The young banker at the center of Securities and Exchange Commission's case against Goldman Sachs, Fabrice Tourre will be in the hot seat today on Capitol Hill. The Senate Subcommittee on Homeland Security and Govermental Affairs has just begun its hearing titled, "Wall Street and the Financial Crisis: The Role of Investment Banks." It should instead be subtitled, "The Role of Goldman Sachs," as all seven witnesses are current or former Goldman employees. Tourre is on the first panel to be questioned by Senators. His prepared testimony (.pdf) makes crystal clear the defense Goldman intends to take in response to the SEC's allegations of fraud.
If you are unfamiliar with the Goldman-SEC case, a brief synopsis can be found at the top of this post.
IKB and ACA Were Sophisticated Investors
This serves as the buyer-beware defense. Tourre says that the two investors who lost a great deal of money on the transaction -- collateral manager ACA and German bank IKB -- were sophisticated investors who should have understood the risks of purchasing the securities at the heart of the SEC case. This point is important because it casts doubt on two questions. First, could ACA have reasonably been misled about hedge fund manager John Paulson's role as a short investor? Second, could IKB have been reasonably misled that the role of an independent collateral manager meant that no one else would have any influence on what might have went in the portfolio? If the answer to both of these questions is "no," then the SEC will have a very difficult time winning its case.
ACA Was Never Mislead
One of the key disputes of fact in the case is whether Goldman Sachs, through Tourre, intentionally misled collateral manager ACA. The SEC alleges that Toure told ACA that Paulson would be a long equity investor. Tourre denies that categorically. In fact, he essentially says that ACA would have had to be crazy to think that. This will have to be hashed out in court.
Security Not Designed To Fail
Next, Tourre explains that the security in question was not designed to fail. It did poorly because the subprime mortgage market collapsed. Whether or not the security would perform depended on future events, and Goldman could not have known that the housing market would collapse. Had the housing market continued to flourish, so would have the security. Tourre adds that the bonds referenced by the security did not perform any worse than similar subprime mortgage-backed securities. The entire sector did poorly.
ACA Ultimately Selected Portfolio
Finally, Tourre says that ACA was ultimately responsible for selecting the portfolio. Possibly the strongest claim in the SEC's case is that Goldman misled investors by representing the portfolio as having an independent collateral manager. That was ACA. But it received some suggestions from Paulson, who shorted the security it created. Whether investors should have known about that is pivotal to the SEC's case. Tourre argues that it's immaterial, because ACA was ultimately responsible for choosing the securities, so the disclosure was accurate. This question will also need to be decided by a court.
Things should get interesting when Tourre is grilled. His prepared testimony makes utterly clear that he denies all of the SEC's charges, but the Senate may get more into questions of ethics. It is pretty clear that, even if Tourre didn't break the law, there are certainly things he did to make his role in the deal look worse than it should have.