April 22, 2010
Valuation and Materiality
Last week, Larry Ribstein (who’s been all over this story) put up an excellent post explaining why the issue of materiality is at the center of the Goldman case. I agree with Larry that the critical materiality question is whether the influence of Paulson on the structure of ABACUS would have been material to sophisticated investors like ACA/IKB.
On the one hand, Leslie Rahl, president of Capital Markets Risk Advisors, a derivatives and structured finance consultancy in New York, is quoted in the Wall Street Journal as saying: "If ACA performed an independent analysis and concluded that the [Abacus] portfolio met ACA's criteria, I'm not sure what the issue is." (HT: Ribstein.)
On the other hand, John Coffee is quoted by Charlie Gasparino over at The Daily Beast as follows:
“Even if ACA knew Paulson was short, Goldman
couldn’t have sold the investment to IKB without the notion that a neutral
third party evaluated the investment,” Coffee told The Daily Beast, adding that
“enough of the portfolio was influenced by Paulson & Co.,” that its
omission from the sales documents and pitches by Goldman “could be
material”—meaning a court could rule on the side of Goldman.
I tend to agree with Coffee here. As I understand it, even the best valuation experts can come to widely diverging conclusions about the same set of assets—it is arguably as much art as science. So it is hard for me to believe that even sophisticated investors with great confidence in their valuation models would consider immaterial the fact that the assets in which they were about to go long were cherry-picked by a bear just looking for someone to let him go short (assuming that is what happened). This is particularly true because for a fact to be material does not mean it would necessarily cause me to act differently. I may still ultimately buy the assets. All that is required is for there to be a substantial likelihood that a reasonable investor would consider the fact important in deciding whether to buy or sell.