SEC Lawyer on Goldman CDO Case Describes How the Agency Wimped Out

Susan Beck at American Lawyer (hat tip Abigail Field) has managed to get an inside view of what was going on at the SEC when it launched its case against Goldman and a Goldman vice president, Fabrice Tourre, over a Goldman CDO called Abacus that went spectacularly bad. At the time, the reaction to the filing was explosive; even though Matt Taibbi had already run his vampire squid piece, Goldman still enjoyed a stellar reputation with customers.

One of the big puzzles of the case was why Tourre was singled out. Many assumed this was an effort to target a relatively low-level employee and pressure him to testify against the higher-ups. Another was the fact that the SEC had charged Goldman on only one CDO. Goldman had sold 25 Abacus CDOs, which were pure synthetics (the assets were all credit default swaps). Goldman also sold other CDOs that were only part synthetic or all cash (the assets were a mix of CDS and bonds or all bonds). This Abacus CDO was, like all hybrid and synthetic 2005 and onward asset-backed-securities CDOs, teed up to suit the appetites of short sellers, which meant, in colloquial terms, they were designed to fail.

American Lawyer made a Freedom of Information Act filing to obtain documents, including those developed in the course of an SEC Inspector General investigation into whether the suit against Goldman was politically motivated. It shows that, quelle surprise, one of the agency’s most highly respected trial attorneys was stymied in his efforts to take the probe further and target more senior Goldman executives.

Bloomberg did a peculiar piggyback story which focused on James Kidney, the attorney that was pushing for more aggressive prosecution, without mentioning the American Lawyer story or having access to its documents. Nevertheless, Bloomberg interviewed Kidney and also gives a sense of how Kidney was seen at the agency:

James Kidney, who joined the SEC in 1986 and retired this month, offered the critique in a speech at his goodbye party…

The SEC has become “an agency that polices the broken windows on the street level and rarely goes to the penthouse floors,” Kidney said, according to a copy of his remarks obtained by Bloomberg News. “On the rare occasions when enforcement does go to the penthouse, good manners are paramount. Tough enforcement, risky enforcement, is subject to extensive negotiation and weakening.”…

Kidney, who was part of the initial team that was building the Goldman Sachs case, pressed his bosses in the enforcement division to go higher up the chain. He later took himself off the team after being given a lesser role, according to people familiar with the matter.

In particular, the people said, Kidney argued that the commission should sue Tourre’s boss, Jonathan Egol. Kidney also wanted to bring a case against Paulson & Co. or some executives at the hedge fund, which helped pick the portfolio of securities that were underlying the Abacus vehicle and then bet against it…

Stephen Crimmins, a former colleague of Kidney’s at the SEC who attended the retirement party, said he was one of the “finest lawyers ever to serve in the enforcement division.” Kidney was known for winning the SEC’s first jury trial, which was an insider trading case.

This doesn’t sound too hot…aggressive attorney eased out of an important role on a case he helped develop. But the American Lawyer account is far more detailed and damning. For instance:

Kidney was one of at least 30 SEC lawyers and officials who gave sworn testimony in the summer of 2010 as part of a probe by the SEC’s then–inspector general, David Kotz, into whether the Goldman Sachs case was politically motivated. Kotz included portions of those interviews in a heavily redacted 2010 report that concluded the case wasn’t politically motivated. But the transcripts, obtained through the FOIA, fill in many details. Not only do they reveal more fully the discord within the SEC over the handling of the case, they also suggest that the SEC’s $550 million settlement with Goldman secretly ended roughly a dozen other related investigations into collateralized debt obligations that the agency dropped.

This is more damning than it might seem. As we wrote in Was the SEC Rolled by Goldman?, this was as defacto global settlement for all Goldman CDOs, even though the settlement was formally limited to the lone Abacus CDO. Even though the formal settlement agreement was limited to the one deal, Goldman brayed on its website that:

We understand that the SEC staff also has completed a review of a number of other Goldman Sachs mortgage-related CDO transactions and does not anticipate recommending any claims against Goldman Sachs or any of its employees with respect to those transactions based on the materials it has reviewed. We recognize that, as is always the case, the SEC has reserved the right to reopen those matters based on new information.

The fact that Goldman couldn’t be bothered to play nicely with the SEC and undercut what looked to be a solid victory. $550 million for a single CDO is a lot of change, but when you figure the SEC could have sued Goldman for even more toxic CDOs it launched, $550 million was cheap to make this embarrassment go away.

This section of the American Lawyer article is critical:

When Kidney joined the Abacus team in the summer of 2009, he was dismayed at the state of the investigation, which was led by then–associate director Cheryl Scarboro and assistant director Reid Muoio. They were focused on charging Tourre, a 28-year-old Goldman vice president at the time of the deal who was tasked with marketing the CDO. “There were obvious holes in the investigation,” Kidney told Kotz. “This was not a case where there was only one low-level vice president involved.”

Kidney was bothered by what he called Muoio’s “extreme reluctance” to take the testimony of Jonathan Egol, then a Goldman Sachs managing director who supervised Tourre.

According to Kidney, Muoio told him he already knew that Egol would say he was too busy to pay much attention to the Abacus deal.

“We were highly unlikely, highly unlikely to have a case against him,” Muoio told Kotz.
Kidney was astounded by this reasoning. “It just seems to me this was the first time in my whole career here that we were not following the string,” he said. “I mean the smallest stock manipulation case, the smallest insider trading case, the smallest almost anything would go at least a little way up the supervisory chain.” Kidney said the issue of taking Egol’s testimony was raised with Scarboro, and then enforcement director Robert Khuzami, and “it wasn’t going anywhere.”

Scarboro told Kotz she supported taking Egol’s testimony; Khuzami said he didn’t recall a dispute over taking the testimony. Scarboro, who is now a partner at Simpson Thacher & Bartlett, did not respond to a request for comment. Muoio, who is still at the SEC, declined to comment, as did Khuzami, who is now a partner at Kirkland & Ellis.

Kidney was further angered when the case was scheduled for a vote by the five commissioners in December 2009 without Egol’s testimony. Kidney threatened to quit the case, and eventually the SEC interviewed Egol on Jan. 7, 2010. Muoio told Kotz the interview was a bust, as he had predicted all along. “We didn’t lay a glove on him,” Muoio asserted. But Kidney said he was encouraged by Egol’s testimony that he had reviewed the marketing materials, as was Lorin Reisner, who was then the deputy director of enforcement. After that interview, the SEC issued a Wells notice to Egol on Jan. 29, 2010, informing him that the enforcement staff planned to recommend charges against him.

After a March 4 meeting with Egol’s lawyer, Frank Wohl of Lankler Siffert & Wohl, Khuzami polled the team: Kidney, Reisner and another SEC lawyer wanted to sue, according to the transcripts; Muoio remained against it.

Khuzami had the final say. On March 23 he emailed the team: “I’m a no on Egol.” Khuzami told Kotz the decision was a “difficult judgment call,” but he concluded they didn’t have evidence that Egol had engaged in deceptive conduct. Egol’s emails weren’t as incriminating as Tourre’s.

So get this: even after hearing the pitch by Egol’s attorney, three of the four lawyers on the case wanted to proceed against him. But they were overruled by head of enforcement Robert Khuzami. Gee, why might THAT be? As we wrote in 2011:

The SEC went after Goldman only on one Abacus deal out of 25 in its program. Even though the $550 million settlement was limited to that transaction, it was widely understood that the SEC was not going to pursue Goldman on other CDOs. And it hasn’t. The SEC has gone through the motions in this arena: it poked around some Magnetar deals (not surprisingly, after the hedge fund got some real press about its destructive strategy) and negotiated a $153.6 million settlement with JP Morgan on a particularly noxious Magnetar trade, a CDO squared imaginatively called Squared.

Look no further for an answer than the SEC chief of enforcement, Robert Khuzami, Stewart’s primary and probably sole source for this article. He was General Counsel for the Americas for Deutsche Bank from 2004 to 2009. That means he had oversight responsibility for the arguable patient zero of the CDO business, one Greg Lippmann, a senior trader at Deutsche, who played a major role in the growth of the CDOs, and in particular, synthetic or hybrid CDOs, which required enlisting short sellers and packaging the credit default swaps they liked, typically on the BBB tranches of the very worst subprime bonds, into CDOs that were then sold to unsuspecting longs. (Readers of Michael Lewis’ The Big Short will remember Lippmann featured prominently. That is not an accident of Lewis’ device of selecting particular actors on which to hang his narrative, but reflects Lippmann’s considerable role in developing that product).

Any serious investigation of CDO bad practices would implicate Deutsche Bank, and presumably, Khuzmami. Why was a Goldman Abacus trade probed, and not deals from Deutsche Bank’s similar CDO program, Start? Khuzami simply can’t afford to dig too deeply in this toxic terrain; questions would correctly be raised as to why Deutsche was not being scrutinized similarly. And recusing himself would be insufficient. Do you really think staffers are sufficiently inattentive of the politics so as to pursue investigations aggressively that might damage the head of their unit?

Bear in mind that the path from Goldman to Deutsche Bank was even more direct than this extract suggests. Famed subprime short John Paulson worked closely with Goldman on the Abacus transaction in question. As Greg Zuckerman recounts in his book, The Greatest Trade Ever (which is less colorfully written but is a far more complete history of the subprime short story than Michael Lewis’s The Big Short), John Paulson was keen to tee up synthetic CDOs where he would select all of the crappy assets. The idea was so clearly smelly that even Bear Stearns refused to play ball. But Goldman and Deutsche were game. So following the Paulson thread, which is what Kidney and his colleagues were keen to do, would have taken them straight to Deutsche Bank and Lippmann, and thus Khuzami.

So it’s not surprising that the comparatively tame Bloomberg story also omits the most stinging quotes from Kidney’s farewell speech, which American Lawyer uses to close its story:

“For the powerful, we are at most a tollbooth on the bankster turnpike,” Kidney said. “We are a cost, not a serious expense. …The system is broken.”

People under 40 find it hard to believe that the SEC was once a respected and feared agency. It’s now widely seen as the worst regulator in Washington DC and shows how quickly effective organizations can be ruined by self-serving leaders.

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  1. Podargus

    Classic case of regulatory capture.Which is a result of political and legislative capture.
    In short,money talks.

  2. Hugh

    In our world, never attribute to incompetence what you can to malice. These deals were part of an inter-related group of frauds that remain the largest in human history. No one has been held accountable for any of them. That bespeaks a high level of competence just of a deeply criminal kind.

    1. Christopher Dale Rogers


      May I remind you go DoJ AG Holder’s remark at the beginning of 2013 – that’s the real shocking indictment and one the USA will pay dearly for.

      Further, forces in the UK’s City of London are railing against the head of the Financial Conduct Authority, headed by Martin Wheatley, for doing the job its says on the can – he’s made mistakes, but the present furore is an embarrassment to the UK and proves conclusively that the USA via Wall Street and the City of London, are up above their heads in shit – they seem like pigs – which I’m afraid to say is an insult to swine, which are actually quite clean animals in the wild.

    2. Ulysses

      Excellent comment! The only mildly heartening aspect of this whole sordid tale is that Mr. James Kidney, a thoroughly respectable member of bourgeois society, who I don’t recall ever seeing at Zuccotti park back in late 2011, freely uses the term “bankster.” Yves is correct to point out that the SEC used to provide at least a modest check on the most outrageous criminality. Now, honest SEC folks must admit (but not until they retire, of course) that they are “at most a tollbooth on the bankster highway!”

  3. Dino Reno

    I pledge my allegiance to the post-Constitutional United States of America and the corporate police state for which it stands. Nothing to see here folks, now move along.

  4. craazyman

    Ah the Golden Oldies . . . Those where the daze when the SEC was the SEC and sheep ran scared. Here’s one spinning next on the turntable from Jay and the Americans, with apologies in advance, from Peanut gallery radio . . .

    This Minsky moment
    so different and so new
    unlike any others
    till it all blew

    and when it happened
    it took you by surprise
    I new that you’d wanna sue
    from the look in your eyes

    Now it’s all mine
    you ain’t got no legal right
    everything you worked for
    and I’m holding it tight

    This Minsky moment
    it should probably be a crime
    but I’ll be playin golf
    forever till the end of time
    whoaaa ohho ohh ohhh ohhh ohhh
    whaooa ohho ohh ohhh ohhh

  5. TheCatSaid

    In theory, isn’t there some way the case (or more cases) could be reopened, despite the previous settlement, seeing as a key principal (Khuzami) didn’t recuse himself, when it’s clear he had vested interests in investigations that were limited in scope so they wouldn’t impact him personally?

  6. sluggeaux

    The presence of Khuzami is key here: he was a Presidential appointment. I had to ask myself why Barak Obama would appoint a Republican who rolled-out the Patriot Act to the 2004 Republican National Convention, who went on to approve financial WMD’s as General Counsel for the Americas at Deutsche Bank, to be Chief of Enforcement at the SEC in the wake of these massive frauds? The capture goes all the way to the top.

    I have always argued that there are two kinds of people trying to get ahead in the world: Brown-nosers and Sh*t-disturbers. It’s obvious what kind of person Barry Obama has been for his entire life…

  7. JEHR

    For general information: Matt Taibbi’s article on the vampire squid was available on July 9, 2009; the Levin/Coburn report on GS and others was available on April 13, 2011.

    1. Yves Smith Post author

      The Levin investigation was spurred by the SEC suit. The staffers on that were way way more impressive than the FCIC commissioners.

      I’ll correct the piece re vampire squid. Most people on Wall Street didn’t take the vampire squid meme that seriously when it first came out; Taibbi’s call was legitimated by the SEC and Wall Street got much more defensive after the SEC suit.

      1. FormerGSGuy

        When it came out, the Matt Taibbi’s article quickly circulated around the GS trading floor, creating a lot of buzz.
        While I agree that a majority of Wall Streeters might not have taken it too seriously, the article had a very significant impact on some people inside GS, including yours truly.

        1. OMF

          A significant impact of what kind? It made you all more wary of potential regulatory blow-back, or it made you all try to live up to the reputation Taibbi’s immortal line had set for you?

  8. Jackrabbit

    Kidney’s complaint seems much like ex-Goldman Gregg Smith’s complaint upon retiring (clients are now “muppets”). No doubt there are many other ‘old-timers’ on Wall Street that are agast the triumph of crony capitalism and the “God’s work” dis-ingenuity that is employed as cover.

  9. Jackrabbit

    While easy for pundits and industry shills to dismiss as “nothing new” or “unsurprising”, the fact is that most people don’t give such dark, conspiratorial stories much weight until it has been confirmed by someone with direct knowledge (an insider or whistle-blower).

  10. Jackrabbit

    Kidney puts more nails into the coffin of the ‘cognitive capture’ theory of regulatory lapses. Regulators are ‘captured’ by their own selfish desire for future personal gain NOT by an amorphous/agent-less analytical framework that exults ‘free markets’ and ‘financial innovation’.

    1. monday1929

      And as I feel necessary to point out to NC’s genteel readers,…………………Envelopes (and briefcases) full of Cash. Sometimes it is that simple.
      Khuzami is in a whole other category- a Sociopath far up the chain of command. Khuzami should read Jim Willie, the “nut” who has been correct on almost everything. If correct again, Mr Khuzami should be watching his back- some very nasty people feel Khuzami and his teamates ripped them off for tens of billions and they are determined to even the score. Would anyone believe a Khuzami “suicide” or nail-gun accident?

  11. allcoppedout

    There is no policing of City and Wall Street much beyond the kind of teeming and lading I might have been let loose on in a retail chain or warehouse. Peter Charles Johnson, Jonathan James Mathew and Stylianos Contouglas have just been charged over Libor fraud between 2005 -7. There is no way it should take so long. Banks have very sophisticated systems to prevent fraud internally, yet we are supposed to believe it is impossible to extend the system coverage to wider thefts. This can’t be true as the obvious points of risk are at external/counter exchange points. A simple example would be like a barman handing over change for,£20 when he’s only taken £5. Another would be a clerk passing through a bent insurance claim. There is all kinds of monitoring to turn up frauds like cash for crash schemes and agents selling insurance that pays out more often than expected The banks must have had models evaluating these crooked deals – otherwise they would have been placing blind bets. Great returns would have flagged-up as off model.

    I don’t think we understand how crooked these people are. I’d say the management term networking is a precursor to fraud. We need a new way of dealing with these people that would see them in court as quickly as a local burglar. We no longer have equality under the law.

  12. steelhead23

    My admiration for Mr. Kidney pales in comparison to my anger that he has waited until retirement to unveil the truth at SEC. In the case of fraud, there is a statute of limitations. Whether that clock starts running the day fraudulent transfers are made, or begins only when the afflicted party recognizes they’ve been had, the clock has likely run out on all Magnetar and Abacus deals. Good job Khuzami. While I was angry the day Barack Obama pronounced that he would rather look ahead than look behind when he publicly stated that he was not going to investigate Bush Administration war crimes, it is this wholesale abandonment of the public trust in dealing with financial fraud I find most despicable. Even now, this president is more focused on political strategizing (yesterday’s equal pay for equal work EO smells more of electioneering than governing) than on protecting the public weal.

    Yes, the SEC is weak and corrupt, but the fish rots from the head down. At its core, the problem is that Barack Obama is hopelessly corrupt.

    1. Jackrabbit

      Your anger at Kidney is misplaced. The US doesn’t treat Whistle-blowers well (despite being acknowledged as important aspect of good government). And how many others have quietly retired with saying anything?

    2. sluggeaux

      Follow the links in the story. Kidney reported all this to the SEC’s Inspector General back in 2010. No action was taken and Khuzami slithered off to his sinecure at Kirkland & Ellis, no doubt representing the very perps he failed to prosecute.

      1. Ulysses

        Important point. K.’s determined attempts to work within the system, all rendered futile by his superiors, is what finally convinced him “the system is broken.” If Snowden had shown the same misguided patience we would never have learned anything about the NSA’s dragnet surveillance.

        We can’t reform this corporate police state, playing by the kleptocrats’ rules, and following the decisions of their referees. We can’t plead with them to do better– we must overthrow their regime before any progress can occur.

  13. rich

    Injustice and Inequality

    Tuesday, April 08, 2014

    Matt Taibbi discusses the intersection of two of the most troubling trends in American society—growing wealth inequality and mass incarceration. He argues that our current system of justice allows massively destructive fraud by the hyper-wealthy to go unpunished, while it turns poverty itself into a crime. His new book on the topic is The Divide: American Injustice in the Age of the Wealth Gap.

  14. usgrant

    How large is the financial derivitives market right now and do CDOs still make up the bulk of that market?

  15. diptherio

    So following the Paulson threat, which is what Kidney and his colleagues were keen to do, would have taken them straight to Deutsche Bank and Lippmann, and thus Khuzami.

    Think you probably meant “thread” instead of “threat”…although “threat” works pretty well too, considering the context…

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