Last week, when news broke of the SEC’s lawsuit against Goldman Sachs--in which the bank was accused of failing to disclose to investors that a hedge fund had helped stock a Goldman CDO and then bet against it -- we pointed out that what Goldman did is quite similar to what other major investment banks seem to have done with the hedge fund Magnetar. (Goldman denies that its investments were built to fail. Magnetar also denies it was betting against CDOs it helped create.)
As it turns out, Goldman Sachs itself beat us to pointing out those similarities.
In documents Goldman submitted to the SEC in September 2009, after the regulator officially notified Goldman of possible civil charges, the investment bank argued that other investment banks also hadn’t fully disclosed to CDO investors the involvement of third-party hedge funds, namely Magnetar.
In a section entitled, “Market Practice Did Not Entail Disclosure of a Short Investor’s Participation,” Goldman pinpointed nondisclosure by other investment banks in several Magnetar CDO deals, including Auriga and Norma. Here's what Goldman wrote about Merrill's disclosures in the Auriga deal:
Goldman Sachs understands that the Initial Preferred Securityholder was Magnetar Capital LLC (“Magnetar”), but this information is not disclosed in the offering circular. Goldman Sachs does not know the extent to which Magnetar played a role in the selection of the Auriga portfolio, and this too is not disclosed in the offering circular. In fact, other than listing 18 pages of “eligibility criteria” (id. at 143-161), which state in general terms what the portfolio may contain, the Auriga offering circular does not mention the contents of the portfolio at all.
Goldman also made the same point about Merrill's failure to disclose Magnetar’s role in creating Norma, a deal we've written about. (The Wall Street Journal also had a detailed piece on Norma, in 2007.) From Goldman's letter to the SEC:
The Norma CDO, which also was an actively managed transaction underwritten by Merrill Lynch & Co., contained disclosures that were materially similar to those used in Auriga. (Norma Offering Circular at 56, 67.) We understand that Magnetar was the “Initial Preference Shareholder”6 for the Norma transaction, but this information is not disclosed in the offering circular. Similarly, we do not know whether Magnetar played a role in the selection of the Norma portfolio, and this too is not disclosed in the offering circular.
Goldman has consistently maintained that not disclosing a hedge fund's bets against a CDO was “normal business practice,” and has cited other examples of nondisclosure to buttress its point. It remains to be seen whether this defense will work -- or whether the SEC will simply go after the others as well.