Goldman Sachs Fraud: A Flaw in the SEC's Case?

It looks like the Securities and Exchange Commission might not have picked the world's strongest case when it decided to accuse Goldman Sachs (GS) of fraud in its selling of a synthetic collateralized debt obligation (CDO) called Abacus. This raises some questions about the SEC's legal judgment, and it may mean that Goldman will be able to wriggle out of the SEC's attempt to pin it to the wall.

CNBC reports that the SEC received testimony that undermines one of its key claims against Goldman. Specifically, the SEC has accused Goldman of not disclosing to ACA Management, the company in charge of picking the securities to toss into Abacus, and German bank IKB, an Abacus investor, that Paulson & Co., which grew famous and rich shorting the subprime market, was planning to short Abacus.

But now comes the CNBC disclosure that the SEC has testimony from a Paulson & Co. executive who says he informed ACA that Paulson was planning to short Abacus. To wit, CNBC says that Paulson employee Paolo Pellegrini told ACA CDO manager Laura Schwartz, about Paulson's position. When a government official asked Pellegrini, "Did you tell her that you were interested in taking a short position in Abacus?" he responded, "Yes, that was the purpose of the meeting." If Schwartz corroborates what Pellegrini said, the SEC's case will take a hit.

To succeed, the SEC must prove that Goldman did two things: First, that it withheld information that would have caused ACA and IKB to have refrained from investing in Abacus. Second, that it intended to withhold that information in order to deceive them into investing.

The testimony by Pellegrini certainly represents a point in Goldman's favor since it suggests that ACA knew that Paulson intended to short Abacus. However, it does not shed light on whether IKB knew this, or whether Goldman deliberately misled IKB about Paulson's intentions.

I expect both sides to keep trying this case in the court of public opinion. And at this point, I would say that Goldman is doing a pretty good job of fighting back.