The SEC’s blockbuster announcement last Friday of its civil enforcement action against Goldman Sachs and one of its investment bankers rocked the securities markets and made headlines in the financial press around the world. Undoubtedly because of Goldman’s prominence and perhaps also because of the nature of the allegations, the SEC’s action is widely seen as a watershed event.
Beyond the implications for Goldman itself, however, the development may be even more significant for what it may portend about possible future actions and claims, both by the SEC and by aggrieved investors. Here are some questions about what may be coming next.
Can we Expect Further SEC Enforcement Actions involved Subprime-Related Financial Instruments?:
According a March 29, 2010 CNBC interview with SEC Chairman Mary Shapiro (here), the agency has been working since the subprime meltdown emerged to build up staff with the right skill and experience to pursue financial-crisis related cases. Now that the SEC has staffed up, she advised, we can expect to see more crisis-related enforcement actions. She said, with reference to these actions, "there are more in the pipeline."
Indeed, in its April 16, 2010 Litigation Release related to the Goldman Sachs action (here), the SEC specifically said that its "investigation is continuing into the practices of investment banks and others that purchased and securitized pools of subprime mortgages and the resecuritized CDO market with a focus on products structured and marketed in late 2006 and early 2007 as the U.S. housing market was beginning to show signs of distress."
There has already been extensive press coverage raising questions some other transactions that may be under scrutiny. Gretchen Morgenson’s December 23, 2009 New York Times article raising questions about many of these transactions, including in particular the so-called Abacus transaction that is at the heart of the SEC’s action against Goldman, refers to numerous other transactions at Goldman and elsewhere where, as in the Abacus transaction, the investment banks created investment securities that were structured so that the banks and others could profit on financial bets that the investments would lose money.
There have also been a number of press articles (refer here for example) about Illinois-based hedge fund Magnetar, which sponsored over 30 CDO transactions in late 2006 and early 2007, which the hedge fund itself shorted, allowing it to make significant profits when the underlying mortgages began to default.
As the New York Times stated in an article on Sunday, the Goldman Sachs action is the SEC’s "the first big case — but probably not the last." Whether or not there may be more SEC actions relating to the toxic subprime-related transactions remains to be seen, but in the meantime concerned parties seem to be taking defensive measures. By way of illustration, when J.P. Morgan Chase released its first quarter financial results on April 14, 2010 (refer here), the firm disclosed that it "$2.3 billion in additional litigation reserves, including those for mortgage-related matters"
It should be noted that further regulatory action may come not just from officials in the U.S. According to press reports (here), German and U.K. government officials are conferring about possible regulatory actions against Goldman, in light of the revelations in the SEC’s complaint against the firm.
Finally, it should probably also be noted quite a number of observers have commented that the SEC’s case is far from a slam dunk, and the SEC could face formidable hurdles in attempting to sustain its allegation. The most balanced of these types of commentaries, by Professors Henning and Davidoff, appears in the Dealbook blog (here). An April 18, 2010 Wall Street Journal article (here) raises many of the same questions.
Will More Senior Officials Get Dragged In?:
The SEC named 31-year old Fabrice Tourre as a defendant because, the SEC alleged, Tourre was "principally responsible" for the Abacus transaction," having "devised the transaction, prepared the marketing materials and communicated directly investors." He also drew a big bull’s-eye on himself in an email suggesting that he ("the fabulous Fab") is the "only potential survivor" of the coming collapse, standing in the middle of "monstrosities" he had "created without necessarily understanding." (Note to file: It is never a good thing to have a personal email reproduced on the front page of the Wall Street Journal, above the fold.)
Tourre, who was 28- years old at the time of the Abacus deal, was not, however, simply off on a personal frolic in putting together this $2 billion transaction. Indeed, "senior level management" of Goldman Sachs is alleged, in paragraph 40 of the SEC’s complaint, to have approved the transaction. The referenced individuals, apparently members of Goldman’s Mortgage Capital Committee, were neither identified by name in the complaint, nor were they named as defendants.
Gretchen Morgenson’s April 18, 2010 New York Times article (here) suggests that the SEC may try to use Tourre to "get" more senior officials. Morgenson also suggests that as the subprime market began to unravel in 2007, senior Goldman officials became more directly involved in the firm’s mortgage department. A separate April 19, 2010 New York Times article talking about senior Goldman executives' supervision of and involvement in the mortgage unit can be found here.
Susan Beck, in her April 16, 2010 Am Law Litigation Daily article about the SEC’s action against Goldman (here), suggests that perhaps New York Attorney General Andrew Cuomo may "start rooting around and come up with other individuals," noting that Cuomo has had not been afraid to name top executives as defendants in his action against BofA.
The pressure the SEC faced from Judge Jed Rakoff in attempting to settle its enforcement action against BofA, among other reasons for its failure to name the specific individuals responsible for the alleged violations, suggests the likelihood that any future SEC enforcement actions will include individuals among those targeted. But the question remains, both with respect to any further regulatory against, whether against Goldman or other financial players, more senior company officials will become involved.
Will the SEC’s Action Against Goldman Spawn Further Investor Litigation?:
In an April 17, 2010 post on WSJ.com Law Blog (here), Amir Efrati quotes a leading plaintiffs’ securities class action attorney as saying that "private lawyers are foaming at the mouth" over the prospects of pursuing claims against Goldman. (Presumably, this expression was merely a figure of speech.). An April 17, 2010 Reuters story (here) quote one plaintiffs’ attorney as saying that Goldman investors have already contacted him about pursing actions to recover their losses.
These developments also suggest that investors who lost money in other subprime-related investments may be asking whether their transaction involved the same kind of undisclosed conflict of interest as the SEC alleges in the Abacus deal. Indeed, one claimant that has a case pending against Merrill Lynch based on a subprime-backed security has alleged (refer here) that Merrill failed to disclose that it had a relationship with another client that was betting against the investment, similar to what happened at Goldman Sachs.
These developments arise just as the long-running subprime and credit crisis-related litigation wave appeared that it might be losing momentum. Many commentators recently have noted the dwindling numbers of new subprime related securities class action lawsuits. Moreover, in an April 8, 2010 Wall Street Journal article entitled "Banks Winning When Investors Sue" (here), Ashby Jones suggested that plaintiffs were faring poorly on dismissal motions in subprime-related securities lawsuits against previously filed against financial firms.
In light of popular and press reaction to the SEC’s allegations against Goldman, it is possible that these revelations in the Goldman complaint could revitalize the subprime litigation wave. Indeed, the SEC’s action may be only one of several recent developments that could reinforce a renewed interest in pursuing claims against Wall Street firms. The examiner’s report in the Lehman bankruptcy and the revelations of the Senate subcommittee investigation into the financial crisis could drive a renewed interest in holding financial firms accountable. These accumulating developments could also counterbalance the apparent judicial skepticism of fraud claims raised in the wake of the financial crisis.
The bottom line is that the SEC’s enforcement action is a significant event with important implications. How all of this will unfold remains to be seen, but it seems possible in the wake of the SEC’s complaint there could be a cascade of consequences.
National Public Radio’s April 16, 2010 "All Thing Considered" report about the SEC's complaint against Goldman Sachs can be found below. The report includes my recorded comments about these developments.
Another Surge of Failed Banks: Amidst all of the hoopla surrounding the Goldman Sachs enforcement action you may not have noticed that on Friday, April 16, 2010, after the close of business, the FDIC took control of eight more banks, bringing the year to date total of bank closures to 50. During 2009, when there were a total of 140 failed banks, the FDIC did not close its 50th bank until July 2, 2009, suggesting that the pace of bank failures is well ahead of last year’s pace.
Three of the banks closed on April 16 were based in Florida, bringing the number of 2010 bank closures in that state to nine, the highest for any state this year. Since the beginning of 2008, there have 25 bank failures in Florida. The state with the highest number of bank failures during the period 2008-10 is Georgia with 37, including seven in 2010, the second highest number for any state this year. Other states with the highest numbers of bank failures this year include Washington (5), California (4), and Minnesota (3).