What About the Rating Agencies?

There has been lots of criticism aimed at Goldman Sachs over the Abacus 2007-AC1 deal. They help set up a CDO so their client, Paulson & Company, could make a bet on a downturn in the residential real estate market. To make that bet, they allowed Paulson to influence the securities that went into the CDO. Most of them turned out to be dreck and the CDO ended up tanking. Paulson made money from his short position and the investors in the CDO lost more than $1 billion.

Who Was the Client?

Paulson & Company hired Goldman Sachs and paid them $15 million for the structuring of the Ababcus 2001-AC1 CDO. So they were clearly a client.

The purchasers of the CDO were clients of Goldman Sachs. Since they were purchasing securities from Goldman Sachs as a broker-dealer, they were not owed a fiduciary duty by Goldman Sachs. That is one of the current differences between the law governing investment advisers and broker-dealers. Goldman made a statement in the materials that they do not have a fiduciary obligation to the investors.

Goldman Sachs had a split loyalty that is common with Wall Street transactions.


In selling securities you are required to disclose all material information and risks in a prospectus for the security and deliver that prospectus to purchasers.

Goldman claims that its Abacus investors had all the information needed to evaluate risks for themselves in the prospectus.

The SEC is claiming that Goldman should have disclosed that Paulson influenced the selection of securities placed in the CDO and that they were engaged by Paulson to build the CDO so Paulson could take a short position against it.

Illegal or Unethical?

Obviously, the SEC is taking the position that Goldman acted illegally. Personally, I’m not sure it was illegal. If it turns out that they said Paulson was long on the CDO, when he was actually short, then they are in trouble.

Lots of people are arguing that they acted unethically. That is a stronger argument. Goldman may not have been required to disclose Paulson’s role in the transaction, but they probable should have disclosed it.

I prefer to use the very technical term “yechy.” Goldman looks very bad. As a company, they seek to have a better reputation than this.

They should not have structured the transaction this way. They should settle this case, chalk it up as a mistake and act better. (I own some stock in Goldman Sachs that I bought when the price dropped because of these accusations.)

What about the Rating Agencies?

Even with all the dreck in this CDO, the rating agencies still gave a AAA rating to the $480 million Class A, AA to the $60 million Class B, AA- to the $100 million Class C, and A to the $60 million Class D.

Clearly one of the factors in the sub-prime market was the failure of the rating agencies. They were giving AAA ratings to collections of dreck.

S&P defines the AAA rating for structured finance as “judged to be of the highest quality, with minimal credit risk.”

Maybe this chart is better explanation of the ratings: