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September 10, 2010
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FSA has fined Goldman’s London-based unit Goldman Sachs International for not satisfying UK regulatory reporting obligations. Goldman Sachs International failed to disclose to the U.K. authorities about the scrutiny being carried out by the U.S. Securities and Exchange Commission (SEC) on one of its London-based executives in connection with the Abacus 2007-AC1 synthetic collateralized debt obligation (Abacus).
SEC Charges
SEC claimed that Goldman Sachs created an investment vehicle named Abacus 2007-AC1, comprising subprime mortgage-backed securities. It was created just at the onset of the housing bubble bursting.
The investors were informed by Goldman that the mortgage bonds would be selected by an independent manager. However, according to SEC charges, Goldman asked its client Paulson & Co. to select those mortgage bonds that they believed were most likely to decline in value.
Once the Abacus portfolios declined as they were bound to, European banks and other investors lost more than $1 billion, while Paulson made money from the bets against the mortgage bonds.
Companies like ABN Amro and IKB Deutsche Industriebank AG, a German bank, made huge investments in Abacus and incurred severe losses. Ultimately, IKB received a government support while Royal Bank of Scotland Group plc (RBS) acquired ABN Amro.
The UK Connection
The Abacus product, though structured by Goldman’s US affiliate, was partly marketed from UK by Goldman Sachs International to institutional investors. The executive in question, Fabrice Tourre, was a part of the US team that structured this product. He was later transferred to Goldman’s UK unit in London and became an FSA-approved person in November 2008.
In August 2008, SEC started investigating Goldman’s US unit over the Abacus and following its investigation, SEC served a Wells Notice to Goldman’s US unit and Fabrice Tourre, alleging significant violations of the US securities law.
Typically a Wells notice is, in effect, an indication from the SEC staff that they intend to recommend that the SEC has filed an enforcement action against the person or entity to whom the notice is addressed.
However, despite the involvement of the UK unit and the FSA approved personnel Fabrice Tourre in the marketing of the product, this information regarding the Wells Notice was not shared with the FSA. As a result, Mr. Tourre continued working with the UK unit.
The FSA was rather disappointed with the omission despite the fact that a number of senior executives at Goldman Sachs International in London knew about Tourre’s Wells notice.
SEC Settlement
In July, Goldman Sachs agreed to settle the SEC lawsuit for $550 million. The settlement involved a civil penalty of $535 million and required Goldman to pay $15 million of profits from the Abacus deal. However, Mr. Tourre has denied the allegations.
FSA Settlement
Finally, Goldman agreed to the £17.5 million ($27 million) settlement with the FSA. Since the FSA investigation did not find Goldman’s UK unit to intentionally withhold any information and since the company had fully cooperated with the authority, agreeing for an early settlement, it was given a 30% discount from the maximum fine; otherwise, it would have had to pay £25 million.
FSA has intensified its regulatory scrutiny activities over the past couple of years following criticism over its role prior to the financial crisis. In June, JPMorgan Chase & Co. (JPM) had been fined £33.3 million for mishandling clients’ money by not separating their funds securely from its own available liquidity.
Our Take
Such run-ins with financial authorities could shatter investors’ confidence, even when -- or especially when -- giants like Goldman are involved. Such issues are also likely to cast a shadow over the financials of the company.
However, Goldman maintains a well managed global franchise with a strong capital base and a leading position in investment banking, capital markets, trading and asset management business. We also believe that with the recovery of the U.S. economy, the company should experience improvements in credit spreads.
Goldman currently carries a Zacks #3 Rank (Hold), implying no clear directional pressure on the stocks over the next one to three months.
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