Many economists consider the 2008 economic meltdown the worst financial crisis in the U.S. since the 1930’s Great Depression. The threat of the total collapse of large financial institutions and key businesses, a devastated housing market rife with foreclosures and evictions, government bailouts, and stock markets’ downturns around the world triggered a decline in consumer wealth estimated in trillions of U.S. dollars, all leading to global recession and contributing to the European sovereign-debt crisis.
In the midst of the chaos, the U.S. Security and Exchange Commission (SEC) responded with the promise of stricter enforcement of the procedures regulating the financial sector. However, as the financial sector braced itself, the SEC actually settled with several firms and failed to prosecute senior executives and other individuals, drawing widespread criticism.
Then, on August 1, 2013, many of those critics were silenced. A federal jury in the Southern District Court of New York found former Goldman Sachs (Goldman) employee Fabrice Tourre—The Fabulous Fab—liable on six counts of securities fraud including a count on “aiding and abetting,” where Goldman Sachs was named. The case has become a symbolic win for the SEC and a clear and certain warning for other individuals and financial entities to abide with the regulations imposed by the SEC and other governmental agencies.
The Case of Fabrice Tourre.
It started back in April 2010, when the SEC brought a securities fraud action against Goldman Sachs (“Goldman”) and a Goldman employee, Fabrice Tourre, for allegedly making misleading statements and omissions in connection with the synthetic collateralized debt obligation known as Abacus 2007-AC1 (the Abacus).
In its complaint, the SEC alleged that Goldman represented to its investors that the Abacus was based on 90 bonds derived from residential subprime mortgages. Therefore, as long as the people whose mortgages made up the bonds would keep up with their payments, Abacus investors would make money. Goldman allegedly represented to investors that the bonds in the Abacus were chosen by ACA Management Inc., (ACA), a firm experienced in analyzing credit risks related to residential subprime mortgages. However, what Goldman allegedly failed to disclose was that Paulson & Co., Inc. (Paulson), an investment management firm that actually had economic interests adverse to Abacus investors, participated in the Abacus’ portfolio selection process. In fact, Paulson allegedly picked the portfolio for the Abacus in order to bet against the assets and purchase what are known as “credit default swaps”—insurance policies that pay out if a borrower defaults. According to the SEC, Tourre structured, marketed, and communicated directly with Abacus investors. The Abacus deal closed in April 2007. By January 2008, Abacus investors had lost over US $1billion. Yet Paulson’s credit default swaps yielded a profit of approximately US $1billion.
By July 2010, Goldman settled the case with the SEC for a whopping $550 million. As part of its settlement, Goldman did not admit or deny any wrongdoing alleged by the SEC. However, Tourre did not settle and decided to fight the SEC’s allegations—becoming one of the few banking officers to appear in court over wrongdoings related to the financial crisis.
The SEC’s case against Tourre was based on his role in Abacus. It alleged that he knowingly misrepresented to investors the nature of Abacus and the roles of both Paulson and ACA. As such, the SEC was set to prove whether the three investors listed in its complaint suffered losses as a result of investing in the Abacus, and that they understood Paulson’s role in the creation of Abacus’ portfolio. In turn, Tourre’s counsel claimed that the SEC was using Tourre, a former mid-level executive, as a scapegoat for the 2008 economic collapse. Nonetheless, on August 1, 2013, a federal jury in the Southern District Court of New York found Tourre liable on six counts of securities fraud including a count on “aiding and abetting,” where Goldman Sachs was named.
Although it is highly likely that Tourre will file an appeal, this win has gained the SEC more respect and less criticism from those who stated that it did not go after the firms and individuals that helped cause the 2008 financial crisis. Notwithstanding, to date the SEC has brought charges linked to the 2008 financial crisis against 157 firms and individuals, and has obtained more than $2.68 billion in penalties, settlements, and judgments. Given this, and the outcome of Tourre’s trial, a new day has dawned, where both firms and individuals must closely follow and abide by all financial regulations interposed by the SEC and other governmental agencies.