Sunday, September 4, 2011


parties’ original expectations and will negatively impact the performance of both the debt
and equity issued by Timberwolf. Give me a call when you can.”2646
When asked by Subcommittee what he meant when he wrote that “a blanket refusal to
approve any assets is inappropriate, inconsistent with the parties’ original expectations and will
negatively impact the performance of both the debt and equity issued by Timberwolf,” Mr. Marconi
explained that if Goldman wouldn’t approve any new purchases as the default swap collateral
securities matured, the CDO would have an increasing amount of cash on hand that would produce
less income for Timberwolf than if that cash were invested in new securities.2647
Later on September 6, 2007, Mr. Lehman telephoned and spoke with Mr. Marconi. Neither
he nor Mr. Marconi recalled exactly what was discussed, but the following day Mr. Marconi sent
Mr. Lehman an email that repeated Greywolf’s objections to Goldman’s decision not to consent to
the purchase of new default swap collateral securities:
9/7/2007 email 2648 from Joe Marconi to David Lehman, GW 107909.
2649 Subcommittee interview of Joseph Marconi (Greywolf Capital) (10/19/2010).
2650 Id.
2651 Section 12.5(b) of the Timberwolf Indenture agreement stated: “The Synthetic Securities shall be structured as
‘pay-as-you-go’ credit default swaps. As part of the purchase of each Synthetic Security on or before the Closing
Date, the Issuer will be required to purchase Default Swap Collateral which satisfies the Default Swap Collateral
“David: As we discussed yesterday, I believe that your refusal to approve the purchase of
any additional Default Swap Collateral into Timberwolf is unreasonable and inconsistent
with the way the transaction structure was originally presented to us. We were told that the
purpose of the approval rights was to permit GS to review specific assets and approve or
disapprove specific assets based on their relative credit merits. If we thought for a second
that you had the right to prohibit all new purchases indefinitely, we would have
implemented the much simpler GIC [Guaranteed Investment Contract] structure that is used
in most other synthetic CDOs and CDO^2 transactions and thereby locked in a fixed spread
to LlBOR for the term of our transaction. Also, the Timberwolf CDS economics include an
ongoing fee to GS for the put swap component of the trade; we would not have agreed to
those terms if we thought you had this option. Finally, I believe that if anyone on the deal
team thought you had this option, it would have been clearly disclosed in the OM [Offering
Memorandum]. Especially given current market conditions, I am surprised that you are
taking a position that will directly result in less cash flow being available to debt and equity
investors. As I said yesterday, we recognize the impact of current market conditions and,
even before I spoke with Matt, I was suggesting we collectively focus on shorter average life
AAA RMBS for the deal and I specifically solicited feedback on securities where GS would
be comfortable. I continue to be surprised by your response.”2648
When asked by the Subcommittee why he sent such a strongly worded email to Goldman regarding
its refusal to approve the reinvestment of Timberwolf’s cash collateral, Mr. Marconi responded:
“We felt strongly about this. We had an obligation to investors to do the right thing.”2649
Mr. Marconi told the Subcommittee that Goldman had rationalized its decision by
contending that it was less risky to have more cash and fewer securities. Mr. Marconi also told the
Subcommittee that Greywolf felt Goldman’s blanket refusal to approve the purchase of additional
securities was inconsistent with the terms of the CDO, and if anyone at Greywolf had believed that
Goldman possessed that authority, Greywolf would have structured the deal differently.2650 In
addition, Mr. Marconi’s September 6 email pointed out that Goldman was receiving an “ongoing
fee” to serve as the collateral put provider and undertake the risk of guaranteeing the par value of
the default swap collateral securities. The email stated that Greywolf would not have agreed to pay
that fee to Goldman if it had thought Goldman could use its approval authority to stop the purchase
of all default swap collateral securities and mitigate the risk it was being paid to bear.
The exchanges between Greywolf and Goldman brought into question the proper
interpretation of Section 12.5 of the Timberwolf Indenture agreement which required the CDO to
purchase default swap collateral which satisfied certain criteria and which received the “consent” of
and was not “objected to” by Goldman as the “Synthetic Security Counterparty.”2651 The issue was
Eligibility Criteria set forth in the related Synthetic Security and the inclusion of which has been consented to by the
Synthetic Security Counterparty in the amount required to secure the obligations of the Issuer in accordance with the
terms of the related Synthetic Security which shall be in at least an amount equal to the Aggregate Reference
Obligation Notional Amount. The Synthetic Security Counterparty shall have consent rights with respect to the
Default Swap Collateral and no Default Swap Collateral objected to by the Synthetic Security Counterparty may be
purchased by the Issuer. Default Swap Collateral shall be credited to the Default Swap Collateral Account. The
amount payable by the Issuer to the Synthetic Security Counterparty under a Synthetic Security shall not exceed the
Default Swap Collateral.” 3/27/2007 Timberwolf I, LTD. Indenture Agreement, GS MBS-E-021825583 at 711.
7/25/2007 email from Matthew 2652 Bieber, GS MBS-E-001989091.
2653 1/7/2011 email from Goldman counsel to the Subcommittee.
2654 9/7/2007 email from Matthew Bieber to Tim Saunders, Susan Helfrick, and Jordan Horvath, GS MBS-E-
2655 Id.
2656 9/7/2007 email from Susan Helfrick to Matthew Bieber, Tim Saunders, and Jordan Horvath, GS MBS-E-
whether that authority allowed Goldman to block the purchase of all default swap collateral
securities and essentially limit the default swap collateral to cash. In a July 2007 email, Mr. Bieber
wrote: “We have discretionary approval over default swap collateral, however, it will be difficult
for us to take the non-reinvestment approach.”2652 But when the Subcommittee asked about the
matter, Goldman’s legal counsel sent a written statement indicating the Indenture agreement
authorized Goldman’s actions:
“Section 12.5 of the Indenture for the Timberwolf CDO confers on the Secured Party the
right to consent to the selection and reinvestment of default swap collateral. It is the
position of Goldman Sachs that neither Section 12.5 of the Indenture nor any other relevant
deal documents impose any obligation on the Secured Party to consent to reinvestment of
default swap collateral, either on a case-by-case basis or generally.”2653
Goldman’s internal documents show that on September 7, 2007, the day after the email
exchange between Mr. Marconi and Mr. Lehman, Mr. Bieber scheduled a meeting with Goldman’s
legal counsel and a key compliance officer to discuss the issue. His email stated:
“Pls see email we received below - - wanted to get your take on what response (if any) we
should craft. This is related to the default swap collateral account in Timberwolf used to
collateralize the exposure we have to the CDO on the CDS contracts that are the assets in
The meeting was scheduled for 1:15 p.m. that same day,2655 and one of the counsels requested a
copy of the Offering Memorandum and “the operative documents that contain our rights/obligations
with respect to the Collateral.”2656
The Subcommittee did not locate any documents recounting exactly what was discussed at
the meeting. The default swap collateral issue involved a significant number of Goldman CDOs,
affected Goldman’s relationships with investors and other financial firms serving as collateral
managers of its CDOs, and entailed substantial financial risk for Goldman. Yet, when asked about
Mr. Saunders, Ms. Helfrick, and Mr. Horvath provided signed statements 2657 to the Subcommittee to the same
effect. See written statements submitted to the Subcommittee by Timothy Saunders (12/22/2010), Susan Helfrick
(1/7/2011), and Jordan Horvath (1/7/2011). Although Mr. Lehman was not invited to the meeting, he told the
Subcommittee that he generally recalled having discussions with his colleagues, including Goldman’s legal
department, about the general issue of default swap collateral, but did not recall his conversation with Mr. Marconi.
He also submitted a statement to the Subcommittee saying he had no recollection of whether the meeting took place
or, if a meeting was held, what was discussed or decided. Written statement of Mr. Lehman (1/26/2011). Mr.
Sparks, the head of the Mortgage Department, told the Subcommittee that while he had a general knowledge of the
issue regarding default swap collateral securities, he had no recollection of any meeting or decisions made.
Subcommittee interview of Daniel Sparks (1/13/2011).
2658 Subcommittee interview of Matthew Bieber (10/21/2010).
2659 9/7/2007 email exchange between David Lehman and Matthew Bieber, GS MBS-E-000766414. The reference
to “slmas” is to asset backed securities that were issued by Sallie Mae and backed by pools of student loans.
2660 Id.
it, the key participants said they could not recall whether the meeting took place, what was
discussed at the meeting if it did take place, or what determinations were reached regarding
Goldman’s authority or actions. The participants who could not recall the meeting included Mr.
Bieber, the Timberwolf deal captain; Tim Saunders, counsel from Goldman’s legal department;
Susan Helfrick, another legal counsel; and Jordan Horvath, the compliance officer. Mr. Saunders,
the lead Goldman legal counsel on the matter, informed the Subcommittee that he had “no present
recollection of the circumstances surrounding any disagreement between Goldman Sachs and
Greywolf Capital Management LP regarding Goldman Sachs’ right to consent to reinvestment of
default swap collateral in Timberwolf.”2657 Mr. Bieber, the Timberwolf deal captain, told the
Subcommittee that he did not recall whether Goldman developed any specific strategy limiting the
type of default swap collateral securities that could be purchased for its CDOs.2658
However, documents obtained by the Subcommittee indicate that the meeting did take place,
and Goldman did develop a strategy to respond to Greywolf’s concerns. On September 7, 2007, the
same day as the meeting, Mr. Lehman sent a email to Mr. Bieber stating:
“U spoke w[ith] [Jonathan] egol? What ab[ou]t legal/compliance[?] Just make sure Dan
[Sparks] is ok w[ith] it[.] Also I do th[in]k we sh[oul]d be consistent across deals . . . so if
slmas and credit cards are ‘ok’ I th[in]k we tell our mgrs [managers] that . . . maybe 2
y[ea]rs and shorter.”2659
Mr. Bieber responded: “Spoke with legal/compliance. Not doing anything w/o [without]
discussing with dan [Sparks] first. Agree with the point on consistency.”2660
Also on September 7, 2007, Jonathan Egol, head of the Mortgage Department’s Correlation
Trading Desk, sent an email to Mr. Lehman and others suggesting that Goldman identify a narrow
set of very safe asset backed securities that it could propose to Greywolf as possible default swap
collateral securities, such as AAA rated securities backed by credit card receivables or student
9/7/2007 email from Jonathan Egol to Michael Swenson and David Lehman, G 2661 S MBS-E-000765854.
2662 See 9/7/2007 email from Matthew Bieber to David Lehman, GS MBS-E-000766414 (“I need to speak with
dan... we’re thinking about offering some 1-3 year SLMAs.”).
2663 9/10/2007 email from Matthew Bieber to David Lehman, GS MBS-E-000765316. “SLMA” refers to asset
backed securities that were issued by Sallie Mae and backed by pools of student loans.
2664 9/25/2007 email from Matthew Bieber to Joe Marconi, GS MBS-E-000766338. The action taken by Goldman
to stop the purchase of new default swap collateral securities was not the only instance in which it attempted to exert
control over the collateral in the CDOs it constructed. In the case of the Broadwick CDO, for example, when some
investors were entitled to the return of some collateral, Goldman attempted to have the CDO pay them with securities
rather than cash, so that the CDO would preserve the cash in its collateral account. The Broadwick collateral
manager objected and complained in an email sent to Mr. Sparks, stating in part:
“In case I wasn’t clear on the call, our three main points would be:
1. The aim of the collateral account was to provide LIBOR and not add additional risk to the deal.
2. GS said they would take market risk and clearly represented that to us and to the ratings agencies.
3. The only way the deal works, and the way the deal was marketed and explained to us, is that paydowns
are equivalent to partial terminations. We do not believe you have any right to refuse to release excess
cash that is no longer needed as collateral, and we do not believe you have the right to release bonds
into the waterfall ever, and certainly not when cash exists. Perhaps the way you did these deals
changed over time and you are comparing our deal to ones which you marketed or structured
later/differently? I look forward to hearing from you.”
11/20/2007 email from Ron Beller to Matthew Bieber, GS MBS-E-013746516.
2665 Documents show that a list of assets was sent to Aladdin Capital Management and Trust Company of the West.
See 9/24/2007 email from Benjamin Case to Marty Devote of Aladdin Capital Management, GS MBS-E 022138816;
9/20/2007 email from Matthew Bieber to Vincent Fiorillo of Trust Company of the West, GS MBS-E-022141026-
loans.2661 Mr. Bieber sent an email the same day indicating he supported that approach, but wanted
to speak first with Mr. Sparks, head of the Mortgage Department.2662
Subsequent documents indicate that Goldman reversed its initial position and decided to
consent to the purchase of more default swap collateral securities. However, Goldman appeared to
narrow the class of asset backed securities that it would consent to be acquired as default swap
collateral. On September 10, 2007, Mr. Bieber sent an email to Mr. Lehman reporting:
“Managed to catch up with Dan [Sparks] just now. . .we’re going to put together a list of
SLMA floaters in our inventory to show Joe [Marconi at Greywolf]. Going over w/ Dan
tomorrow before sending anything externally.”2663
Goldman also sent a short list of commercial mortgage backed securities (CMBS) in its inventory
that it would consent to be acquired for Timberwolf.2664
Over the next two weeks, Goldman sent a list of acceptable securities to two more collateral
managers of its CDOs.2665 On October 15, 2007, Mr. Bieber provided virtually the same list to a
Goldman colleague together with a short explanation of some of the criteria used to identify the
10/15/2007 email from Matthew Bieber to Matthew Verrochi, GS MBS-E-2666 015732147. The list had one more
RMBS security than the lists sent to the collateral managers.
2667 9/27/2007 email from Joe Marconi to Matthew Bieber, GW 108645.
2668 Written statement of David Lehman (1/26/2011).
2669 Subcommittee interview of Daniel Sparks (1/13/2011).
2670 The seven CDOs were Fort Denison, Camber 7, Timberwolf, Anderson Mezzanine, Point Pleasant, Hudson
Mezzanine 2006-1, and Hudson Mezzanine 2006-2. Goldman lost $1.018 billion from acting as the collateral put
provider for their default swap collateral securities. See Goldman response to Subcommittee QFR at
“Here are the shelves we’d like to use for default swap collateral reinvestment.
In addition to the default swap collateral constraints in the docs for each transaction, also
looking to securities that are (a) floating rate (b) monthly pay (c) senior-most bond in capital
structure (d) avg life of less than or equal to 2 years (e) currently amortizing.
Please let me know if you have any questions.”2666
All of the listed securities consisted of AAA rated securities backed by residential
mortgages, credit card receivables, automobile loans, or student loans, and had an expected maturity
of two years or less. It appears as if Goldman was restricting the selection of default swap collateral
securities to a limited list of assets that it believed were likely to maintain their par value in order to
minimize its financial exposure.
After indicating it would allow these new purchases, Goldman maintained tight control over
the actual purchases made by the collateral managers. A September 27, 2007 email exchange
between Mr. Marconi of Greywolf and Mr. Bieber of Goldman, for example, demonstrates
Goldman’s intense monitoring effort:
Mr. Marconi: “Matt: I am seeing this list from another dealer. Can I assume that I can buy
any name on your approved list?” ...
Mr. Bieber: “No-we need to give approval on a security by security basis.”2667
When asked about these matters, both Mr. Sparks and Mr. Lehman characterized the default
swap collateral securities issue as a minor issue. Mr. Lehman informed the Subcommittee that he
did not recall significant debate with collateral managers on the matter.2668 Mr. Sparks said the yield
difference between keeping the collateral in cash and investing in securities was minimal and
characterized the whole issue as “structured finance gymnastics.”2669 But information supplied by
Goldman to the Subcommittee on seven Goldman-originated CDOs shows that, due to its duties as
collateral put provider and the declining value of the CDOs’ default swap collateral securities,
Goldman eventually lost over $1 billion.2670
Analysis. In its synthetic CDOs, Goldman arranged for its subsidiary, GSI, to act as both
the primary CDS counterparty and the collateral put provider. Goldman also arranged for GSI to
receive a fee for serving as the collateral put provider, through paying reduced premiums in
connection with the CDS contracts it entered into with the CDOs. Despite this fee, Goldman took
actions to evade its responsibilities as the collateral put provider, including by refusing to approve
the purchase of new default swap collateral securities whose values might decline below par value.
Instead, Goldman tried to force the CDOs to keep their collateral in cash. While this effort provided
more protection for Goldman’s financial interest as the short party, it worked to the disadvantage of
the CDO investors because it produced lower returns for the CDOs than the purchase of default
swap collateral securities.
When the Timberwolf collateral manager objected, Goldman backed down and allowed the
purchase of a narrow range of very safe, short term asset backed securities as collateral for
Timberwolf and other CDOs. Goldman’s conduct in the Timberwolf CDO demonstrates how a
financial institution that plays multiple roles in a CDO can develop conflicts of interest and attempt
to manipulate the CDO to place its own financial interests before those of the investors to whom it
sold the CDO securities.
(6) Analysis of Goldman’s Conflicts of Interest
The Goldman Sachs case study identifies a number of practices that raise conflict of
interest concerns. Those practices include the following.
1. Shorting Its Own Securities. In Hudson, Anderson, and Timberwolf, Goldman
marketed CDO securities to clients, took a substantial portion of the short side of
the CDO, bet the CDO would fall in value, and profited from its short position at
the expense of the clients to whom it sold the securities.
2. Failing to Disclose Key Information to Investors. In Hudson, Anderson, and
Timberwolf, Goldman represented to potential investors that its interests “were
aligned” with theirs or advertised its retention of a portion of the CDO’s equity
tranche, without disclosing that it had an even larger short position in the CDO and
held a financial interest directly adverse to the investors to whom it was selling the
CDO securities.
3. Misrepresenting Source of Assets. In Hudson, Goldman provided 100% of the
CDO assets using CDS contracts it controlled and priced, transferred $1.2 billion of
risk from its own inventory to the CDO, and told investors the assets had been
“sourced from the Street,” when they had been supplied solely by Goldman and not
priced from transactions with third parties.
4. Failing to Disclose Client Involvement. In Abacus, Goldman enabled a client
who was shorting the CDO to help select the CDO’s assets, solicited investors to
buy the Abacus securities without disclosing the short party’s asset selection role or
investment objective, and helped the client gain a $1 billion profit at the expense of
the investors to whom Goldman sold the securities.
5. Minimizing Premiums. In Abacus, Goldman entered into an undisclosed
agreement with the sole short party to accept a fee for arranging low premium
payments by the short party to the CDO, even though low premium payments
meant less money for the long investors to whom Goldman had sold the Abacus
6. Selling Securities Designed to Fail. Goldman sold Hudson and Abacus securities
to clients knowing the securities were designed to fall in value and benefit the short
party, which was a client in the case of Abacus and itself in the case of Hudson.
7. Delaying Liquidation. In Hudson, Goldman was paid a fee to serve as the
liquidation agent, but delayed liquidating assets that were losing value for eight
months, enhancing its financial gain as the CDO’s short party at the expense of the
long parties whose losses would have been staunched if the assets had been
8. Misrepresenting Assets. In Anderson, when clients asked how Goldman got
“comfortable” with poor quality New Century loans in the CDO, Goldman worked
to dispel those concerns and failed to disclose its own discomfort with New Century
loans and that it held 40% of the short side of the CDO, betting its assets would lose
9. Taking Immediate Post-Sale Markdowns. In Timberwolf, Goldman knowingly
sold Timberwolf securities to clients at prices above its own book values and then,
often within days or weeks of a sale, marked down the value of the sold securities,
causing clients to incur quick losses and requiring some to post higher margin or
cash collateral.
10. Evading Put Obligation. In Timberwolf, Goldman was paid a fee to serve as the
collateral put provider, but refused for two months to allow the purchase of default
swap collateral securities, even though they meant better returns for long investors,
because Goldman did not want to assume the risk that the collateral securities might
lose value.
11. Using Poor Quality Loans in Securitizations. Goldman provided securitization
services and warehouse accounts to lenders with a history of issuing high risk, poor
quality loans, and knowingly included poor quality loans in Goldman-originated
RMBS and CDO securities.
12. Concealing Its Net Short Position. From late 2006 through most of 2007,
Goldman engaged in a relentless effort to sell the CDO and RMBS securities it
underwrote, without disclosing to the clients it solicited that Goldman was
simultaneously shorting the subprime market and betting it would lose value.
These practices raise a wide range of ethical and legal concerns. This section examines
the key issues of whether Goldman had a legal obligation to disclose to clients the existence of
material adverse information, including conflicts of interest, when selling them RMBS and CDO
securities; whether Goldman had material adverse interests that should have been disclosed to
investors; and whether Goldman had an obligation not to recommend securities that were
designed to lose value. Many of these issues hinge upon the proper treatment of financial
instruments, such as credit default swaps and CDOs, which enable an investment bank to bet
against the very same securities it is selling to clients.
(a) Securities Laws
To protect fair, open, and efficient markets for investors, federal securities laws impose a
range of specific disclosure and fair dealing obligations on market participants, depending upon
the securities activities they undertake. In the matters examined by the Subcommittee, the key
roles under the securities laws include market maker, underwriter, placement agent, brokerdealer,
and investment adviser.
Market Maker. A “market maker” is typically a dealer in financial instruments that
stands ready to buy and sell a particular financial instrument on a regular and continuous basis at
a publicly quoted price.2671 A major responsibility of a market maker is filling orders on behalf
of customers. Market markers do not solicit customers; instead they maintain buy and sell
quotes in a public setting, demonstrating their readiness to either buy or sell the specified
security, and customers come to them. For example, a market maker in a particular stock
typically posts the prices at which it is willing to buy or sell that stock, attracting customers
based on the competitiveness of its prices. This activity by market makers helps provide
liquidity and efficiency in the trading market for that security.2672 Market makers do not keep
the financial instruments they buy and sell in their own investment portfolio, but instead keep
them in their sales portfolio or “trading book.”
Market makers have among the most narrow disclosure obligations under federal
securities law, since they typically do not actively solicit clients or make investment
recommendations to them. Their disclosure obligations are generally limited to providing fair
and accurate information related to the execution of a particular trade.2673 Market makers are
also subject to the securities laws’ prohibitions against fraud and market manipulation. In
addition, they are subject to legal requirements relating to the handling of customer orders, for
example using best execution efforts when placing a client’s buy or sell order.2674
Underwriter and Placement Agent. Underwriters and placement agents have greater
disclosure obligations than market makers, because in this role they are actively soliciting
customers to buy new securities they have helped an issuer bring to market.
When securities are offered to the public for sale, they are typically underwritten by one
or more investment banks, each of which is a broker-dealer registered with the Financial Industry
Regulatory Authority (FINRA).2675
2671 Section 3(a)(38) of the Securities Exchange Act of 1934 (“The term ‘market maker’ means any specialist
permitted to act as a dealer, any dealer acting in the capacity of block positioner, and any dealer who, with respect to
a security, holds himself out (by entering quotations in an inter-dealer communications system or otherwise) as
being willing to buy and sell such security for his own account on a regular or continuous basis.”); see also SEC
website,; see also FINRA website, FAQs, “What Does a Market Maker
An underwriter is typically hired by the issuer of the new
securities to help the issuer register the securities with the SEC and conduct a public offering of
the securities. The underwriter typically purchases the securities from the issuer, holds them on
its books, conducts the public offering, and bears the financial risk until the securities are sold to
the public.
2672 SEC website,
2673 1/2011 “Study on Investment Advisers and Broker-Dealers,” study conducted by the U.S. Securities and
Exchange Commission, at 55,, (hereinafter “SEC Study on
Investment Advisers and Broker-Dealers”).
2674 See Goldman response to Subcommittee QFR at PSI_QFR_GS0046.
2675 FINRA is the largest independent self-regulatory organization for securities firms doing business in the United
States. FINRA has been delegated authority by the SEC and a number of securities exchanges to regulate the
broker-dealer industry. Its stated mission is “to protect America’s investors by making sure the securities industry
operates fairly and honestly.” See FINRA website,
Investment banks can also act as “placement agents,” assisting those seeking to raise
money through a private offering of securities by helping them design the securities, produce the
offering materials, and market the new securities to investors. Placement agents are also
registered broker-dealers. While public offerings of securities are required to be registered and
filed with the SEC, private offerings are made to a limited number of investors and are exempt
from SEC registration. In the securitization industry, RMBS securities are generally sold
through public offerings, while CDO securities are generally sold through private placements.
Whether acting as an underwriter or placement agent, a major part of the investment
bank’s responsibility is to solicit customers to buy the new securities being offered. Under the
securities laws, an issuer selling new securities to potential investors has an affirmative duty to
disclose material information that a reasonable investor would want to know.2676 In addition,
under securities law, a broker-dealer acting as an underwriter or placement agent is liable for any
material misrepresentation or omission of material fact made in connection with a solicitation or
sale of securities to an investor.2677
The Supreme Court has held that a fact is material if there is a “substantial likelihood that
the disclosure of the omitted fact would have been viewed by the reasonable investor as having
significantly altered the ‘total mix’ of information made available.”2678 The SEC has provided
this additional guidance:
“‘The question of materiality, it is universally agreed, is an objective one, involving the
significance of an omitted or misrepresented fact to a reasonable investor.’ ‘[T]he
reaction of individual investors is not determinative of materiality, since the standard is
objective, not subjective.’ ‘[M]ateriality depends on the significance the reasonable
investor would place on the withheld or misrepresented information.’ Although in
general materiality is primarily a factual inquiry, ‘the question of materiality is to be
resolved as a matter of law when the information is ‘so obviously important [or
2676 See, e.g., SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 201 (1963) (“Experience has shown that
disclosure in such situations, while not onerous to the advisor, is needed to preserve the climate of fair dealing
which is so essential to maintain public confidence in the securities industry and to preserve the economic health of
the country.”). See also SEC Study on Investment Advisers and Broker-Dealers at 51 [citations omitted] (“Under
the so-called ‘shingle’ theory … a broker-dealer makes an implicit representation to those persons with whom it
transacts business that it will deal fairly with them, consistent with the standards of the profession. … Actions
taken by the broker-dealer that are not fair to the customer must be disclosed in order to make this implied
representation of fairness not misleading.”).
2677 See Sections 11 and 12 of Securities Act of 1933. See also Rule 10b-5 of the Securities Exchange Act of
1934. See also SEC v. Capital Gains Research Bureau, Inc., 375 U.S. at 200 (“Failure to disclose material facts
must be deemed fraud or deceit within its intended meaning, for, as the experience of the 1920’s and 1930’s amply
reveals, the darkness and ignorance of commercial secrecy are the conditions upon which predatory practices best
thrive.”). See also Goldman response to Subcommittee QFR, at PSI_QFR_GS0046.
2678 Basic v. Levinson, 485 U.S. 224, 231-32 (1988) (quoting TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438,
449 (1976)).
unimportant] to an investor, that reasonable minds cannot differ on the question of
Unlike when a broker-dealer is acting as a market maker, a broker-dealer acting as an
underwriter or placement agent has an obligation to disclose material information to every
investor it solicits, including the existence of any material conflict of interest or adverse interest.
This duty arises from two sources: the duties of an underwriter specifically, and the duties of a
broker-dealer generally, when making an investment recommendation to a customer.
With respect to the duties of an underwriter, the First Circuit has observed that
underwriters have a “unique position” in the securities industry:
“[T]he relationship between the underwriter and its customer implicitly involves a
favorable recommendation of the issued security. Although the underwriter cannot be
a guarantor of the soundness of any issue, he may not give it his implied stamp of
approval without having a reasonable basis for concluding that the issue is sound.”2680
With respect to a broker-dealer, the SEC has held:
“[W]hen a securities dealer recommends a stock to a customer, it is not only obligated to
avoid affirmative misstatements, but also must disclose material adverse facts to which it
is aware. That includes disclosure of ‘adverse interests’ such as ‘economic self interest’
that could have influenced its recommendation.”2681
The SEC has also stated that, if a broker intends to sell a security from its own inventory and
recommends it to a customer, “the broker dealer must disclose all material facts.”2682
To help broker-dealers understand when they are obligated to disclose to investors
material information, including any material adverse interest, FINRA has further defined the
term “recommendation”:
2679 In the Matter of David Henry Disraeli and Lifeplan Associates, Securities Exchange Act Rel. No. 34-2686
(December 21, 2007) at 10-11 [citations omitted].
2680 SEC v. Tambone, 550 F.3d 106, 135 (1st Cir. 2008) [citations omitted].
2681 In the Matter of Richmark Capital Corporation, Securities Exchange Act Rel. No. 48757 (Nov. 7, 2003) (citing
Chasins v. Smith Barney & Co., Inc., 438 F.3d 1167, 1172 (2d. Cir. 1970) (“The investormust be permitted to
evaluate overlapping motivations through appropriate disclosures, especially where one motivation is economic
self-interest”). See also SEC Study on Investment Advisers and Broker-Dealers at 55. In this recent study
examining the disclosure obligations of broker-dealers and investment advisers, the SEC has explained:
“Generally, under the anti-fraud provisions, a broker-dealer’s duty to disclose material information to its customer
is based upon the scope of the relationship with the customer, which is fact intensive.” According to the SEC,
when a broker-dealer acts as an order taker or market maker in effecting a transaction for a customer, the brokerdealer
generally does not have a duty to disclose information regarding the security or the broker-dealer’s
economic interest. The duty to disclose this information is triggered, however, when the broker-dealer
recommends a security. Id.
2682 SEC Study on Investment Advisers and Broker-Dealers at 56, n.252.
“[A] broad range of circumstances may cause a transaction to be considered
recommended, and this determination does not depend on the classification of the
transaction by a particular member as ‘solicited’ or ‘unsolicited.’ In particular a
transaction will be considered to be recommended when the member or its associated
person brings a specific security to the attention of the customer through any means,
including, but not limited to, direct telephone communication, the delivery of
promotional material through the mail, or the transmission of electronic messages.”2683
Goldman’s own compliance manual essentially incorporates this guidance and instructs Goldman
personnel that a proactive effort to sell a specific investment to a specific customer constitutes a
recommendation of that investment.2684
Once a broker-dealer, acting in the role of an underwriter or placement agent, has made
an investment recommendation and triggered the duty to disclose any material adverse interest to
a potential investor, it must disclose not only that the adverse interest exists, but also the “nature
and extent” of the adverse interest.2685 In addition, it is not enough to inform a customer that the
underwriter or placement agent “may” have an adverse interest if, in fact, the adverse interest
already exists.2686 Further, there is no indication in any law or regulation that the obligation to
disclose material adverse information is diminished or waived in relation to the level of
sophistication of the potential investor.2687
2683 FINRA Notice to Members 96-60.
2684 See 2/1/2001 Goldman document, “United States Policies for the Preparation, Supervision, Distribution and
Retention of Written and Electronic Communications,” at 9, GS MBS 0000035799.
2685 See ,e.g., In the Matter of Arleen Hughes, Securities Exchange Act Rel. No. 4048 (Feb. 1948) (holding a
broker-dealer, who is also a registered investment adviser, violated the anti-fraud provisions of the federal
securities laws by failing to at minimum disclose the “nature and extent” of its adverse interest); In the Matter of
Edward D. Jones & Co., L.P., Exchange Act Rel. No. 50910 (Dec. 22, 2004) (settled order), at 21(broker-dealer
consents to an order finding that disclosure to its customers was inadequate, because it failed to disclose the full
nature and extent of its agreement, including “information about the source and the amount of the revenue sharing
payments to [the broker-dealer] and the dimensions of the resulting potential conflicts of interest”).
2686 See, e.g., SEC v. Czuczko, Case No. CV06-4792 (USDC CD Calif.), Order Granting Plaintiff’s Unopposed
Motion for Summary Judgment (Dec. 5, 2007). In Czuczko, the defendant, who offered online investment advice,
included a disclaimer on his website advising that officers, directors, employees and members of their families
may, from time to time, trade in these securities for their own accounts” [emphasis in original]. Id. at 8. Relying
on SEC v. Blavin, 760 F.2d 706 (6th Cir. 1985), the court held such an assertion “is itself a material misstatement
because the Defendant knew he, his father, and his business partner did trade in the stocks and had a biased interest
in the recommended stocks” [emphasis in original]. Czuczko, at 8.
2687 See FINRA Rules 2210(d)(1)(A) and 2211(a)(3) and (d)(1) (by rule all institutional sales material and
correspondence may not “omit any material fact or qualification if the omission, in the light of the context of the
material presented, would cause the communications to be misleading.”); and FINRA Rule 2310 and IM-2310-3
(suitability obligation to institutional customers). See also Hanly v. SEC, 415 F.2d 589, 596 (2d Cir. 1969)
(holding that sophistication and knowledge of a broker’s customers do not warrant a less stringent standard of
conduct under federal securities laws); Spatz v. Borenstein, 513 F. Supp. 571, 580 (N.D. Ill. 1981) (finding
investors’ experience does not mitigate a broker’s duty to fully and truthfully disclose material facts, nor does the
potential for investors to discover information not disclosed by a prospectus vitiate any legal liability stemming
from a failure to disclose material facts); Department of Enforcement v. Kesner, FINRA Complaint No.
2005001729501 (February 26, 2010) (finding sophistication of investors does not relieve a securities representative
from disclosing material facts to investors).
Suitable Investment Recommendations. In addition to requiring disclosure of material
adverse information, federal securities laws and FINRA rules prohibit broker-dealers from
making investment recommendations that would be unsuitable for any customer.2688
In a recent study, the SEC explained: “[W]hile the suitability obligation under the federal
securities laws arises from the anti-fraud provisions, the SRO [Self Regulatory Organization]
rules are grounded in concepts of ethics, professionalism, fair dealing, and just and equitable
principles of trade.2689 For example, FINRA Rule 2010, providing Standards of Commercial
Honor and Principles of Trade, states: “A member, in the conduct of its business, shall observe
high standards of commercial honor and just and equitable principles of trade.”2690
A broker-dealer violates the suitability rule if it makes a recommendation that “is
unsuitable for any investor, regardless of the investor’s wealth, willingness to bear risk, age or
other individual characteristics.”2691 Under the applicable case law and FINRA rules, a brokerdealer
is also obligated “to have an ‘adequate and reasonable basis’ for any security or strategy
recommendation that it makes.”2692
Suitability rules are intended to prevent abuses that contributed to the stock crash of 1929
and the Great Depression of the 1930s, when Senators investigating investment bank activities at
the time wrote the following:
“[Investors] must believe that their investment banker would not offer them the bonds
unless the banker believed them to be safe. This throws a heavy responsibility upon the
banker. He may and does make mistakes. There is no way that he can avoid making
mistakes because he is human and because in this world, things are only relatively secure.
There is no such thing as absolute security. But while the banker may make mistakes, he
2688 SEC Study on Investment Advisers and Broker-Dealers at 61.
2689 Id.
2690 FINRA Rule 2010. See also Study on Investment Advisers and Broker-Dealers at 55 (broker-dealers also have
an obligation under the federal securities laws and FINRA rules to deal fairly with their customers).
2691 F.J. Kaufman and Co., Securities Exchange Act Rel. No. 27535 at 5 (December 13, 1989).
2692 SEC Study on Investment Advisers and Broker-Dealers at 63 [citations omitted]. The suitability rule also
requires the broker to determine that the specific security recommended is appropriate based on the customer’s
financial situation and needs. FINRA Rule 2310. The suitability obligation clearly applies to institutional
customers, FINRA IM-2310-3 (suitability obligations to institutional customers require members have a reasonable
basis for recommending a particular security or strategy), but may not apply when a broker-dealer solicits another
broker-dealer to buy an investment since, under FINRA Rules, the term “customer” does not include a broker or
dealer. FINRA Manual, 0120 Definition. On the other hand, the term “customer” has been given a broad
definition under the securities case law. See, e.g., Department of Enforcement v. Zayed, FINRA Complaint No.
2006003834901 (August 19, 2010) (“Cases interpreting the term ‘customer’ in the securities context have viewed
the term broadly to encompass individuals or entities that have some brokerage or investment relationship with the
broker-dealer. Specifically, courts have rejected the argument that an account is necessary to establish an
investor’s status as a customer.” [citations omitted]). When the Subcommittee asked Mr. Blankfein whether he
believed there was a difference between a “customer” and a “client,” Mr. Blankfein said he had “never
distinguished” between the two terms. Subcommittee deposition of Lloyd Blankfein (12/15/2009), Hearing Exhibit
4/27-176 [Sealed Exhibit].
must never make the mistake of offering investments to his clients which he does not
believe to be good.”2693
Investment Advisers. For investment banks that act, not just as a broker-dealer,
underwriter, or placement agent, but also as an investment adviser to their customers, federal
securities laws impose still a higher legal duty. When acting as an investment adviser, the law
imposes a fiduciary obligation on the investment bank to act in the “best interests of its
clients.”2694 A person qualifies as an “investment adviser” under the Investment Advisers Act if
that person: provides advice regarding securities, is in the business of providing such advice,
and provides that advice for compensation.2695 A broker-dealer, however, is excluded from the
Investment Advisers Act if the performance of its investment advisory services is “solely”
incidental to its business as a broker-dealer, and the broker-dealer does not receive “special
compensation” for providing those advisory services.2696 Because Goldman appears to have
acted primarily as an underwriter, placement agent, or broker-dealer in carrying out its
securitization activities, this section analyzes Goldman’s conduct in that context and not in the
context of an investment adviser.2697
(b) Analysis
One key issue is whether Goldman was acting as a market maker versus an underwriter
or placement agent when it recommended that its clients purchase its CDO and RMBS securities,
since those roles have different disclosure and suitability obligations under the law. A second
key issue is whether Goldman withheld material adverse information when recommending its
securities to its clients, including the fact that it was shorting the securities it was selling. A third
key issue is whether Goldman violated its obligation to make suitable investment
recommendations when urging customers to purchase securities that Goldman knew were
designed to lose value.
(i) Claiming Market Maker Status
Given its active role in the securitization markets, Goldman assumed a variety of roles in
the development, marketing, and trade of RMBS and CDO products. At times, it acted as a
market maker responding to client orders to buy and sell RMBS and CDO products. In addition,
from 2006 to 2007, Goldman originated and served as an underwriter or placement agent for 27
CDOs and 86 RMBS securitizations, and sold the resulting RMBS and CDO securities to a broad
range of clients around the world.
2693 6/16/1934 “Stock Exchange Practices,” Report of the Senate Committee on Banking and Currency, S. Rep. 73-
1455, at 88 (quoting “Who Buys Foreign Bonds,” Foreign Affairs (1/1927)).
2694 SEC Study on Investment Advisers and Broker-Dealers at 15-16.
2695 Id.
2696 Id.
2697 The Subcommittee did not examine the extent to which Goldman was acting as an investment adviser within
the meaning of the Investment Advisers Act when recommending that various customers buy its RMBS and CDO
In public statements and testimony regarding the financial crisis, Goldman has often
highlighted its role as a market maker and downplayed its role as an underwriter or placement
agent in the securitization markets.2698 In the April 27, 2010 Subcommittee hearing, for
example, Goldman executives repeatedly highlighted the firm’s role as market makers – buying
and selling RMBS and CDO securities at the request of clients – while deemphasizing that the
firm also originated new securities and affirmatively solicited clients to buy those new securities.
In an exchange with Senator Susan Collins, for example, executives from Goldman’s
Mortgage Department were asked questions about whether they were investment advisers with a
fiduciary duty to their clients. While not denying this duty, they emphasized their role as market
makers with more limited client obligations:2699
Senator Collins: Thank you, Mr. Chairman. I would like to start my questioning by
asking each of you a fundamental question. Investment advisers have a legal obligation
to act in the best interests of their clients. Mr. Sparks, when you were working at
Goldman, did you consider yourself to have a duty to act in the best interests of your
Mr. Sparks: Senator, I had a duty to act in a very straightforward way, in a very open
way with my clients. Technically, with respect to investment advice, we were a market
maker in that regard. But with respect to being a prudent and a responsible participant in
the market, we do have a duty to do that.
Senator Collins: Mr. Swenson?
Mr. Swenson: I believe it is our responsibility as market makers to provide a marketlevel
bid and offer to our clients and to serve our clients and helping them transact at
levels that are fair market prices and help meet their needs.
Mr. Tourre made similar representations in his prepared testimony to the Subcommittee:
“Between 2004 and 2007, my job was primarily to make markets for clients. I made
markets by connecting clients who wished to take a long exposure to an asset – meaning
they anticipated the value of the asset would rise – with clients who wished to take a
short exposure to an asset – meaning they anticipated the value of the asset would fall. I
2698 See, e.g., 3/1/2010 letter from Goldman’s legal counsel to the Financial Crisis Inquiry Commission,
GS-PSI-01310 (discussing Goldman Sachs’ “Role as a market maker” in detail and distinguishing it, in a much
shorter description, from its underwriting and placement roles). Although the letter acknowledged that Goldman
acted as an underwriter and placement agent for RMBS and CDO transactions, it also suggested that those
transactions were commonly designed in response to client inquiries and did not discuss efforts by the firm to
solicit customers to buy the securities: “Goldman Sachs’ CDOs ... were initially created in response to the request
of a sophisticated institutional investor that approached the firm specifically seeking that particular exposure.
Reverse inquiries from clients were a common feature of this market.”
2699 April 27, 2010 Subcommittee Hearing Transcript at 26-27.
was an intermediary between highly sophisticated professional investors – all of which
were institutions. None of my clients were individual, retail investors.2700
In another exchange, when Subcommittee Chairman Levin asked Goldman CEO Lloyd
Blankfein about the firm’s duty as an underwriter and placement agent to disclose its adverse
interests when selling its CDO securities to potential investors, Mr. Blankfein responded that
market makers had no such disclosure obligations:
Senator Levin: You are betting against the very security that you are selling to that
person. You don’t see any problem? You don’t see that you have to disclose, when you
have put together a deal and you go looking for people to buy those securities, it just adds
insult to injury when your people think it is a pile of junk. But the underlying injury is
that you have determined that you are going to keep the opposite position from the
security that you are selling to someone. You just don’t see any obligation to disclose
that. That is what seems to be coming through here.
Mr. Blankfein: I don’t believe there is a disclosure obligation, but as a market maker, I
am not sure how a market would work if it was premised on the assumption that the other
side of the market cared what your opinion was about the position they were taking.
Senator Levin: Do they have a belief that you, at least when you are going out peddling
securities, that you want that security to succeed? Don’t they have that right to assume
that if you are going out selling securities, that you have a belief that that is something
which would be good for that client?
Mr. Blankfein: I think we have to have a belief, and we do have a belief that if somebody
wants an exposure to housing –
Senator Levin: They don’t want – you are out there selling it to them. You are out there
selling these securities. This isn’t someone walking in the door.
Mr. Blankfein: Again, I want –
Senator Levin: You are picking up the phone. You are calling all these people. You
don’t tell them that you think it is a piece of junk. You don’t tell them that this is a
security which incorporates or which in some way references a whole lot of bad stuff in
your own inventory – bad lemons, they were called. ... You are out there looking around
for buyers of stuff, whether it is junk or not junk, where you are betting against what you
are selling. You are intending to keep the opposite side. This isn’t where you are just
selling something from your inventory. This is where you are betting against the very
product you are selling, and you are just not troubled by it. That is the bottom line.
There is no trouble in your mind –
2700 Prepared statement of Fabrice Tourre, April 27, 2010 Subcommittee Hearing at 1.
Mr. Blankfein: Senator, I am sorry. I can't endorse your characterization.
Senator Levin: It is a question, not a characterization. I am saying, you are not troubled.
Mr. Blankfein: I am not troubled by the fact that we market make as principal and that
we are the opposite – when somebody sells, they sell to us, or when they buy, they buy
from us.2701
Although Goldman representatives routinely emphasized the firm’s role as a market
maker, when asked directly if the firm also functioned as an underwriter or placement agent
when selling the CDO securities it originated, its executives agreed that in some circumstances,
the firm played that role:
Senator Pryor: OK. But let me ask this: When you are selling a security such as a CDO,
my understanding is you are not a market maker. Isn’t it true that you are placement
agent and as a placement agent you have a duty of full disclosure?
Mr. Sparks: Senator, that is correct.2702
Similarly, in a written response to a Subcommittee question asking about the firm’s role in
relation to Anderson, Hudson 1, Timberwolf and other CDOs, Mr. Blankfein wrote: “Goldman
Sachs or an affiliate served as a placement agent.”2703
Despite this acknowledged fact, Goldman continued to claim it was a market maker with
limited disclosure and client obligations. On May 1, 2010, for example, less than a week after
the Subcommittee’s April 27 hearing, an article entitled, “Goldman Sachs’ Lloyd Blankfein
Defends ‘Market Maker’ Firm on ‘Charlie Rose’ Show,” described Mr. Blankfein’s statements
on the televised show as follows:
“Asked by Rose whether Goldman investment advisers had ever bought securities from
the firm, sold them to clients, and then bet against those same securities, Blankfein
paused. And after a solid six seconds of silence, sought to explain … Goldman’s role as
a ‘market maker.’
‘We’re like a machine, that lets people buy and sell what they want to buy and sell’
Blankfein said. ‘That’s not the advisory business. That’s just a facility for market
2701 April 27, 2010 Subcommittee Hearing at 137-138.
2702 Id. at 53.
2703 Goldman response to Subcommittee QFR at PSI_QFR_GS0026.
2704 “Goldman Sachs’ Lloyd Blankfein Defends ‘Market Maker’ Firm On ‘Charlie Rose Show,’” Huffington Post
(video of Charlie Rose interview of Lloyd Blankfein embedded).
During the interview, Mr. Blankfein compared Goldman’s activity to that of the New York Stock
Exchange, claiming that the firm was a market maker taking buy and sell orders from clients.2705
At one point, Mr. Rose asked: “Has there ever been a time when Goldman’s investment advisers
bought securities from Goldman for a client and at the same time Goldman was simultaneously
shorting it?” Mr. Blankfein responded: “I have to explain, see this is a problem. As a market
maker, we are buying and selling a thousand times a minute, probably.” Mr. Blankfein also
stated during the interview: “If we believed it would fail, the security wouldn’t work, we would
not sell it.”2706
(ii) Soliciting Clients and Recommending Investments
Under federal securities law and FINRA Rules detailed above, when a broker-dealer,
acting as an underwriter or placement agent brings a specific security to the attention of a
particular customer, it is considered to be recommending the security to that customer and has an
obligation to disclose all material adverse information to that customer, including any adverse
interest that a reasonable investor would consider material in considering the broker-dealer’s
recommendation. Despite Goldman’s frequent efforts to characterize its CDO and RMBS sales
efforts as a market making activity in response to client demand, Goldman’s internal documents,
emails, and interviews indicate that, from late 2006 through 2007, Goldman was not always
responding to client demand, but was also aggressively soliciting customers in an attempt to sell
its CDO and RMBS products.
In December 2006, for example, Goldman CFO David Viniar instructed the Mortgage
Department to reduce its long position in mortgage related assets, including by selling RMBS
and CDO products on its books.2707 The Mortgage Department responded with a concerted
effort to sell to clients the bulk of the RMBS and CDO products in its inventory. The
Subcommittee saw no evidence that this intensive selling campaign was undertaken in response
to client demand. To the contrary, the evidence shows that the sales effort was undertaken at the
request of senior management, despite what was then waning investor interest in securitization
In December 2006, on the same day Mr. Viniar directed the Mortgage Department to
reduce its long assets, Kevin Gasvoda, head of the desk that handled RMBS securities, told his
staff to “move stuff out even if you have to take a small loss.”2708
2705 Id.
In January 2007, Mr. Sparks,
head of the Mortgage Department, asked a senior executive to compliment the CDO Origination
Desk head and his staffer for their efforts to sell a specific CDO’s securities over the prior
2706 April 30, 2010 Transcript of The Charlie Rose Show at 12-14. Mr. Blankfein made similar claims the
following week on CNBC’s “Power Lunch” during a one-on-one interview with David Faber. May 7, 2010
Transcript of Power Lunch at 4.
2707 See, e.g., 12/14/2006 email from Daniel Sparks to Thomas Montag, “Subprime risk meeting with
Viniar/McMahon Summary,” GS MBS-E-009726498, Hearing Exhibit 4/27-3; Subcommittee interview of David
Viniar (4/13/2010).
2708 12/14/2006 email from Kevin Gasvoda to his staff, “Retained bonds,” GS MBS-E-010935323, Hearing Exhibit
month: “They structured like mad and traveled the world, and worked their tails off to make
some lemonade out of some big old lemons.”2709 In March 2007, Mr. Sparks emailed a call for
“help” to Goldman’s top sales managers around the world to “sell our new issues – CDOs and
RMBS – and to sell our other cash trading positions.”2710 He wrote: “I can’t over state the
importance to the business of selling these positions and new issues. … Priority 1 – sell our new
issues and cash positions.”2711 In April 2007, the Mortgage Department issued one of many
sales directives to Goldman’s global sales force, placing a priority on selling certain CDO
securities in its inventory, including securities from Anderson, Timberwolf, Point Pleasant, and
Altius CDOs, and Mr. Sparks recommended providing large sales credits for those able to
complete the sales.2712
The documents also show that Goldman personnel worked relentlessly to identify
possible clients and pitch CDO securities to them. In March 2007, for example, the Syndicate
Desk contributed a list of “non-traditional buyers” that could be targeted for CDO sales, writing
that “we continue to push for leads.”2713 A Goldman sales manager suggested targeting
European and Middle Eastern banks and hedge funds.2714 In New York, a Goldman sales
representative recounted that the Abacus CDO security “has been showed to selected accounts
for the past few weeks. Those selected accounts previously declined participating in Anderson
mezz, Point Pleasant, and Timberwolf.”2715
When CDO sales slowed in May 2007, the Mortgage Department produced a new
“target” list of four primary and 35 secondary clients for CDO sales.2716 A few days later, a
Goldman salesperson reported that he planned to contact a hedge fund about Timberwolf and
Point Pleasant securities, noting that the customer was “[n]ot expert[] in this space at all but [I]
made them a lot of money in correlation dislocation and will do as I suggest.”2717 In Australia, a
Goldman sales representative contacted an Australian hedge fund, Basis Capital, and mounted a
sustained effort to sell it $100 million in Timberwolf securities, overcoming investor concerns to
make the sale.2718
2709 1/31/2007 email from Daniel Sparks to Tom Montag, “MTModel,” Hearing Exhibit 4/27-91.
In Korea, a Goldman sales representative attempting to sell $56 million in
2710 3/9/2007 email exchange between Mr. Sparks and sales managers, “help,” GS MBS-E-010643213.
2711 Id.
2712 4/19/2007 email from Daniel Sparks to Bunty Bohra, GS MBS-E-010539324, Hearing Exhibit 4/27-102.
2713 3/21/2007 email from Syndicate, “Non-traditional Buyer Base for CDO ASEX,” GS MBS-E-003296460,
Hearing Exhibit 4/27-78.
2714 3/9/2007 email exchange between Mr. Sparks and sales managers, “help,” GS MBS-E-010643213, Hearing
Exhibit 4/27-76.
2715 3/30/2007 email from Fabrice Tourre to Mr. Sparks and others, GS MBS-E-002678071.
2716 5/20/2007 Goldman presentation, “Mortgage Department, May 2007,” GS MBS-E-010965212. See also
3/1/2007 email from Michael Swenson, “names,” GS MBS-E-012504595 (SPG Trading target list tiered according
to likelihood of purchasing); 2/14/2007 email to Matthew Bieber, “Timberwolf I, Ltd. – Target Account List,” GS
MBS-E-001996121 (list of U.S. accounts “we should be directly targeting” for Timberwolf sales); 3/2/2007 email
from David Lehman, “ABX/Mtg Credit Accts,” GS MBS-E-011057632 (mortgage credit business shared with SPG
Trading Desk “a fairly lengthy list of accounts that are considered to be ‘key’”).
2717 5/24/2007 email from Ysuf Aliredha to Mr. Sparks and others, “Priority Axes,” GS MBS-E-001934732.
2718 See, e.g., 5/20/2007 email from George Maltezos to Mr. Lehman, “T/wolf and Basis,” GS MBS-E-001863555;
5/22/2007 email from Mr. Maltezos to Basis Capital, JUL 000685.
Timberwolf securities to a Korean life insurance firm was encouraged to “Get ‘er done” and “go
for it” by his superiors when he informed them “we are pushing on our personal relationships to
get this done.”2719
These and other documents show that, in late 2006 and 2007, Goldman was not acting as
primarily a market maker responding to client demand when it originated and sold Hudson,
Anderson, Timberwolf, and Abacus securities, or when it sold other RMBS and CDO assets that
senior management wanted to remove from the firm’s books due to their declining values and
increasing risk. Instead, Goldman was acting as an underwriter, placement agent, or brokerdealer,
aggressively soliciting its clients to purchase the CDO and RMBS products that senior
management wanted to eliminate from its inventory.
(iii) Failing to Disclose Material Adverse Information
Goldman’s marketing and solicitation efforts to sell Hudson, Anderson, Timberwolf, and
Abacus securities, along with other CDO and RMBS assets, to clients raise multiple questions
about whether Goldman met its obligation to disclose material adverse information to potential
investors. A related question is whether Goldman met its obligation to avoid material
misrepresentations and omissions of material facts when recommending the purchase of those
securities. One key issue is whether Goldman’s failure to disclose its shorting activities, which
would enable it to profit from a decline in the value of the very securities Goldman was
recommending to its clients to purchase, qualified as an “omitted fact” that “would have been
viewed by the reasonable investor as having significantly altered the ‘total mix’ of information
made available” about the security being recommended by Goldman.2720
Taking the Short Side of a CDO. In the four CDOs examined in this Report, Goldman
took 100% of the short side of Hudson, 40% of the short side of Anderson, and 36% of the short
side of Timberwolf.2721 In each of these CDOs, Goldman also made a relatively small
investment in the long side of the CDO by initially retaining all or a portion of its equity tranche,
allowing Goldman to claim an “interest” in the CDO’s long term success.2722 In Abacus,
Goldman did not intend to make any investment in the CDO itself, and instead enabled the client
that had requested construction of the CDO and played a key role in selecting its assets to hold
100% of the short side of the CDO.
2719 6/7/2007 email from Omar Chaudhary to Mr. Sparks and others, GS MBS-E-001866450, Hearing Exhibit
2720 Basic v. Levinson, 485 U.S. 224, 231-32 (1988) (quoting TSC Industries v. Northway, 426 U.S. 438, 449
(1976)). Utilizing the SEC’s guidance, the issue could also be framed as evaluating “the significance the
reasonable investor would place on the withheld or misrepresented information.”
2721 Goldman Response to Subcommittee QFR at PSI_QFR_GS0192.
2722 Typically, the equity tranche, which is the first to incur any losses sustained by a securitization, is retained by
the originator. Equity tranches are typically not rated by the credit rating agencies and often not sold to third
Goldman did not accurately or fully disclose its short interest in Hudson, Anderson, or
Timberwolf to potential investors.2723 Instead, the CDO’s offering materials advised potential
investors, in difficult to understand language, that a Goldman affiliate “may” adopt a financial
interest or investment position adverse to the investors when, in fact, Goldman had already
determined to do so. In a section entitled, “Certain Conflicts of Interest,” for example, the
Hudson 1 Offering Circular stated in part:
“Certain Conflicts of Interest. Various potential and actual conflicts of interest may arise
from the overall activities of the Credit Protection Buyer, the overall underwriting,
investment and other activities of the Liquidation Agent, the Senior Swap Counterparty
and the Collateral Put Provider, their respective affiliates and its clients and employees
and from the overall investment activity of the Initial Purchaser, including in other
transactions with the Issuer. The following briefly summarizes some of these conflicts,
but is not intended to be an exhaustive list of all such conflicts.
“The Credit Protection Buyer and Senior Swap Counterparty. GSI [Goldman Sachs
International] will be the initial Credit Protection Buyer and the initial Senior Swap
Counterparty. The following briefly summarizes some potential and actual conflicts of
interests related to the Credit Protection Buyer and Senior Swap Counterparty, but the
following isn’t intended to be an exhaustive list of all such conflicts. ...
“GSI and/or any of its affiliates may invest and/or deal, for their own respective accounts
for which they have investment discretion, in securities or in other interests in the
Reference Entities, in obligations of the Reference Entities or in the obligors in respect of
any Reference Obligations or Collateral Securities (the “Investments”) or in credit default
swaps (whether as protection buyer or seller) .... In addition, GSI and/or any of its
affiliates may invest and/or deal, for their own respective accounts or for accounts for
which they have investment discretion, in securities (or make loans or have other rights)
that are senior to, or have interests different from or adverse to, any of the Investments
and may act as adviser to, may be lenders to, and may have other ongoing relationships
with, the issuers or obligors of Investments and obligations of any Reference
This disclosure indicates that GSI or an affiliate “may invest and/or deal” in securities or
other “interests” in the assets underlying the Hudson CDO, and “may invest and/or deal” in
securities that are “adverse to” the Hudson “investments.” The Offering Circular, however,
misrepresented Goldman’s investment plans. At the time it was created in December 2006,
Goldman had already determined to keep 100% of the short side of the Hudson CDO and act as
2723 In Abacus, Goldman also failed to disclose the role of the hedge fund in the Abacus asset selection process.
See Abacus section C(5)(b)(ii)DD, above.
2724 12/3/2006 Goldman Offering Circular, “Hudson Mezzanine 2006-1, LTD.,” at 56, GS MBS-E-021821196.
The Goldman offering circulars for Timberwolf and Anderson contain similar sections. See 3/23/2007 Goldman
Offering Circular, “Timberwolf I, LTD.,” GS MBS-E-021825371 at 427; 3/16/2007 Goldman Offering Circular,
“Anderson Mezzanine Funding 2007-1, LTD.,” GS MBS-E-000912574, at 623.
the sole counterparty to the investors buying Hudson securities, thereby acquiring a $2 billion
financial interest that was directly adverse to theirs.2725
A federal court has held that disclosing a potential adverse interest, when a known
adverse interest already exists, can constitute a material misstatement to investors.2726 In the
case of the Hudson CDO, much of the profit Goldman obtained would be generated from the
losses incurred by clients that bought Hudson securities, creating an actual, undisclosed adverse
interest. This construct, in which Goldman’s profits depended in part upon its clients’ losses,
created a clear conflict of interest between Goldman and the clients to whom it was selling the
Hudson securities, once Goldman had decided to become a short party in the CDO it was
simultaneously marketing.
In another part of the Offering Circular, Goldman stated that GSI would serve as the sole
counterparty to the CDO, but that disclosure was made in the context of a common industry
practice in which the CDO originator or its designate typically took the entire short side of the
transaction in the first instance and was the only party that dealt directly with the shell
corporation actually issuing the CDO’s securities. The CDO originator, or its designate, then
acted as an intermediary between the shell corporation and the other broker-dealers buying short
positions in the CDO on behalf of themselves or a customer. By placing itself in the middle of
each CDS contract, the originator or its designate provided stronger financial backing for the
CDS contracts being issued by the CDO and obtained more favorable credit ratings for the CDO
securities. In the CDOs examined by the Subcommittee, Goldman followed industry practice by
designating its affiliate, GSI, as the initial sole counterparty in the Hudson, Anderson, and
Timberwolf CDOs.2727 Customers learning of GSI’s role as the initial sole counterparty in the
Hudson CDO would likely have assumed that GSI planned to sell its initial short position to
other parties, since that was industry practice. What Goldman failed to disclose to those
customers is that it planned to hold (or already held) all or a substantial portion of the short side
of the CDO as a proprietary investment adverse to the interests of the customers to whom
Goldman was selling the CDO securities. Had those customers known of Goldman’s substantial
short investment, they would likely have understood that Goldman viewed the very CDO
securities it was recommending they purchase as likely not to perform.
2725 See, e.g., Goldman response to Subcommittee QFR at PSI_QFR_GS0192 and PSI_QFR_GS00235.
2726 See, e.g., SEC v. Czuczko, Case No. CV06-4792 (USDC CD Calif.), Order Granting Plaintiff’s Unopposed
Motion for Summary Judgment (Dec. 5, 2007) (finding defendant made a material misstatement to potential
investors when he disclosed that officers, directors, employees and members of their families “may” trade in the
stocks recommended on his website, without disclosing that he, his father, and business partner were trading in
those stocks and had an interest in them). See also In the Matter of Arleen Hughes, Securities Exchange Act Rel.
No. 4048 (Feb. 1948) (holding a broker-dealer, who is also a registered investment adviser, had to disclose the
“nature and extent” of its adverse interest); In the Matter of Edward D. Jones & Co., L.P., Exchange Act Rel. No.
50910 (Dec. 22, 2004) (settled order), at 21 (disclosure inadequate for failing to disclose full nature and extent of
the broker-dealer’s conflict of interest).
2727 Goldman sometimes referred to this position as the “Credit Protection Buyer” or “Synthetic Security
Goldman’s failure to disclose its short interest was further compounded when it told
investors that its interests “were aligned” with those of the long investors or when it advertised
its retention of a portion of the CDO’s equity tranche. The Hudson marketing booklet stated:
“Goldman Sachs has aligned incentives with the Hudson program by investing in a portion of
equity and playing the ongoing role of Liquidation Agent.”2728 What made the statement
misleading and what Goldman failed to disclose in the booklet was that its $6 million equity
investment2729 was far outweighed by its $2 billion short investment.2730 In addition, Goldman
later used its liquidation agent position to benefit its short investment at the expense of the long
investors in Hudson.2731 In Anderson, talking points prepared for the Goldman sales force
advocated telling investors: “Goldman is underwriting the equity and expects to hold up to
50%.”2732 What the talking points left out was that Goldman’s $21 million equity investment in
Anderson was less than one sixth the size of its $135 million short position.2733 In Timberwolf,
the marketing booklet stated that Goldman was purchasing 50% of the equity tranche, and the
collateral manager Greywolf was purchasing the other 50%.2734 Again, the booklet failed to
disclose that Goldman’s equity investment was far outweighed by its short investment.2735 In
each CDO, Goldman withheld from investors information that it had a more significant financial
interest in seeing the CDO decline in value than increase in value. In light of its short
investments, Goldman’s claims that its interests were aligned with, rather than adverse, to the
investors to whom it was selling the CDO securities were misleading.
Shorting the Subprime Market. Goldman also failed to disclose to clients that, at the
same time it was recommending investments in Goldman-originated RMBS and CDO securities,
it was committing billions of dollars to short the same types of securities, as well as their
underlying assets,2736 and even some of the lenders whose mortgage pools were included or
referenced in the securities.2737 In February 2007, Goldman’s net short totaled about $10
2728 10/2006 Hudson Mezzanine Funding 2006-1, LTD., GS MBS-E-009546963, at 966, Hearing Exhibit 4/27-87.
In June 2007, its net short reached about $13.9 billion. A significant issue is whether
this omitted information – that Goldman was heavily shorting the same types of investments it
was recommending – “would have been viewed by the reasonable investor as having
2729 See Goldman response to Subcommittee QFR at PSI_QFR_GS0223.
2730 See, e.g., 10/30/2006 email from Mr. Ostrem, “Great Job on Hudson Mezz,” GS MBS-E-0000057886, Hearing
Exhibit 4/27-90.
2731 See discussion of Goldman’s actions as the Hudson liquidation agent, above.
2732 3/13/2007 email from Mr. Ostrem to Scott Wisenbaker and Matthew Bieber, GS MBS-E-000898410, Hearing
Exhibit 4/27-172.
2733 See Goldman response to Subcommittee QFR at PSI_QFR_GS0192.
2734 Timberwolf flipbook, GS MBS-E-000676809, Hearing Exhibit 4/27-99a.
2735 Goldman purchased its share of the Timberwolf equity tranche in March 2007, actually held it for only two
months, and then, in May, sold it to Greywolf. See also Goldman response to Subcommittee QFR at
2736 See, e.g., 6/5/2007 email from Benjamin Case to David Lehman, GS-MBS-E-001919861 (indicating Goldman
was shorting some of the assets underlying Timberwolf using CDS contracts outside of the CDO).
2737 See, e.g., Goldman spreadsheet produced in response to a Subcommittee QFR, at GS MBS 0000037361
(identifying lenders whose stock Goldman shorted).
2738 See discussion of Goldman’s net short positions, section C(4)(b), above.
significantly altered the ‘total mix’ of information made available” about the securities Goldman
was recommending.2739
Other Adverse Information. In addition to its failure to disclose that it was shorting
specific CDOs as well as the subprime mortgage market as a whole, Goldman failed to disclose
other arrangements which created conflicts of interest and undisclosed financial interests that
were adverse to its clients. Concerning Abacus, Goldman failed to disclose a compensation
arrangement in which Goldman agreed to accept a fee for arranging low premium payments by
the short party; those lower payments disadvantaged the long investors by reducing cash
payments to the CDO. Concerning Hudson, Goldman failed to disclose that its dual roles as
liquidation agent and sole short party meant that it could delay liquidating Hudson assets that
were losing value and simultaneously increase the value of its short position; that same action
increased the losses of the long investors. In Timberwolf, Goldman failed to disclose that it
viewed its role as collateral put provider allowed it to refuse to consent to the purchase of default
swap collateral securities and avoid any risk that the securities would decline in value – the very
risk the long investors were paying Goldman a fee to assume.2740 In each CDO, Goldman took
actions that created an undisclosed conflict of interest between itself and the investors to whom it
recommended and sold the CDO securities.
These types of arrangements, when undisclosed, can result in conflicts of interest that
disadvantage investors. The existence, nature, and extent of such arrangements are the type of
material adverse information that the securities laws were designed to ensure were accurately
described and disclosed to investors.
(iv) Making Unsuitable Investment Recommendations
In addition to the disclosure issues, Goldman’s efforts to sell Hudson, Anderson,
Timberwolf, and Abacus securities raise a set of issues related to whether Goldman met its
obligation to engage in fair dealing with its clients and avoid recommending investments that
were unsuitable for any investor. The focus here is on Goldman’s sale of CDO securities that
were designed to lose value, either because the short party selected the assets or the assets were
so poor that Goldman knew or should have known they would perform poorly or fail, yet
marketed them to customers anyway.
2739 That Goldman’s own investment decisions might be material information for an investor is demonstrated by a
court ruling in a famous case in the 1970s, in which Goldman, an exclusive dealer, was sued by an investor who
alleged that Goldman had sold it Penn Central notes without disclosing, among other things, that Goldman had
recently reduced and placed limits on its own inventory of those same notes. Alton Boxboard v. Goldman, Sachs
and Company, 560 F.2d 916 (8th Cir. 1977). Although the court decided the case on another basis, the Eighth
Circuit found that the materiality of the undisclosed facts alleged was a question to be decided by a trier of fact.
The court took note of the testimony from two sophisticated institutional purchasers concerning Goldman’s
reduction of inventory in Penn Central notes. Id at n.10. One sophisticated investor “testified that this information
would have been a ‘red flag’ to him, and had he known of Goldman Sachs’ inventory decision, he would have
wanted notes from another issuer.” Id. The other witness “stated he would have been concerned about such
information and would have conveyed it to his customers, because it indicated that Goldman, Sachs did not have
confidence in ... [the] notes.” Id.
2740 Each of these matters is discussed in detail, above.
As detailed earlier, broker-dealers are required to deal fairly with their customers and
observe high standards of honor in the conduct of their business.2741 When a broker-dealer,
acting as an underwriter, makes an investment recommendation to a client, it is implicit that the
broker-dealer has a reasonable basis to believe that the issue is sound.2742 A broker-dealer is also
required “to have an ‘adequate and reasonable basis’ for any security or strategy
recommendation that it makes.”2743 Broker-dealers are barred from offering investments that are
unsuitable for any investor.2744 Goldman itself, in response to a Subcommittee question, has
acknowledged that broker-dealers owe a “general suitability” obligation to its institutional
investors, and “[t]his suitability duty requires the broker-dealer to determine, in the first instance,
that the transaction is suitable for at least some investors.”2745 Despite those requirements, the
evidence gathered by the Subcommittee indicates that Goldman did not view any of the four
CDOs examined in this Report as sound investments for the clients to whom it sold the
Selection of Assets by Short Party. Internal documents and emails from Goldman
indicate that both Abacus and Hudson were designed with the expectation they would lose value
and produce a profit for the short side of the CDOs. The sole short party in Abacus was the
Paulson hedge fund; the sole short party in Hudson was Goldman itself.
With respect to Abacus, Goldman knew that the Paulson hedge fund wanted to take
100% of the short side and would profit only if the CDO lost value, yet allowed the hedge fund
to play a major but hidden role in selecting the CDO assets.2747 The Goldman employee with
lead responsibility for Abacus, Fabrice Tourre, called it a “weak quality portfolio.”2748 The
Paulson hedge fund executive who participated in the asset selection process acknowledged he
selected assets that he expected would not perform well.2749 A Moody’s executive who oversaw
CDO ratings when Abacus was rated – and testified that he did not know of Paulson’s role in the
Abacus asset selection process – explained that “[i]t just changes the whole dynamic of the
structure where the person who is putting it together, choosing it, wants it to blow up.”2750 When
Goldman began to publicly market the Abacus securities, Ed Steffelin, a Senior trader at GSC
who had declined Goldman’s request that his firm serve as the CDO’s portfolio selection agent,
sent an email to Peter Ostrem, head of Goldman’s CDO Origination Desk, stating: “I do not
have to say how bad it is that you guys are pushing this thing.”2751
2741 SEC Study on Investment Advisers and Broker-Dealers at 55.
When asked by the

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