Sunday, September 4, 2011


The Hudson term sheet provided additional information about the liquidation agent role and the
“Credit Risk Assets” that would have to be liquidated:
“Goldman as Liquidation Agent, will liquidate any asset determined to be a ‘credit risk’
within 12 months of said determination. Credit Risk assets will include: any asset
downgraded by Moody’s or S&P below Ba3 or BB-, any asset that is defaulted or would be
experiencing a credit event as defined by the PAUG [Pay As You Go] confirm. There will
be no reinvestment, substitution, discretionary trading or discretionary sales. After closing,
assets that are determined to be ‘credit risk’ securities will be sold by the Liquidation Agent
within one year of such determination.”2574
The Hudson Offering Circular repeated that information and added:
“The Liquidation Agent will not have the right, or the obligation, to exercise any discretion
with respect to the method or the price of any assignment, termination or disposition of a
CDS Transaction; the sole obligation of the Liquidation Agent will be to execute such
assignment or termination of a CDS Transaction in accordance with the terms of the
Liquidation Agency Agreement. ... [T]he Liquidation Agent shall have no responsibility for,
or liability relating to, the performance of the Issuer or any CDS Transaction, Reference
Obligation, Collateral Security or Eligible Investment.”2575
Goldman charged a 10 basis point ongoing fee for serving as the Hudson Liquidation Agent,2576
which resulted in its being paid a total fee of approximately $3.1 million.2577
While Goldman was marketing Hudson in 2007, a client asked why the liquidation agent
was “afforded up to 12 months to sell a credit risk asset.”2578 The Subcommittee was unable to find
Goldman’s contemporaneous response, but when asked the same question, Darryl Herrick, the
Hudson deal captain, told the Subcommittee that there was “headline risk” associated with the
downgrade of an asset, and twelve months gave Goldman “flexibility to try to get a better price
later.”2579 When asked whether the “flexibility” to delay a sale violated Hudson’s prohibition
against discretionary trading by the liquidation agent, Mr. Herrick said that Goldman had
Id. Mr. Herrick was not employed by Goldman when its CDO assets were 2580 downgraded and triggered its
liquidation agent duties.
2581 1/3/2008 email from Shelly Lin to Mr. Sparks, GS MBS-E-021880171 (attached file, “Deal Summary,” GS
2582 Id.
2583 10/15/2007 email from Naina Kalavar, “NAB/Hudson Mezz Update 2,” GS MBS-E-015738973. Mr. Case used
this email to circulate his notes of the two telephone conversations.
2584 Id. at 2. The notes included the following: “[C]urrent distressed nature of the assets has been fully priced in and
has not moved over the past 2 months - if unwound those cds would be at 80-90 points, that is % points to be paid up
front to unwind swap - equiv of 20 cents to dollar in cash bond terms ... Across entire universe of loans already in
liquidation - been generally se[e]n 50-60-70 % recovery rates. Rates are not coming back high enough to make the
market opt[i]mistic that bonds will come back to recover princi[pal]. ... Our view that there is upside in waiting
an[d] evaluating mtkt conditions before liquidating. ... We think that the shorts may get impatient – minor rallies
from short covering – domino effect/momentum creates a rally b/c shorts get nervous at little rally – this provides
potential upside to waiting to liquidate.”
2585 Id. at 3. Such an amendment would require investor consent.
“discretion based on a rule,” and that the liquidation agent provisions had been vetted with the
credit rating agencies which “probably wanted the deal to avoid forced sales.”2580
Failure to Liquidate. In July 2007, after the credit rating agencies began the mass
downgrades of RMBS securities, the first RMBS securities underlying the Hudson CDO lost their
investment grade ratings, and the CDS contracts referencing those assets qualified as Credit Risk
Assets requiring liquidation.2581 Within three months, by October 15, 2007, over 28% of the
Hudson assets qualified as Credit Risk Assets.2582 As liquidation agent, Goldman should have
begun issuing bids to sell the assets at the best possible price and remove them from the Hudson
CDO, but it did not.
In October 2007, Goldman began to contact Hudson investors to discuss transferring its
liquidation agent responsibilities to a third party. That transfer required investor consent. Benjamin
Case took notes of two telephone conversations he had with a Hudson investor, National Australia
Bank (NAB), discussing the issues.2583 In the calls, Mr. Case explained why Goldman had yet to
liquidate any of the Credit Risk Assets, explaining that Goldman was waiting for asset prices to
improve.2584 He also reported that Goldman was considering an amendment to the Hudson
transaction that would extend the maximum liquidation period, as well as make other structural
changes to the Hudson deal.2585
According to his notes, Mr. Case informed NAB that Goldman was seeking to transfer its
liquidation role to a third party with more liquidation experience, because that change:
“will be in the best interest of investors - the credit obligation term was originally written
with the expectation that was unlikely to happen. ...
Good for several reasons:
1. Large institutional assets manager will be able to access more liquidity b/c [because] they
can access other broker dealers and get good pricing[.]
10/15/2007 email from Naina Kalavar, “NAB/2586 Hudson Mezz Update 2,” GS MBS-E-015738973.
2587 Id. at 75.
2588 Id. at 76.
2589 Id.
2590 11/9/2007 email from Mr. Case to Mr. Lehman, GS MBS-E-021876334.
2591 2/29/2008 letter from Morgan Stanley to Goldman, HUD-CDO-00006877.
2592 Reference asset OOMLT 2006-2 M8. See 1/3/2008 email from Shelly Lin to Mr. Sparks, GS MBS-E-
021880171 (attached file, “Deal Summary,” GS MBS-E-021880172).
2593 Reference asset MSAC 2006-WMC2 B3. See 1/3/2008 email from Shelly Lin to Mr. Sparks, GS MBS-E-
021880171 (attached file, “Deal Summary,” GS MBS-E-021880172).
2. Even keeping the deal the way it is, the decision of when in the 12 month period to
liquidate could be better handled by an experienced manager[.]
3. Potential amendment could be made to benefit the deal by giving more flexibility to
These notes indicate that, although Goldman was the architect of the Hudson CDO and selected
itself to serve as liquidation agent at a fee of $3.1 million, when Goldman was called upon to
execute its role, it believed the decision of when to liquidate the impaired assets “could be better
handled by an experienced manager.”
According to Mr. Case’s notes, NAB sent Mr. Case an email asking if Goldman held any of
the Hudson investments: “does GS hold any of this?” Mr. Case responded:
“def own equity and different pieces of various tranches no [sic] exactly, but decent size and
numbers of cl[a]sses on our books.”2587
Mr. Case apparently did not disclose that, in addition to its $6 million equity tranche, Goldman also
held 100% of the short position in the $2 billion CDO, and that its short investment would increase
in value as the Hudson assets lost value.
According to Mr. Case’s notes, NAB replied by asking Goldman to provide more specific
information about Goldman’s holdings in the transaction: “Could you please follow up with what
Goldman holds?”2588 When Mr. Case asked why NAB wanted that information, NAB responded:
“Want to make sure you [Goldman] are making restructuring decisions for the right reasons - make
sure serving the right interests.” According to his notes, Mr. Case replied: “Our intended goal of
liquidation agent is to serve the best interests of the CDO - that is the duty of the liquidation agent -
it is a policy and process.”2589
In November 2007, Goldman took initial steps to transfer its liquidation agent
responsibilities to a third party.2590 At that point, Goldman had yet to liquidate any of the Hudson
Credit Risk Assets.2591 The nine assets that had become Credit Risks in July had already dropped
significantly in value. One asset which, on July 16, had a value of 61% of its face (par) value, had
fallen by November 1 to 16% of par.2592 Another asset that, on July 16, had a value of 43% of par,
had fallen in value by November 1 to 7% of par.2593
See 11/29/2007 email from Mr. Case to Mr. Sparks, 2594 Mr. Lehman, and others, GS MBS-E-021876502.
2595 Subcommittee interview of David Lehman (9/27/2010).
2596 12/18/2007 email from Lira Lee to [investor], GS MBS-E-021878556.
2597 See discussion of Hudson 1, above.
2598 12/19/2007 email from Mr. Case to Nicole Martin of Morgan Stanley, GS MBS-E-021876172.
2599 Subcommittee interview of Morgan Stanley (8/6/2009).
2600 Id.
2601 1/3/2008 email from Shelly Lin to Mr. Sparks, GS MBS-E-021880171 (attached file, “Deal Summary,” GS
At the end of November, Goldman reached an agreement with Trust Company of the West
(TCW), subject to investor approval, in which Goldman would assign its liquidation agent duties to
TCW, and TCW would “share back” 30% of the fees with Goldman.2594 Mr. Lehman told the
Subcommittee that Goldman’s decision to assign the liquidation agent rights to a third party was
because liquidation was a non core business for Goldman, and TCW was better suited to liquidate
the Credit Risk Assets.2595 On December 18, 2007, while Goldman was still seeking investor
approval to assign the liquidation agent role to TCW, a Goldman representative explained to an
investor the firm’s thinking:
“GS [Goldman Sachs] is soliciting consent to assign GS role as liquidation agent to TCW
bec[ause] when liquidation agent role was designed, it was very ‘out of the money’; now
when the risk is very real, it is much more efficient to have a sophisticated collateral
manager bec[ause]
(i) TCW can access better liquidity than GS, ie get bids from the entire street
(ii) real asset manager can pursue further amendments to the doc to make liquidation more
efficient bec[ause] is not an asset [manager] under the investment act in 1940 and cannot act
[sic] investment advisory services and can’t act with optimal discretion.”2596
On December 19, 2007, Morgan Stanley, the largest Hudson long investor with a $1.2
billion interest encompassing the entire super-senior tranche,2597 was presented with a consent form
to assign the liquidation agent rights to TCW.2598 Morgan Stanley told the Subcommittee that it had
declined to consent to the transfer, because the liquidation agent role was ministerial, had no
discretionary authority, and could quickly and easily be accomplished by Goldman.2599 Morgan
Stanley told the Subcommittee that it instead asked Goldman to begin liquidating the $596.5 million
in Credit Risk Assets immediately, some of which had been designated as Credit Risks for five
months, and all of which had declined in value.2600
On January 3, 2008, Daniel Sparks, the Mortgage Department head, was given a
spreadsheet listing the Credit Risk Assets in each of the CDOs in which Goldman was serving as
the liquidation agent, including Hudson 1. The spreadsheet showed that, in Hudson, 44 assets were
Credit Risks with a face value of $635 million, totaling about 30% of the asset pool.2601
[SEE CHART NEXT PAGE: Credit Risk Assets, prepared by
Goldman Sachs.]
Credit Risk Assets (%)
G) I Anderson (,J c:
nI 25.00% Hout Bay
I-n II Hudson High Grade G) 20.00%
I/) II Hudson Mezz 1
<-C II Hudson Mezz 2 c: 15.00% e...
:::l .(.). 10.00% 0
0~ 5.00%
7/1/2007 7/31/2007 8/30/2007 9/29/2007 10/29/2007 11/28/2007 12/28/2007
2602 Id.
2603 See, e.g., 1/16/2008 email from Nicole Martin to Mr. Lehman, GS MBS-E-022164848.
2604 Due to the extensive losses experienced by Hudson 1, by January 2008, Morgan Stanley was likely the only long
investor whose investment was not completely extinguished.
The spreadsheet also showed that the weighted average values of the Hudson assets had fallen
dramatically, causing losses that could have been avoided had Goldman liquidated them sooner.
The weighted average values had fallen from 45% of face (par) value in July, to a low of 15% on
November 1, 2007, and were about 20% of par value on January 2, 2008.2602
[SEE CHART NEXT PAGE: Weighted Average Levels, prepared by
Goldman Sachs.]
Hudson Conflict of Interest. Despite the falling values and Morgan Stanley’s ongoing
request to initiate liquidation of the Credit Risk Assets as set out in the Hudson 1 agreement,
Goldman still did not begin liquidating.
During January and February 2008, Morgan Stanley engaged in frequent communications
with Goldman personnel, including Mr. Lehman who oversaw Goldman’s CDOs, and Mr. Case
who oversaw the liquidation agent function, to initiate liquidation of the Hudson assets.2603 The
falling value of the Hudson assets caused sharp losses in Morgan Stanley’s $1.2 billion investment,
leading Morgan Stanley to press for the Credit Risk Assets to be liquidated and removed from the
CDO as soon as possible. In contrast, as the Hudson assets fell in value, Goldman, as the CDO’s
sole short party, saw its short position become increasingly profitable. Goldman had little financial
incentive to liquidate the Credit Risk Assets, because the more they fell in value, the more Goldman
was able to maximize the profits from its short position in the CDO. Goldman’s dual roles as
liquidation agent and short party, thus, created a conflict of interest that disadvantaged the long
investors in the Hudson CDO, such as Morgan Stanley.2604
~ 30.00%
Weighted Average Levels
I Anderson
Houl Bay
o Hudson High Grade
II Hudson Mezz 1
II Hudson Mezz 2
8/15/2007 9/14/2007 10/14/2007 11/13/2007 12/13/2007
1/16/2008 email from John Pearce of Morgan Stanley 2605 to Michael Petrick, HUD-CDO-00004851.
2606 2/5/2008 email from Mr. Pearce to Mr. Lehman and Nicole Martin, HUD-CDO-00004852.
2607 2/6/2008 email from Mr. Pearce to Michael Petrick, HUD-CDO-00005146.
2608 2/7/2008 email from Mr. Pearce to Mr. Lehman, HUD-CDO-00005147.
2609 Transcript of 2/13/2008 telephone call between Morgan Stanley and Goldman, HUD-CDO-00006894. See also
2/28/2008 email from Sue Fertel-Kramer to Mr. Case and others, GS MBS-E-021881029.
Morgan Stanley personnel expressed increasing frustration with Goldman’s failure to
liquidate the Hudson Credit Risk Assets, in both internal communications and with Goldman
representatives. On January 16, 2008, for example, the key trader on Morgan Stanley’s Proprietary
Trading Desk dealing with Hudson wrote to a colleague: “Had another call with [Goldman’s] sr.
trader about GS’s liquidation agent role in the $1.2bn HUDSON deal. They insist they are NOT
acting as a fiduciary per the docs in this deal.”2605 On February 5, he sent Mr. Lehman an email:
“[P]lease call when possible - $969mm now eligible to be liquidated post S&P do[w]ngrades.”2606
On February 6, the Morgan Stanley trader wrote to a colleague:
“[W]ent down the road with Goldman on liquidation agent assets (now ~$1bb of eligible
assets post downgrades). They told me they will ‘continue to take my opinion under
advisement’ but provided no course of action. I broke my phone. Will talk to [Morgan
Stanley legal counsel] tomorrow but don’t think there is any probable way for us to force
them to liquidate assets.”2607
On February 7, the Morgan Stanley trader sent another email to Mr. Lehman:
“Spoke with Ben [Case] re: Hudson today.
Goes without saying I remain very frustrated by the way GS is handling the liquidation agent
role. There is almost $1bb of eligible assets in that deal now, every one of which has lost
value since it was downgraded.
No good reason to wait other th[a]n to devalue our position. It’s a shame .... [O]ne day I
hope I get the real reason why you are doing this to me.”2608
According to Morgan Stanley, Goldman continued to explain its seven-month delay in
liquidating the Credit Risk Assets by asserting that the market would rebound during a rally to cover
shorts, and it should wait to liquidate until asset prices rose. In a February 13, 2008 telephone call
between Morgan Stanley and Goldman, for example, which was recorded and transcribed, Mr. Case
“So I think, as we see the short covering wave kind of continue to proceed ... it’s gonna get
to the point where it’s in the best interest of the deal to start liquidating then. ... I know
we’ve talked about this twelve month period ... it doesn’t seem like it’s gonna take till late in
the twelve month process for the majority of these assets to get to that point.”2609
Morgan Stanley asked if there was anything beyond the “technical nature of the markets,” such as
government intervention, to produce “any kind of real pop” that would improve the underlying
Transcript of 2/13/2008 telephone call between Morgan Stanley and Goldman, H 2610 UD-CDO-00006894.
2611 Id.
2612 2/21/2008 email from Vanessa Vanacker to Mr. Pearce, HUD-CDO-00004882. 2/29/2008 letter from Morgan
Stanley to Goldman, HUD-CDO-00006877.
2613 12/3/2006 Hudson Mezzanine 2006-1, LTD. Offering Circular, section entitled, “Disposition of CDS
Transactions by the Liquidation Agent Under Certain Circumstances,” GS MBS- E-021821196 at 241. See
2/29/2008 letter from Morgan Stanley to Goldman, HUD-CDO-00006877.
2614 2/29/2008 letter from Morgan Stanley to Goldman, HUD-CDO-00006877 [emphasis in original].
fundamentals in the mortgage market. Mr. Case responded: “The chance that it could move in that
direction, at least in the next few months . . . is de minimis I’d say.”2610 During the call, Morgan
Stanley’s representative again urged Goldman to begin the liquidation process: “Just so you know,
my opinion stays the same, I’d like to see a bid list before three o’clock today.”2611
Morgan Stanley told the Subcommittee that the Hudson assets had been in near continuous
decline, and Goldman’s refusal to liquidate assets shortly after they became Credit Risk Assets
allowed them to decline further, rather than limiting losses for bondholders. By February 21, 2008,
Morgan Stanley had calculated that the liquidation delay had cost it $130.5 million; the next week it
calculated the losses had increased to $150 million.2612
Morgan Stanley told Goldman that by delaying the liquidation of the Credit Risk Assets,
Goldman was in violation of the terms in the Hudson 1 offering circular, in particular the provision:
“The Liquidation Agent will not have the right, or the obligation, to exercise any discretion with
respect to the method or the price of any assignment, termination or disposition of a ... Credit Risk
Obligation.”2613 On February 29, 2008, Morgan Stanley sent Goldman a letter demanding that it
immediately initiate liquidation of $1 billion in Hudson Credit Risk Assets:
“As Liquidation Agent, [Goldman] is currently responsible for liquidating approximately
$1,000,000,000 of Credit Risk Obligations. The transaction documents clearly state that
[Goldman] would not exercise investment discretion in its role as Liquidation Agent.
[Goldman] has not yet liquidated a single Credit Risk Obligation, notwithstanding that some
date back to August of 2007. The [Goldman] employee handling the liquidation has
explained this by stating that he believes the price for these obligations will increase in the
future and it is better for the deal to liquidate these obligations at a later date. ...
The Liquidation Agency Agreement states that “the Liquidation Agent ... shall not provide
investment advisory services to the Issuer or act as the “collateral manager” for the
Pledged Assets. ...
While the Liquidation Agency Agreement provides that the Liquidation Agent must
complete the process of liquidating the relevant assets within twelve months, it does not
provide the Liquidation Agent with any right to delay the liquidation process based on the
exercise of Investment discretion. To the contrary, the Liquidation Agency Agreement and
the [Offering Circular] clearly state that no discretion or investment advisory services are
ever to be provided by the Liquidation Agent.”2614
3/10/2008 letter from Goldman to Morgan Stanley, HUD-CDO-00006881. 2615 The letter also states: “Morgan
Stanley’s lack of standing even to advance many positions that are within the exclusive province of Hudson, and the
preclusive effect on Morgan Stanley’s contentions of the Agreement’s broad exculpation and conflict waiver
provisions provide sufficient response.”
2616 See 3/27/2008 email from Morgan Stanley to Goldman, HUD-CDO-00004378. On March 24, 2008, Goldman
offered to unwind the Hudson 1 trade with Morgan Stanley by paying it 9% of the face (par) value of the Hudson
securities. 3/24/2008 email from Goldman to Morgan Stanley, GS MBS-E-022012805.
2617 See, e.g., 3/27/2008 email from Morgan Stanley to Goldman, HUD-CDO-00004378. See also 3/20/2008 email
from Mr. Case, GS MBS-E-021880596.
2618 See 6/6/2008 letter from Goldman as liquidation agent, “Hudson Mezzanine Funding 2006-1, Ltd. - Certain
Dispositions of Assets,” HUD-CDO-00003155.
Morgan Stanley concluded by “demanding only that [Goldman] fulfill its contractual duties as
required by the Liquidation Agency Agreement and assign, terminate or otherwise dispose of the
relevant CDS transaction forthwith.”
On March 10, 2008, Goldman responded:
“[Y]our letter is entirely mistaken in its suggestion that Goldman Sachs has somehow
breached its obligations under the Liquidation Agency Agreement. As [Morgan Stanley’s]
letter recognizes, Section 2(b) of the Liquidation Agency Agreement specifically provides
that Goldman, acting as Liquidation Agent, has up to twelve months in which to assign,
terminate or otherwise dispose of Credit Risk Obligations assigned to it for that purpose.
Obviously, establishment of a liquidation period of that duration contemplates - and, indeed,
embodies Hudson’s informed consent - that the Liquidation Agent will necessarily exercise
judgement in determining when and how to dispose of Credit Risk Obligations assigned to it
for that purpose. ...
Nor does this expressly intended contractual latitude transform Goldman Sachs into a de
facto ‘investment adviser’ to Hudson, as you suggest. The Agreement ... in fact
categorically disclaims that Goldman Sachs or its affiliates will be providing investment
advisory services or otherwise acting as an adviser or fiduciary to Hudson by virtue of its
liquidation services. That disclaimer is perfectly consistent with discretion routinely
accorded to securities brokers in seeking to fulfill their obligation to obtain the best
execution possible for their clients without making them ‘investment advisors.’”2615
Several days before Goldman’s response letter was sent to Morgan Stanley, however,
Goldman began liquidating the Credit Risk Assets in Hudson 1. On March 7, 2008, Goldman
liquidated eight assets, followed by more on March 20 and 28, liquidating nearly one third of the
eligible assets over the course of the month.2616 In its role as liquidation agent, Goldman was
required to solicit bids from at least three independent dealers for the Credit Risk Assets, and
Morgan Stanley was given an opportunity to bid on many of the liquidated assets.2617 Liquidation
proceeded over the next two months, from April through June.2618 On July 22, 2008, Hudson’s
realized losses exceeded $800 million, and Hudson 1 went into default. Hudson’s remaining assets
See 11/21/2008 letter from Goldman to Morgan 2619 Stanley, HUD-CDO-00005125.
2620 The amount of assets in the default swap collateral account was required to equal the total face (“notional”)
value of the CDS entered into by the CDO. This arrangement provided assurance to the short parties that funds
would be available if and when payments were due to them under the CDS. CDO agreements often required that the
cash placed in the default swap collateral account be kept in very secure, short term, cash-like instruments such as
Treasury notes or Certificates of Deposit (called “Eligible Investments”) until the cash was used to acquire default
swap collateral or make payments to a short party. If any credit event resulted in payments from the default swap
collateral account to the short parties under the CDS contracts, the long parties might not receive all of their principal
investment at the maturity of the deal.
were liquidated in November 2008. Morgan Stanley’s losses from its Hudson investment exceeded
$930 million.2619
Analysis. In several of the CDOs it constructed, Goldman established a new position of
liquidation agent and appointed itself to play that role for a substantial fee. In the case of Hudson 1,
by taking on the role of liquidation agent at the same time it was the sole short party in the CDO,
Goldman created a conflict of interest. When the Hudson 1 assets began falling in value, the long
investors wanted the poorly performing assets liquidated as soon as possible; Goldman, on the other
hand, benefitted financially the farther the assets fell in value since that allowed Goldman to
maximize the value of its short position.
Goldman delayed liquidating the Credit Risk Assets, despite urgent requests from the largest
Hudson investor, Morgan Stanley, placing its own financial interests ahead of the client to whom it
had sold a $1.2 billion Hudson investment.
BB. Collateral Put Provider in Timberwolf
The second example of a conflict of interest affecting how Goldman carried out a CDO
administrative function involves Goldman’s role as the collateral put provider in Timberwolf I.
Synthetic CDOs like Timberwolf collected cash from the long investors that purchased its securities
as well as from the short parties that paid CDS premiums to the CDO. A portion of the cash
collected from the long investors was placed by the CDO into a “default swap collateral account” to
be used if the CDO performed poorly and payments had to be made to the short parties.2620 At one
time, many CDOs used the cash in the default swap collateral account to purchase Guaranteed
Investment Contracts (GICs), which guaranteed repayment of the principal and a fixed or floating
interest rate for a fixed period of time. But in the years leading up to the financial crisis, CDO
issuers sought to use the cash in the default swap collateral account to make investments that
generated higher returns, in order to improve financial performance, obtain better credit ratings, and
attract investors. To obtain those higher returns, CDO issuers began to invest the incoming cash in
“default swap collateral securities.”
Goldman’s synthetic CDOs generally invested in default swap collateral securities, and its
CDO agreements typically set out parameters for the types of default swap collateral securities that
could be purchased with investor funds, often requiring them to be high quality, low risk, liquid
The parameters governing the type of default swap collateral securities that 2621 could be purchased with investor
funds were generally outlined in the CDO agreement documents and offering memorandum. Typical criteria
included: a AAA credit rating; a yield slightly greater than LIBOR; limitations on the maturation dates of the
securities; and limited exposure to a single counterparty. Generally, the CDO agreement required that some of the
default swap collateral be retained in Eligible Investments in order be able to fulfill any obligations or payments due
in the short term. In CDOs reviewed by the Subcommittee, the default collateral securities were sometimes RMBS
or CDO securities bearing AAA ratings. These securities often lost substantial value which the collateral put
provider then had to absorb.
2622 The Timberwolf Indenture agreement referred to this role as the “Synthetic Security Counterparty.” See
3/27/2007 Timberwolf I, LTD. Indenture Agreement, at § 12.5(b), GS MBS-E-021825583 at 711.
2623 Typically a shell company incorporated in a foreign jurisdiction (often the Cayman Islands) and a shell company
incorporated in the United States (often Delaware) served as the “Issuer” and “Co-Issuer,” respectively of the CDO.
Generally, the financial institution that was underwriting the CDO, in this case Goldman, would arrange for the
establishment of those entities. For simplicity, this section will refer to both companies as the “Issuer” of the CDO
investments.2621 If the CDO had a collateral manager, the manager often selected the CDO’s default
swap collateral securities. The returns earned by the default swap collateral securities often became
an important component of the CDO’s income. The principal proceeds of the default swap
collateral securities were typically re-invested in similar securities until the CDO matured or the
proceeds were needed to make payments to short parties.
Goldman’s Dual Roles. In its synthetic CDOs, Goldman often took on two roles that
affected the default swap collateral securities, acting as both the CDO’s primary CDS
counterparty2622 and its collateral put provider. Goldman’s synthetic CDOs typically followed
industry practice by making one entity the sole counterparty for all of the CDS contracts issued by
the CDO. In Goldman CDOs, that party was generally Goldman Sachs International (GSI), a
United Kingdom subsidiary that was wholly owned by Goldman. Typically, GSI was the sole party
that entered into a CDS contract directly with the domestic and offshore companies that served as
the issuers of the CDO’s securities (hereinafter collectively referred to as the “Issuer”).2623 GSI
then acted as an intermediary for the Issuer by entering into a corresponding CDS contract with each
party seeking to take a short position in the CDO. By inserting itself into the middle of the CDS
transactions, GSI put Goldman’s financial standing behind the CDS contracts issued by the Issuer
and improved the credit ratings assigned to and investor confidence in the CDO. If a credit event
later took place, the Issuer was responsible for making payments to GSI, and GSI, whether or not it
received sufficient payments from the Issuer, was responsible for making the payments owed to the
short parties in the corresponding CDS contracts. Sometimes, instead of contracting with a third
party, GSI kept some or all of the short positions in the CDO on behalf of Goldman itself.
By acting as the primary CDS counterparty, GSI necessarily took the short side of each
CDS contract it entered into with the Issuer. Those CDS contracts typically provided that, in the
event of a specified credit event that required payment to GSI, GSI could collect a specified amount
of funds from the Issuer. The Issuer paid its obligations to GSI by first drawing down any available
cash in the default swap collateral account. If that cash was insufficient, GSI also had the right to
identify one or more of the default swap collateral securities that together had a face (par) value
equal to the amount owed to GSI. Those securities could then be sold and the sale proceeds used to
Another option was for Goldman 2624 to take physical possession of the security.
2625 In a typical put agreement, the put provider guarantees to pay to the put purchaser the face (par) value of a
specified security upon delivery of the security, or pay to the put purchaser the difference between the security’s par
value and actual market price when sold. In exchange for that protection, the put purchaser typically pays a fee to
the put provider. In many of the CDS contracts associated with synthetic CDOs, as described above, GSI fulfilled
the role of a put provider, by absorbing any shortfall between the face (par) value and market price of any default
swap collateral securities sold to pay amounts owing to the short party in the CDS contract.
2626 See 3/27/2007 Timberwolf I, LTD. Indenture Agreement, at § 12.5(b), GS MBS-E-021825583 at 712. For
accounting purposes, Goldman established a CDO Put Reserve, to account for potential losses that might result from
its role as a collateral put provider in CDOs.
2627 Any subsequent losses resulting from Goldman’s role as the collateral put provider would reduce the profit
resulting from that fee. In responses to Subcommittee questions for the record regarding 7 CDOs (Fort Denison,
Camber 7, Timberwolf, Anderson Mezzanine, Point Pleasant, Hudson Mezzanine 2006-1, and Hudson Mezzanine
2006-2), Goldman reported that for most of the CDOs, the net profit was less than $500,000. One exception was
Hudson Mezzanine 2006-1, which yielded a profit of approximately $1 million. See Goldman response to
satisfy the amount owed to GSI under the CDS contracts.2624 GSI would then use the cash it
received from the sale proceeds to pay off the short parties in the corresponding CDS contracts.
Since GSI’s financial obligations under the CDS contracts were dependent in part upon the quality
of the default swap collateral securities, Goldman provided in the CDO agreement that those
securities could be purchased only with the prior “consent” of GSI. This arrangement enabled
Goldman to exert control over the selection of the default swap collateral securities.
In addition to acting as the primary CDS counterparty in the CDOs it constructed, Goldman
often acted as the CDO’s default swap collateral put provider (hereinafter “collateral put provider”).
The collateral put provider essentially guarantees the face (par) value of the CDO’s default swap
collateral securities.2625
Since GSI was already acting as the primary CDS counterparty, the CDO indenture
agreement typically provided that, if the market value of any default collateral security selected by
GSI to satisfy an amount owed to GSI fell below its face (par) value, then GSI suffered the market
risk, and could not recover additional funds from the Issuer to make up for the security’s loss in
value. GSI was still responsible, however, for making full payments to the short parties in the
corresponding CDS contracts. This arrangement functioned effectively as a “put” agreement that
guaranteed the face (par) value of the default swap collateral securities, and Goldman treated the
arrangement as a put agreement.
Due to the dual roles played by GSI in its CDOs, many of Goldman’s CDO indenture
agreements did not contain an explicit put agreement, but simply constructed GSI’s CDS contracts
to include the provisions that achieved the same result. For example, the Timberwolf Indenture
agreement specified that the primary CDS counterparty in its CDS contract – GSI – bore the market
risk associated with any default swap collateral sold to satisfy an obligation to that counterparty.2626
In exchange for bearing the risk of not receiving the full payment owed to it from the sale of the
default swap collateral securities, GSI received a discount – typically equal to 5 basis points – on
the premiums GSI paid to the Issuer under the primary CDS contract. In a CDO deal of $1 billion,
the premium discount would yield a “fee” of approximately $500,000.2627 In most cases, however,
Subcommittee QFR at PSI_QFR_GS0249. For another CDO, Broadwick, Goldman also projected that the premium
discount would yield a profit of more than $1 million, less any costs it might have to absorb in its role as put
provider. See 4/12/2006 email from Peter Ostrem to John Little and Robert Leventhal, GS MBS-E-010808964 at
66-67 (“Can we agree on how we want to treat P&L [profit and loss] on Peloton relative to the put swap? We expect
P&L of over $1mm [million] for the 5bp [basis point] reduction in the CDS premiums. ... I propose we separately
book the put swap at close to zero (contingent MTM risk on 2 yr AAA diversified portfolio where Goldman retains
selection optionality seems low), but we are open to booking 1bp in negative put cost (i.e., -$200k).”). In some other
CDOs, the projected put fee was about $500,000.
Timberwolf used this reduced premium approach, but in a few other instances, 2628 such as Hudson Mezzanine 2006-
1 and Point Pleasant, Goldman received a direct fee for acting as the collateral put provider. Goldman
representatives told the Subcommittee that, because the put fee was “embedded” in the CDS agreement in some of
the CDOs, Goldman’s operations group sometimes overlooked and failed to “book” the profit and loss associated
with those put arrangements. When this oversight was discovered in 2007, Goldman identified 18 CDO put
arrangements that had not been identified and accounted for in Goldman’s books. See 6/28/2007 email from Carly
Scales to Phil Armstrong and Steve Schultz, GS MBS-E-015192547:
• “Current Put Option Booking State: 22 Deals with the Put Option Feature
C 4 Deals that do have a Put Option Booked:
- For these trades, Ops [the operations group] knew about the Put as there was a confirmation and a
trade booked. ...
• 18 Deals that do not have a Put option Booked:
- For these deals, there was no mention of a Put at all at the time of closing. ...
- The Put option was embedded into the deal documents (Indenture, Offering Circular, etc – both of
which are reviewed by outside counsel and GS legal as a normal course of business – but are not
reviewed by Operations.)
- For these trades, an intermediation fee was being taken on the CDS trades, but no specific Put
was booked in our systems.
- The original explanation from the desk was the intermediation fee was being taken for the risks
associated with standing in between the Street and the deal with no mention of the Put.”
the CDO indenture agreements did not specifically cite the connection between GSI’s bearing the
market risk of the default swap collateral sales and receiving a CDS premium discount. The CDO
agreements simply included a reduced premium payment by GSI under the primary CDS contract
with the Issuer.2628
Timberwolf Conflict of Interest. In the Timberwolf CDO, GSI acted as both the primary
CDS counterparty and the collateral put provider. Documents provided to the Subcommittee show
how these dual roles created a conflict between Goldman and the Timberwolf long investors, and
how Goldman reacted by placing its interests before those of the clients to whom it had sold the
Timberwolf securities.
In 2007, as the mortgage market deteriorated, the value of many types of default swap
collateral securities also declined. Goldman became concerned that if the market value of the
securities fell below par and a credit event occurred, those securities would provide insufficient
funds to pay the amounts owed to GSI under its primary CDS contract with the Issuer. In addition,
Goldman knew that the more the default swap collateral securities fell in value, the more of a
shortfall Goldman would have to make up if GSI had to make payments to other short parties.
Goldman wanted to maximize the value of the default swap collateral and what would be available
One reason Goldman was so concerned about the value of the 2629 default swap collateral securities was because
those securities included AAA rated RMBS securities whose values were declining in line with the entire mortgage
2630 6/20/2007 email from Matthew Bieber to Goldman colleagues, GS MBS-E-001912772 (“Below are the deals I
recall us having significant exposure to in terms of default swap collateral. Who is responsible for each of the deals?
We need to get Dan a list this morning. If there are any missing, please let me know.”).
2631 Id. Mr. Bieber listed the following CDOs: Adirondack 1; Adirondack 2; Coolidge Funding; Broadwick;
Hudson High Grade; Hudson Mezzanine 1; Hudson Mezzanine 2; Fortius I; Fortius II; Camber 7; Hout Bay; Point
Pleasant; Timberwolf; Anderson Mezzanine; Altius I; Altius III; and Altius IV.
2632 Subcommittee interview of Matthew Bieber (10/21/2010).
2633 7/18/2007 email from Alfa Kiflu, GS MBS-E-001866507. The six CDOs in which Goldman had large short
positions were: Hudson Mezzanine 1; Timberwolf; Camber 7; Hudson Mezzanine 2; GSC ABS Funding 2006-3G;
and Anderson Mezzanine.
to make all of the payments needed pursuant to Goldman’s own short positions as well as any
payments it would need to make to other short parties.
In the late spring of 2007, Goldman began to closely monitor the value of the default swap
collateral securities in its synthetic CDOs.2629 On June 20, 2007, Matthew Bieber, a Goldman
employee on the CDO Origination Desk and the deal captain of the Timberwolf CDO, sent an email
to his colleagues requesting information on CDOs that Goldman had “significant exposure to in
terms of default swap collateral.”2630 Mr. Bieber identified 17 possible CDOs where the default
swap collateral securities may have lost value and stated: “we need to get Dan [Sparks, the
Mortgage Department head,] a list this morning.”2631 When asked about this email, Mr. Bieber told
the Subcommittee that he did not recall why he had sent it or why he had to deliver the list to Mr.
Sparks that same day, but he said he did recall that the decline in the value of the default swap
securities was an issue.2632 In response to the email, Goldman employees associated with the
various CDOs submitted lists of the existing default swap collateral securities with their par and
market values.
As the mortgage market worsened, Goldman’s attention to the value of the default collateral
securities increased. On July 18, 2007, the Goldman Credit Department sent an email to Mr. Bieber
indicating that Goldman had large, valuable short positions in six of the CDOs it had originated, but
that the department needed to monitor the value of the default swap collateral securities in each
CDO to understand Goldman’s “exposure” under the CDS contracts:
“From our discussion earlier today, we were able to verify the MTM [mark to market]
exposures on the below CDOs against what we have in our credit systems (they are in fact as
large as we mentioned). Our next step is understanding how the collateral pools are
performing in each of the deals. Would you be able to give us a summary of the current
marks and default writedowns for the below deals? This would help us in monitoring the
collateralization in relation to our exposure from CDS.”2633
The next day, July 19, 2007, Mr. Bieber informed David Lehman, who then oversaw
Goldman’s CDOs, that the Credit Department had asked the ABS Desk in the Mortgage Department
to “mark” the value of all of the default swap collateral securities in the Goldman-originated CDOs
7/19/2007 email from Matthew Bieber to David Lehman, G 2634 S MBS-E-011178225.
2635 7/19/2007 email from Patrick Welch, GS MBS-E-001866507.
2636 7/25/2007 email from Fabrice Tourre, GS MBS-E-001989091.
2637 Id. Greywolf Capital was the collateral manager of the Timberwolf CDO.
2638 7/25/2007 email from Matthew Bieber, GS MBS-E-001989091.
to “get a sense of the MV [market value] supporting the deals[’] obligation to pay us, if
Later that same day, another Credit Department official sent an email message to Mr.
Lehman similar to the one that had been sent to Mr. Bieber:
“We understand that you are responsible for marking the collateral in relation to the below
CDOs. Is that true? If so, can you please put us on your distribution list for these. We have
some sizeable in the money swap positions (i.e. cdo owes GS) and Credit needs to monitor
these positions vs. collateral market value.”2635
With respect to Timberwolf, on July 25, 2007, Fabrice Tourre, a Goldman employee on the
Mortgage Department’s Correlation Trading Desk, circulated an internal Goldman analysis showing
that the weighted average value or “mark” of Timberwolf’s default swap collateral securities had
declined over 3%.2636 During the same period, the value of Goldman’s short position had increased.
Mr. Tourre suggested to his colleagues that as Timberwolf’s default swap collateral securities
matured, the resulting cash proceeds should not be re-invested in new securities, but instead be
retained as cash:
“We need to start monitoring MtM [mark to market value] of the CDS collateral for the
Wolf, given how much in the money the CDS are - right now, average bid side for the AAA
cash bonds is approx 96.89 - per Mahesh analysis below. Matt/Mehesh - maybe we should
look at the collateral reinvestment provisions in this deal - ideally principal proceeds on the
CDS collateral should not be reinvested but I guess Greywolfe [sic] has discretion on this,
In response, Mr. Bieber noted that the same situation applied to all of Goldman’s CDOs; the
declining value of the default swap collateral securities was increasing Goldman’s exposure, and a
weekly monitoring program was being set up. He also noted that it would be difficult for Goldman
to oppose re-investment of the cash proceeds from maturing securities across the board:
“CDS across all of our transactions are in the money. We’ve had conversations at length
with credit regarding our exposure to the default swap collateral and are setting ourselves up
for weekly monitoring/pricing of the default swap collateral across the cdo business.
“We have discretionary approval over default swap collateral, however, it will be difficult
for us to take the non-reinvestment approach.”2638
2639 7/26/2007 email from Shelly Lin, GS MBS-E-015232129.
2640 7/30/2007 email from Matthew Bieber to David Lehman, GS MBS-E-001867239.
2641 See 8/6/2007 email from Connie Kang to David Lehman, GS MBS-E-001992556; 8/9/2007 email from Mahesh
Ganapathy to David Lehman, Matthew Bieber, and Jonathan Egol, GS MBS-E-001930307; 8/12/2007 email from
Mahesh Ganapathy to David Lehman and Matthew Bieber, GS MBS-E-001930343; 8/13/2007 email from Mahesh
Ganapathy to Matthew Bieber, David Lehman, and Jonathan Egol, GS MBS-E-001930571.
2642 In addition, since the yield of most default swap collateral securities was linked to their “face (par) value,” when
the same securities could be obtained at a price lower than their par value, their yield (return on investment)
increased as long as they continued to meet their scheduled principal and interest payments. This was another
potential benefit to the long investors which conflicted with the interest of Goldman, the short party.
2643 8/21/2007 email from Matthew Bieber to David Lehman, GS MBS-E-011273913.
The next day, on July 26, 2007, the collateral manager of one of Goldman’s CDOs sought
approval to purchase some new default swap collateral securities. A Goldman employee responded:
“We are going to pass on this bond. Given current market conditions, we’d like to keep some cash
in the default swap collateral.”2639 A few days later, after receiving more requests to approve the
purchase of new default swap collateral securities, Mr. Bieber asked Mr. Lehman for a meeting to
discuss how to proceed:
“Have gotten several requests today for reinvestment (Greywolf on TWOLF and TCW on
DS7 [Davis Square 7]). Would like to sit down this evening to discuss how we’re going to
respond as this comes up.”2640
In early August, Goldman conducted an internal analysis to assess the decrease in the return
to the CDOs if the default swap collateral was kept in cash rather than re-invested in securities.2641
As expected, that analysis showed that using the cash in the default swap collateral account to buy
new securities would yield a larger return and more money for the CDO investors.2642 But buying
new securities also meant that Goldman, as the primary CDS counterparty and collateral put
provider, would bear the risk if those securities later declined in market value. If the securities’
market value fell below their par value, but had to be sold to make payments to the CDOs’ short
parties, Goldman would have to absorb any shortfall in the course of making the required payments
to the short parties. Goldman’s risk would be mitigated, however, if the default swap collateral was
kept in cash, since cash is not subject to the same market fluctuation. The result was that Goldman
benefitted more if the CDO default swap collateral was kept in cash, but the CDO investors
benefitted more if the collateral was kept in securities. In short, what was best for Goldman clashed
with what was best for the investors to whom Goldman had sold the Timberwolf securities.
Subsequent documents show that Goldman placed its financial interests before those of the
CDO investors by taking actions to keep the CDO default swap collateral in cash, rather than
securities. On August 21, 2007, Mr. Bieber sent an email to Mr. Lehman asking about what
Goldman had decided regarding re-investment of the cash collateral: “Was there any further
discussion over the past few days on what were going to be doing? With the 25th coming up, I
suspect a bunch of managers are going to be looking to put cash to work.”2643 Mr. Lehman
responded: “Nothing further - I think our gameplan remains to build cash for now.” Mr. Bieber
replied: “Ok. I think we should be proactive in letting managers know, then, rather than waiting for
them to come to us for approval and then denying.” Mr. Lehman agreed.
See 9/21/2007 email from Marty Devote of Aladdin Capital Management t 2644 o Benjamin Case, GS MBS-E
022138816 (“We, at the direction of Connie and Roman [Goldman employees], have not been reinvesting CDS
collateral as it matures. We’ve brought the topic up a few times over the past few months with your team. Last I
heard, you were re-evaluating the market, and would come back to us with a breakdown of acceptable replacements.
As the cash balances continue to grow, I’d like to address this issue, as the amount of cash drag is beginning to
become meaningful.”).
2645 9/6/2007 email from Roman Shimonov to Matthew Bieber, GS MBS-E-000765873.
2646 9/6/2007 email from Joe Marconi to David Lehman, GW 107909.
2647 Subcommittee interview of Joseph Marconi (Greywolf Capital) (10/19/2010).
Greywolf Objections. Over the next three or four weeks, Goldman continued to refuse to
consent to the purchase of new default swap collateral securities by the collateral managers of its
At first, Goldman delayed telling Greywolf, Timberwolf’s collateral manager, what it had
decided. In late August and early September, Joseph Marconi, a Greywolf executive, former
Goldman employee, and key member of the Greywolf team managing Timberwolf, sent Goldman
several requests to buy new default swap collateral securities, without receiving a response. On
September 6, 2007, a Goldman employee on the CDO Origination Desk forwarded one of the
requests to Mr. Bieber with the comment: “Guess we can’t delay talking to him anymore.”2645 Mr.
Bieber informed Mr. Marconi that Goldman would no longer approve the purchase of additional
default swap collateral securities for Timberwolf. When informed of Goldman’s decision,
Mr. Marconi protested in an email to Mr. Lehman, who was Mr. Bieber’s supervisor:
“David: I would like to have a call with you to discuss the purchase of Default Swap
Collateral into Timberwolf. I understand you are traveling this week. Let me know when
you will have some time to talk. In response to the attached message, Matt [Bieber] told me
that GS will not approve the purchase of any additional Default Swap Collateral into
Timberwolf. While GS does have consent rights regarding the purchase of Default Swap
Collateral, a blanket refusal to approve any assets is inappropriate, inconsistent with the

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