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Motion to Dismiss Denied in Goldman Sachs

June 21, 2012

On June 21, 2012, U.S. District Judge Paul A. Crotty upheld a securities class action against Goldman Sachs for its business practices in selling mortgage-backed securities to investors as investment grade products at the same time it was shorting those same securities (the Abacus, Timberwolf, Anderson, and Hudson deals) and favoring certain clients’ interests over others. These practices were the subject of a congressional investigation. Judge Crotty made it clear that Goldman cannot evade liability by arguing that its public statements concerning the firm’s “honesty,” “integrity” and “fair dealing” were simply “puffery,” and therefore not actionable. “Goldman’s arguments in this respect are Orwellian,” Judge Crotty wrote in a footnote to his 27-page order. “Words such as ‘honesty,’ ‘integrity,’ and ‘fair dealing’ apparently do not mean what they say; they do not set standards; they are mere shibboleths. If Goldman’s claim of ‘honesty’ and ‘integrity’ are simply puffery, the world of finance may be in more trouble than we recognize.”

In April 2010, shareholders filed a securities class action against Goldman in the wake of the SEC’s lawsuit against Goldman for its infamous Abacus deal. Goldman eventually agreed to pay $550 million in July 2010 to settle the SEC’s suit. The lead plaintiffs in the securities class action are the Arkansas Teacher Retirement System, the West Virginia Investment Management Board and Plumbers and Pipefitters National Pension Fund.

At the time, the SEC called it the largest penalty a Wall Street firm ever paid, with $300 million going to the U.S. Treasury and the rest going to investor restitution. But the settlement did not resolve plaintiffs’ securities class action, which alleges that statements the bank made about its business practices materially misled Goldman’s own shareholders and artificially inflated Goldman’s stock price.

Some of those allegedly misleading statements include a Form 10-K stating, “We have extensive procedures and controls that are designed to . . . address conflicts of interest”; and annual reports stating, “Integrity and honesty are at the heart of our business,” and “We are dedicated to complying fully with the letter and spirit of the laws, rules and ethical principles that govern us.”

Goldman argued in its motion to dismiss that “[e]xpressions of puffery and corporate optimism do not give rise to securities violations.” Judge Crotty explicitly rejected that argument, stating that “Goldman must not be allowed to pass off its repeated assertions that it complies with the letter and spirit of the law, values its reputation, and is able to address ‘potential’ conflicts of interest as mere puffery or statements of opinion.” Judge Crotty went on to conclude that “[a]ssuming the truth of plaintiffs’ allegations, they involve ‘misrepresentations of existing facts.’” Plaintiffs’ allegations included internal e-mails, such as CEO Lloyd Blankfein’s request that Goldman get rid of all the poor quality CDOs on its books – the “cats and dogs” – and sell them to clients as investment grade products. Another internal e-mail referred to the Timberwolf deal as “one sh@#%y deal.”

Judge Crotty added that Goldman’s refusal to admit guilt about the Abacus deal in the SEC settlement rang hollow in light of the company’s subsequent statements: “Goldman’s assertion that it ‘neither admitted, nor denied’ that its Abacus disclosures were fraudulent is eviscerated by its concession that ‘it was a mistake for the Goldman marketing materials to state that the reference portfolio was “selected by” ACA Management LLC without disclosing the role of Paulson & Co. Inc. in the portfolio selection process and that Paulson’s economic interests were adverse to CDO investors.’” Judge Crotty further opined that “Goldman paid a $550 Million settlement to the SEC – the largest SEC penalty in history – because of the ‘mistake’ it acknowledged.”

Judge Crotty even rejected the notion that it was a “mistake” at all. “With respect to Abacus, Goldman certainly knew that Paulson played an active role in the asset selection process,” Judge Crotty held. “How else could Goldman admit that it was a ‘mistake’ not to have disclosed such information.”

Executives Lloyd Blankfein, David Viniar and Gary Cohn also knew, Judge Crotty held. “These allegations, taken as true, show that each Individual Defendant actively monitored the status of Goldman’s subprime assets and subprime deals during the relevant time, and that each knew that Goldman was trying to purge these assets from its books and stay on the short side,” the order states. “These allegations create a strong inference that the Individual Defendants knew that Goldman was making material misstatements in the Abacus, Hudson, Anderson, and Timberwolf I CDOs, when it sold poor quality assets to investors without disclosing its or Paulson’s substantial short positions.”

The bank and its executives were not obligated, however, to disclose the Wells Notice informing them that the SEC would bring an enforcement action against them, Judge Crotty decided, in the only part of the ruling favorable to the banks. The case now proceeds into discovery and towards trial.

In re Goldman Sachs Grp., Inc. Sec. Litig., 868 F. Supp. 2d 261 (S.D.N.Y. 2012).

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