Sunday, April 18, 2010

More on Goldman as Bookie: What About "Bespeaks Caution?"

Posted by Jeff Lipshaw

It's certainly not my goal to defend Goldman Sachs any more than it is to defend bookies.  And I acknowledge that as to materiality, it's entirely possible that you get to the trier of fact on the question whether the actual selector of the Reference Portfolio was something for which there is a substantial likelihood that a reasonable investor would find that the information significantly altered the total mix.  (That's the legal standard.)  But, as we teach our students, the mere materiality of undisclosed information doesn't create liability for its omission; as opposed to a misrepresentation, the culpability of an omission depends first on a duty to disclose. 

So here's a quote from the Goldman Sachs flip book under "Risk Factors."  And remember this thing wasn't going to Mom and Pop up in Lowell; it was going to IKB Deutsche IndustrieBank and ABN Amro:

  • Goldman Sachs may, by virtue of its status as an underwriter, advisor or otherwise, possess or have access to non-publicly available information relating to the Reference Obligations, the Reference Entities and/or other obligations of the Reference Entities and has not undertaken, and does not intend, to disclose, such status or non-public information in connection with the Transaction. Accordingly, this presentation may not contain all information that would be material to the evaluation of the merits and risks of purchasing the Notes.
  • Goldman Sachs does not make any representation, recommendation or warranty, express or implied, regarding the accuracy, adequacy, reasonableness or completeness of the information contained herein or in any further information, notice or other document which may at any time be supplied in connection with the Transaction and accepts no responsibility or liability therefore. Goldman Sachs is currently and may be from time to time in the future an active participant on both sides of the market and have long or short positions in, or buy and sell, securities, commodities, futures, options or other derivatives identical or related to those mentioned herein. Goldman Sachs may have potential conflicts of interest due to present or future relationships between Goldman Sachs and any Collateral, the issuer thereof, any Reference Entity or any obligation of any Reference Entity.

Isn't there a real question whether Goldman owed a legal duty that would make the omission actionable?  Didn't Goldman tell the Investors in the flip book that it might well have non-public information relating to the Reference Portfolio?  Didn't it say that it might have "short positions in . . . other derivatives identical or related to those mentioned here"?  This is the "bespeaks caution" doctrine:  optimistic forecasts or projections in a prospectus aren't actionable if they are accompanied by meaningful disclaimers or warnings of the risk involved.

I'd like to be a fly on the wall when the sophisticated investor representatives get deposed on this issue.

Q:  "Did you read the flip book?"

A:  "Well, parts of it."

Q:  "Which parts?"

A:  "The parts that talked about the Reference Portfolio."

Q:  "Did you read the disclaimer about 'non-public information' that Goldman might have?"

A:  "I don't recall at this time."

Q:  "You don't disagree that the disclaimer is there, do you?"

A:  "No."

Q:  "Did you ask Goldman to reveal to you the undisclosed information?"

A:  "I don't recall at this time."

Q:  "Did you read the risk factor that said Goldman might be shorting the identical reference portfolio?"

A:  "I don't recall at this time."

Q:  "Did you actually ask Goldman if it was shorting the identical reference portfolio?"

A:  "I don't recall at this time."

Q:  "Remind me again how long you've been in this business."

I find myself in a funny position, intellectually speaking.  The lawyer in me, applying a legal model to what I've seen so far, is saying this case is a real stretch.  The business ethicist in me is saying, "ugh, what a squirrelly business to be in.  You must have to take a scalding shower when you get home every night to play it that close to the vest."  The sociologist-psychologist-philosopher-Tina Turner in me is saying:  "Well, of course, Jeff, what's law got to do with it?"  The cognitive scientist in me is saying, "It all depends on the metaphor.  If you think of Goldman as the bookie, and ABN Amro as a high roller, you reach one result.  If you think of Goldman as your doctor or lawyer, you reach another one."

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W/respect, this misstates the "bespeaks caution" doctrine. That doctrine allows an issuer to avoid liability for good faith financial projections, reasonable when made, that turn out to be wrong. IMO, the doctrine doesn't permit the issuer to disclaim its obligation to disclose all material facts about the securities it issues. Section 11 of the 33 Act has been held to require that the issuer disclose information that might tend to deter an investor from purchasing. As I understand it, an issuer who doesn't comply with that obligation is liable, even if it admits that it hasn't complied. In other words, you can't just warn prospective purchasers that you've failed to disclose material information - you have to disclose. And, again IMO, it seems hard to argue that purchasers would not have wanted to know that the guy who secretly assembled the portfolio was shorting it.

Posted by: Mr. P | Apr 18, 2010 10:26:17 PM

A synthetic CDO is inherently a portfolio of short positions. So it is hard to see the materiality case being made here.
There weren't that many people shorting RMBS so it's hard to say that the specific identity of one of them in relation to the portfolio is material by itself. And it is clear from the complaint that the portfolio selection agent was told what was going on and ratified the portfolio composition. I see this case as more negligence of that company than a Pecora like fraud case.

Posted by: mark | Apr 19, 2010 8:18:47 AM

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