Sunday, September 4, 2011


2492 Goldman trading datasheet, GS MBS 0000004276 (showing closing dates and trade details on various CDOs,
including Abacus).
2493 3/12/2007 Goldman memorandum to Mortgage Capital Committee, “ABACUS Transaction sponsored by
ACA,” GS MBS-E-002406025, Hearing Exhibit 4/27-118.
2494 Id.
to loss.2490 Abacus also enabled investors to short a selected group of RMBS or CDO securities at
the same time. Goldman used the Abacus CDOs not only to sell short positions to investors, but
also to carry out its own shorts. As summarized in one Goldman Mortgage Capital Committee
Memorandum, the Abacus design allowed “Goldman to short spreads in our core structured
products business in large size.”2491 Between 2004 and 2007, Goldman issued 16 Abacus deals
referencing RMBS securities, including Abacus 2007-AC1, which together had an aggregate value
of $13 billion.2492
Responding to Paulson Inquiry. In mid to late 2006, Goldman was approached by the
hedge fund Paulson & Co. Inc. (“Paulson”), and asked to structure a transaction that would enable
the hedge fund to short multiple RMBS securities.2493 Goldman had previously worked with
Paulson and was aware that Paulson held strong negative views of the residential mortgage market
and was making investments based on that view. The Goldman Mortgage Capital Committee
Memorandum seeking approval of Abacus 2007-AC1, for example, stated:
“Paulson is a macro hedge fund that has taken directional views on the subprime RMBS
market for the past few months. In 2006 the Desk worked an order for Paulson to buy
protection on a supersenior tranche off a portfolio similar to the Reference Portfolio selected
by ACA, and the AC1 Transaction is another means for Paulson to accomplish their trading
objective: buying protection in tranched format on the subprime RMBS market.”2494
An email sent to Daniel Sparks, head of the Mortgage Department, by Fabrice Tourre, a Correlation
Trading Desk employee who led the effort on the Abacus CDO for Paulson, was even more blunt:
2/7/2007 email from Fabrice Tourre, 2495 GS MBS-E-003277939, Hearing Exhibit 4/27-114.
2496 See also 12/18/2006 email from Fabrice Tourre, “Re: Paulson,” GS MBS-E-003246145 (a series of email
communications regarding the Abacus 2007-AC1 CDO in which Mr. Tourre referred to the asset portfolio that
Paulson was proposing for the CDO as “a weak quality portfolio.”).
2497 Subcommittee interview of Fabrice Tourre (4/24/2010). Mr. Tourre also told the SEC that he believed
Paulson’s selection criteria, such as interest-only mortgages and high loan-to-value ratios, were based on Paulson’s
view that securities meeting those criteria were “weaker from the credit quality standpoint than other obligations that
did not have those characteristics.” SEC deposition of Fabrice Tourre (3/3/2009), GS MBS 0000022785, at 813-14.
2498 Subcommittee interview of Fabrice Tourre (4/24/2010).
2499 See, e.g., 12/10/2006 email from Fabrice Tourre to David Lehman, GS MBS-E-003453843, Hearing Exhibit
2500 Subcommittee interview of Fabrice Tourre (4/24/2010); 2/21/2007 email from Fabrice Tourre to David Lehman,
GS MBS-E-011359460-61, Hearing Exhibit 4/27-115.
2501 SEC deposition of Paolo Pellegrini (12/3/2008), PSI-Paulson-04 (Pellegrini Depo)-0001, at 82-85, 175.
“Gerstie and I are finishing up engagement letters ... for the large RMBS CDO Abacus trade
that will help Paulson short senior tranches off a reference portfolio of Baa2 subprime
RMBS risk selected by ACA.”2495
These documents make it clear that Goldman knew Paulson’s investment strategy was to
identify a reference portfolio of assets for the Abacus CDO that Paulson believed would perform
poorly or fail, so that its short position would profit at the expense of the long investors.2496 In
addition, during his Subcommittee interview, Mr. Tourre made it clear that he was aware of the
Paulson investment strategy.2497
In response to the inquiry from Paulson, Goldman proposed structuring an Abacus CDO.2498
Fabrice Tourre was given lead responsibility for organizing and structuring the Abacus transaction.
Goldman’s primary role was to act as an agent and administrator of the CDO, obtaining its profit
from the fees it charged for the services rendered, rather than from any investment in the CDO
itself. In effect, Goldman “rented” the Abacus platform to the Paulson hedge fund and served as
Paulson’s agent in carrying out the hedge fund’s investment objectives. Mr. Tourre had been
suggesting that Goldman employ such an approach and supported the arrangement.2499
Finding a Portfolio Selection Agent. According to Mr. Tourre, Paulson suggested that
Goldman employ an outside portfolio selection agent for the CDO.2500 However, Paolo Pellegrini,
Paulson’s Managing Director who led Paulson’s selection of the reference assets for the Abacus
2007-AC1 transaction, told the SEC that it was Goldman’s idea to have a portfolio selection
agent.2501 At the same time, Goldman internal communications made it clear that the objective was
to select a portfolio selection agent that would comply with Paulson’s suggestions for the assets to
be referenced in the CDO. In an email to colleagues discussing the matter, Mr. Tourre suggested
finding a manager that:
12/18/2006 email from Fabrice Tourre, “Paulson,” GS MBS-2502 E-003246145; 12/20/2006 email from Fabrice
Tourre, GS MBS-E-002534649.
2503 1/10/2007 Goldman internal email, GS MBS-E-002480520, Hearing Exhibit 4/27-108; 1/9/2007 email from
Fabrice Tourre, “For ACA,” GS MBS-E-002480516.
2504 12/18/2006 Goldman internal email, GS MBS-E-003246145-46.
2505 Mr. Egol also suggested HBK as a possible portfolio selection agent. 12/18/2006 email from Fabrice Tourre,
“Re: Paulson,” GS MBS-E-003246145.
“will be flexible w.r.t. [with respect to] portfolio selection (i.e. ideally we will send them a
list of 200 Baa2-rated 2006-vintage RMBS bonds that fit certain criteria, and the portfolio
selection agent will select 100 out of the 200 bonds).”2502
In the early part of January 2007, Mr. Tourre sent an email to prospective selection agents
describing their anticipated role in the CDO. One of his points was the following:
“Reference Portfolio: static, fully identified upfront, and consisting of approx 100 equallysized
mezzanine subprime RMBS names issued between Q4 [the fourth quarter of] 2005 and
today. Starting portfolio would be ideally what the Transaction Sponsor shared, but there is
flexibility around the names.”2503
Goldman’s internal communications also suggest that Goldman was, in fact, more interested
in identifying cooperative portfolio selection agents for its own transactions, rather than locating
one for the Paulson CDO. In an email chain discussing a portfolio selection agent for Abacus 2007-
AC1, a Goldman employee wrote to a colleague that Mr. Tourre “suggested Faxtor was a potential
portfolio selection agent [for Paulson] since they are relatively inexpensive and easy to work with.”
The colleague responded: “We already have a portfolio in front of Faxtor; they probably will be
willing to structure a short that I believe we would want to keep for ourselves ... not sure if this is
the best fit.”2504
Jonathan Egol, chief architect of the Abacus structure and head of the Correlation Trading
Desk, suggested that Goldman approach GSC Partners, a New York hedge fund that Goldman had
worked with on other CDOs, including Anderson. Mr. Tourre sent an email to colleagues asking:
“Do you think gsc is easier to work with than faxtor? They will never agree to the type of
names paulson wants to use, I don’t think steffelin [a senior trader at GSC] will be willing to
put gsc’s name at risk for small economics on a weak quality portfolio whose bonds are
distributed globally.”2505
A colleague replied:
“There are more managers out there than just GSC / Faxtor. The way I look at it, the easiest
managers to work with should be used for our own axes. Managers that are a bit more
Id. An email indicates that, in late December 2006, Mr. Tourre was c 2506 ontemplating several possible portfolio
selection agents, including “Aladdin, DRCM, Greywolf, and . . . GSC.” He also suggested Investec and TCW as
possible candidates. 12/18/2006 email from Fabrice Tourre, “Re: Paulson,” GS MBS-E-003246145.
2507 See, e.g., 1/4/2007 email from Fabrice Tourre to Daniel Sparks, “Paulson post,” GS MBS-E-002526707 (On
January 4, 2007, Goldman “reached out [to] GSC, Greywolf and ACA today re: acting as portfolio selection agent
for a Paulson-sponsored trade.”).
2508 1/6/2007 Goldman email, GS MBS-E-003445985, Hearing Exhibit 4/27-152.
2509 1/29/2007 email from Fabrice Tourre, GS MBS-E-003248998, Hearing Exhibit 4/27-112.
2510 2/27/2007 email from Ed Steffelin to Peter Ostrem, “FW: ABACUS 2007-AC1, Ltd. -- New Issue
Announcement (144a/RegS),” GS MBS-E-009209654.
2511 Subcommittee interview of Edward Steffelin (12/10/2010).
difficult should be used for trades like Paulson given how axed Paulson seems to be (i.e. I’m
betting they can give on certain terms and overall portfolio increase).”2506
On January 4, 2007, on behalf of Paulson, Goldman approached GSC Partners as well as
two other companies to act as the portfolio selection agent for the Abacus CDO.2507 Following a
meeting among representatives of Goldman, Paulson, and GSC, Mr. Tourre sent an email to his
colleagues summarizing the meeting and indicating that Paulson was also looking for a portfolio
selection agent that would be willing to accept many of the reference assets it identified:
“At the end of the meeting, the Paulson team told us that they were happy to have met GSC
and assuming that (1) GSC could get comfortable with a sufficient number of obligations
that Paulson is looking to buy protection on in ABACUS format, (2) GSC could get
comfortable being in the market as early as end of January with a transaction under which
Gsc is disclosed as Portfolio Selection Agent (without any credit risk removal rights), and
(3) Paulson, Goldman, and GSC agree[] on GSC’s required compensation for a transaction
like this, then Paulson will want to proceed with gsc as soon as possible and be in the market
as soon as possible.”2508
Subsequently, Mr. Tourre reported to his colleagues that GSC had declined the offer to act
as the Abacus portfolio selection agent due to its negative views of the assets Paulson wanted to
include in the CDO:
“As you know, a couple of weeks ago we had approached GSC to ask them to act as
portfolio selection agent for that Paulson-sponsored trade, and GSC declined given their
negative views on most of the credits that Paulson had selected.”2509
Later, when Goldman began to market Abacus 2007-AC1 securities, Edward Steffelin, a
senior trader at GSC, sent an email to Peter Ostrem, head of Goldman’s CDO Origination Desk
saying: “I do not have to say how bad it is that you guys are pushing this thing.”2510 When asked by
the Subcommittee what he meant, Mr. Steffelin responded that he believed that particular Abacus
CDO created “reputational risk” for GSC as the collateral manager and for the whole market.2511
Goldman and Paulson eventually settled on ACA Capital Management, LLC, a company
with experience in selecting assets for CDOs. Goldman employees expressed the hope that ACA’s
3/12/2007 Goldman memorandum to Mortgage Capital Committee, 2512 “ABACUS Transaction sponsored by
ACA,” GS MBS-E-002406025, Hearing Exhibit 4/27-118 (The memorandum also stated: “We expect the strong
brand-name of ACA as well as our market-leading position in synthetic CDOs of structured products to result in a
successful offering.” “Partnering with ACA on this innovative, franchise-building transaction will enhance our
leadership in the market for structured product synthetic CDOs. We expect that the role of ACA as Portfolio
Selection Agent will broaden the investor base for this and future ABACUS offerings.” “We intend to target suitable
structured product investors who have previously participated in ACA-managed cashflow CDO transactions or who
have previously participated in prior ABACUS transactions.”). See also SEC Complaint against Goldman at 8.
When asked to confirm that Mr. Tourre “suggested that it would be easier to market or to find sort of a counterparty
to [Paulson’s] short trade if there was a portfolio selection agent involved,” Mr. Pellegrini responded, “Right.” SEC
deposition of Paolo Pellegrini (12/3/2008), PSI-Paulson-04 (Pellegrini Depo)-0001, at 113. Mr. Tourre told the
Subcommittee that having an agent gives comfort to potential investors. Subcommittee interview of Fabrice Tourre
2513 At the Subcommittee hearing, Mr. Tourre testified that Paulson produced the portfolio selection criteria.
Senator Levin then asked Mr. Tourre, “And did those criteria which Paulson gave to you, were they plugged into
your model? Did they generate a list of possible reference securities for that portfolio?” Mr. Tourre responded:
“Yes.” They “were used to actually trim down the universe of RMBS.” April 27, 2010 Subcommittee Hearing at 82.
2514 Subcommittee interview of Fabrice Tourre (4/24/2010).
2515 Paolo Pellegrini told the SEC that Paulson’s selection criteria for Abacus 2007-AC1 included RMBS with a
maximum weighted average FICO score of 640 and a minimum percentage (80%) of adjustable rate mortgages.
Paulson also sought a minimum portfolio size of $750 million. SEC deposition of Paolo Pellegrini (12/3/2008), PSIPaulson-
04 (Pellegrini Depo)-0001, at 140-142. Sihan Shu, an analyst working for Paulson on the Abacus 2007-
AC1 reference asset selection, told the Subcommittee that Paulson’s selection criteria generally included large
percentages of adjustable rate mortgages; high concentrations of mortgages in areas such as California and Florida,
where Paulson believed the housing bubble was greater than in other areas; and limited due diligence. Subcommittee
interview of Sihan Shu (2/24/2010). See also SEC deposition of Sihan Shu (12/4/2008), PSI-Paulson-04 (Shu
Depo)-0001, at 26-28. Similarly, the SEC Complaint listed Paulson’s selection criteria as favoring “RMBS that
included a high percentage of adjustable rate mortgages, relatively low borrower FICO scores, and a high
concentration of mortgages in states like Arizona, California, Florida and Nevada that had recently experienced high
rates of home price appreciation.” SEC Complaint against Goldman Sachs at 9. However, Goldman’s initial
submission to the SEC listed Paulson’s criteria as only 2006-vintage subprime RMBS rated Baa2 by Moody’s. In
the Matter of Abacus 2007-AC1 CDO, File No. HO-10911 (SEC), Submission on behalf of Goldman Sachs
(September 10, 2009), at 11 (hereinafter “Goldman Sachs Submission”). Goldman’s supplemental submission
disclosed that Goldman did use additional criteria listed in draft engagement letters between Goldman and Paulson
“to guide Goldman Sachs’ preliminary search for potential reference securities” that complied with Paulson’s
criteria, which confirms what Mr. Tourre told the Subcommittee in his testimony at the April 27, 2010 Subcommittee
Hearing. In the Matter of ABACUS CDO, File No. HO-10911 (SEC), Supplemental Submission on behalf of
involvement would improve the sales of the Abacus securities. In an internal memorandum seeking
approval of the CDO, for example, Goldman personnel wrote: “We expect to leverage ACA’s
credibility and franchise to help distribute this Transaction.”2512
Selecting Assets. During January, February, and March 2007, the Abacus reference assets
were selected. The Paulson hedge fund initiated the asset selection process by providing Goldman
with criteria for choosing RMBS securities for the CDO.2513 According to Mr. Tourre, Goldman’s
subsequent identification of candidate assets was essentially ministerial, as Paulson’s specified
criteria had restricted the scope of the RMBS securities that could be proposed.2514 For example,
Paulson wanted RMBS securities that had adjustable rate mortgages, low borrower FICO scores,
and mortgages in states with slowing home price appreciation, like Arizona, California, Florida, and
Nevada.2515 Paulson specifically required 2006-vintage or 2007-vintage subprime RMBS that were
Goldman Sachs (September 25, 2009), at 3, 4 (hereinafter “Goldman Supp. Submission”). A January 3, 2007 draft
engagement letter listed the following portfolio selection criteria: Baa2 ratings; RMBS issued after March 1, 2006;
weighted average FICO scores between 600 and 675; and at least 80% adjustable rate mortgages underlying the
RMBS. 1/3/2007 draft engagement letter, PAULSON-ABACUS 0252736, at 40. See also 1/6/2007 email from
Fabrice Tourre to Ed Steffelin and others, GS MBS-E-002754054 (listing criteria for the Abacus portfolio as 2006
vintage bonds underwritten after March 1, 2006; Baa2 rated bonds; average FICO score between 600 and 675;
RMBS transaction size greater than $500 million; and percentage of adjustable rate mortgages greater than 80%).
1/29/2007 email from Fabrice Tourre to Peter Ostrem and others, 2516 GS MBS-E-003248998, Hearing Exhibit 4/27-
112; Goldman Sachs Submission at 12 (citing Gerst Tr. 13-14).
2517 See 1/9/2007 email from Gail Kreitman to Laura Schwartz, GS MBS-E-007974381.
2518 Id.
2519 See 3/22/2007 email from Sihan Shu to Fabrice Tourre and David Gerst, GS MBS-E-003010587.
2520 3/12/2007 Goldman memorandum to Mortgage Capital Committee, “ABACUS Transaction sponsored by
ACA,” GS MBS-E-002406025, Hearing Exhibit 4/27-118; 3/23/2007 Goldman presentation, “ABACUS 2007-
AC1,” GS MBS-E-002807082, Hearing Exhibit 4/27-120; SEC Complaint against Goldman Sachs at 11; Goldman
Sachs Submission at 13.
2521 3/12/2007 Goldman internal memorandum to Mortgage Capital Committee, “ABACUS Transaction sponsored
by ACA,” GS MBS-E-002406025, Hearing Exhibit 4/27-118.
2522 See “Abacus 2007-AC1 Reference Portfolio,” chart prepared by Subcommittee. See also 1/5/2007 email from
Sihan Shu to Ed Steffelin, Fabrice Tourre, and others, GS MBS-E-002483408; 1/6/2007 email from Fabrice Tourre
to Ed Steffelin and others, GS MBS-E-002754054; 1/9/2007 email from Gail Kreitman to Laura Schwartz, GS
MBS-E-007974381; 1/22/2007 email from Laura Schwartz to Fabrice Tourre and others, GS MBS-E-002522389;
1/22/2007 email from David Gerst to Paolo Pellegrini and Sihan Shu, GS MBS-E-002480574; 1/28/2007 email from
Fabrice Tourre to Gail Kreitman and David Gerst, GS MBS-E-002444359; 1/31/2007 email from David Gerst to
Laura Schwartz, GS MBS-E-002620419; 2/1/2007 email from Laura Schwartz to David Gerst, GS MBS-E-
003026086; 2/2/2007 email from Paolo Pellegrini to Laura Schwartz and Sihan Shu, GS MBS-E-002483499;
2/2/2007 email from Laura Schwartz to Paolo Pellegrini and Sihan Shu, GS MBS-E-002483496; 2/5/2007 email
from Paolo Pellegrini to Laura Schwartz, GS MBS-E-003062009; 2/5/2007 email from Laura Schwartz to Paolo
Pellegrini and others, GS MBS-E-002856966; 2/5/2007 email from David Gerst to Paolo Pellegrini and Sihan Shu,
PAULSON-ABACUS 0253248; 2/26/2007 email from Fabrice Tourre to Keith Gorman, GS MBS-E-002444961;
3/22/2007 email from Sihan Shu to Fabrice Tourre and David Gerst, GS MBS-E-003010587; 3/23/2007 Goldman
document, “ABACUS 2007-AC1,” GS MBS-E-002807082, Hearing Exhibit 4/27-120. Goldman asserted: “The
record in this investigation is clear that the overwhelming majority of the securities were identified by ACA.”
Goldman Supp. Submission at 13. However, the Goldman and Paulson documents reviewed by the Subcommittee
show otherwise.
rated BBB by S&P or Baa2 by Moody’s.2516 Goldman sent Paulson a database and spreadsheet
listing the securities that met Paulson’s criteria.2517 Paulson used that database to select 123
securities, and Goldman forwarded the resulting list to ACA.2518 Over the next two months, a series
of negotiations and meetings took place to finalize selection of the reference assets and the structure
of the CDO.
On March 22, 2007, ACA and Paulson agreed on the final $2 billion reference portfolio for
Abacus 2007-AC1.2519 The assets consisted of 90 Baa2 rated mid and subprime RMBS securities
issued after January 1, 2006.2520 The RMBS securities were “equally-sized,” each with a $22.22
million notional value.2521 Each asset in the final reference portfolio was approved by both Paulson
and ACA. Of the final 90 RMBS securities, 49 had been initially proposed by Paulson, and 41 had
been initially proposed by ACA.2522
Goldman 2523 Supp. Submission at 10, 13.
2524 Id. at 10.
2525 SEC deposition of Paolo Pellegrini (12/3/2008), PSI-Paulson-04 (Pellegrini Depo)-0001, at 175-76.
2526 3/12/2007 Goldman memorandum to Mortgage Capital Committee, “ABACUS Transaction sponsored by
ACA,” at 3, GS MBS-E-002406025, Hearing Exhibit 4/27-118.
2527 5/8/2007 email from Fabrice Tourre to Josh Birnbaum, GS MBS-E-003611826, Hearing Exhibit 4/27-123.
2528 3/23/2007 Goldman document, “Abacus 2007-AC1,” at 11-12, GS MBS-E-002807082, Hearing Exhibit 4/27-
2529 4/26/2007 Goldman Sachs Offering Circular, “Abacus 2007-AC1, Ltd.,” at 2, GS MBS-E-001918034.
Goldman characterized Paulson’s participation in the asset selection process as one in which
the hedge fund merely “express[ed] [its] views” about the reference portfolio,2523 which often
happens in synthetic CDO transactions.2524 The evidence indicates, however, that Paulson did more
than express its views; it played an active and determinative role in the asset selection process.
Paulson established the criteria used to identify the initial list of RMBS securities, proposed a
majority of the reference assets in the final portfolio, and approved 100% of the reference assets.
Moreover, the “views” expressed by Paulson directly conflicted with the interests of the investors to
whom Goldman was marketing the Abacus 2007-AC1 deal. Mr. Pellegrini was quite clear about
Paulson’s intentions in a deposition with the SEC:
Question: Your portfolio analysis was designed in large part to identify bonds that weren’t
going to perform, right?
Answer: Right.
Question: Because you wanted to short those bonds?
Answer: Right.2525
Goldman documents reviewed by the Subcommittee contain conflicting information on
exactly who was involved in the asset selection process. Goldman’s Mortgage Capital Committee
Memorandum on the Abacus CDO, the key internal Goldman document describing the new CDO,
stated: “The Reference portfolio has been selected and mutually agreed upon by ACA and
Goldman.”2526 In an email to a colleague, however, Mr. Tourre wrote that the portfolio had been
selected by “ACA/Paulson.”2527 The Abacus Marketing book identified ACA as the portfolio
selection agent for the CDO, and stated that the portfolio selection agent had selected the reference
assets.2528 The Abacus Offering Memorandum stated: “The Initial Reference Portfolio will be
selected by ACA Management, L.L.C.”2529
Another email exchange, between Mr. Tourre and his colleague Mr. Egol, demonstrates the
strong influence Paulson had in the selection process. IKB, a German bank that was a frequent
investor in past Abacus CDOs and was considering purchasing securities issued by Abacus 2007-
AC1, apparently asked to have certain RMBS securities removed from the portfolio and sent the
following email to a Goldman sales representative:
3/12/2007 email from Jorg Zimmerman (IKB) 2530 to Michael Nartey, GS MBS-E-002683134.
2531 3/12/2007 email from Fabrice Tourre to Jonathan Egol, GS MBS-E-002648826.
“[D]id you hear something on my request to remove Fremont and New Century serviced
bonds? I would like to try to [sic] the advisory com[m]it[t]ee this week and would need
consent on it.”2530
The IKB email was forwarded to Mr. Tourre, who sent it to Mr. Egol with the following message:
“Paulson will likely not agree to this unless we tell them that nobody will buy these bonds if we
don’t make that change.”2531 Mr. Tourre expressed concern, not about what ACA, the portfolio
selection agent, might or might not agree to, but only about what the Paulson hedge fund might
agree to.
Failing to Disclose Key Information. Evidence obtained by the Subcommittee indicates
that Paulson’s role in the Abacus asset selection process and its investment objectives for the CDO
were not fully or accurately disclosed to key parties or investors at the time the CDO was being
structured and sold.
Moody’s, one of the credit rating agencies asked to rate the Abacus securities, was not
informed of Paulson’s role or investment objectives. At a Subcommittee hearing on the role of the
credit rating agencies in the financial crisis, Eric Kolchinsky, a former Moody’s managing director
who oversaw its CDO ratings and was familiar with Abacus 2007-AC1, provided sworn testimony
that he had not known of Paulson’s involvement with the CDO at the time it was rated, did not
know of Paulson’s role in selecting the referenced assets, and believed his staff did not know either.
He testified that allowing an entity that wants a CDO to “blow up” to pick its assets “changes the
whole dynamic,” and was information that he would have wanted to know when rating the
Senator Levin: And were you or your staff aware at the time that Moody’s was working on
the ABACUS rating that Paulson was shorting the assets in ABACUS and playing a role in
selecting referenced assets expected to perform poorly?
Mr. Kolchinsky: I did not know, and I suspect, I am fairly sure, that my staff did not know
Senator Levin: And are these facts that you or your staff would have wanted to know before
rating ABACUS?
Mr. Kolchinsky: From my personal perspective, it is something that I would have wanted to
know because it is more of a qualitative not a quantitative assessment if someone who
intends the deal to blow up is picking the portfolio. But, yes, that is something that I would
have personally wanted to know. It changes the incentives in the structure.
2532 April 23, 2010 Subcommittee Hearing at 63-64.
2533 See 3/23/2007 Goldman document, “Abacus 2007-AC1,” at 14, GS MBS-E-002807082, Hearing Exhibit 4/27-
120. Moody’s rating of Aaa is equivalent to a AAA rating. Standard and Poor’s also rated the Abacus Class A-1
notes and the Class A-2 notes as AAA.
2534 Subcommittee interview of Laura Schwartz (ACA) (4/23/2010).
2535 2/12/2007 “CDO Asset ‘Management’ Proposal for Abacus 2007-AC1,” submitted to ACA Commitments
Committee, at 2, ACA-ABACUS-0000121560-66.
2536 2/23/2007 handwritten notes of Laura Schwartz, ACA Managing Director of CDO asset management, ACA
ABACUS 00004171 at 173.
2537 4/10/2007 email from ACA Managing Director Laura Schwartz, ACA-ABACUS-0000006327.
2538 1/10/2007 email from Fabrice Tourre to Laura Schwartz, GS MBS-E-002480520, Hearing Exhibit 4/27-108.
Senator Levin: Are people usually putting deals together that want the deal to succeed?
Isn’t that the usual assumption?
Mr. Kolchinsky: That is the basic assumption, yes.
Senator Levin: And if the person wanting the deal to blow up is picking the assets, that
would run counter to what the usual assumption is?
Mr. Kolchinsky: It just changes the whole dynamic of the structure where the person who is
putting it together, choosing it, wants it to blow up.2532
Moody’s assigned AAA ratings to two tranches of the Abacus CDO.2533
ACA told the Subcommittee that, throughout the asset selection process, it was not informed
and remained unaware of Paulson’s true investment objective, which was to identify and short a set
of assets that it believed would not perform and would lose value.2534 According to ACA, it
believed that Paulson was going to be a long investor in the CDO through its purchase of the equity
share that would incur the first losses in the CDO. Contemporaneous ACA documents support that
position. An internal ACA Commitments Committee Memorandum on Abacus 2007-AC1 dated
February 12, 2007, for example, stated: “The hedge fund is taking the 0-9% equity tranche.”2535
Ten days later, on February 23, 2007, the ACA Managing Director who worked on the Abacus
transaction spoke with a Goldman representative, and took notes of the conversation which stated in
part: “Paulson taking 0-10%.”2536 In April 2007, the same ACA Managing Director sent an email to
the CEO and President of ACA’s parent company, ACA Capital Holdings Inc., which was
considering buying Abacus securities for itself. Her email stated: “We did price $192 million in
total of Class A1 and A2 today to settle April 26th. Paulson took down a proportionate amount of
equity (0-10% tranche).”2537
In addition, on January 10, 2007, a few days after ACA was first approached by Goldman
about working on the Abacus CDO, Mr. Tourre sent ACA a “Transaction Summary” describing the
proposed transaction. The Transaction Summary identified the Paulson hedge fund as the
“Transaction Sponsor,” described the “Contemplated Capital Structure” of the CDO, and indicated
that the lowest tranche, “[0]%-[9]%,” was “pre-committed first loss.”2538 The ACA Managing
Director told the Subcommittee that the “[0]%-[9]%” tranche identified in the Transaction
2539 Subcommittee interview of Laura Schwartz (4/23/2010). See also Statement of Laura Schwartz, ACA ABACUS
00004406 at 408.
2540 Id. See also 1/10/2007 email from Fabrice Tourre to Laura Schwartz, “Transaction Summary,” GS MBS-E-
002480520, Hearing Exhibit 4/27-108; SEC Complaint against Goldman Sachs at 14, 15; Goldman Sachs
Submission at 32 (citing 1/10/2007 email from Fabrice Tourre to Laura Schwartz, “Transaction Summary,” GS
2541 3/23/2007 ACA/Goldman document, “Abacus 2007-AC1,” ACA-ABACUS-002807082, Hearing Exhibit 4/27-
120; Statement of Laura Schwartz, ACA ABACUS 00004406 at 408.
2542 Statement of Laura Schwartz, ACA ABACUS 00004406 at 408.
2543 Subcommittee interview of Fabrice Tourre (4/24/2010).
2544 April 27, 2010 Subcommittee Hearing at 44.
Summary matched the general description of an equity tranche, and the wording suggested that
someone had already committed to buy it.2539 She explained that it was typical for a CDO sponsor
to purchase the equity tranche, and she believed that Paulson, as the Abacus “sponsor,” had
committed to buy that tranche.2540 The Abacus Marketing book also specified that the “First Loss”
tranche of the CDO, of a “[+10%]” size, was “Not Offered” for sale.2541 The ACA Managing
Director declared in a statement to the SEC that she had interpreted the phrase, “Not Offered,” to
indicate the equity tranche had been “pre-placed” and “ha[d] already been committed to purchase by
an investor and [would] not be marketed.”2542 She thought that investor was the Paulson hedge
When asked about the Transaction Summary description of the lowest tranche in the Abacus
CDO, Mr. Tourre told the Subcommittee that the phrase “pre-committed first loss” normally
indicated that the tranche had been sold. He stated that he actually meant to communicate that the
tranche had not been sold, and that portion of the Transaction Summary was poorly worded.2543
In his prepared statement at the Subcommittee hearing, Mr. Tourre testified that he never
told ACA that the Paulson hedge fund would be a long investor in the Abacus CDO:
“I never told ACA, the portfolio selection agent, that Paulson and Company would be an
equity investor in the AC-1 transaction or would take any long position in the deal. Although
I don’t recall the exact words that I used, I recall informing ACA that Paulson’s fund was
expected to buy credit protection on some of the senior tranches in this deal. This necessarily
meant that Paulson was expected to take some short position in the transaction.”2544
In addition, Mr. Tourre testified that he informed ACA that the Paulson hedge fund was
going to invest only on the short side of the transaction:
Senator Levin: You did not disclose to ACA that Paulson was on the short side of this deal.
Is that correct?
Mr. Tourre: I did mention to ACA that the expectation was that Paulson was going to buy
protection on senior layers of risk in the transaction.
Senator Levin: That they were going to be only on the short side.
2545 Id. at 86.
2546 ACA Financial Guaranty Corp. v. Goldman Sachs & Co., Index No. 650027/2011 (N.Y. Sup.), Complaint
(January 6, 2011), at 1, 23 (hereinafter “ACA Complaint against Goldman Sachs).
2547 April 27, 2010 Subcommittee Hearing at 86.
2548 See 3/12/2007 Goldman memorandum to Mortgage Capital Committee, “ABACUS Transaction sponsored by
ACA,” GS MBS-E-002406025, Hearing Exhibit 4/27-118 (“Goldman will receive an upfront premium from Paulson
for distributing risk at or within specified strike spreads.” “If Goldman succeeds in placing a given Targeted
Tranche inside the related Strike Spread, Goldman will receive from Paulson a fee on the notional amount of such
Targeted Tranche distributed. Such fee will have a floor component (the ‘Minimum Fee Rate’) and an upside sharing
component, under which Goldman will share with Paulson any execution delivered at levels tighter than the Strike
Spreads.”). See also 1/18/2007 email from Fabrice Tourre to David Lehman and others, GS MBS-E-002483446
(detailing the additional fees Goldman could earn by executing trades within the strike spread of each tranche);
3/14/2007 email from Paolo Pellegrini to Sihan Shu with “ACA ABACUS Paulson Fee Illustration” spreadsheet
attached (the spreadsheet provides details of the incentive-based fees paid to Goldman, including for Goldman’s
pricing of spreads), PAULSON-ABACUS 0250401. Mr. Pellegrini told the SEC that Goldman and Paulson had
discussions regarding Goldman’s compensation, resulting in “a formula that tied their compensation to sort of kind
of the spread that they sort of presented to or that they would present to us.” SEC deposition of Paolo Pellegrini
(12/3/2008), PSI-Paulson-04 (Pellegrini Depo)-0001, at 118-19. Mr. Tourre described the compensation agreement
in an email to Mr. Sparks, writing that if Goldman could place super senior risk inside a certain spread, Paulson
would pay Goldman an upfront fee and periodic fees reflecting the money Goldman saved Paulson. 9/8/2006 email
from Fabrice Tourre to Dan Sparks, GS MBS-E-009516671. Mr. Tourre told the SEC that Paulson was
Mr. Tourre: Yes.2545
ACA has since filed a civil lawsuit against Goldman asserting that Goldman did not inform ACA
that “Paulson intended to take an enormous short position” in Abacus and is seeking to recover $30
million in compensatory damages and $90 million in punitive damages for fraudulent inducement,
fraudulent concealment, and unjust enrichment.2546
Regardless of the communications between Goldman and ACA, it is clear that the Abacus
marketing material and offering documents provided by Goldman to investors contained no mention
of Paulson’s short position in the CDO nor the significant role it played in the selection of the
CDO’s reference assets. This was confirmed by Mr. Tourre at the Subcommittee hearing:
Senator Levin: And was it reflected in the Goldman Sachs security offering to investors that
Paulson had been part of the selection process? Was that represented in that document?
Mr. Tourre: Paulson was not disclosed in the Abacus 07 AC-1 transaction, Mr. Chairman.
Senator Levin: It was not?
Mr. Tourre: No, it was not.2547
Still another troubling omission was Goldman’s failure to advise potential Abacus investors
that the firm’s own economic interests were aligned with those of the Paulson hedge fund. As part
of the Abacus CDO arrangement, Paulson agreed to pay Goldman a higher fee if Goldman could
provide Paulson with CDS contracts containing premium payments below a certain level.2548 The
“comfortable buying protection only to the extent that the spreads they were paying were less than a certain level.”
SEC deposition of Fabrice Tourre (3/3/2009), GS MBS 0000022785, at 899-900.
SEC Complaint against Goldman Sachs at 18. See Credit Default Swap Insurance 2549 Policy, ACA ABACUS
00001593. ACA complaint against Goldman Sachs at 15, 16.
2550 See Goldman trading datasheet, GS MBS 0000004276 (showing closing dates and details on various deals,
including Abacus).
2551 5/8/2007 email exchange between Joshua Birnbaum and Fabrice Tourre, “Post on Paulson and ABACUS 07-
AC1,” GS MBS-E-003352815; 4/13/2007 email exchange between Fabrice Tourre and Charlie Remnant, “ABACUS
07-AC1,” GS MBS-E-002485172; 5/9/2007 email to Fabrice Tourre, “ABN Amro,” GS MBS-E-002461503. ABN
AMRO Bank N.V. (ABN), a large European bank, intermediated the swap between Goldman and ACA Financial
Guaranty Corp.
2552 The CDS contracts were executed between Goldman Sachs International and Paulson Credit Opportunities
Master II Ltd., one of the Paulson hedge funds. 4/9/2007 email from Nicholas Friedman to Fabrice Tourre and
others, “Re: ABACUS 07-AC1,” GS MBS-E-002449178.
Shortly before the Abacus 2007-AC1 transaction closed, Goldman agreed to take the long side of a CDS
contract on the performance of a small portion of Abacus’ underlying assets when Paulson wanted to increase its
short position at the last minute. Although Goldman ended up retaining this long investment, it did so only because
it could not find an investor who would buy it. Mr. Tourre admitted this fact in the April 27, 2010 Subcommittee
Senator Levin: Did Goldman intend to keep a long stake in that transaction when the deal was structured? I
know it ended up with a piece. Was it intended that it end up with a piece of that deal?
Mr. Tourre: We tried to hedge our risk by selling that piece as well, but were not successful in doing so.
Senator Levin: So it was intended to sell that piece?
Mr. Tourre: For prudent risk management reasons, we were trying –
Senator Levin: Oh, I am sure for all the right reasons. But it was intended that Goldman not have any long
stake on that piece. Is that correct?
Mr. Tourre: Yes.
See also 6/5/2007 email from David Gerst to Jonathan Egol, GS MBS-E-002469912, Hearing Exhibit 4/27-126.
problem with the fee incentive offer was that, while lower premiums would result in lower costs to
Paulson, it would also result in lower premium payments to the CDO, directly reducing the amount
of cash available to the long investors. The Paulson-Goldman compensation arrangement, thus,
created a direct conflict of interest between Goldman and the investors to whom it was selling the
Abacus securities.
Selling Abacus Securities. Abacus 2007-AC1 closed, and its securities were issued on
April 26, 2007. They were issued later than the securities from the Hudson, Anderson, and
Timberwolf CDOs and hit the market as subprime mortgages were hitting record delinquency and
default rates. Goldman sold the Abacus 2007-AC1 securities to just three investors: IKB, the
German bank; ACA, the portfolio selection agent; and ACA Financial Guaranty Corp., the owner of
ACA and a wholly owned subsidiary of ACA Capital Holdings Inc.2549 IKB bought $150 million of
the AAA rated Abacus securities. ACA bought about $42 million in the AAA securities for
placement in another CDO it was managing. 2550 ACA Financial Guaranty Corp. was by far the
largest investor, taking the long side of a $909 million CDS contract referencing the super senior
portion of the CDO.2551 Goldman took the short side of the CDS contract, which it then transferred
to Paulson.2552
2553 SEC Complaint against Goldman Sachs at 3.
2554 10/26/2007 email from Goldman salesman to Michael Swenson, “ABACUS 2007-AC1 – Marketing Points
(INTERNAL ONLY) [T-Mail],” GS MBS-E-016034495.
2555 SEC Complaint against Goldman Sachs at 3.
2556 See SEC Complaint against Goldman Sachs.
2557 Pursuant to 15 U.S.C. §78j(b) and 17 C.F.R. §240.10b-5, the SEC alleged that Goldman and Mr. Tourre, “in
connection with the purchase or sale of securities or securities-based swap agreements, by the use of means or
instrumentalities of interstate commerce or of the mails, directly or indirectly (a) employed devices, schemes or
artifices to defraud; (b) made untrue statements of material facts or omissions of material facts necessary in order to
make the statements made, in the light of the circumstances under which they were made, not misleading; or (c)
engaged in transactions, practices or courses of business which operated or would operate as a fraud or deceit upon
persons.” SEC Complaint against Goldman Sachs at 20-21. The SEC alleged that Goldman and Mr. Tourre
“knowingly or recklessly misrepresented in the term sheet, flip book and offering memorandum for ABACUS 2007-
AC1 that the reference portfolio was selected by ACA without disclosing the significant role in the portfolio
selection process played by Paulson, a hedge fund with financial interests in the transaction adverse to IKB, ACA
Capital and ABN. Goldman&Co and Tourre also knowingly or recklessly misled ACA into believing that Paulson
invested in the equity of ABACUS 2007-AC1 and, accordingly, that Paulson’s interests in the collateral section
process were closely aligned with ACA’s when in reality their interests were sharply conflicting.” SEC Complaint
against Goldman Sachs at 21. Similar charged were filed pursuant to 15 U.S.C. § 77q(a)(1), (2) and (3). See SEC
Complaint against Goldman Sachs at 19.
2558 SEC Complaint against Goldman Sachs at 2, 20, 21.
2559 Securities and Exchange Commission v. Goldman, Sachs & Co. and Fabrice Tourre, Case No. 10-CV-3229,
(S.D.N.Y.), Consent of Goldman Sachs, (July 14, 2010), at 1, 2, 10 (hereinafter “Consent of Goldman Sachs”).
Within months, the high risk subprime mortgages underlying the RMBS securities
referenced in the Abacus portfolio incurred steep rates of default, and the Abacus securities began to
lose value. According to the SEC, by October 2007, six months after the securities were issued,
83% of the underlying assets had received a credit rating downgrade and 17% of the underlying
assets had been placed on a negative credit watch.2553 On October 26, 2007, a Goldman employee
sent an email about Abacus 2007-AC1 with an assessment even more negative than that of the SEC:
“This deal was number 1 in the universe of CDO’s that were downgraded by Moody’s and
S&P. 99.89% of the underlying assets were downgraded.”2554
The three long investors in Abacus 2007-AC1 together lost more than $1 billion. As the
sole short investor, Paulson recorded a corresponding profit of about $1 billion.2555
On April 16, 2010, the SEC filed a complaint against Goldman and Mr. Tourre, alleging
their actions constituted securities fraud.2556 The SEC specifically alleged violations of Section
17(a) of the Securities Act of 1933, as well as Section 10(b) and Rule 10b-5 of the Securities
Exchange Act of 1934.2557 The SEC contended that Goldman had failed to disclose to potential
investors materially adverse information, that the party shorting the reference assets was the same
party that had played a significant role in selecting those assets.2558 On July 14, 2010, Goldman
reached a $550 million settlement with the SEC.2559 In connection with the settlement, Goldman
“[T]he marketing materials for the ABACUS 2007-AC1 transaction contained incomplete
information. In particular, it was a mistake for the Goldman marketing materials to state
Consent of Goldman Sachs at 2. Despite this acknowledgment by 2560 Goldman as part of the settlement, when asked
during the Subcommittee hearing if “a non-biased person [could] look at the facts [of Abacus 2007-AC1] as you see
them and say there is a question of unethical behavior here,” David Viniar, the executive vice present and chief
financial officer for Goldman, stated he “didn’t believe so.” April 27, 2010 Subcommittee Hearing at 125.
2561 Some of the administrative roles that Goldman filled in its CDOs, as described in its CDO agreements, included:
Initial Purchaser, Synthetic Security Counterparty, Senior Swap Counterparty, Credit Protection Buyer, Liquidation
Agent, Calculation Agent under U.S. Dollar Cash Flow Swap Transaction, Collateral Put Provider, CP Note
Placement Agent, Portfolio CDS Counterparty, Hedge Counterparty - Cashflow Swap, Collateral Disposal Agent,
Credit Default Swap Calculation Agent, Basis Swap Counterparty, and Basis Swap Calculation Agent. 2/18/2008
document prepared by Goldman Sachs, outlining the parties serving each role in Goldman underwritten CDOs, GS
MBS 0000004337.
that the reference portfolio was ‘selected by’ ACA Management LLC without disclosing the
role of Paulson & Co. Inc. in the portfolio selection process and that Paulson’s economic
interests were adverse to CDO investors.”2560
Analysis. Goldman constructed Abacus 2007-AC1 to help a hedge fund short multiple
RMBS securities. Goldman allowed the hedge fund to play a significant role in the selection of the
CDO’s referenced assets, while employing an outside portfolio agent to give the impression that the
CDO assets were selected by a disinterested third party. Goldman failed to disclose the hedge
fund’s investment objective and asset selection role to a credit rating agency that assigned AAA
ratings to two tranches of the Abacus securities. Goldman also failed to provide full disclosure to
the long investors to whom it sold the Abacus securities. In addition, Goldman failed to disclose to
the investors a compensation arrangement that provided incentives for Goldman to minimize the
premium payments into the CDO. Within six months, the Abacus securities began incurring losses
and ratings downgrades. Goldman watched the long investors to whom it had sold the securities
lose virtually all the funds they had invested, while the hedge fund it had assisted walked away with
a profit of approximately $1 billion.
(iii) Additional CDO Conflicts of Interest
In addition to creating and failing to manage conflicts of interest arising from its design and
sale of CDO securities, Goldman at times allowed conflicts of interest to affect how it carried out
key roles in the administration of its CDOs.2561 Two examples, in which Goldman acted as the
liquidation agent in Hudson 1 and the collateral put provider in Timberwolf, illustrate the problems.
In both cases, Goldman used its administrative roles to promote and enhance its own financial
interests at the expense of the clients to whom it had sold the CDO securities.
AA. Liquidation Agent in Hudson 1
In 2006 and 2007, several Goldman CDOs included provisions establishing a “liquidation
agent” to sell any poorly performing assets in the CDO. This feature appeared in Hudson
Mezzanine 2006-1, which is examined in this Report, as well as Hout Bay 2006-1, Hudson High
2/18/2008 Goldman presentation, “CDO Transactions 2562 (July 1, 2006 - December 31, 2007) in which Goldman
Sachs acted as underwriter,” GS MBS 0000004337, at 4340; 7/19/2007 Goldman document, “GS Liquidation Agent
Role in ABS CDOs,” GS MBS-E-014055117.
2563 Subcommittee interview of Darryl Herrick (10/13/2010).
2564 Subcommittee interview of Peter Ostrem (10/5/2010).
2565 Id. Although Mr. Ostrem helped design the liquidation agent feature, he was not employed by Goldman when its
CDO assets were downgraded and triggered its liquidation agent duties.
2566 See 7/17/2006 Goldman memorandum to the Mortgage Capital Committee, “Placing debt and equity on a static
high grade structured product CDO Squared with Investec (UK) Limited,” GS MBS-E-013458155.
2567 Id.
Grade 2006-1, Hudson Mezzanine 2006-2, and Anderson Mezzanine 2007-1.2562 In each instance,
Goldman served as the initial liquidation agent, although in several CDOs, it later transferred the
role to a third party. In Hudson 1, Goldman’s dual roles as liquidation agent and sole short party in
the CDO created a direct conflict of interest between Goldman and the clients to whom it sold the
Hudson securities, which Goldman exploited by placing its own financial interests ahead of those of
its clients.
Designing the Liquidation Agent Role. According to Goldman, appointing a CDO
liquidation agent was a “fairly novel idea” that was first implemented in the 2006 Hout Bay
CDO.2563 Peter Ostrem, then head of the CDO Origination Desk, oversaw the drafting of the
liquidation agent feature.2564 He told the Subcommittee that Goldman wanted to issue static
portfolio CDOs, meaning CDOs whose assets did not change over time, but also wanted to protect
investors from poorly performing assets. He explained that the liquidation agent feature was
intended to be triggered by a specified event and provided the liquidation agent with “no discretion”
other than to sell the poorly performing asset, which was referred to as a “Credit Risk Asset.” He
explained that, without such a feature, poorly performing assets would “just stay there” in a CDO,
further harming investors.2565 The CDO Origination Desk also favored the approach, because it
could be performed by Goldman itself at a lower cost than retaining a traditional collateral
The liquidation agent provisions established criteria for identifying “Credit Risk Assets” and
removing them from the CDO. In a July 2006 memorandum to the Goldman Mortgage Capital
Committee, the CDO Origination Desk described the liquidation agent role as follows:
“As Liquidation Agent, Goldman will liquidate assets determined by the Trustee to be
‘Credit Risk Assets’ based on specific guidelines. Goldman will have 12 months to sell
these assets. Sales will be made under a competitive bidding process, whereby we will
solicit three outside bids and select the highest. Prior to executing Hout Bay 1, in which we
also played the Liquidation Agent role, we spoke to multiple counterparties as to our role as
Liquidation Agent. We received approval for our role in this transaction from legal and
accounting. ... Finally, we spoke with outside counsel, Wilmer Cutler, about potential issues
related to the Investment Advisor Act. They are of the opinion that our role of Liquidation
Agent does not cause us to be deemed an Investment Advisor based on the exception to the
Advisors Act for a ‘limited grant of discretion.’”2567
2568 Id.
2569 Id.
One key issue discussed in the memorandum was whether, by assuming the role of
liquidation agent, Goldman would trigger registration and disclosure obligations under the
Investment Advisers Act of 1940. The CDO Origination Desk wrote:
“We have discussed Goldman’s role as Liquidation Agent internally with Tim Saunders
[counsel in Goldman’s legal department] and externally with outside counsel, Wilmer
Cutler. One concern about that role was whether Goldman would be viewed as an
Investment Advisor. We specifically crafted Goldman’s role in Hout Bay 1 and in this case
to eliminate both internal and external counsel’s concern about Goldman being treated as an
Investment Advisor. The main factors that made Tim Saunders and Wilmer Cutler
comfortable that Goldman will not be treated as an Investment Advisor were:
- Goldman’s role is Liquidation Agent and not Collateral Manager. Goldman is
engaged by the CDO to liquidate Credit Risk Assets and will receive an ongoing
Liquidation Agent Fee for such services;
- Goldman does not determine whether an asset is a Credit Risk Asset. Such
determination is made by the CDO based on specific rules . . . ;
- Goldman must liquidate such Credit Risk Assets within 12 months of such
determination and the price received on such liquidation must be in the context of a
three-bid process;
- Goldman does not receive additional compensation and or control of the CDO for
acting as a Liquidation Agent. ...
We will build a provision in the deal documents to allow Goldman to resign as Liquidation
Agent if appropriate notice is given and a replacement Liquidation Agent is in place.”2568
This memorandum indicates that, from its inception, the liquidation agent function was designed as
a narrow, ministerial role, in part to avoid the legal obligations applicable under federal law to
investment advisers.
The memorandum also indicated that “Credit Risk Assets” would be identified through
objective criteria. For example, in the CDO under review, the memorandum stated that Credit Risk
Assets would be defined as “[a]ny asset that is downgraded by Moody’s or S&P below Ba2" and
“[a]ny asset that is defaulted.”2569
Credit Rating Downgrades. One year later, on July 19, 2007, after Mr. Ostrem had left
Goldman and Mr. Lehman had assumed responsibility for all Goldman-originated CDOs, he held a
conference call with members of the CDO team and Goldman in-house legal counsel Tim Saunders,
7/19/2007 Goldman document, “GS Liquidation Agent Role in ABS 2570 CDOs,” GS MBS-E-014055117.
2571 7/23/2007 email from Mr. Case to Mr. Bieber, “CDO Liquidation Agent Role - Draft Talking Points -
2572 7/17/2006 Goldman memorandum to Mortgage Capital Committee, GS MBS-E-013458155, at 57. A
“mezzanine” CDO is one in which the underlying assets carry credit ratings such as BBB or BBB-.
to discuss how to carry out Goldman’s CDO liquidation agent responsibilities. The prior week,
Moody’s and S&P had suddenly downgraded hundreds of RMBS and CDO securities in the first of
many mass downgrades. Those downgrades suddenly caused a number of assets in Goldman’s
CDOs to qualify as Credit Risk Assets that had to be liquidated.
In advance of the conference call, Mr. Lehman’s staff prepared a two-page summary of
Goldman’s liquidation agent duties, the liquidation procedures specified in the CDO documents, the
CDOs affected, and the assets that Goldman anticipated would be affected by the downgrades.2570
Four days after the conference call, on July 23, 2007, Benjamin Case, who had been
assigned lead responsibility for carrying out Goldman’s liquidation agent functions, circulated a
draft document describing Goldman’s role. It stated that Goldman’s goal as liquidation agent was:
“to attempt to maximize proceeds on the unwind of credit risk assets pursuant to the
liquidation process governed by the CDO documents, rather than to liquidate at an arbitrary
pre-specified time without regard to market conditions.”2571
It identified the assets that had been classified as Credit Risk Assets and provided Goldman’s
“Current Strategy” for handling them:
“– wait and continue to evaluate market conditions, rather than liquidating now.
- upside is that continued short-covering by hedge funds anxious to monetize profits could
cause minor rally (5-10 points)[.]
- downside is that speed up of foreclosure process vs. current timeline expected by market
could decrease IO value, or significant forced selling of similar names by CDO vehicles
could push levels wider [lower prices].”
Hudson Liquidation Agent. Although the liquidation agent role was originally designed
for use in Goldman’s “high grade” CDOs, where “there is substantially less credit risk in the assets
vs. a mezzanine structured product CDO portfolio,” the feature was also added to some of its riskier
mezzanine CDOs, including Hudson Mezzanine 2007-1 (Hudson 1).2572 Hudson 1 was a synthetic
CDO whose assets consisted entirely of CDS contracts referencing subprime RMBS or ABX assets
with BBB or BBB- ratings. Goldman had selected 100% of the reference assets and held 100% of
the short side of the CDO.
Hudson 1’s marketing materials outlined Goldman’s liquidation agent role. The Hudson
marketing booklet, for example, told potential investors:
10/2006 “Hudson Mezzanine 2006-1 Flipbook,” GS MBS-E-009546963, H 2573 earing Exhibit 4/27-87.
2574 Goldman Sachs Hudson Mezzanine Funding 2006-1, LTD Preliminary Termsheet, GS MBS-E-001557869.
2575 12/3/2006 Hudson Mezzanine 2006-1, LTD. Offering Circular, GS MBS-E-021821196 at 234.
2576 10/2006 “Hudson Mezzanine 2006-1 Flipbook,” GS MBS-E-009546963, Hearing Exhibit 4/27-87.
2577 See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0239.
2578 10/6/2006 email from Michael Halevi to Olivia Ha, GS MBS-E-014338525.
2579 Subcommittee interview of Darryl Herrick (10/13/2010).
“Hudson CDOs are non-managed and static in nature and provide term non-recourse funding
where Goldman Sachs acts as Liquidation Agent on an ongoing basis. The Liquidation
Agent will be responsible for efficiently selling credit risk assets.”2573

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