Sunday, August 11, 2013

Tourre, Goldman Sachs and Corporate Ethics: Nothing Has Changed

So, the financial crisis has past, we've prosecuted the first and only face from the crisis in Farbrice Tourre, and lots more ink is wasted on corporate disclosures.

Have financial markets become more fair, efficient and transparent?  No.

Have additional financial disclosures spread the antiseptic of sunshine into dark corners of corporate behavior so that abuses of the past are precluded for the future?  No.

Have the bad guys been made to pay where it hurts, and are they pariahs in their own country clubs? No.

Fabrice Tourre has been successfully prosecuted for "for making materially misleading statements and omissions in connection with a synthetic collateralized debt obligation (“CDO”) GS&Co structured and marketed to investors." No C-suite executives from Goldman, Sachs and Company, which created and sold the product have been prosecuted.  So, who is Fabrice Tourre?

According to the complaint, "Tourre was principally responsible for ABACUS 2007-AC1. Tourre devised the transaction, prepared the marketing materials and communicated directly with investors."

This is absolutely inconceivable in any kind of factual reality.  Were it true, his bonus would have been multiples of the already excessive $1 million or so that he earned.  Goldman had done enough of these deals well before Mr. Tourre's joining so that there was nothing for him to "devise."  When John Paulson approached Goldman to structure the equity tranche of the ABACUS 2007-AC1 CDO for him and offered to pay Goldman $15 million in fees, you can bet that he never spoke to, or heard of, Fabrice Tourre.  So, this part of the accusation is pure prosecutorial fiction, setting up a fall guy.

So, if devising the transaction was a fiction, what did Mr. Tourre actually do?  The closes thing to a tangible accusation is ,"Tourre had primary responsibility for preparing the term sheet and flip book." Note that word, "primary," which is not "sole."  In other words, he constructed a term sheet based on the text and boilerplate provided to him by lawyers and sales traders. Mr. Tourre can read, and he can cut and paste text. Also, he employed the PowerPoint he learned in university to produced a slide presentation in a flip book format.  Since his were the only personal emails from Goldman presented during the trial, all we know is that Mr. Tourre became delusional enough to believe that he was a player rather than a cog in the powerful CDO machine.

Mr. Tourre's legal costs were paid for by his former employer, and his role will soon be forgotten, as were the roles of Howard Rubin, Joe Jett, Jerome Kerviel and other traders in past financial crises. He will rehabilitate himself as a PhD. economist from the University of Chicago; I would guess that his thesis title might be, "Adverse Selection: The Behavioral Economics of Constructing Equity Tranches of Synthetic CDOs."  All will be well.

What was the nature of the misleading statements that Mr. Tourre made about the ABACUS deal? ACA Capital, hired as a "Portfolio Selection Agent," was to select the reference securities for the equity tranche that would produce a security with the appropriate risk-reward profile that Goldman's client John Paulson hired the firm to produce and market. Through a lot of fog and innuendo, Ms. Schwartz thought that Paulson's firm was long the equity tranche and would not have rated the deal had they known that Paulson was short.  In the case of ABACUS, ACA and Laura Schwartz were apparently duped by the earnest neophyte Mr. Tourre who made representations that Paulson's money was long the equity tranche.  This is probably nothing more than Mr. Tourre overreaching, trying to ingratiate himself and revealing his total lack of understanding of the deal's players.

According to the complaint,
"Had ACA been aware that Paulson was taking a short position against the CDO, ACA would have been reluctant to allow Paulson to occupy an influential role in the selection of the reference portfolio because it would present serious reputational risk to ACA, which was in effect endorsing (very much akin to a rating agency) the reference portfolio. In fact, it is unlikely that ACA would have served as portfolio selection agent had it known that Paulson was taking a significant short position instead of a long equity stake in ABACUS 2007-AC1"
This is totally laughable.  Anyone who even scans the business section of a newspaper would know that Mr. Paulson was broadcasting to anyone who would cover his story, his pessimism about the housing market bubble and how it could only end badly.  A person with the experience of Ms. Schwartz and ACA would never accept the contrary thesis on the basis of an email from a minor league player like Mr. Tourre.  With so much money at stake, either Ms. Schwartz or a principal of ACA Capital would surely just have called Mr. Paulson himself.

In the end, the verdict on Mr. Tourre was, in the words of jurors interviewed by the New York Times about "Wall Street greed," which had gone unpunished because no CEOs had gone to jail.  So, Mr. Tourre takes the fall, with an air mattress underneath him.

With all the ballyhooed academic legal writing about improved corporate governance and disclosure, let's read from Goldman's own published principles for running its business.  Here is Principle No. 1,
Our clients’ interests always come first. 
Our experience shows that if we 
serve our clients well, our own 
success will follow.
This isn't a principle, but a platitude.  Let's try and apply this in the case of ABACUS.  John Paulson and his hedge fund must have been such a client, because he came specifically came to Goldman to design an equity CDO tranche in which he could place the kind of bet for he was widely known to anyone with a pulse. Goldman took a $15 million fee and presumably took a fiduciary interest in Paulson's project.

A deal isn't a deal unless it is sold in the market place, and ABACUS couldn't be sold unless it had the "brand equity" of ACA as Selection Agent for the reference securities in the equity tranche.  If ACA Capital took the other side from Paulson, then they shouldn't be bailed out for being stupid.  Being stupid is not a violation of the securities laws, but perhaps it should be.

Goldman itself took some losses from the selling of swaps to Paulson, which is a bit hard to understand, but it appears that the market froze up on them before they could net out their exposure. So, Goldman takes the other side of Paulson's transaction, which is a service and arguably consistent with their principle that the client's interest comes first. Goldman also takes a bath, net of fees paid upfront.

What about the other big suckers in the deal?   German bank IKB Deutsche and Dutch bank ING.  But, they bought into what they thought was a AAA tranche at a time when the housing market fissures were about to explode.  These are sophisticated investors: what additional protections do they need which they themselves cannot demand from the marketplace?

Goldman, which itself came to see the wisdom in the positions of their client John A. Paulson, soon began trading against the very CDO instruments coming out of the other side of the sausage factory. Does this represent putting "clients first?"  Or, is it just legitimate proprietary trading?   But, isn't it based on material non-public information and communications coming from contacts with Mr. Paulson, the client?

The complaint cites this communication from an employee of John Paulson's hedge fund,
“It is true that the market is not pricing the subprime RMBS wipeout scenario.
In my opinion this situation is due to the fact that rating agencies, CDO
managers and underwriters have all the incentives to keep the game going,
while ‘real money’ investors have neither the analytical tools nor the
institutional framework
to take action before the losses that one could
anticipate based [on] the ‘news’ available everywhere are actually realized.” 
This about sums things up.  The second sentence reprises Charles Prince's statement that as long as the music is playing, you have to keep dancing.  Rating agencies (like Moody's and ACA in this case), CDO managers and underwriters (like Goldman and Lehman) have all the incentives to keep the music playing.  Investors like IKB Deutsche and ING are too lazy or not smart enough to tease out the market's truth from publicly available information.

So, Fabrice Tourre is guilty of making misleading statements.  His bosses, who are the managers and underwriters and who hire the rating agencies, escape any prosecution and pay fines with shareholders' money.  Disclosures give no guidance about present or future behavior.  Nothing has changed, save for some intra-system transfer of funds, and life goes on.

No comments: