of €5.1 billion and its
Private Clients and Asset Management division which reported a pre-tax profit of €2.1 billion. See Deutsche Bank’s
2007 annual report filed with the SEC, in particular the Executive Summary of Deutsche Bank’s Annual Report and
the letter from the Chairman of the Board.
1324 Subcommittee interview with Deutsche Bank’s counsel (3/7/2011). See also 3/21/2011 letter and accompanying
chart from Deutsche Bank’s counsel to the Subcommittee, PSI-Deutsche_Bank-32-0001-04.
“Why have we done this? It is not without reluctance and we are looking for ways to get
out of this risk, but for now the view has been, we like the fees and the league table credit
(and dammit we have a budget to make).”1325
In January 2007, after a trader asked Mr. Lippmann why the CDO market hadn’t imploded, Mr.
Lippmann responded: “league table, fees, never has one blown up yet.”1326 The reference to
“league table credit” indicates that investment banks considered it prestigious to be listed as the
leading producer of a complex structured finance product like CDOs, and used their standing in
the tables that tracked total origination numbers as a way of burnishing their reputations,
attracting top talent, and generating new business. An October 2006 “Progress Report” on its
CDO business, for example, which was prepared internally by the bank, included a slide entitled,
“CDO Primary Revenue Forecast and League Tables,” in which a chart ranked Deutsche Bank
third in CDO issuance, behind Merrill Lynch and Citigroup.1327 The slide indicated that
Deutsche Bank had completed 38 CDOs to date, had a 7% share of the CDO market, and
“expected to close 50 deals by year end,” with the “pipeline for Q1 and Q2 2007 building.” The
final page of the presentation, providing a chart listing the top 20 Deutsche Bank CDO
salespersons by region, together with their individual sales credits, identifies some of the bank
personnel invested in the continuation of the CDO business.
On the issue of fees, the head of Deutsche Bank’s CDO Group Michael Lamont told the
Subcommittee that he estimated the bank received 40-200 basis points for each CDO created,
depending upon the complexity of the CDO.1328 He indicated those fees translated into about $5
to $10 million per CDO.1329 When asked what he meant by saying “we have a budget to make,”
Mr. Lippmann explained that new CDO deals had to be completed continuously to produce the
revenues needed to support the budgets of the CDO desks and departments involved with their
1325 8/26/2006 email from Greg Lippmann to Richard Axilrod at Moore Capital, DBSI_PSI_EMAIL01618236-42.
On August 1, 2006, Mr. Lippmann wrote to Mr. Milman, “who has all this crap and let me know which ones to look
at looks like a lot of crappy deals.” 8/1/2006 email from Greg Lippmann to Jordan Milman,
DBSI_PSI_EMAIL01510643. Mr. Lippmann’s negative views were shared by his traders. In an email originally
sent by one of the traders on his desk, Rocky Kurita, the CDO business is set to a song, “CDO Oh Baby,” by Vanilla
Ice with the following lyrics: “Yo vip let’s kick it! CDO oh baby, CDO oh baby. All right, stop, collaborate and
listen. Spreads are wide with a technical invasion. Home Eq Subs were trading so tightly. Until Hedge Funds Bot
Protection daily and nightly. Will they stop? Yo I don’t know. Turn up the Arb and let’s go. To the extreme Macro
Funds do damage like a vandal. Now, BBs are trading with a new handle. Print, even if the housing bubble looms.
There are never ends to real estate booms. If there is a problem, yo, we’ll solve it. Check out the spreads while my
structurer revolves it. CDO oh baby, CDO oh baby.” 11/8/2005 email from Jordan Milman to Greg Lippmann,
DBSI_PSI_EMAIL00686597-601 (forwarding an 11/8/2005 email from Rocky Kurita at Deutsche Bank).
1326 1/5/2007 email from Greg Lippmann to Chris Madison at Mast Capital, DBSI_PSI_EMAIL02333467-68.
1327 10/2006, “CDO Primary Update Progress Report,” DBSI_PSI_EMAIL03970167-72, at 68.
1328 Subcommittee interview of Michael Lamont (9/29/2010).
1329 Id.
1330 Subcommittee interview of Greg Lippmann (10/18/2010).
A similar view as to why the CDO business continued to operate despite increasing
market risk was expressed by a former executive at the hedge fund Paulson & Co. in a January
2007 email exchange with another investor. The Paulson executive wrote:
“It is true that the market is not pricing the subprime RMBS wipeout scenario. In my
opinion this situation is due to the fact that rating agencies, CDO managers and
underwriters have all the incentives to keep the game going, while ‘real money’ investors
have neither the analytic tools nor the institutional framework to take action before the
losses that one could anticipate based [on] the ‘news’ available everywhere are actually
At the end of September 2006, the head of Deutsche Bank’s sales force, Sean Whelan,
wrote to Mr. Lippmann expressing concern that some CDO tranches were getting increasingly
difficult to sell: “[T]he equity and the AAA were the parts we found difficult to place.”1332 Mr.
Lippmann told the Subcommittee that once firms could not sell an entire CDO to investors, it
was a warning that the market was waning, and the investment banks should have stopped
structuring new ones.1333
“As the housing boom began to slow in mid-2006, investors became skittish about the
riskier parts of those investments. So the banks created – and ultimately provided most
of the money for – new CDOs. Those new CDOs bought the hard-to-sell pieces of the
original CDOs. The result was
Instead of getting out of the CDO business, however, he said, a new
source of CDO demand was found – when new CDOs started buying old CDO securities to
include in their assets. One media report explained how this worked:
a daisy chain that solved one problem but created another:
Each new CDO had its own risky pieces. Banks created yet other CDOs to buy
Research conducted by Thetica Systems, at the request of ProPublica, found that in the
last years before the financial crisis, CDOs had become the dominant purchaser of high risk
CDO securities, largely replacing real money investors like pension funds, insurance companies,
and hedge funds. The CDO market analysis found that, by 2007, 67% of the high risk mezzanine
CDO securities had been purchased by other CDOs, up from 36% in 2004.1335
1331 1/14/2007 email from Paolo Pellegrini at Paulson to Ananth Krishnamurthy at 3a Investors, PAULSON
ABACUS 0234459.
1332 9/27/2006 email from Sean Whelan to Greg Lippmann, DBSI_PSI_EMAIL02255361-63.
1333 Subcommittee interview of Greg Lippmann (10/18/2010). Mr. Lippmann told the Subcommittee that he thought
Mr. Lamont’s CDO Group at Deutsche Bank had too many CDOs in the pipeline in the spring of 2007, when it
could not sell all of its CDO securities. He reported that he told Mr. Lamont that defaults would increase.
1334 “Banks’ Self-Dealing Super Charged Financial Crisis,” ProPublica, (8/26/2010),
1335 Id. ProPublica even found that, from 2006 to 2007, nearly half of all the CDOs sponsored by Merrill Lynch
bought significant portions of other Merrill CDOs.
Mr. Lippmann told the Subcommittee that he considered it a “shady” practice when, in
2006, difficult-to-sell BBB CDO tranches began to be placed in new CDOs.1336 In a June 2007
email to Mr. Lippmann, Richard Kim, a Deutsche Bank Managing Director, described placing
unsold CDO tranches into a new CDO to be sold to investors as a “CDO2 balance sheet
In addition to placing unsold CDO securities in newly issued CDOs, investment banks
turned increasingly to non-U.S. investors to keep the CDO machine going. In August 2006, Mr.
Lippmann noted that European and Asian banks were being targeted to buy CDOs:
“Hear what you are saying and in a normal market your logic would be inarguable, but
the demand for this crap is virtually entirely technically driven, all cdos. And each
person at the cdo table thinks someone else is the fool- cdo equity, ostensibly only two
buyers one mutual fund in Australia, and one hedge fund in Chicago, who is actually
putting on a bearish correlation trade: bbb sold mostly ponzi-like to other cdos with
limited distribution in Europe. AA and Junior AAA sold mostly to high grade cdos and
to a certain extent European and Asian banks and lastly the senior AAA, this may
ultimately break the cdo market.”1338
In a December 2006 email, Mr. Lippmann wrote to a client: “[W]ho owns the cdos…insurance
company and german and asian banks…and high grade cdos (can you say ponzi scheme)[?]”1339
In early 2007, he wrote:
“[T]he other side is all it is the cdo investors who r on the other side who buys cdos:
aaa-reinsurance, ws [Wall Street] conduits, European and Asian banks, aa-high grade cdos,
European and Asian banks and insurers..some US insurers, bbb other mezz [mezzanine] abs
[asset-backed security] cdos (i.e. ponzi scheme), European banks and insurers, equity some US
hedge funds, Asian insurance companies, Australian and Japanese retail investors through
mutual funds.” 1340
In February 2007, when an investor wrote to Mr. Lippmann inquiring about the status of
the “CDO machine,” Mr. Lippmann responded: “[G]etting slower but not dead yet[.] … 2-5
ramping a day instead of 10-15[.] … [H]earing of many investors in asia especially shutting
down … but the window is not completely shut yet.”1341 Deutsche Bank emails demonstrate
that, in 2007, like other investment banks, it was actively trying to sell CDOs in Asia.1342
1336 Subcommittee interview of Greg Lippmann (10/18/2010).
1337 6/14/2007 email from Richard Kim at Deutsche Bank to Greg Lippmann, DBSI_PSI_EMAIL02202920.
1338 8/26/2006 email from Greg Lippmann to Richard Axilrod at Moore Capital, DBSI_PSI_EMAIL01618236.
1339 12/4/2006 email from Greg Lippmann to Deutsche Bank employee, DBSI_PSI_EMAIL01867147-49.
1340 2/27/2007 email from Greg Lippmann to Fabrizio Wittenburg at Deutsche Bank, DBSI_PSI_EMAIL02027053-
1341 2/20/2007 email from Greg Lippmann to David Homan at Moore Capital, DBSI_PSI_EMAIL02006853-54.
1342 See, e.g., “I would like these guys to push Asia sales on this…, but also as Ilinca said, the question arises why
weren’t they working on this thus far?” 2/21/2007 email from Abhayad Kamat at Deutsche Bank to Michael
Lamont and others at Deutsche Bank, DBSI_PSI_EMAIL04056326-36.
Mr. Lippmann had an unrelentingly negative view of the RMBS and CDO securities he
traded. He believed the securities would ultimately lose value, but he also believed investment
banks would do all they could to sustain the CDO market for as long as possible due to the CDO
fees, prestige, market share, and jobs at stake.
(5) Gemstone
To understand how one investment bank, Deutsche Bank, continued to develop and
aggressively solicit its clients to purchase CDO securities even as mortgage related securities lost
value and the CDO market began collapsing, the Subcommittee examined in detail Gemstone 7,
a $1.1 billion CDO. Gemstone 7 was assembled and marketed by Deutsche Bank, as sole
placement agent, from October 2006 to March 2007.1343 Gemstone 7 was the last in a series of
CDOs sponsored by HBK Capital Management (HBK), a large hedge fund.1344
Deutsche Bank issued the Gemstone 7 securities in March 2007. Six out of Gemstone’s
seven tranches received investment grade ratings, including AAA ratings for the top three
tranches. Two months later, in July 2007, the major credit rating agencies issued mass rating
downgrades of RMBS and CDO securities, including 19 of the 115 RMBS securities included or
referenced in Gemstone 7. In November 2007, the credit rating agencies began to downgrade the
Gemstone 7 securities. Today, all seven tranches have been downgraded to junk status, and the
Gemstone 7 securities are nearly worthless.
(a) Background on Gemstone
Gemstone 7 was a $1.1 billion hybrid CDO whose assets consisted predominantly of high
risk subprime RMBS securities. Nearly 90% of its assets were mid and subprime RMBS
securities with 33% carrying non-investment grade ratings.1345 Of the remaining assets, 4.5%
were CDO securities; 3.3% were commercial mortgage backed securities; and 3.5% were
securities backed by pools of student loans.1346 When the deal closed in March 2007, Gemstone
7 had about $476 million in cash RMBS assets as well as $625 million in synthetic assets.1347
1343 In the Gemstone 7 offering circular, Deutsche Bank is described as the placement agent: “The Notes purchased
by the Initial Purchaser, if any, will be privately placed with eligible investors by the Initial Purchaser” where the
Initial Purchaser was Deutsche Bank. Gemstone 7 Offering Circular, GEM7-00000427-816 at GEM7-00000640. In
contrast, other documents produced by Deutsche Bank indicate that the bank was acting as an underwriter in the
Gemstone 7 transaction. See, e.g., 12/20/2006 Gemstone 7 Securitization Credit Report, DB_PSI_00237655-71 and
undated Gemstone 7 Securitization Credit Report, MTSS000011-13. For ease of reference but without making a
judgment on the matter, this Report uses the term “placement agent” when describing Deutsche Bank’s role in
Gemstone 7.
Gemstone 7 was constructed as a “partially static” CDO, meaning that while some of its assets
were set and could not change, others could be replaced by the collateral manager, HBK.
1344 Subcommittee interview of HBK Managing Director Jamiel Akhtar (9/15/2010).
1345 The intended portfolio composition of Gemstone 7 was disclosed to investors in a Debt Investor Presentation.
See 2/2007 Gemstone 7 Debt Investor Presentation, GEM7-00001687-1747 at 1695.
1346 Id. at 1691.
1347 9/14/2010 Gemstone 7 Asset Chart, PSI-Deutsche Bank-17-Gemstone7-0001-03.
HBK is a Dallas based hedge fund that was founded in October 1991, and by 2007,
managed approximately $12 billion in capital.1348 According to HBK, its Structured Products
Group, one of its 21 business units, was “one of the leading purchasers and long-term investors
in credit sensitive mortgages … including RMBS and ABS, a component in HBK’s overall
strategy since 2002.”1349 Deutsche Bank told the Subcommittee that HBK had a reputation as a
competent manager of mortgage related assets.1350 HBK had acted as the collateral manager for
seven previous CDO deals (six named Gemstone), choosing to alternate the mandate for the
deals between Lehman Brothers and Deutsche Bank.
In October 2006, HBK retained Deutsche Bank to act as the placement agent for
Gemstone 7. Under the agreement, HBK was to receive 30 basis points, or 0.3%, per year of the
notional amount of Gemstone 7 (approximately $3.3 million) in return for serving as the
collateral manager. Deutsche Bank was slated to receive $6.79 million in “underwriting fees,”
but because the deal did not sell completely, Deutsche Bank ultimately received a lesser amount
of $4.7 million.1351
On October 25, 2006, HBK and Deutsche Bank signed an agreement outlining the terms
of Gemstone 7. HBK told the Subcommittee:
“The collateral purchased under the warehouse arrangement was selected by HBK and
subject to Deutsche Bank’s right of approval. The warehouse documents originally
contemplated a total collateral pool of $750 million, which was increased to $1.1 billion
in late December 2006.”1352
On October 24, 2006, Deutsche Bank opened a warehouse account to store the assets that would
serve as the collateral for the CDO when it closed.1353
1348 1/2007 Gemstone 7 Debt Investor Presentation, at 17, DBSI_PSI_EMAIL01980000-60.
Deutsche Bank and HBK shared the risk
1349 Id.
1350 Subcommittee interview of Sean Whelan, co-head of Deutsche Bank sales force (9/22/2010).
1351 See 12/20/2006 Gemstone 7 Securitization Credit Report, DB_PSI_00237655-71; undated Gemstone 7
Securitization Credit Report, MTSS000011-13; 3/15/2007 Gemstone CDO VII Ltd. Closing Memorandum,
DB_PSI_00133536-41. According to the Gemstone Offering Circular, HBK was to receive “0.30% per annum on
the Quarterly Amount payable in arrears on each distribution date.” 3/15/2007 Offering Circular for Gemstone
CDO VII, Ltd., GEM7-00000427-816, “The Management Agreement,” at 168. As opposed to an upfront fee, which
Deutsche Bank received, the fee to HBK was paid quarterly. Thus, 0.30% of $1.1 billion translates to a fee of
approximately $3.3 million for HBK. See 7/11/2007 email from Chehao Lu at Deutsche Bank to Marco Lukesch at
HBK, GEM7-00003568. See also email noting HBK’s quarterly collateral management fee of $826,067.88 as of
September 11, 2007. 9/11/2007 email from Eric Martel at HBK to Jamiel Akhtar at HBK, GEM7-00006900.
1352 8/20/2010 letter from HBK’s counsel to the Subcommittee, at 2.
1353 See chart, “Assets Purchased by Gemstone VII CDO during Warehouse Period,” GEM7-00001831-33 (showing
assets purchased during the warehouse period). According to Credit magazine, “The financial press will often make
its first mention of a ‘new’ CDO on or around the time of its closing – with the closing date generally the day on
which the CDO issues tranches of debt and equity to investors. Prior to that day, however, there will have been a socalled
pre-closing or ‘warehousing’ period, typically lasting between three and six months. During that period the
asset manager will have acquired (or ‘warehoused’) assets to act as collateral for the securities to be issued by the
CDO … on the closing day.” See “CDO Guide: recovery rates,” Credit (May 2004),
for any change in value of the warehoused assets if the deal failed to close. Pursuant to the risk
sharing agreement, if the deal failed to close, HBK would incur the risk for the first $80 million
in losses, and Deutsche Bank would bear the remaining risk.1354
Deutsche Bank CDO Group. Several departments and desks at Deutsche Bank were
involved in designing, marketing, and selling the Gemstone 7 securities. The CDO Group, coheaded
by Michael Lamont and Michael Herzig, was responsible for designing its structure,
monitoring the purchasing and warehousing of its assets, obtaining its credit ratings, preparing
the legal documentation, establishing its administrative structure, obtaining underwriting
approval of the deal, designing the marketing materials, and overseeing the issuance of the CDO
securities.1355 Abhayad Kamat within the CDO Group was assigned lead responsibility for
structuring Gemstone 7.1356 The CDO Trading Desk, headed by Greg Lippmann, participated in
the CDO approval process once HBK selected assets. The CDO sales force, headed by Sean
Whelan and Michael Jones, was responsible for selling the Gemstone 7 CDO securities.
To issue the CDO securities, Deutsche Bank established an offshore corporation in the
Cayman Islands called Gemstone CDO VII, Ltd.1357 To administer the corporation, Deutsche
Bank appointed its Cayman Island affiliate, Deutsche Bank Cayman, which is a licensed trust
company.1358 As administrator, Deutsche Bank Cayman provided Gemstone 7 with the
administrative services needed to operate the CDO securitization, including but not limited to,
providing office facilities and secretarial staff, maintaining the books and records required by
Cayman law, naming at least two Cayman directors, and acting as the Share Registrar for
Gemstone shares.1359
HBK’s Long Investment in Gemstone. HBK routinely purchased the equity
tranche,1360 also known as the residual interest, in all of its Gemstone deals, including Gemstone
1354 12/20/2006 Gemstone 7 Securitization Credit Report, DB_PSI_00237655-71.
HBK told investors in its sales presentation that “HBK has retained 100% of the equity
1355 Subcommittee interview of Michael Lamont (9/29/2010).
1356 Subcommittee interview of Abhayad Kamat (10/8/2010).
1357 Gemstone CDO VII Ltd. Certificate of Incorporation and Memorandum and Articles of Association of
Gemstone CDO VII Ltd., DB_PSI_00236844.
1358 Deutsche Bank International Limited is a wholly owned subsidiary of Deutsche Bank AG. It currently has
several offices around the world, including one in the Cayman Islands, Deutsche Bank (Cayman) Limited (“DB
Cayman”), that was opened in 1983. “Deutsche Bank International Ltd.,” Bloomberg Businessweek,; “Deutsche Bank in the
Cayman Islands,” Deutsche Bank, DB Cayman is a
licensed trust company incorporated in the Cayman Islands. Preference Share Paying Agency Agreement, GEM7-
00001089-1030, at 1092.
1359 Amended and Restated Administrative Agreement, GEM7-00001223-31; Preference Share Paying Agency
Agreement, GEM7-00001089-1130 at 1095-96.
1360 An equity tranche is the tranche in an RMBS or CDO structure that is designed to be the first to incur any losses
from the securitization. Since it is expected to incur at least some level of losses, the equity tranche is usually not
given a credit rating and is often retained by the originator of the securitization. See American Banker definition,
1361 According to HBK, “HBK’s investment process integrates expertise in capital markets, structural analysis,
collateral and loan level analysis, due diligence, and in house surveillance. HBK is seen as not as a trader but as a
from CDO transactions resulting in strong alignment of interests between HBK and
investors.”1362 According to Kevin Jenks, HBK’s collateral manager, HBK had a “buy and hold”
approach to all of its Gemstone CDOs.1363 HBK also told the Subcommittee that it participated
in Gemstone 7 with “the objective of obtaining long exposure to the CDO’s collateral, on a
leveraged basis, through ownership of the Residual interest.”1364
HBK deals were known for containing above average concentrations of BB or lower
rated assets, but HBK prided itself on its ability to run in-depth analysis and accurate stress tests
on assets it selected for its CDOs.1365 HBK expected to receive a 15% return on its investment in
the equity tranche.1366 In its investor presentation, HBK stated: “The firm strives to provide
superior risk-adjusted rates of return with relatively low volatility and relatively low correlation
to most major market indices.”1367 HBK’s presentation also claimed that, as of January 2007, it
had only three downgrades in its asset backed security portfolio, and that its upgrade to
downgrade ratio was 23 to 3.1368 Investor M&T Bank, who later purchased Gemstone 7
securities, told the Subcommittee that it had relied on HBK’s assertions when choosing what it
thought was an investment with “minimal risk.”1369
HBK informed the Subcommittee that it had never shorted any of the assets in its seven
Gemstone CDOs, that its CDO trade book was evenly matched with long and short CDO assets
during the 2006-2007 period,1370 and that it lost over $700 million in its Structured Credit
business unit during 2007.1371
(b) Gemstone Asset Selection
As the collateral manager, HBK selected the assets for Gemstone 7, subject to approval
by Deutsche Bank’s structuring and trading groups before each asset could be placed in the
Deutsche Bank warehouse account for the CDO.1372
vigilant investor that maximizes value through intensive analysis and surveillance.” 1/2007 Gemstone 7 Debt
Investor Presentation, DBSI_PSI_EMAIL01980000-60 at 23.
According to HBK and Deutsche Bank
1362 Id.
1363Subcommittee interview of Kevin Jenks (10/13/2010). Also see 1/2007 Gemstone 7 Debt Investor Presentation,
DBSI_PSI_EMAIL01980000-60 at 25.
1364 8/20/2010 letter from HBK’s counsel to the Subcommittee.
1365 Subcommittee interview of Abhayad Kamat (10/8/2010). Mr. Kamat was the individual at Deutsche Bank who
was primarily responsible for structuring Gemstone 7.
1366 Subcommittee interview of Jamiel Akhtar (9/15/2010).
1367 1/2007 Gemstone 7 Debt Investor Presentation, DBSI_PSI_EMAIL01980000-60 at 17.
1368 Id. at 25.
1369 Subcommittee interview of M&T (9/20/2010).
1370 According to HBK, “HBK never had a short position in any securities issued by the Gemstone 7 CDO.” HBK
also told the Subcommittee staff that it had approximately $350 million of long exposure in Gemstone 7 and another
$800 million of “additional long exposure to the same assets underlying collateral outside the CDO.” 8/20/2010
letter from HBK’s counsel to the Subcommittee. HBK told the Subcommittee that it did at times take short
positions in certain mortgage backed securities unrelated to the Gemstone transactions.
1371 8/20/2010 letter from HBK’s counsel to the Subcommittee, and exhibit to letter, HBK’s exposure to Gemstone
VII Notes, GEM7-00000001-10.
1372 Subcommittee interview of Abhayad Kamat (10/8/2010).
personnel, the approval process worked in the following manner. First, HBK identified the
RMBS, CDO, and other securities it wanted to include or reference in the CDO. HBK then sent
an email to Mr. Lippmann or his traders at Deutsche Bank requesting that the identified assets be
placed in the warehouse account for Gemstone 7. Deutsche Bank traders, sometimes in
consultation with Mr. Lamont’s structuring group, would then either approve or voice concerns
regarding the proposed assets. If they had concerns, the traders would work with HBK personnel
to resolve them. For example, on January 9, 2007, HBK’s Jason Lowry sent an email to Mr.
Lippmann and his trader, Jordan Milman, with a list of RMBS securities proposed for inclusion
in Gemstone 7, and asked: “This is the last BB list for approval. Could you take a look?” On
the same day, Mr. Milman wrote back: “approved contingent upon first pay defaults getting
bought back on the 2 heat bonds.”1373
Although the Gemstone 7 offering circular did not describe Deutsche Bank’s role in the
asset selection process, the private engagement agreement between HBK and Deutsche Bank
did.1374 According to the terms of the engagement agreement, Deutsche Bank agreed to provide,
among other items, the following service: “advising the Issuer [Gemstone 7] and the Company
[HBK] on the selection and acquisition of the Underlying Assets” and “the scope of due
diligence for the Underlying Assets.”1375 Under both the engagement agreement and a separate
risk sharing agreement, Deutsche Bank also had the right to reject assets selected by HBK for the
Gemstone warehouse account.1376 When asked about Deutsche Bank’s obligations under these
agreements, Mr. Lippmann told the Subcommittee that he viewed Deutsche Bank as having an
obligation to the entity, Gemstone 7, to price the assets accurately as they were purchased, which
included comparing the price of each security or CDS contract on the date it went into the
warehouse account to its market price and ensuring that the CDO did not overpay for the assets it
purchased.1377 Mr. Lippmann’s trader, Mr. Milman, and Mr. Kamat, of Mr. Lamont’s CDO
Group, agreed with that assessment.1378 All three also stated that the engagement agreement did
not require Deutsche Bank to analyze the quality of the assets being purchased or how those
assets were expected to perform.
On the other hand, documents reviewed by the Subcommittee indicate, in at least a few
instances, that Deutsche Bank personnel voiced concerns about an RMBS security being placed
in the deal due to performance concerns in addition to price. For example, Mr. Kamat, who also
assisted Mr. Lippmann’s trading desks, wrote to Mr. Jenks about the quality of an asset being
1373 See, e.g., 1/9/2007 email from Jason Lowry to Greg Lippmann, GEM7-00002154; and 12/11/2006 email from
Greg Lippmann to Kevin Jenks, GEM7-00002805. The term “heat” refers to an RMBS security issued by Home
Equity Asset Trust.
1374 The Gemstone 7 offering circular states that with regard to the purchase of underlying assets: “The Issuer
[Gemstone 7] will acquire Underlying Assets from a warehouse facility (the ‘Warehouse Facility’) provided by an
affiliate of DBSI [Deutsche Bank Securities, Inc.], which provides for the purchase of Asset-Backed Securities at the
direction of the Collateral Manager [HBK] on behalf of the Issuer prior to the Closing Date.” Gemstone 7 Offering
Circular, GEM7-00000427-816 at 494.
1375 10/25/2006 signed letter agreement between HBK and Deutsche Bank, GEM7-00000071-89 at 72.
1376 10/25/2006 signed letter agreement between HBK and Deutsche Bank, GEM7-00000071-89 at 72; and
10/24/2006 Risk Sharing Agreement, GEM7-00000090-99 at 91.
1377 Subcommittee interview of Greg Lippmann (10/18/2010).
1378 Subcommittee interview of Jordan Milman (10/22/2010) and Abhayad Kamat (10/8/2010).
considered for Gemstone 7. Mr. Kamat wrote: “MLMI 2005-HE1 B3 [is] on credit watch – do
you want to move this out of the portfolio – investors might question/resist[.]” Mr. Jenks
responded: “[N]o let’s leave it in[.]”1379
On another occasion, Mr. Jenks from HBK exchanged several emails with Mr. Lippmann
about several RMBS securities that Mr. Jenks wanted to include in the Gemstone 7 warehouse
account. Mr. Jenks sent the list to Mr. Lippmann and wrote: “please approve.” Mr. Lippmann
responded: “ok approved but would like to lower these 2 pts each given recent press on fhlt and
significant widening in the baa3 cds. Is that cool?” The term “fhlt” referred to RMBS securities
issued by Fremont; by saying he wanted to “lower these 2 pts,” Mr. Lippman indicated he
wanted to assign them a lower value for warehouse purposes. Mr. Jenks replied: “Greg,
Fremont overall is really not trading badly just the ones on downgrade watch,” to which Mr.
Lippmann responded: “we have seen the fhlt 05-d bbb-trade wide …. please work with me on
this. … I am trying to work with you.” Mr. Jenks replied:
“Greg, I have been trying to work with you. Doing trades just with you and not on bid
lists. But we play in the higher quality part of the market, I really expected you to
approve the list as is. We still have several hundred million of bonds to do in cds form to
do [sic].”1380
This exchange shows that Mr. Lippmann was cognizant of the quality of the assets being
included in the CDO, and pushed for lower prices when he thought the assets were of poor
HBK told the Subcommittee that it selected good quality bonds using a very complex
model to analyze them.1381 It told investors that it “analyze[d] every bond in the market,
providing for a vast range of data …. [F]rom this data, trends can be observed early regarding
the bonds themselves as well as the general economy and the implications on future
issuance.”1382 HBK provided this description for the Subcommittee regarding the tools it used in
the asset selection process:
“HBK used a statistically driven mortgage behavior model to help make trading decisions
and select assets for inclusion in the Gemstone VII CDO. Three separate database tools
were utilized in this process. First, HBK licensed a commercial database called LP
Database, which contained detailed information and performance history for millions of
non-agency mortgages. The LP Database was a robust dataset comprising close to 80%
of the market, back to the 1996 vintage. Utilizing the data acquired from the LP
1379 1/5/2007 email from Abhayad Kamat to Kevin Jenks, GEM7-00001977.
1380 12/8/2006 and 12/11/2006 emails between Mr. Lippmann and Mr. Jenks, DBSI_PSI_EMAIL01886779-80.
1381 See 1/2007 Gemstone 7 Debt Investor Presentation, DBSI_PSI_EMAIL01980000-60 (“HBK’s investment
model utilizes proprietary default, prepay and severity loan level models to make investments in the residential
market. ... Transaction performance is tracked monthly via trustee surveillance reports and ongoing loan level
information to monitor and analyze parameters such as collateral yields, delinquency and default trends, recoveries,
prepayments, and available credit enhancement.”).
1382 Id. at 42.
Database, HBK then developed a proprietary system called the Loss Model that
forecasted the likelihood of default, prepayment, delinquency, or timely payment for an
individual mortgage monthly over a ten-year time horizon. The Loss Model made these
forecasts based on a series of 50 loan characteristics, including whether the mortgage was
a first or second lien mortgage, the type of mortgage (e.g., fixed or ARM), its geographic
location, FICO score, loan-to-value ratio, and level of documentation, and projections of
home price appreciation and unemployment rates.
Finally, HBK merged the information from the Loss Model into a Bond Evaluation
Engine, which was based on software licensed from Intex Solutions. The Bond
Evaluation Engine provided information that assisted HBK traders in pricing mortgage
bonds and evaluating how the bonds might perform under certain stresses. … This
portion of the analysis focused on the structure and enhancements of the RMBS and how
those structures would contribute to bond performance.”1383
Mr. Jenks of HBK told the Subcommittee that HBK “never had a bond that we thought
was bad that was put in a CDO.”1384 Mr. Jenks also told the Subcommittee that he had frequent
conversations with Mr. Lippmann, was aware of his “negative housing view,” but disagreed with
the magnitude of Mr. Lippmann’s negative views.1385 Mr. Lippmann told the Subcommittee that
although he occasionally suggested bonds to Mr. Jenks for Gemstone 7, and Mr. Jenks at times
purchased them, Mr. Jenks had strong views on the assets that should be included in the CDO
and was not required to listen to him. HBK and Deutsche Bank emails confirm that Mr.
Lippmann or his traders offered at times to sell certain bonds to HBK, which occasionally
purchased them.1386 Deutsche Bank sold five bonds from its inventory, with a value of more
than $27 million, to HBK for inclusion in Gemstone 7.1387 According to Mr. Lamont, his CDO
Group was “agnostic” towards the quality of the assets that HBK purchased for Gemstone 7, and
told the Subcommittee that investors had relied on HBK, the collateral manager, to analyze their
quality.1388 Mr. Lamont said that the role of the CDO Group was, not to select the CDO’s assets,
but to structure the deal and then use models to conduct stress tests on it.1389
1383 10/12/2010 letter from HBK’s counsel to the Subcommittee.
1384 Subcommittee interview of Kevin Jenks (10/13/2010).
1385 Id.
1386 See, e.g., 12/8/2006 email from Greg Lippmann to Kevin Jenks, DBSI_PSI_EMAIL01883072 (discussing trade
they agreed to). See also 2/23/2007 email from Jordan Milman to Greg Lippmann, DBSI_PSI_EMAIL02022054
(“I’d rather just have Ilinca show hbk, he loves bonds like this.”).
1387 Assets Purchased by Gemstone VII CDO during Warehouse Period, GEM7-00001831-33.
1388 Subcommittee interview of Michael Lamont (9/29/2010). Kamat also agreed that Deutsche Bank was agnostic
with regard to the quality of the assets. Subcommittee interview of Abhayad Kamat (10/8/2010).
1389 Subcommittee interview of Michael Lamont (9/29/2010).
(c) Gemstone Risks and Poor Quality Assets
Gemstone 7’s assets were assembled in late 2006 and early 2007, when the mortgage
market was deteriorating and subprime mortgages were experiencing record delinquency rates.
The CDO posed a host of risks due to both the state of the market and the poor quality of many
of its underlying assets.
Credit Report. In December 2006, Mr. Lamont’s CDO Group prepared a Credit Report
for Deutsche Bank’s credit risk management group to obtain internal approval for the
securitization of Gemstone 7.1390 The Credit Report noted the following business risks for
Deutsche Bank regarding Gemstone 7, including the possibility that the bank would be unable to
sell $400 million of the Gemstone securities, which carried “significant” risk:
“The portfolio is concentrated on RMBS obligations, with 67.6%, 20.2% and 1.9% of
the RMBS exposure represented by 2005, 2006, and 2007 vintages, respectively,
which results in significant vintage risk.”
“RMBS accounts for ~90.0% of the initial collateral portfolio.”
“All unsold tranches have been taken back by HBK except for the Class A-1B
($400mm). Currently, we are working with [redacted] to see if they will be interested
in taking the tranche. The plan for distribution if [redacted] decides not to take the
tranche, will be a senior sequential repack. The Class A-1B will be broken into two
tranches. DB will take the senior part (Class A-1B(i) $200mm) and HBK will take
the bottom part (Class A-1B(i) $200mm). Once the repack is setup, then DB will try
to syndicate the Class A-1B(i).” 1391
The business risks described in the internal Deutsche Bank credit report relating to
“significant vintage risk” for the 2005, 2006, and 2007 vintage RMBS securities1392were not
disclosed in the Gemstone 7 offering materials given to investors. Although the March 15, 2007
Offering Circular contained a “Risk Factor” section describing multiple risks associated with an
investment in Gemstone 7, including those associated with residential asset backed securities, the
Offering Circular was silent with respect to the above risks identified in the Credit Report, which
were highlighted for Deutsche Bank management.
1390 Id. See undated Gemstone 7 Securitization Credit Report, MTSS000011-13 and 12/20/2006 Gemstone 7
Securitization Credit Report, DB_PSI_00237655-71. The 12/20/2006 Credit Report appears to be an earlier version
of the document.
1391 Gemstone 7 Securitization Credit Report, MTSS000011-13.
1392 Id.
The Offering Circular did, however, describe in detail a number of significant risks
associated with RMBS securities. For example, it stated:
“The risk of losses on residential mortgage loans is particularly relevant now. While
there is always a risk of defaults or delinquencies in payment, recently losses on
residential mortgage loans have been increasing and may continue to increase in the
future. The losses have been most significant in respect of subprime mortgage loans
but all are affected.
A number of factors are contributing to the increase in losses. Residential property
values that increased for many years are now declining. … Declining property values
also exacerbate the losses due to a failure to apply adequate standards to potential
borrowers. Failures to properly screen borrowers may include failures to do adequate
due diligence on a borrower (including employment and income history) or the
relevant property (including valuation) or failures to follow predatory lending and the
other borrower-protection statutes. Increases in interest rates may also contribute to
higher rates of loss. ...
The increase in delinquencies and defaults has contributed to a declining market for
mortgage loans. The declining market has, in turn, seriously impacted mortgage
originators and servicers. … The financial difficulties of servicers in particular are
likely to result in losses in respect of securities backed by residential mortgage loans.
… At any one time, the portfolio of Residential ABS Securities may be backed by
residential loans with disproportionately large aggregate principal amounts secured
by properties in only a few states or regions.”1393
These disclosures demonstrate that both HBK and Deutsche Bank were well aware of the
deteriorating mortgage market and increased risks associated with RMBS and CDO securities,
even as they were marketing the Gemstone 7 securities and claiming HBK had applied careful
analysis in the asset selection process to ensure good quality CDO securities.
Long Beach-Fremont-New Century Bonds. A substantial portion of the cash and
synthetic assets included in Gemstone 7, 30% in all, involved subprime residential mortgages
issued by three subprime lenders, Long Beach, Fremont, and New Century, all known for issuing
poor quality loans and securities.1394
1393 3/15/2007 Offering Circular for Gemstone CDO VII, Ltd., GEM7-00000427-816 at 483-84. While an earlier
offering circular for Gemstone 7, dated February 14, 2007, identifies some risks associated with the CDO, the March
offering circular contains additional language, quoted above, on the risks associated with the deteriorating mortgage
market. 2/14/2007 Offering Circular for Gemstone CDO VII, Ltd., PSI-M&T_Bank-02-0001-370.
Loans by these lenders were among the first to collapse.
According to Moody’s, these three originators, plus WMC Corporation, accounted for 31% of
1394 For more information on these three lenders, see sections D(3)(d) and E(2)(c)-(d) of Chapter IV. Mr. Jenks of
HBK told the Subcommittee that he saw data showing that Long Beach and Fremont were poor performers, but he
thought the performance varied depending upon the tranche, and he believed he could pick the better tranches. He
thought he could buy low, structure the deal well, and make money. Subcommittee interview of Kevin Jenks
the subprime RMBS securities issued in 2006, but 63% of the rating downgrades issued in the
second week of July 2007, when the mass rating downgrades began.1395
During the period when securities were being assembled for the Gemstone 7 warehouse
in late 2006 and early 2007, Mr. Lippmann frequently disparaged many of the same assets he and
his traders allowed to be included in Gemstone 7. About $27 million of these assets came from
Deutsche Bank’s own inventory. In emails to colleagues and his clients, Mr. Lippmann used
words like “crap” and “pig” to describe the assets. Mr. Lippmann brought some of the assets of
Gemstone 7 to the attention of some of his clients that shorted these assets.1396
On October 20, 2006, for example, one of Mr. Lippmann’s clients sent him an email
seeking advice about certain subprime bonds issued by Long Beach Mortgage Loan and Trust
(LBMLT) and other originators. Mr. Lippmann responded:
“LBMLT-06-5 M9-375. Long Beach is one of the weakest names in the market. We
shorted this bond to a CDO in the mid-300s on October 13[.] Deal was done before S&P
changed their criteria on July 1. Lots of 40 year mortgages …. Less than half the loans
have full documentation and 10% are investor properties. This is a real pig.
LBMLT -06-2 M9 350. See above on Long Beach. This one is already performing
poorly with substantial delinquencies .… Further the FICO is less than the 06-05 and
there are fewer full doc loans. This seems a better short than the 06-5. Only reason I can
think for my guys showing you a tighter level is that we are short this one and that the
June 06 deals have a taint that earlier months don[’]t due to the theory that late June deals
were crammed with bad stuff in order to beat the S & P revisions.”1397
Despite these negative views of Long Beach, Mr. Lippmann’s group raised no concerns
when $25 million in LBMLT 2006-5 M9 securities was purchased by HBK for Gemstone 7’s
warehouse account, $20 million of which was purchased on October 24, 2006, four days after
Mr. Lippmann’s email. Altogether, a total of $79.5 million in Long Beach bonds went into
Gemstone 7.1398
Mr. Lippmann had similar negative views of RMBS securities containing subprime loans
originated by Fremont, yet his group did not object to including Fremont securities in Gemstone
7. For instance, on December 6, 2006, Mr. Lippmann’s traders did not object to including $20
million of an RMBS known as SABR 2005-FR4 B3 for Gemstone 7, which contained Fremont
1395 7/12/2007 Moody’s Structured Finance Teleconference and Web Cast: RMBS and CDO Rating Actions, at
Moody’s SI 2010-0046902, Hearing Exhibit 4/23-106.
One week earlier, on November 29, 2006, when asked by a bank colleague about the
1396 Subcommittee interview of counsel for Deutsche Bank (2/1/2011).
1397 10/20/2006 email from Greg Lippmann to Craig Carlozzi at Mast Capital, DBSI_PSI_EMAIL01774820-21.
1398 9/14/2010 Gemstone 7 Asset Chart, PSI-DeutscheBank-17-Gemstone7-0001-03.
1399 Id.
same RMBS security, Mr. Lippmann labeled it a “pig.”1400 Two days later, on December 1,
2006, Mr. Lippmann declared in an email to a client that the security was “blowing up.”1401
In addition, on November 29, 2006, Mr. Lippmann called still another RMBS security
with Fremont loans, FHLT 2005-A M9, a “pig.”1402 Yet a month earlier, on October 30, 2006,
approximately $1 million of FHLT 2005-A M9 had been purchased for Gemstone 7, with no
objection from Mr. Lippmann’s trading desk.1403
Mr. Lippmann made similar negative remarks about RMBS securities containing
subprime loans originated by New Century. On November 28, 2006, Mr. Lippmann wrote:
“MABS 2005-NC2 M9 … huge payment shock coming.”1404 Yet six weeks later, on January 17,
2007, $10 million of this exact asset, MABS 2005-NC2 M9, was purchased by Gemstone 7,
without objection from Mr. Lippmann’s traders.1405 On December 8, 2006, Mr. Lippmann wrote
about another New Century security underwritten by Goldman Sachs: “GSAMP 06-nc2 m8 this
is an absolute pig.”1406 Although Gemstone 7 did not purchase the M8 securities, it did purchase
a total of $30 million in GSAMP 2006-NC2 M9 securities – from a lower tranche in the same
securitization with less subordination. It purchased those securities over a month-long period,
with $10 million of the securities on November 13, 2006; another $10 million on December 8,
2006; and still another $10 million on December 21, 2006.1407 In addition, on December 18,
2006, Gemstone 7 purchased $8.8 million worth of a similar security, GSAMP 2006-NC2
Mr. Lippmann was equally critical of New Century loans securitized by ACE, an entity
created by and associated with Deutsche Bank. On September 21, 2006, for example, when
asked by a Deutsche Bank salesperson for his opinion of ACE 2006-NC1 M9, an RMBS issued
by ACE with New Century subprime loans, Mr. Lippmann responded that ACE was “generally
1400 With regard to the asset, Mr. Lippmann wrote: “pig probably a 400-525 market.” 11/29/2006 email from Greg
Lippmann to Francis Blair at Deutsche Bank, DBSI_PSI_EMAIL01853153.
On March 2, 2007, a client sent an email to Mr. Lippmann stating: “[T]hey are
1401 See 12/1/2006 email from Greg Lippmann to Tyler Duncan at Wayzata Investment Partners,
DBSI_PSI_EMAIL01864446 (Mr. Lippmann wrote: “sabr 05-fr4 b3 another Fremont blowing up we traded in
august at 260”). Later in January 2007, Greg Lippmann wrote: “SABR Fr [Fremont] blows.” 1/25/2007 email from
Greg Lippmann to Mark Lee at Contrarian Capital, DBSI_PSI_EMAIL01961580.
1402 11/29/2006 email from Greg Lippmann to Jashin Patel at Deutsche Bank, “Where is this pig marked?,”
1403 9/14/2010 Gemstone 7 Asset Chart, PSI-DeutscheBank-17-Gemstone7-0001-03.
1404 11/28/2006 email from Greg Lippmann to Rocky Kurita, DBSI_PSI_EMAIL01846000.
1405 See 9/14/2010 Gemstone 7 Asset Chart, PSI-DeutscheBank-17-Gemstone7-0001-03.
1406 12/8/2006 email from Greg Lippmann to Peter Faulkner at PSAM, LLC, DBSI_PSI_EMAIL01882188.
1407 See 9/14/2010 Gemstone 7 Asset Chart, PSI-DeutscheBank-17-Gemstone7-0001-03.
1408 Id.
1409 9/21/2006 email from Greg Lippmann to Melissa Goldsmith at Deutsche Bank, DBSI_PSI_EMAIL01689001-
02. Mr. Lippmann confirmed to the Subcommittee that he believed ACE was “horrible.” Subcommittee interview
of Greg Lippmann (10/18/2010). On May 19, 2006, Mr. Lippmann wrote to a Deutsche Bank colleague, “We
traded that ACE piece of crap with Ike at 380.” 5/19/2006 email from Greg Lippmann to Rocky Kurita at Deutsche
Bank, DBSI_PSI_EMAIL0120552. On May 29, 2007, Mr. Lippmann wrote with regard to ACE 2006-ASP3 M7,
claiming that DB [Deutsche Bank] was one of the last ones to tighten standards on buying loans
to securitize. [Y]ou were right - ACE is crap.” Mr. Lippmann responded: “INDEED … IT
IS.”1410 Yet on December 19, 2006, Mr. Lippmann’s traders did not object to the purchase of $10
million of ACE 2006-NC1 M9 for Gemstone 7.1411
Mr. Lippmann also had negative opinions about other securities purchased for Gemstone
7. On March 1, 2007, for example, Mr. Lippmann wrote that ABSHE 2006-HE1 M7 was
“crap.”1412 But $5 million of this same security had been purchased three months earlier by
Gemstone 7, on November 16, 2006, without objection from Mr. Lippmann’s trading desk.1413
In still another instance, on March 19, 2007, Mr. Milman described FFML 2006-FF13 as “a
piece of crap.”1414 Yet over the prior five months, the Lippmann trading desk had approved the
purchase of a total of $38.5 million of this exact bond, FFML 2006-FF13, for inclusion in
Gemstone 7: $11.7 million of the class B1 securities on October 30, 2006; $16.2 million of the
class B2 securities on November 17, 2006 and January 9, 2007; and $10.6 million of the class
M9 securities on March 15, 2007.1415
Securities from Deutsche Bank’s Inventory. Gemstone 7 purchased five securities
totaling $27 million directly from Deutsche Bank’s inventory.1416 Mr. Lippmann, and his trader
Jordan Milman, shared negative views of one of the bonds, ACE 2006-HE1 M10, a security in
which over 75% of the loans had been originated by Fremont.1417 In an instant message
conversation in December 2006, Mr. Lippmann asked Mr. Milman his thoughts on ACE 2006-
HE1 M10. Mr. Lippmann asked: “DOESNT THIS DEAL BLOW,” to which Mr. Milman
replied: “yes it blows I am seeing 20-40% writedowns.”1418 Not only did HBK include $10
million of this asset in the Gemstone 7 warehouse account, HBK purchased it from Deutsche
Bank that same month through one of Mr. Lippmann’s traders.1419
“this stinks though I didn’t mention it.” 5/29/2007 email from Greg Lippmann to Danielle Pluthero at Deutsche
Bank, DBSI_PSI_EMAIL02532365.
Thus, Deutsche Bank
allowed Gemstone 7 to acquire a $10 million asset that its traders believed would perform
poorly, and effectively removed the financial risk of this asset from its own inventory, shifting it
to its customers.
1410 3/2/2007 email from Greg Lippmann to Clark Baker at Harbinger Capital, DBSI_PSI_EMAIL02038599.
1411 9/14/2010 Gemstone 7 Asset Chart, PSI-DeutscheBank-17-Gemstone7-0001-03.
1412 3/1/2007 email from Greg Lippmann to Joris Hoedemaekers at Oasis Capital, DBSI_PSI_EMAIL02033845.
1413 9/14/2010 Gemstone 7 Asset Chart, PSI-DeutscheBank-17-Gemstone7-0001-03.
1414 3/19/2007 email from Jordan Milman to Greg Lippmann, DBSI_PSI_EMAIL02412084.
1415 9/14/2010 Gemstone 7 Asset Chart, PSI-Deutsche Bank-17-Gemstone7-0001-03.
1416 These five securities were: (1) ACE 2006-HE1 M10, (2) Securitized Asset Backed Receivables (SABR) 2005-
OP1 B4, (3) Ameriquest Mortgage Securities Inc. (AMSI) 2005-R11 M10, (4) Deutsche Bank Alt-A Securities, Inc.
(DBALT) 2006-AR6 M10, and (5) First Franklin Mtg Loan Asset Backed Certificate (FFML) 2005-1 B4. See
Assets Purchased by Gemstone VII CDO during Warehouse Period, GEM7-00001831-33. See also 9/14/2010
Gemstone 7 Asset Chart, PSI-Deutsche Bank-17-Gemstone7-0001-03.
1417 9/14/2010 Gemstone 7 Asset Chart, PSI-Deutsche Bank-17-Gemstone7-0001-03.
1418 12/1/2006 instant message conversation between Greg Lippmann and Jordan Milman,
1419 12/19/2006 email from Jason Lowry at HBK to Greg Lippmann and others at Deutsche Bank,
DBSI_PSI_EMAIL01910568; 12/19/2006 email from Greg Lippmann to Jordan Milman and others at Deutsche
Bank, DBSI_PSI_EMAIL01910580.
Mr. Lippmann expressed a negative outlook for other assets as well, including SABR
2005-OP1, that was taken from Deutsche Bank’s inventory and sold to Gemstone 7. On August
26, 2006, Mr. Lippmann wrote to a client about more securities “blowing up,” including SABR
“I am encouraged that in spite of the virility of the cdo bid, there are numerous examples
of bonds blowing up … the tripling of serious delinq [delinquencies] in sabr 05-opl to
over 6.5% since feb even though the avg [average] mortgage age is now only 21 months
i.e. hasn’t reset yet .… What I’m saying is there is plenty of fundamental evidence that
bonds are blowing up even as the new issue and index market are remaining
On December 12, 2006, with no objection from Mr. Lippmann’s desk, Gemstone 7 purchased
$5.5 million of SABR 2005-OP1 B4 from Deutsche Bank, the same asset that he had described
months earlier as incurring “serious delinquencies.”1421
A third example involved securities issued by Ameriquest Mortgage Securities Inc.
(AMSI), which Gemstone purchased from Deutsche Bank’s inventory. On April 6, 2006, Mr.
Lippmann called AMSI 2005-R7 M8 a “crap name.”1422 In a June 16, 2006 email, Mr. Lippmann
called AMSI generally a “weakish name.”1423 On December 12, 2006, Gemstone 7 purchased $5
million of another RMBS, AMSI 2005-R11 M10, with no objection from the Lippmann trading
In still another instance, Deutsche Bank praised its sales force for placing a security it
was having difficulty selling as the underwriter, Deutsche Alt-A Securities Inc. (DBALT) 2006-
AR6, in Gemstone 7. On November 17, 2006, the Deutsche Bank Option Arms Desk sent the
following email, “The Arms Desk would like to express its sincere appreciation to the sales force
for an outstanding job in helping us place the bonds off DBALT 06-AR6. Thanks a lot!!”1425
1420 8/26/2006 email from Greg Lippmann to Richard Axilrod, DBSI_PSI_EMAIL01618236.
Less than two weeks later, on November 29, 2006, a member of the Deutsche Bank sales force
wrote: “Some success in CMO [collateralized mortgage obligation] land today: Sold 9 mm
[million] DBALT 06-AR6 M10 (Ba2/BBB-) to HBK. This class was never sold in the new issue
1421 Assets Purchased by Gemstone VII CDO during Warehouse Period, GEM7-00001831-33.
1422 4/6/2006 email from Greg Lippmann to himself, DBSI_PSI_EMAIL01075218.
1423 6/16/2006 email from Greg Lippmann to Rocky Kurita, DBSI_PSI_EMAIL01314036.
1424 Assets Purchased by Gemstone VII CDO during Warehouse Period. GEM7-00001831-33.
1425 11/17/2006 email from Deutsche Arms to Deutsche Bank employees, DBSI_PSI_EMAIL01831021; 11/14/2006
email from Deutsche Arms to Deutsche Bank employees, DBSI_PSI_EMAIL01822045. DBALT was “one of
Deutsche Bank’s own shelf offerings.” 3/21/2011 letter from Deutsche Bank’s counsel to the Subcommittee, PSIDeutsche_
marketing.” 1426 HBK records indicate that, the next day, it agreed to purchase $8.8 million of
DBALT 2006-AR6 M10.1427
Many investors would likely have found the negative views of Mr. Lippmann, Deutsche
Bank’s top CDO trader, important to their decision as to whether or not to buy Gemstone 7, but
his views, as described above, were not disclosed to them. At the time, the traders on his desk as
well as other Deutsche Bank CDO personnel knew that many clients valued and relied on Mr.
Lippmann’s opinion when making investment decisions, yet did not disclose his views of the
specific assets included in Gemstone 7.1428 M&T Bank told the Subcommittee that had it known
about Mr. Lippmann’s views, it might have “thought twice” before purchasing Gemstone 7
(d) Gemstone Sales Effort
Deutsche Bank began aggressively marketing Gemstone 7 to investors beginning in
January 2007.1430 The bank communicated with potential investors about Gemstone 7 in a
variety of ways, including through emails, telephone calls, face to face meetings, and at
conferences. Deutsche Bank personnel also went on what they called “road shows” to cities
around the world, to meet investors and pitch the CDO to them.1431 Sean Whelan, co-head of the
Deutsche Bank CDO sales force, and Ilinca Bogza, a vice president in the Deutsche Bank
syndicate group, worked to market Gemstone 7 to investors, including by scheduling road shows
and personal meetings with potential investors.
Investors were typically shown a “Debt Investor Presentation” that had been prepared by
HBK and Deutsche Bank.1432 That presentation provided an overview of the transaction, a
description of HBK’s organization, and its investment strategy. The presentation highlighted
investment considerations, including HBK’s expertise in the capital markets, how its structured
products exhibit relatively stable performance, and their low default history. The presentation
also contained a description of HBK’s analytical systems and surveillance capabilities, and
included an appendix describing the risk factors for the deal. HBK told the Subcommittee that
its employees attended investor meetings, and were at times called upon to answer questions, but
did not always participate in the Gemstone 7 sales efforts which were led by Deutsche Bank.1433
1426 11/29/2006 email from Larry Pike to Eleanny Pichardo and others, DB_PSI_01731794.
1427 11/30/2006 email from Jason Lowry at HBK to Abhayad Kamat and others, GEM7-00005480. See also Assets
Purchased by Gemstone VII CDO during Warehouse Period, GEM7-00001831-33.
1428 See 7/6/2006 email from Axel Kunde to Greg Lippmann, DBSI_PSI_EMAIL01374694 (“If you tell the sales
guy the bond is really bad his investor will use that as an argument against us and demand we buy back his note,
because he trusted DB [Deutsche Bank] to pick a good portfolio etc, etc.”).
1429 Subcommittee Interview of M&T (9/20/2010).
1430 See, e.g., 1/25/2007 Deutsche Bank internal email chain, DB_PSI_00346491-99, at 99.
1431 Subcommittee interview of Sean Whelan (9/22/2010).
1432 See, e.g., 1/2007 Gemstone 7 Debt Investor Presentation, DBSI_PSI_EMAIL01980000-60 and 2/8/2007
Gemstone 7 Debt Investor Presentation, GEM7-00001687-1747.
1433 Subcommittee interview of Kevin Jenks (10/13/2010).
One Gemstone investor, M&T Bank, told the Subcommittee that, after observing a
presentation made by Mr. Jenks and receiving Deutsche Bank’s assurances in connection with its
solicitation efforts, it believed that Gemstone 7 securities posed minimal investment risk.1434
According to the transcript of a telephone call on February 5, 2007, Sean Whelan of Deutsche
Bank’s sales force pitched the Gemstone 7 deal to M&T Bank and stated in part: “If you
indicate early, like Gemstone deals go very well, and this deal will all go very well and it will get
oversubscribed.”1435 The following day, February 6, 2007, Mr. Whelan again pitched the deal to
M&T and stated that Gemstone 7 “was like a lay up.”1436 When asked about these comments,
Mr. Whelan told the Subcommittee that what he meant was that working with a quality hedge
fund like HBK was a “lay up,” not that the Gemstone 7 deal itself was a “lay up.”1437 With
regards to his comment about oversubscription, he said he was referring to the tranches that
M&T Bank was considering purchasing, which ultimately were fully subscribed.1438
In early 2007, as the closing date for Gemstone 7 neared, the Deutsche Bank sales force
was having difficulty getting commitments from investors to buy Gemstone securities. Many
investors who were solicited declined to invest because of concerns about the high concentration
in subprime RMBS with BBB or BB ratings.1439 In the beginning of 2007, there was a general
lack of buyer interest in mortgage related securities in the United States, other than from new
CDOs purchasing CDO securities from prior deals. It was not the first time, however, that a
Gemstone deal involving Deutsche Bank and HBK could not be fully sold. HBK had
conditioned Deutsche Bank’s participation in Gemstone 7 on its purchasing unsold securities
from Gemstone 4 and 5, BB rated securities that HBK still had on its books for $13.1 million. In
an email sent to a colleague, an HBK Managing Director Jamiel Akhtar wrote:
“As a condition for receiving the underwriting mandate, Kevin [Jenks] and I insisted that
DB [Deutsche Bank] buy from us the $13.1mm of BB rated CDO liabilities HBK
retained on its own books from Gemstone IV and V. This was a fairly sharp-elbowed
tactic on our part, as the BB bonds are the worst part of the capital structure, but I felt like
we should be sharp-elbowed with DB right now.”1440
The head of Deutsche Bank’s CDO Group, Michael Lamont, sent an email to the CDO
Group banker assigned lead responsibility for structuring Gemstone 7, acknowledging the risk
the bank took on by purchasing the earlier unsold securities, but also noting the “nice” fee being
paid to the bank: “[T]hat is part of the risk we took when we were awarded the mandate and we
are still making a nice all in fee.”1441
1434 Subcommittee interview of M&T (9/20/2010).
When Deutsche Bank told HBK that it intended to resell
the Gemstone 4 and 5 securities, the HBK official indicated it was “ok with that as long as it is
1435 2/5/2007 telephone transcript between Sean Whelan and Alex Craig of M&T, MTSS000920-25, at 22.
1436 2/6/2007 telephone transcript between Sean Whelan, and Alex Craig and David Borchard of M&T,
MTSS000929-31, at 31.
1437 Subcommittee interview of Sean Whelan (9/22/2010).
1438 Id.
1439 See spreadsheet containing potential investor feedback regarding Gemstone 7, DBSI_PSI00117568.
1440 10/5/2006 email from Jamiel Akhtar at HBK to Jon Mosle at HBK, GEM7-00006353.
1441 2/8/2007 email from Michael Lamont to Abhayad Kamat, DBSI_PSI_EMAIL04045219-24.
not blasted out to everyone so as not to affect his current deal [Gemstone 7] in the market.”1442
Deutsche Bank and HBK did not disclose in the Gemstone 7 offering materials both the bank’s
purchase of the Gemstone 4 and 5 securities as a precondition to the deal and the bank’s plan to
sell the Gemstone 4 and 5 securities contemporaneously with the Gemstone 7 securities.
Struggle to Sell Gemstone. Evidence obtained by the Subcommittee shows that both
HBK and Deutsche Bank were concerned about their exposure should Gemstone 7 not be fully
subscribed and worked hard to sell the deal in the face of U.S. investor disinterest.1443
According to the terms of the Gemstone deal, if the securities were not fully sold, the risk of the
first $80 million in losses would fall on HBK, while all remaining losses would fall on Deutsche
Bank.1444 On February 27, 2007, Mr. Kamat of Deutsche Bank wrote to Mr. Jenks of HBK
about selling the Gemstone 4 and 5 securities and brought up the CDO Group’s need to reduce
risk: “[W]e are trying to reduce our exposure right now given internal very senior mgmt review
of our business.” Mr. Jenks responded: “We are also trying to reduce exposure.”1445
In January 2007, Michael Lamont, head of Deutsche Bank’s CDO Group, and Mr. Jenks,
the HBK collateral manager, discussed the urgency of selling Gemstone 7 in the face of a
deteriorating market. On January 9, 2007, Mr. Jenks wrote to Mr. Lamont: “[W]ith this market
this way and probably going to get worse we would like to really move on the cdo. Please
allocate the resources to expedite this.” Four minutes later Mr. Lamont responded: “[W]e are
focused on this as well. We don’t have a deal in the market and you will be first.”1446
Several developments in early 2007 signaled problems in the mortgage industry. On
January 29, 2007, subprime lender Fremont Investment & Loan announced that it had “severed
ties” with 8,000 brokers whose loans had high delinquency rates.1447 The following week on
February 7, 2007, New Century, another major subprime lender, disclosed in a conference call
with investors that “the level of early-payment defaults and loan repurchases [had] led to tighter
underwriting guidelines,” that its nonprime loan production would be declining, and that it would
be restating its earnings.1448
1442 Id. at 24.
An additional warning to the market that occurred as Gemstone was
being marketed to investors was the plunge in the ABX Index that tracked the value of subprime
RMBS securities. In February 2007, the ABX Index fell from a high of $0.90 early in the month
1443 Subcommittee interview of Kevin Jenks (10/13/2010). Mr. Jenks recalled that there were more non U.S.
investors in CDOs in 2007, but he believed that was because there was not much of a CDO market in Europe.
Subcommittee interview of Kevin Jenks (10/13/2010). Mr. Whelan told the Subcommittee that in 2006 and 2007,
CDO subscription was “spotty.” Subcommittee interview of Sean Whelan (9/22/2010).
1444 12/20/2006 Gemstone 7 Securitization Credit Report, DB_PSI_00237655-71.
1445 2/27/2007 email between Abhayad Kamat and Kevin Jenks, DB_PSI_00421609 (discussing potential exposure
due to purchase of earlier Gemstone 4 and 5 tranches in Gemstone 7).
1446 1/9/2007 email chain between Michael Lamont and Kevin Jenks, GEM7-00002156.
1447 2/1/2007 S&P internal email, “Defaults cause Fremont to end ties to 8,000 brokers,” Hearing Exhibit 4/23-93d.
1448 “New Century plunges on loan production,” MarketWatch (2/8/2007),
shares-punished-over-loan-production-warning. On the day before the New Century conference call,
Deutsche Bank received a request from HBK to approve a New Century asset purchase for the Gemstone 7 deal and
approved this request on February 9. See 2/9/2007 email from Jordan Milman to Ashley Bonilla at HBK,
to $0.69 by the end of the month, indicating a drop of more than 23% in the value of subprime
RMBS securities.1449
Emails reviewed by the Subcommittee show that CDO personnel at Deutsche Bank were
well aware of the worsening CDO market and were rushing to sell Gemstone 7 before the market
collapsed. On February 7, 2007, Mr. Lippmann, reacting to the New Century developments,
raised concerns with Mr. Lamont about the ability of Deutsche Bank to continue to sell CDO
securities: “I was calling about warehouse marks and distribution risk b/c [because] hearing
rumors about other dealers having big trouble placing this stuff.”
These and other events affected both the RMBS and CDO markets, since
so many CDOs included or referenced subprime RMBS securities.
1450 The next day, February 8,
2007, Mr. Lamont told Abhayad Kamat, the CDO Group employee structuring Gemstone 7:
“[R]egardless we need to sell it [Gemstone 7] now while we still can.”1451 The same day, Mr.
Lamont wrote to Mr. Jenks at HBK: “Keep your fingers crossed but I think we will price this
just before the market falls off a cliff.”1452 The next day, February 9, 2007, Ilinca Bogza, of the
Deutsche Bank syndicate group, wrote to Mr. Lamont: “Jenks just called me. … He is
frightened that accounts will pull their orders given the widening in abx today. … He
mentioned he was going to give you a call. He is very nervous.”1453
On February 13, 2007, the head of Deutsche Bank’s syndicate group, Anthony
Pawlowski, wrote to Mr. Lamont: “I am not sure how to push guys upstairs without having them
crack. Everyone wants to price this deal asap (Sean Whelan [co-head of Deutsche Bank’s CDO
sales force] is pushing for Friday to lock up his guys on the AAA and AA)[.] Let me know.”1454
A week later, on February 20, 2007, Mr. Lamont wrote to Deutsche Bank syndicate to ask:
“[O]n our managed mezz[anine] abs [asset backed security] CDOs last year what was the
split by risk tranche across deals between real money and cdo warehouses. The street
may be pulling back so this would be good info to have as we think about how we are
going to place risk.”1455
1449 On Feb. 23, 2007, MarketWatch announced: “The ABX.HE index that tracks CDS on the riskiest subprime
loans, rated BBB-, that were sold in the second half of 2006 fell to $0.69 on Friday, according to, which
administers the indexes. That’s down from $0.72 on Thursday and $0.79 at the beginning of the week. In early
February, this index was above 90.” “Subprime mortgage derivatives index plunges; Bankruptcies, losses in
subprime home loan industry spark drop,” MarketWatch (2/23/2007),
1450 2/7/2007 email from Greg Lippmann to Michael Lamont, DBSI_PSI_EMAIL02366193-96, at 94. When Mr.
Lamont heard about the New Century developments he wrote: “yikes. I think we will stay short a while.” 2/7/2007
email from Michael Lamont to Greg Lippmann, DBSI_PSI_EMAIL02366194.
1451 2/8/2007 email from Michael Lamont to Abhayad Kamat, DBSI_PSI_EMAIL04045219-24.
1452 2/8/2007 email from Michael Lamont to Kevin Jenks, DBSI_PSI_EMAIL04045360.
1453 2/9/2007 email from Ilinca Bogza to Michael Lamont, DBSI_PSI_EMAIL04047421-23.
1454 2/13/2007 email from Anthony Pawlowski at Deutsche Bank to Michael Lamont, DBSI_PSI_EMAIL04049521.
1455 2/20/2007 email from Michael Lamont to Ilinca Bogza, DBSI_PSI_EMAIL04054492. On February 20, 2007, a
client of Mr. Lippmann’s who was looking to short more RMBS commented in an email to him about the negative
news concerning Novastar Financial Inc., which announced losses that day. His client described the situation in the
market “like the plague.” 2/20/2007 email from Steven Eisman at Frontpoint Partners to Greg Lippmann,
In one odd instance, Ms. Bogza, from the CDO syndicate, sent an email to the Deutsche
Bank sales force suggesting that Gemstone 7 was experiencing greater investor interest than it
really was. The February 20, 2007 email by Ms. Bogza stated that the bank had received an
“indication of [investor] interest” in 75% of the BBB securities in Gemstone 7.1456 After
receiving this email, Mr. Lippmann wrote to Ms. Bogza: “[W]ow that much interest in the bbb?
Is that real?? We would take as much as you can oversell.”1457 Ms. Bogza responded: “no, that
is definitely not real …. it is at 50%; can’t oversell any tranche to be honest,” to which Mr.
Lippmann responded: “very sneaky.”1458
In late February, as the market continued to deteriorate, Deutsche Bank attempted to
motivate its employees to sell Gemstone 7 by providing special incentives to its sales force for
selling the deal. On February 21, 2007, Mr. Kamat wrote to Ms. Bogza: “[W]e need help on
selling the As and BBBs in the Gemstone CDO 7 transaction – we have nearly 50% unsold on
both tranches in the transaction.”1459 In another email the same day, he wrote: “[S]hould we
offer more PCs for Gemstone 7 CDO given the market?”1460 “PCs” refers to Production Credits,
which were used to boost a salesperson’s compensation including through an end-of-year bonus.
Later the same night, Mr. Kamat sent an email to the co-head of the CDO Group seeking to
increase the Production Credits that could be awarded for selling Gemstone 7: “[D]ouble digit
PCs? I guess my original offer of 300 on single-As and 600 on triple-Bs is too low … what can
we offer?”1461
Showing Investors Higher Marks. As the value of mortgage related assets grew more
volatile, some potential investors in Gemstone 7 inquired about the mark to market (MTM) value
of the CDO’s underlying assets. MTM is a valuation method by which the current value of an
asset is recorded on a firm’s books at the price it would sell in the marketplace on the day it is
marked. Investors at times inquire about MTM values to determine if the underlying assets of a
CDO have dropped in value since their inclusion in the warehouse account. Traders who closely
follow buy and sell activity for a particular class of assets are generally best able to provide the
most accurate current valuation. At Deutsche Bank, the CDO Trading Desk marked the value of
assets monthly as a service to its clients and at times provided this service to HBK for the assets
underlying Gemstone 7.1462 HBK also prepared its own internal marks valuing Gemstone’s
assets. According to both Deutsche Bank and HBK, assigning a mark is a very complicated
process that involves credit analysis of the securities at issue. Both explained it was not unusual
for different entities to mark an asset differently.1463
1456 2/20/2007 email from Ilinca Bogza to sales force, DBSI_PSI_EMAIL02007608.
1457 2/20/2007 email from Greg Lippmann to Ilinca Bogza, DBSI_PSI_EMAIL02007608.
1458 2/20/2007 email between Greg Lippmann and Ilinca Bogza, DBSI_PSI_EMAIL02007794.
1459 2/21/2007 email from Abhayad Kamat to Ilinca Bogza, DBSI_PSI_EMAIL04055827.
1460 Id.
1461 2/21/2007 email from Abhayad Kamat at Deutsche Bank to Michael Lamont and others at Deutsche Bank,
1462 3/27/2007 email from Richard Leclezio at Deutsche Bank to Jordan Milman noting that HBK has requested
marks from Deutsche Bank, DB_PSI_00423053-61.
1463 Subcommittee interview of Jordan Milman (10/22/2010). Subcommittee interview of Kevin Jenks (10/13/2010).
During the marketing phase of Gemstone 7, documents indicate several potential
investors asked Deutsche Bank to provide MTM values for the underlying assets in the CDO. In
response, those potential investors were given HBK’s marks, rather than the generally lower
valuations assigned to the assets by Deutsche Bank’s CDO Trading Desk. On January 23, 2007,
Mr. Kamat sent an email to HBK explaining that some potential investors had requested marks
for the Gemstone 7 assets:
“Some investors are asking for current marks on the Gemstone 7 CDO portfolio. The
attached file has the purchase price and the current marks that we got from our desk.
There are many bonds where the price difference between purchase price and current
mark is more than 4% .… I have asked Jordan [Milman, a Deutsche Bank trader] to
review the marks but it would be great if you could have someone at HBK review also to
check if the current marks seem correct. It seems as if the entire portfolio price has
dropped since purchase by 1.74% which does not show well to investors.”1464
Before he heard back from HBK, Mr. Kamat sent a very similar request to Mr. Milman to
review the marks to verify them. He wrote:
“There are many [Gemstone 7] bonds where the price difference between purchase price
and the current mark is more than 4% .… Before we send these over to CDO investors,
pls could you review to check if the current marks are correct. It seems as if the entire
portfolio price has dropped since purchase by 1.74% which does not show well to
The next day, a Deutsche Bank trader verified the marks: “I checked the names that Abhayad
[Kamat] highlighted [and] most are marked within the recent color[.] [T]here are 4 which should
be tightened.”1466
On January 23, 2007, Mr. Kamat learned that HBK’s marks showed a loss of 0.9% or
$9.4 million in the Gemstone 7 portfolio, while Deutsche Bank’s marks showed a greater loss of
1.7% or $19 million.1467 On January 24, 2007, Mr. Kamat directed Deutsche Bank’s syndicate
group to share HBK’s marks with investors instead of Deutsche Bank’s. He wrote: “[F]or
investors who have asked for current marks on the Gemstone CDO 7 portfolio, tell them: HBK
says that the overall current portfolio is down USD 9 million.”1468
A couple weeks later, a question arose about using Deutsche Bank marks for Gemstone 7.
On February 7, 2007, Ms. Bogza from the syndicate group wrote to Mr. Kamat: “Why can we
1464 1/23/2007 email from Abhayad Kamat to HBK, GEM7-00003101. This document has HBK showing a loss of
$9.4 million in the value of the Gemstone assets, whereas Deutsche Bank showed a loss of $19 million. In
interviews with the Subcommittee, both Mr. Milman and Mr. Lippmann said that a 1.74% drop would not have
concerned them because of the relative small dollars involved compared to the $1.1 billion deal.
1465 1/23/2007 email from Abhayad Kamat to Jordan Milman, DB_PSI_00465462.
1466 1/24/2007 email from Jashin Patel to Jordan Milman, DB_PSI_00843917.
1467 1/23/2007 email from Abhayad Kamat to HBK, GEM7-00003101.
1468 1/24/2007 email from Abhayad Kamat to Chehao Lu and others at Deutsche Bank, DB_PSI_00741750-52.
not show a priced [marked] portfolio?? We need to show this [to investors].” Mr. Kamat
responded: “[T]he marks we got from Jordan are too low … and it will take quite some time if
we try to take on an exercise where we try to get kevin and jordan to agree on the correct
marks.”1469 Mr. Kamat wrote to another colleague later that day: “[U]se this for the current
prices to be sent to investors, but please note to investors that this is from HBK.”1470 HBK also
appeared to want to show higher marks to investors. When Mr. Kamat emailed Mr. Jenks
seeking marks for the Gemstone 7 portfolio on February 7, Mr. Jenks sent an internal email to an
HBK assistant trader. Mr. Jenks wrote: “Need line item marks for cdo portfolio[.] use dec or jan
depending on which is better[.]1471
When asked about these documents, Mr. Kamat stated that he advised using HBK’s
marks instead of Deutsche Bank’s marks, because HBK’s marks were better due to the collateral
manager’s familiarity with the assets.1472 However, Deutsche Bank’s trading desk was one of
the biggest traders in RMBS and CDOs on Wall Street, making it unlikely that the desk could not
adequately price the assets that it traded. Deutsche Bank also chose not to share both sets of
marks with investors; it shared only the HBK marks showing higher asset values.
When HBK was asked about this matter, Mr. Jenks told the Subcommittee that he did not
authorize Deutsche Bank to give out HBK’s marks to investors and would be “surprised” if
Deutsche Bank had given out HBK’s marks.1473 Mr. Jenks only recalled one time when an
investor asked Deutsche Bank for Gemstone 7 marks. When the Subcommittee asked several of
the investors who ultimately purchased Gemstone securities if they had asked for marks showing
the current value of the underlying assets, M&T Bank told the Subcommittee that it did not know
to ask for marks.1474 Standard Chartered, Wachovia, and Commerzbank told the Subcommittee
that they did not ask for the marks and it would have been unusual for them to do so. Eight days
before the Gemstone CDO closed and its securities issued, HBK estimated that its portfolio
marks were down approximately $30 million.1475
$400 Million of Unsold Securities. The mortgage market continued to worsen in March
as Deutsche Bank continued to market the Gemstone securities. On March 8, 2007, one week
before the Gemstone 7 deal closed, New Century – the subprime lender whose RMBS securities
made up part of Gemstone – filed an 8-K with the SEC which said: “The Company has only
been able to fund a portion of its loans this week. In addition, its capacity to fund new
originations is substantially limited due to its lenders’ restrictions or refusals to allow the
Company to access their financing arrangements.”1476
1469 2/7/2007 emails between Abhayad Kamat and Ilinca Bogza, DB_PSI_00434692-96.
New Century’s financial troubles were
1470 2/7/2007 email from Abhayad Kamat to Chehao Lu, DB_PSI_00711486.
1471 2/7/2007 email from Kevin Jenks to Jason Lowry, GEM7-00003084.
1472 Subcommittee interview of Abhayad Kamat (10/8/2010).
1473 Subcommittee interview of Kevin Jenks (10/13/2010).
1474 Subcommittee interview of M&T (9/20/2010).
1475 3/7/2007 email from Kevin Jenks to Abhayad Kamat, GEM7-00001958.
1476 3/8/2007 New Century Financial Corporation 8-K filing with the SEC. Even senior Deutsche Bank management
was aware of the problems involving New Century and Fremont during this time period. On March 2, 2007, Mr.
Lippmann sent an email to Mr. Misra, copying Mr. D’Albert, with a subject line: “Fremont Shut Down Sub-Prime
prominently reported in the financial press on March 11, 2007.1477 On March 15, 2007, the day
Gemstone 7 closed, Bear Stearns said that “residential mortgage-related revenue decreased from
the prior year period, reflecting weakness in the U.S. residential mortgage-backed securities
market. … New Century Financial Corp., which had been a major provider of loans to people
with risky credit, said it has lost support from its financial backers and is being delisted from the
NYSE.”1478 New Century comprised 15% of Gemstone 7.
Ultimately $400 million of Gemstone 7 was unsold. Although not contractually
obligated to do so, Deutsche Bank agreed to split the unsold $400 million of Gemstone 7
securities between itself and HBK.1479 Meetings concerning taking back the $400 million were
held at the highest levels of both Deutsche Bank and HBK.1480 As Mr. Lippmann put it: “[W]e
don’t have much choice … either we repo for them or we take it down.”1481
Deutsche Bank and HBK were unable to sell 36% of the securities and instead kept those
securities on their books. Mr. Jenks of HBK told the Subcommittee that he always wanted to
know if unsold portions of a CDO he was interested in investing in would be bought back by the
business” that contained a number of negative news headlines concerning New Century including, “New Century
says U.S. attorney conducting criminal probe … New Century says NYSE reviewing transactions in its securities …
New Century says SEC requested meeting on restatement.” The next day Mr. Misra replied to Mr. Lippmann,
“Well, no regrets. Let’s hold tight on our shorts now. It will be a bumpy market to market ride but we will prevail.”
3/2/2007 and 3/3/2007 email chain between Mr. Lippmann and Mr. Misra, DBSI_PSI_EMAIL02392659-61.
1477 See, e.g., “Crisis Looms In Market for Mortgages,” The New York Times (3/11/2007), (“On March 1, a Wall Street analyst at Bear
Stearns wrote an upbeat report on a company that specializes in making mortgages to cash-poor homebuyers. The
company, New Century Financial, had already disclosed that a growing number of borrowers were defaulting, and
its stock, at around $15, had lost half its value in three weeks. What happened next seems all too familiar to
investors who bought technology stocks in 2000 at the breathless urging of Wall Street analysts. Last week, New
Century said it would stop making loans and needed emergency financing to survive. The stock collapsed to
1478 “Bear Stearns 1Q profit rises 8 percent on strong results in bonds, credit,” Associated Press Financial Wire
(3/15/2007). Also see “New Century Understated Debt; Faces SEC Probe, Stock Delisting,” Associated Press
(3/13/2007),; “New
Century Subpoenaed, Faces Delisting,” Washington Post (3/13/2007),
1479 On 3/14/2007, Fred Brettschneider, head of Deutsche Bank institutional sales, wrote: “We believe that we have
reached an acceptable compromise with HBK. We will be restructuring the unsold mezz AAA and we will
underwrite the senior portion leaving them [HBK] with the junior piece.” 3/14/2007 email from Fred Brettschneider
to Anshu Jain and others, DBSI_PSI_EMAIL02064810-12. On 3/27/2007, Larry Pike of Deutsche Bank wrote with
regard to Gemstone 7, “400mm of the unsold bonds were a middle (mezz) AAA class that were expected to be
purchased by an investor who backed out at a late stage due to a deteriorating market. HBK was upset about this
and wanted DB to take these bonds down, threatening to curtail business globally with HBK if we didn’t.”
3/27/2007 email from Larry Pike to Sean Whelan and others, DB_PSI_00859611.
1480 Subcommittee interview of Michael Lamont (9/29/2010).
1481 Apparently, Mr. Lippmann was explaining that either Deutsche Bank could “repo” or loan money to HBK in
order for HBK to purchase the unsold Gemstone 7 securities or Deutsche Bank would have to “take it down” –
either purchase the securities itself or liquidate the CDO. 2/20/2007 email from Greg Lippmann to Rich Rizzo at
Deutsche Bank, DBSI_PSI_EMAIL02377303.
underwriter, but he did not know if everyone asked about this.1482 M&T Bank told the

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