Quelle Surprise! New York Times’ “Deal Professor” Ignores Facts and Law to Defend Citi Employee Stoker in SEC Toxic CDO Case Rakoff Highlighted

While the New York Times’ DealBook section generally hews to a financial-services-industry-friendly line, presumably as a Faustian bargain for being a preferred leakee, there’s not even a weak defense for the article by the New York Times’ so called “Deal Professor” Steven Davidoff, “If Little Else, Banker’s Trial May Show Wall St. Foolishness.” It’s yet another brazen effort to diminish the seriousness of rampant fraud by arguing it was just carelessness. But to make his case, Davidoff misrepresents both the facts of the situation as well as the law. Since Davidoff’s lawyer union card is an explicit part of his brand at the Times, this story amounts to another credentialed effort to run the “nothing to see here, it’s too hard to get these guys” line that has become the Administration’s pet excuse for not going after one of its biggest sources of campaign funds.

But in this whitewashing by Davidoff plays so fast and loose with the underlying material, one is forced to one of two conclusions: either he didn’t even remotely do his homework or he decided (or was encouraged) to engage in baldfaced misrepresentation.

The case in question is the SEC’s suit against Brian Stoker, a Citigroup staffer who was responsible for structuring and marketing a CDO squared, Class V III, which closed at the end of February 2007 and was toast by November, when it declared an event of default. This case has gotten considerable attention because Judge Jed Rakoff flagged it when he rejected a proposed settlement between Citi and the SEC on the very same CDO. As we wrote:

What has Rakoff’s dander up is that the allegations made by the SEC in its lawsuit were that Citigroup stuffed the fund full of crappy CDO tranches and went short against them, and got investors to buy it by telling them the assets were selected by an independent party. Citi was a typically inefficient looter, earning about $160 million while investors lost $700 million (note that Rakoff had to pry that information out of the parties). Citi is admitting only to negligence when the violations the SEC described its filing and in a related case amount to fraud, or in securities speak, scienter.

Rakoff’s ruling calls the entire process a sham:

Here, the S.E.C.’s long-standing policy – hallowed by history, but not by reason – of allowing defendants to enter into Consent Judgments without admitting or denying the underlying allegations, deprives the Court of even the most minimal assurance that the substantial injunctive relief it is being asked to impose has any basis in fact.

Rakoff appears to have been particularly incensed at the fact that the SEC included allegations only in its filing against Brian Stoker that were germane in its case against Citi, specifically, that the bank knowingly engaged in fraud because it was necessary to get the deal placed:

Citigroup knew it would be difficult to place the liabilities of a CDO squared ifit disclosed to investors its intention to use the vehicle to short a hand-picked set of CDOs and to buy Citigroup’s hard-to-sell cash CDOs. By contrast, Citigroup knew that representing to investors that an experienced, third-party investment adviser had selected the investment portfolio would facilitate the placement ofthe CDO squared’s liabilities


If I’m reading between the lines correctly, Davidoff’s piece looks like an effort to discredit Judge Rakoff’s attack on the settlement. He had ordered the case to trial, and the outcome is still in play (his ruling was appealed by the Citi and the SEC, and the decision is pending).

Before we get to the substance, such as it is, of Davidoff’s piece, let’s first look at how it tries to dismiss the significance of the case:

A midlevel former banker at Citigroup, Brian Stoker, is in court this week in connection with his role in creating exotic mortgage securities. While the civil trial is being hyped as a great exposé of Wall Street’s role in the financial crisis, it may be something more banal, merely showing how clueless financiers can be.

Even in this bit, there is lot to unpack. First, “midlevel” is meant to suggest that Stoker was a mere foot soldier. In fact. one of salient characteristics of investment banking businesses, as Davidoff surely knows well, is the way they delegate authority and give large numbers of people autonomy and decision making authority. While it is fair to question whether Stoker should be singled out for punishment, Davidoff is saying that all that happened here was that the banks were dopey, and he does not mean dopey in the sense that they neglected to cover their tracks. Since not all that many media outlets are in fact taking note of the Stoker case, it isn’t clear whether his “hyped” is a dig at, say, The Litigation Daily’s even-handed observation that the trial might provide some useful insights into Wall Street’s inner workings, or a cheap shot at Rakoff.

So how does Davidoff accomplish his whitewash? He makes four fundamental misrepresentations. First, he resorts to the Lloyd Blankfein market maker argument (without using those words), arguing that Citi was just finding a way to profit for demand for CDOs. This omits the fact that Citi from the start conceived of this deal as “prop” or proprietary trade, meaning one undertaken with the intent that it would take a position, as opposed to matching up buyer and seller interest in the marketplace. Par for this dissimulation, he characterizes the hedge fund Magnetar, which “sponsored” as in created, a toxic CDO program which our analysis suggests drove at least 60% of subprime demand in the toxic phase, as having “invested in” these CDOs, as opposed to having designed them to fail. For instance, Davidoff claims that “Citigroup created its own C.D.O. to meet this demand” when half the short demand in the CDO was always intended to be from Citi itself!

Second, he tries arguing that “everyone knew that the other side of the CDO was shorts”. That’s simply not true. First, the banks misrepresented this actively in their marketing, claiming that synthetic and hybrid CDOs (ones that had credit default swaps as all or part of their assets) were the same as cash CDOs (ones made entirely of actual bonds) but faster to tee up. Cash CDOs were not created to serve the needs of shorts; they were created to offload unloved tranches of mortgage bond deals. More important, at that point, most players though subprime shorts were a noisy fringe activity. Magnetar’s huge role and influence were not recognized (the first coverage of any sort was in a January 2008 Wall Street Journal article, nearly a year after this toxic trade closed). John Paulson was press hungry but seen as a small player (and he was not a major force in CDO creation; of his $25 billion in short bets, only $5 billion came via CDOs where he took the entire short side).

If you had asked the parties that took down the CDO tranches who was on the other side in 2006 and 2007, it’s a safe bet most would have said the CDS buyers were hedgers. It was only after the market failed that the way the short players crafted deals to fail became known. Hedgers would have included commercial banks who wanted to hedge some of the risk of mortgage lending and warehouse line lenders. And they were not an inconsiderable force. The CDO structurers we have spoken to say that 25% of the CDS in subprime CDOs were taken down by hedgers. But the CDO investors at the time would have been shocked to find out the percentage was that low; they would have assumed well over 50%, probably over 75%, went to hedgers. So this statement by Davidoff is abjectly misleading:

After all, to even have this C.D.O., there had to be someone willing to bet against it. That it was Citigroup really didn’t matter.

Davidoff’s third dishonest defense is that Citi disclosed that it might short the deal. Sorry, “might” is not the same as “conceived this entire deal as a way to go short”. Citi might well have had reason to take up a short position if it really had been a mere neutral broker. For instance, if it thought the CDS were going out at too low a price, it might take a short term trading position and offload them later.

The professor’s final misrepresentation concerns the importance of the collateral manager. Citigroup pretended that the assets were being selected by a party that was working on behalf of the investors. And if that had really been the case, the question of whether the other side of the deal was shorts or hedgers would be less important. You as investor would be betting on the competence of the collateral manager. If you had reason to think the collateral manager was good at his job (and all the marketing materials stressed that they were), it would make sense to take the plunge.

In addition, Davidoff says that the investors were sophisticated and should have done their own due diligence. But investors can’t do proper diligence if material information is being withheld from them. It doesn’t matter how sophisticated they are.

He also points out that the exposures in the deal were presented to investors. True, but that’s less useful than you might think. The actual positions for this type of CDO were typically disclosed to investors less than 48 hours before closing. The Alternative Banking Group of Occupy Wall Street’s amicus brief in support of Judge Rakoff’s position in the pending appeal makes clear what would be involved in assessing them (boldface original):

The Citigroup CDO at issue in this case was a “hybrid” – this meant that the CDO included cash bonds, and simultaneously made it possible (through CDS) to bet against the housing market. The fact that the security was also a “CDO squared” meant that it was a repackaging of approximately sixty bonds issued by other CDOs, which in turn were backed by fifty to one hundred tranches of MBS bonds, making the leverage on the mortgage market even greater. It appears that this single CDO transaction was backed by approximately three thousand MBS bonds which, by a conservative estimate, were backed by approximately fifteen hundred MBS transactions. Each MBS transaction contained, on average, over two thousand mortgage loans, with an average balance of approximately $160,000. Therefore, in aggregate, the Class V Funding III transaction referenced approximately three million subprime mortgage loans with an aggregate balance of around five hundred billion dollars.

Davidoff also mentions that the monoline Ambac insured the deal. Ambac’s executive team came from Citigroup; it was very proud of its “relationship” with Citi and would thus have been loath to see a deal be done away from them. Ambac made the fatal mistake of thinking that having a “relationship” meant you were close enough to be treated well, as opposed to close enough to be easy to abuse.

Finally, Davidoff disingenuously contends that the standard at issue is mere negligence, when the famed ruling by Rakoff against the Cit and SEC’s settlement that the argument made by the SEC was “would appear to be tantamount to an allegation of knowing and fraudulent intent.” And where does this “negligence” nonsense come from? The SEC filing is a securities law claim, and our soi disant deal professor surely knows better:

As set forth above, Stoker, in the offer or sale of securities or securities-based swap agreements, by the use of the means or instruments of interstate commerce or by the mails, directly or indirectly, obtained money or property by means of untrue statements of material facts or omissions ofmaterial facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, and engaged in transactions, practices or courses of business which operated or would operate as a fraud or deceit upon purchasers o f securities in violation of Sections 17(a)(2) and (3) of the Securities Act [15 U.S.C. § 77q(a)(2) & (3)].

But you need to do quite the snow job to set up a penultimate paragraph like this:

Although we’re going to get an inside view into an arcane world, the case more than likely won’t show that anybody acted out of malice. Rather, it will highlight that no one thought hard about the risks — not the buyers, the sellers or the investment banks packaging these complex derivatives. Only a few smart hedge funds realized what was going on, and profited from it.

Davidoff craftily uses “malice” which is a criminal law concept, when this is only a civil case, but now that he mentions it, the shoe sure seems to fit. From Black’s Law Dictionary:

In its legal sense, this word does not simply mean ill will against a person, but signifies a wrongful act done intentionally, without just cause or excuse

If the SEC has its facts remotely right, it’s bloomin’ obvious Citi knew damned well what it was doing. If the only way you could offload dreck ($92.5 million of the $1 billion was Citi assets it dumped into the CDO) and set up a prop trade was by falsely telling investors a collateral manager was independent, that is deceptive and predatory.

This piece would be less troubling if Davidoff could be dismissed as a useful idiot. But for a well known lawyer with a public platform to write such an embarrassing article in defense of deliberate, destructive behavior, is yet another sign of how diseased our elites have become.

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  1. YankeeFrank

    Davidoff is clearly just padding his meal ticket here. Write a few of these stinkers and you are a firmly established company man. Maybe he will get a do-nothing for millions post at D.E. Shaw for his troubles, though most likely he will get little for his dishonesty. But hey, its a free market, he can suck as hard as he likes and hope for the best.

    As regards the NY Times publishing such garbage that seems to be their niche these days: to muddy the waters and make even marginally effective regulators (they exist?) or judges look too aggressive and heavy handed when its often exactly the opposite.

    The hopeful news is that people aren’t buying it anymore. The blatant criminality seems to be coming to something of a head now, with libor, the new hsbc cartel laundering scandal, etc. etc. Lets just say the fact that guys like Davidoff are still busy trying to bury the scandals and frauds of 5 years ago doesn’t bode well for their efforts going forward.

  2. joseph keeng

    Yves, Unless I’m blind (always possible), why isn’t there a “printable page” option on your blog? (Don’t you think some of your work is worth saving?)

    1. d cortex

      Maybe you need to select the red icon and print this one in blood.
      Bram Stoker sucked the red ink from these muppets for Citibank and got away with it!

    2. jochen

      There is a firefox extension called ‘Scrapbook Plus’ which allows you to save a page, which works much better than the build in ‘save as’. It flattens the page and once saved also allows you to add comments, highlights etc. A bit like Adobe Acrobat, but for html.

      All saved pages appear in a Menu similar to bookmarks.

    3. Kunst

      If you just want to save it, use control-S, or email the link to yourself (I have an account for just this purpose).

    4. enouf

      If you want just the text, but formatted to some degree, and.. you know linux at all, you could install “links2” (or any of it’s variants, or another TUI (Text User Interface)-based browser) – then; Open an xterm (terminal) and run this command;

      “links2 -dump URL”
      to just view nicely formatted, or alternately;

      “links2 -dump URL > filename.txt”
      which will dump it out to a text file (ASCII English text), yet still formatted (indents/tabs etc, are replaced with plain whitespace (think Spacebar spaces)) that you can then do whatever you want to (with it), Edit, Print, Copy…chop off any riff-raff you don’t want, etc.

      links2 (and its variants) and some others can be used either as TUI-based solely, or as GUI-based as well — the TUI-only mode can be run in a real terminal too, ..heck, i’ve even managed to get it running in GUI-mode in just a plain terminal (Np GUI running, No Windowing system at all)

      to launch in GUI mode, “links2 -g” does that


      p.s. (All i mentioned above can seem quite primitive to many viewers, …oh well) Hopefully it’ll help someone .. at sometime :-)

  3. toxymoron

    This reminds me again of an old story. Back in the old days, when there were still dissidents from the Soviet Union, a journalist asked a dissident about the difference between ‘East’ and ‘West’ (‘East’ has changed a bit since those days as well), and the woman replied that in the East, you must be careful when you speak, because people are listening, while in the west, you can say what you want, because nobody is listening.
    Yves, you may have “the biggest biceps in the world”, but all these gangsters are still walking.
    Thanks anyhow for all your hard work.

  4. jake chase

    The more you rage about fraud here, the less I understand why anybody on the buy side ever fell for one of these CDOs. Once again you whitewash the ‘reaching for yield crowd’, and all this bushwa about misrepresentations concerning an ‘independent’ manager selecting the individual securities is also a cop out, because there is nothing to suggest that any standards were applied, nor that they could have been, since they were simply packaging dreck wrapped in transparently phony ratings. What I see here is a collection of fools responsible for other people’s money who had no idea what they were buying and thus created the opportunity for the shorts, including Citi and Paulson and anybody else with money to bet. Why any of those involved still has a job remains a mystery. The SEC has never understood what is and isn’t fraud, and it has been litigating by press release and consent judgments for forty years, so there’s nothing new here either.

    Not saying the banks shouldn’t be liquidated and their executives stripped naked. They should be. The whole world of securitization and OTC derivatives should be dismantled and banks returned to commercial lending. But when are you going to hold the buy side accountable for its role in this disaster?

    1. doug

      Jake, you’re raising an important point about accountability and responsibility and the buy side. Please re-read that: you’re raising an important point.

      Now, with that in mind, here’s a question: Is there any minimum threshold of behavior on the sell side that, below which, the buy side’s accountability/responsibility becomes irrelevant?

      For example, as per lemon laws, if automobile companies sell defective products, are consumers nonetheless accountable for due diligence, mechanical inspections and so forth?

      Again, this question is posed in the context of acknowledging your observation about the buy side.

      1. jake chase

        You have to remember the buy side was ‘professionals’, so my answer to your question would be no. And I have yet to hear from anybody how one of those CDOs could have been constructed to produce anything but a disaster waiting to happen, since the credit bubble guaranteed cascading defaults when the bubble finally broke. The bottom line is that credit default swaps on MBS should never have existed, and nobody should have ever have bought one after they were allowed to exist. In a low interest environment incompetent money managers chase yield in a frenzy of utter stupidity. They need to be held accountable.

        1. doug

          Thanks Jake. And so, by analogy, car mechanics are should not be protected by lemon laws? Or, put differently, caveat emptor applies to all transactions between and among professionals of any sort. Again, by analogy, doctors can not ever sue another doctor for malpractice and so on?

          As you’ll guess, I disagree with the utter black-and-whiteness of your rule….. which is not to say I disagree with the earlier point you make about buy side responsibility/accountability. It’s just that our world is extraordinarily complex, even for professionals.

          1. LucyLulu

            If you read the case against Citi, some of the 14 investors (other than Ambac) did question the deal, they thought some of the CDO’s in the deal looked very iffy. One was ultimately reassured by the Credit Suisse affiliate being listed as the asset manager. CS had a good reputation for picking sound funds. Another investor had called the designated CS manager to ask why certain CDO’s were in the deal, ones that Citi traders had chosen. At that point, Citi inserted the disclaimer in their circular, that Citi might take a short position. As Yves wrote, Citi knew that they’d never sell the deal unless CS agreed to represent themselves as asset manager. When everything fell apart, it was the 25 CDO’s Citi chose that led the way and brought the rest crumbling down. There were a little over 100 CDO’s in the deal, CS chose the remainder of the investments. Not surprising, Citi only took the (naked) shorts on the ones that they had chosen. For some unknown reason, the SEC chose not to bring charges against the prop traders that hand-picked the funds to go into the CDO.

            OTOH, Jake has a point in that these were sophisticated investors, hedge funds. One hedge fund manager (who did not invest) commented at the time that the CDO was full of “dogsh**t”.

  5. Flying Kiwi

    “But investors can’t do proper diligence if material information is being withheld from them. It doesn’t matter how sophisticated they are..”

    This is true. It doesn’t even matter if they are cynical or suspicious if they can’t trust the information they are given, which is why it appears that no-one today is willing to borrow or lend and the entire system is grinding to a halt.

    1. LeonovaBalletRusse

      FK, ya gotta be an Insider “on the right side of the market” if you wan’t the skinny on the “free trades.” And, even then, does only the tip have the “need to know?”

  6. DP

    Yves, I heard on the radio that the NYT has a new ombudsman coming in. I was wondering if you’ve ever passed on pieces like this to the person who has been in that role. Years ago they had one (Daniel Okrent) who would correspond with readers via email, carefully consider arguments like the one you made and write pieces critical of Times reporting in his column. I suspect the Times has made sure not to hire anybody like that again.

    1. annie

      sorry, you misremember, or are misinformed. okrent was public editor while bush was waging war. he took the nyt line as matter of course. i recall writing so many ‘letters to the public editor’ where replies, if there was one, were merely whitewash. somehow okrent gained some after the fact credibility–entirely unwarranted.

      1. DP

        No Annie, I don’t misremember, I have a different opinion than you based on a couple of direct communications with Mr. Okrent.

        Is your cap locks key broken?

  7. Warren Celli

    “This piece would be less troubling if Davidoff could be dismissed as a useful idiot. But for a well known lawyer with a public platform to write such an embarrassing article in defense of deliberate, destructive behavior, is yet another sign of how diseased our elites have become.”

    Diseased elites, yes, its called Xtrevilism. The symptoms on display here are arrogance and an incessant need to construct “plausible deniability”. The New York Slimes and Davidoff do both well. Their arrogance is based in the reality that they also control the court of public opinion and the ENERGY DISSIPATING scam ‘rule of law’.

    A food for thought analogy…

    • A car dealership that sells new cars decides to sell used vehicles — CDOs — the market maker argument.

    • “With our 17 point inspection program these vehicles will be “just like new” and won’t fail!” — but “everyone knows” that used cars fail — and the dealership will now have a means to dump a lot of faulty carburetors they have accumulated and rebuilt from past new car repairs. A few smart insider folks, knowing that the carburetors use crap parts in the rebuilds, open repair shops.

    • The car dealership announces that the cars “might fail” and ramps up its own repair side of the business. “Just in case” the used vehicles should need repairs.

    • These used vehicles are now “hybrids”, including used parts, and you have 48 hours to take them anywhere you like and have them inspected. An impossibility given the complexity of the vehicles, even if one were an expert mechanic, and so the sale falls back on ‘trust’.

    So what could we say here? Davidoff would contend “mere neglicence” in rebuilding the used vehicles and Rakoff would say that this “would appear to be tantamount to an allegation of knowing and fraudulent intent.”

    Yes a lot of apples and oranges here in the analogy, but the point is that this is a similar in complexity situation that will require a lot of hard facts to prove, and at this point Rakoff’s language is a lot to pin hopes on. The money shot…

    “Would appear to be” does not mean squat!

    Full disclosure: I think the ‘rule of law’ is an effing hopium scam and time spent in validating and legitimizing it with your attention is exactly what Davidoff, and the New York Slimes want you to do. It is their game you play.

    Time would be better spent in organizing proactive election boycotts and doing a Constitutional rewrite.

    Deception is the strongest political force on the planet.

    1. LeonovaBalletRusse

      WC, and that old prohibition against “tampering with the odometer” — akin, perhaps to “tampering with velocity” via “derivatives” Dark Pie-in-Sky profit centers for Insiders.

  8. LeonovaBalletRusse

    “Give ’em hell, Yves.” You should be writing the text books for “Harvard Law School” and other august “entities,” in order to bring that “Lux et Veritas” into reality.

    1. Warren Celli

      Harvard Law School — “which is dedicated to advancing the cause of justice all over the world” — should be bulldozed into the Charles River, along with that odious little prick, “Felix Hot Dog Professor of Law”, Alan M. Dershowitz!

      Deception is the strongest political force on the planet.

  9. IdahoSpud

    Have cheer Yves! While everyone in the old USSR used to read Pravda each day for the news, nobody believed a word of it either.

  10. dirtbagger

    With the exception of murder cases, our laws need to remove the proving of intent to obtain a conviction. If one’s actions (carelessness, ommission, stupidity, greed, fraud, etc) caused proveable harm then one should be held accountable. Motive and intent should only play a role in sentencing.

    1. LucyLulu

      If everything the SEC alleges is true, proving intent is no problem in this case. It’s hard to believe that would be the reason for charging negligence instead of fraud. They have emails.

  11. Phichibe


    Another superb dissection of a diseased specimen of reporting in the mainstream press. I think its worth remembering that “Dealbook” is Andrew Ross Sorkin’s piece of turf, and that goes a long way toward explaining Davidoff’s “thumb on the scales”. I still expect to read one morning that Sorkin has left the Times to join Wall Street a la Steven Rattner. Until then he’s been earning brownie points peddling the “whocouldaknowed?” story line.


  12. Norcal_Steve

    “At the time, many financial institutions were looking to buy these securities for their high rates of return and supposedly strong credit ratings.”

    Correct me if I’m wrong, but the securities were rated and the ratings are not at doubt. They were not ‘supposedly’ strong ratings’ they were indeed strong ratings, that is not at issue. They were fraudulently strong ratings as it turns out because the issuers bought the ratings and the government sanctioned raters issued ratings based solely on how much they were paid by the issuer. “supposely strong credit ratings” is yet another whocoddaknowned “everybody was so confused” throwaway line.

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