Few people in the U.S. have not been touched in same way by the collapse of the domestic housing market in 2007 and 2008. Much has been said of the major financial institutions’ role in the financial crisis, but one of the first cases related to the crisis will test the government’s ability to hold individuals in those institutions accountable. That in turn will demonstrate the government’s ability to regulate the financial markets at all.
In a recent case, entitled Securities and Exchange Commission v. Goldman Sachs & Co. and Fabrice Tourre. Goldman Sachs mid-level executive Fabrice Tourre was accused of multiple violations of the Securities Exchange Act of 1934, or SEA, for fraudulent representations and omissions about a synthetic collateralized debt obligation, or CDO, tied to subprime mortgages.
The Securities and Exchange Commission alleges that Tourre failed to inform investors in the ABACUS 2007-AC1 CDO that a large hedge fund with interests adverse to the CDO’s success “played a significant role in the portfolio selection process.” That large hedge fund, Paulson & Co. Inc., profited approximately $1 billion from its adverse positions while investors in ABACUS 2007-AC1 lost over $1 billion.
Goldman Sachs settled its part of the case with a $550 million penalty, but Tourre continues to fight the charges. Now on its second judge, the case is set for trial in July 2013. In October 2012, the SEC asked the new judge to reserve the former judge’s dismissal of part of the SEC’s complaint. That part related to Goldman Sachs’ sale of the CDO to a German bank. The judge ruled in June 2011 that because the transaction happened outside the U.S. federal securities law did not apply.
The judge relied on Morrison v. National Australia Bank, in which the U.S. Supreme Court held that Section 10(b) of the SEA only governed transactions through U.S. stock exchanges or “domestic transactions in other securities.” The former judge reasoned that although Goldman Sachs was the CDO’s underwriter, a Cayman Islands entity actually sold the CDO to the German bank, removing the connection to the United States and the SEC’s ability to proceed on the claim.
The SEC asked the new judge to consider a more recent case, Absolute Activist Value Master Fund Ltd. v. Ficeto, that it claimed gave a broader reach to federal securities laws. The SEC argued that because the transaction closed in New York there is a sufficient nexus with the U.S. In November 2012, the new judge denied the SEC’s request saying the Absolute Activist case did not change the prior ruling.
The judge ruled that the New York transfer of title was lawful and a subsequent fraudulent transaction involving the same note did not tie the transaction to the U.S. Specifically, the judge ruled, “The alleged fraud even if attenuated (temporally or otherwise) must be ‘in connection with’ the particular securities transaction for which redress is sought.” It is unclear whether the SEC will appeal the recent ruling or simply press forward on the remaining portions of the complaint.
The outcome of the SEC’s case against Tourre will set the precedent for future charges of securities fraud against industry insiders responsible for the country’s financial crisis. So far, it appears the courts are holding the government to its burden. Unfortunately, the limitations of the SEA may prevent the government from holding bad actors accountable in a global economy where transnational transactions are the norm.