Report: ACA Picked Risky Mortgages at Center of Goldman Fraud Case

By: Daniel Carty
Topics: SEC

The SEC fraud case against Goldman Sachs was dealt another potential blow Thursday, as CNBC reported that ACA Management LLC, one of the parties Goldman allegedly misled, actually selected some of the riskiest assets in the complex deal at the heart of the case.

A quick review of the facts:

In 2007, Goldman undertook to create a complex mortgage-backed security for one of its hedge fund clients, Paulson & Co. Paulson wanted to bet against the mortgages in the portfolio on the assumption that the subprime market would collapse, which it did, meaning billions in profits for the fund.

Goldman tapped ACA as a third party to select the mortgage assets that would be included in the security, know as a collateralized debt obligation. Paulson also made recommendations to ACA on which mortgages to include in the portfolio.

The SEC case hinges on two key allegations: that Goldman misled ACA by not disclosing Paulson's intention to bet against the portfolio and that Goldman deceived other investors by not disclosing Paulson's role in selecting the mortgages in the security.

However, according to CNBC's review of documents, ACA was actually responsible for selecting some of the mortgages that brought the portfolio's value down.

According to the report, ACA threw out 68 of the 123 securities Paulson recommended because they had higher delinquency rates than the others. But ACA also selected 14 securities with lower credit ratings than the overall portfolio. The firm also included securities with high percentages of mortgages from California and interest-only loans, both of which had a higher chance of failing.

But ACA's decisions weren't aimed at helping Paulson. On the contrary, ACA was betting the portfolio's value would increase (as evidenced by the firm assuming 85 percent of the deal's risk and its subsequent collapse after the subprime mortgage bubble burst).

According to the report, ACA's selections represented "conventional thinking" about the mortgage market, while Paulson was ahead of the curve.

If CNBC's analysis is accurate, the SEC's charge that Paulson was responsible for loading the CDO with assets that were doomed to fail takes a hit. On top of that, a former Paulson executive said Wednesday the hedge fund had indeed notified ACA of its intention to bet against the portfolio.

All of this bolsters Goldman's likely defense - that those involved in the deal were sophisticated investors who should have done their homework and known better.

More on Goldman Sachs:

Goldman Sachs Plans "Big Boys Defense"
Report: Goldman's Fabrice Tourre to Testify before Senate
Was the Goldman Sachs Suit Politically Timed?
Report: AIG Ponders Action against Goldman Sachs
Goldman Sachs Earns $3.3B in First Quarter
Goldman Sachs Hires Ex-White House Counsel
SEC vs. Goldman: A Matter of "Material"
Goldman Suit No "Slam Dunk" For SEC
Goldman CEO: We'll Defend our Reputation

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by babooph April 22, 2010 5:42 PM EDT: The best way to rob a bank is to own it-seems like it also is a good way to rob taxpayers & clients...[I still recall N.Bush...no arrest of course...]; Reply to this comment


by macira April 22, 2010 12:46 PM EDT: Have any of the Wizards at large yet come to see that Goldman has far to much influence and infiltration into our Government. The "lawyering" of the issue is not relevant, the number of ex-Goldman folks at high and mid levels of Government IS. Start with the last Sec Treas and the current Sec Treas, both ex-Goldman, then work down. Do you really think these folks forgot all their connections and ideas from Goldman?; Reply to this comment

by pragmatist1 April 22, 2010 12:04 PM EDT

Knowing how derelict the SEC was with the Madoff situation, GS probably made the documents known to the SEC, but in their haste to please the president, ignored them to bolster a more believable case against GS. This will go nowhere because it hasn't anywhere to go. Plus the fact that the president and many in Congress benefited substantially from GS donations. There's a definite conflict in all of this and so far, none of the guilty by association are distancing themselves from the litigant.

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by stychokiller April 24, 2010 10:18 PM EDT: Leave the SEC alone! They just want to surf for pr0n!


by soap-suds April 22, 2010 11:37 AM EDT: The SEC investigation was not performed in secret; GS knew about it and apparently had provided other documents to the SEC. Why weren't these documents provided then since they appear to be the heart of the matter?; Reply to this comment