From the Archives, this circulated in April, 2010 - A Parody of the SEC's Goldman Sachs Complaint. (The footnotes are factual, as is the Bloomberg quote on Paulson and the graph of subprime prices.)

ACE Portfolio Selection, Inc.        

Regulated by MIA¹          (Maryland Insurance Administration - www.mdinsurance.state.md.us )

Sublime Securities Fund       

(c) 2007

Our Firm

We select sublime securities for our clients and ourselves.  We have dedicated substantial resources to the analysis of sublime securities and have one of the world’s largest portfolios, outside of Federal Reserve System regulated banks.  We are proud of our record, having taken no write-downs on any of the securities we have purchased.²

We seek to purchase entire portfolios of sublime securities opportunistically with particular focus on motivated sellers.  We believe that the ability to purchase entire portfolios provides us a significant price advantage because of the certainty it provides the seller.  We prefer to negotiate directly with sellers in order to garner detailed information on their analysis from the process of suggesting, discussing, deleting and replacing securities in the prospective sale.³ 

We value our reputation.⁴   We believe in our analysis and we often invest more in a transaction than all of our clients combined.⁵

While all investment strategies have risks, our strategy has some unusual risks.  Clients should carefully review the Risks section.

Risks

Sellers Seeking Buyers.  We seek motivated sellers.  This might cause us to purchase securities from sellers who are actively seeking buyers .⁶  

Selection.  We might select for purchase sublime securities selected by sellers for sale.  While we endeavor to select for purchase only securities sold accidentally by sellers, or not sold by sellers at all, there can be no assurance that we won't buy securities intentionally being sold.⁷

Adverse Selection.  We might purchase securities from a seller who has done analysis.  Such a seller may even have a particular view on how to weigh attributes of those securities.⁸   We might purchase securities from sellers who wish to sell because they think the securities' prices will decline.   

Excessive Interaction with Sellers/Stockholm Syndrome.

We might negotiate with sellers about which parts of their portfolios we’d like to buy.⁹   We might be influenced by facts and arguments about the securities.  We might be subjected to give and take during negotiations with sellers (see GS Wells response footnote 3 above).  We might spend months negotiating such a purchase,¹⁰  triggering Stockholm Syndrome, which could cause us to identify excessively with the seller.  

References: 

Voice and Choice: How too Much Talking Distorts Security Selection, Dr. Richard E. Simpson, ABS.   Annals of Selection as a Choice, Vol. 1, No. 1.

Excessive Interaction with Sellers Turns Selections into Assortments, Journal of Sublime Chocolate Studies,  2010.

Stockholm Syndrome, Securities Selection Pressure Variant, DSM-V Pending.

Selection Pressure: Interaction with Sellers and the Failure of Evolution.  Prof. Simon Richmanson, CCD, 2010.

Loss of Entire Portfolio Concession.  Under proposed SEC Rule ABC-2010, we must avoid even the appearance of selecting jointly with a seller.  Rule ABC-2010 provides a safe harbor for Selection Agents that reject at least 65% of the securities that sellers first wish to sell.  If this rule is adopted, we will lose the price concession that attends our purchase of entire portfolios from sellers.

Loss of Ability to Agree with Sellers' Choices.  If proposed SEC Rule ABC-2010 is adopted,  then on those occasions that the best selection for purchase is the seller's original list offered for sale, we won't be able to avail our clients of this opportunity.  This can be costly when the seller wants to sell the wrong securities.¹¹ 

Failure to Notice Price Changes.  We may fail to adjust the price at which we would purchase a security despite a market price drop of 15% over the selection period.¹²  [see sea blue chart at end for prices]

Alertness in Noticing Price Changes.  We may react quickly to price changes.  This could draw scrutiny from the Subcommittee for Permanent Investigations.

False Impressions.  We may get false impressions about significant conflicts or coincidences of interest by being explicitly misled, by the failure of others to disabuse us of misapprehensions that we evince, by misreading body language, or from the reckless failure of someone to answer a vague email we might send, compounded by our failure to resend.¹³  These false impressions can persist despite our being told otherwise repeatedly.¹⁴   

Specialized Terminology.  We might not understand the terminology of our area of expertise (see Transaction Sponsor, in Glossary, below).

Strange Circumstances/Delusions.  We might fail to use common sense and common knowledge.  Apparently strange circumstances may persist without notice.  For example, we might have an equity purchaser with whom we interact extensively over a four month deal arrangement period.  We might learn in the middle of the period from a Bloomberg Top Story that the equity purchaser has formally predicted that the assets on which the equity sliver lies will "implode" and that the equity purchaser will continue to bet on falling security prices.   

Subprime Defaults to Soar, Hurt Lenders, Funds Say - March 15, 2007 (Bloomberg) -- 

"We believe we are in the early stage of a correction in this market and that the market will eventually implode,'' New York-based Paulson & Co., which manages $11 billion, said in a letter to investors last week. Paulson said bad loans held by the riskiest borrowers will ``skyrocket''.    Paulson's 8-month-old credit fund gained 67 percent, swelling assets to almost $2 billion. [Paulson]... said they continue to bet loan defaults will rise.  ... "While the bonds have fallen significantly, we think they have much further to fall.''¹⁵ 

We might be directly told by the equity partner that in fact they're going short.¹⁶    We might later not notice that in the final documents there is no equity.¹⁷  

  

Failure to: Startle/Heed/Question/be Slightly Curious

We might fail to heed stark warnings about the markets in which we’re active [Paulson, 2007].  This could be despite extreme price declines during deal negotiations.  We might fail to ask the equity purchaser about they're thinking about the securities market or about their counterintuitive purchase.  (See sea blue chart below).

Time Confusion.  We might confuse the present with either the future or the past.  For example,  our Commitments Committee might approve a transaction before the securities are selected,¹⁸  or it might find significance in old, expired, facts.¹⁹

Acknowledgement: I'd like to thank the SEC for helpful complaints.  All remaining errors are my own.

Source: Leak of Confidential Goldman Sachs Document Submitted to the SEC.   Downloaded from Scribd.

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Glossary

Transaction Sponsor, n.:

1 - In a synthetic CDO, the buyer of protection/shorting.   "...in a synthetic CDO...[t]he sponsor of the CDO acts as the buyer of protection".   Fixed Income Markets and Their Derivatives, Suresh M. Sundaresan, Academic Press (Elsevier), 2009. 

2 - In a CDO, the entity buying protection/transferring away credit risk/shorting.   "The sponsoring institution transfers the credit risk", Credit Portfolio Management, Wiley Finance, 2003.    Also, see any internet search for documents created before April 16, 2010.

3 - Not well defined.²⁰

4 - In a synthetic CDO, the equity holder, but not protection buyer.  This definition is speculative.  Etym:  from the implication of the SEC's inference about the recklessly unresponded to and not resent email  (see False Impressions, under Risks).   Caution: This special definition may not apply to native English speakers.  The SEC hasn't opined on this.

Select, vt.:

1 - To choose from among a group by applying skill and effort, except if that choice is agreed to by others.   [preferred usage, obs.]  Etym:  SEC  2010

2 - To choose from among a group by applying skill and effort.    [required when securities are selected for purchase given the necessity of having sellers]

Buy Protection, v.:

go short.   Use in a sentence: Paulson partner described their purpose to ACA: "...we wanted to buy protection on tranches of a synthetic RMBS portfolio." Pellegrini said.  (SEC deposition according to CNBC)

The reader is free to print, post and distribute this.

footnotes

¹ http://www.aca.com/about/  ACA Financial Guaranty Corporation is a monoline bond insurance company ... regulated by the Maryland Insurance Administration.
² MIA BULLETIN NO. 00-16. Maryland Insurance Administration adoption of NAIC Codification of Statutory Accounting Principles.
³ GS Wells Response: The Seller initially suggested 123 securities to ACA. ACA evaluated these, rejected 68, accepted 55 and proposed an additional 31. ACA later proposed an additional 26. GS requested that two be rejected, and ACA suggested three replacements. After a meeting between ACA and the Seller, ACA circulated a spreadsheet of 100 securities, including the securities that the two parties had agreed upon, as well as several additional securities. The Seller requested removal of eight and GS requested removal of two others. The Seller then circulated a list of 90.  ACA requested removal of 3 and proposed 11 alternatives, 3 of which were agreed upon by the Seller.The parties than further discussed the substitution of a handful of securities and settled on the final portfolio.
⁴ SEC/48 "for us to put our name on something, we have to be sure it enhances our reputation.”
⁵ SEC/58, 61, GS Response.  ACA invested $951 million, the other investor, $150 million, and GS bought some.
⁶ SEC/3 In sum, GS&Co arranged a transaction at Paulson’s request  /43 “Goldman is effectively working an order for Paulson"
⁷ SEC/2 "Paulson, with economic interests directly adverse to investors, played a significant role in selection." [by negotiating what securities it wanted to sell].
⁸ SEC/25 ... Paulson performed an analysis of recent-vintage Triple B RMBS ... Paulson's selection criteria favored RMBS that included a high percentage of adjustable rate mortgages, relatively low FICO scores..[etc.] .
⁹ SEC/30  On January 22, 2007, ACA sent an email to Tourre and others at GS&Co with the subject line, “Paulson Portfolio 1-22-10.xls.[sic]” The text of the email began, “Attached please find a worksheet with 86 sub-prime mortgage positions that we would recommend taking exposure to synthetically. Of the 123 names that were originally submitted to us for review, we have included only 55.”
¹⁰ SEC/26  On January 8, 2007, a meeting with Paulson and ACA.SEC/41. On or about April 26, 2007, GS&Co finalized a 178-page offering memorandum for ABACUS 2007-AC1.Also, see sea blue chart at the end.
¹¹ Thu, Apr 22, 2010. CNBC.  Main Investor in Goldman Deal May Have Caused Losses.
ACA actually threw out 68 of the 123 securities suggested by Paulson. Those 68 securities had higher delinquency rates than the remaining ones, according to documents reviewed by CNBC. However, those documents show that ACA added 14 securities with lower credit ratings than the overall portfolio.
Documents also show that ACA added other securities with a higher percentage of mortgages from California and interest-only loans-two favorites of the shorts because they were perceived as having a higher chance of failure.
The apparent reason for adding these securities was that they had lower delinquency percentages overall. But they also has the very characteristics that Paulson and other shorts at the time believed would lead to higher delinquencies in the future.
CNBC asked one investor who was short mortgages during this time how he would have responded to the securities suggested by ACA. His responses: "I'd say, 'Thank you, sir. May I have another?' "
¹² The SEC Complaint never discusses price as part of the security selection process. This recently stable market became very volatile during security selection. Since there are no bad securities, just bad prices, much of the quality of the selection process rests on what prices were chosen.  Perhaps they have reserved for trial the decisive evidence that the buyer and seller agreed on price.  Perhaps even that the seller went first.
¹³ SEC/49  On January 16, 2007, the GS&Co sales representative forwarded that email to Tourre. As of that date, Tourre knew, or was reckless in not knowing, that ACA had been misled into believing Paulson intended to invest in the equity of ABACUS 2007-AC1..
¹⁴ SEC/29 On January 10, 2007, Tourre sent an email to ACA.... The text of Tourre’s email began, “we wanted to summarize ACA’s proposed role ... for the transaction that would be sponsored by Paulson (the ‘Transaction Sponsor’).” 47.On January 10, 2007, Tourre emailed ACA a “Transaction Summary” that included a description of Paulson as the “Transaction Sponsor” ....
¹⁵ http://www.bloomberg.com/apps/news?pid=20601103&sid=agHGvijV55fM&refer=us
¹⁶ CNBC, 21 Apr 2010: from SEC document,  In one part of Paulson partner Pellegrini's testimony, a government official asked him: "Did you tell (ACA) that you were interested in taking a short position in Abacus?"
"Yes, that was the purpose of the meeting," Pellegrini responded.
"How did you explain that ...?" the government official said.
"That we wanted to buy protection on tranches of a synthetic RMBS portfolio." Pellegrini said.
¹⁷ Greg Palm, GC GS, Conf Call Transcript, April 20, 2010, "the term sheets and offering circular did not reflect an equity tranch."
¹⁸ SEC/51  On February 12, 2007, ACA’s Commitments Committee approved the firm’s participation in ABACUS as portfolio selection agent. /35. On or about February 26, 2007, ... Paulson and ACA came to an agreement on a reference portfolio of 90 RMBS for ABACUS 2007-AC1.
¹⁹ SEC/51   The ... approval memorandum described Paulson’s role...: “the hedge fund equity investor wanted to invest in the 0- 9% tranche of a static mezzanine ABS CDO....” 
²⁰ GS Wells Notice Response: several Goldman Sachs employees testified, the term “sponsor” is not uniformly defined in the context of a CDO transaction, and it need not refer to an equity investor at all. (See Tourre Tr. Vol. 1, 13 (stating that the term transaction sponsor is “not necessarily . . . a defined term” and “a very loose concept”); Gerst Tr. 105 ( “I don‟t really think of [“sponsor”] as . . . an official designated role in a transaction per se.”); Nartey Tr. 31 (“[W]e use [transaction sponsor] in different ways.”).)Indeed, the documents and testimony show that that the term “sponsor” was sometimes used to refer to an investor that initiated a reverse inquiry, a counterparty that initiated a reverse inquiry, the entity that selected the portfolio, or Goldman Sachs itself. (See Tourre Tr. Vol. 1, 24 (describing IKB as the “sponsor investor” for the first ABACUS deal ); Tourre Tr. Vol. 1, 71 (stating that the term “ACA Sponsorship” in the 2007-AC1 flipbook referred to the fact that ACA selected the 2007-AC1 Reference Portfolio); GS MBS 0000010036 (ABACUS 2007-AC1 Flipbook dated February 26, 2007) (stating that ABACUS 2007-AC1 was being “sponsored by ACA.”); Gerst Tr. 105 (stating that he thought of the investor who “initiated the inquiry” as a transaction sponsor); Nartey Tr. 31 (stating that clients, managers, and Goldman Sachs itself could be deemed a sponsor)).