Richman v. Goldman Sachs Group: CDOs and Wells Notices

In Richman v. Goldman Sachs Group, Inc., WL 2362539 (S.D.N.Y. June 21, 2012), the court dismissed Plaintiffs' claim regarding Goldman Sachs Group, Inc.’s (“Goldman”) failure to disclose its receipt of Wells Notices but denied Defendants’ motion to dismiss claims pertaining to Goldman’s alleged conflicts of interest in several Collateralized Debt Obligation ("CDOs") placements.

Plaintiffs are purchasers of Goldman's common stock between February 5, 2007 and June 10, 2010 (“Plaintiffs”). Defendants are Goldman Sachs & Co (“Goldman”), Goldman Chairman and CEO Lloyd C. Blankfein, Goldman CFO David Viniar and Goldman COO Gary D. Cohn (“Individual Defendants.”) Plaintiffs claimed that Defendants made misstatements and omissions about Wells Notices the company received from the Securities and Exchange Commission (“SEC”), and about the conflicts of interest arising out of Goldman's role in structuring the CDOs known as Abacus, Hudson Mezzanine Funding ("Hudson"), Anderson Mezzanine Funding ("Anderson") and Timberwolf I.

In the Abacus transaction, for example, Goldman allegedly allowed one of its favored hedge fund clients, Paulson & Co., to select assets for inclusion in the CDO. At the same time, however, Goldman falsely identified ACA Management as the sole portfolio selection agent for the transaction.  Goldman also allegedly told investors that it had "aligned itself with the Hudson program by investing in a portion of equity," while at the same time it failed to disclose that it had the entire short position on the deal (in other words, Goldman did not disclose that its $6 million equity holding in the CDO was dwarfed by the $2 billion short position held in it). Plaintiffs also alleged other examples of undisclosed conflicts.  

The court found that Plaintiffs plausibly alleged that Goldman made material omissions regarding its arrangement with Paulson & Co. in the Abacus transaction because Defendants "knowingly allowed Paulson to select the assets for the Abacus CDO, and knew that Paulson was selecting assets that it believed would perform poorly or fail." Similarly, the court found that Plaintiffs plausibly alleged that in the Hudson, Anderson, and Timberwolf I CDO transactions, Goldman represented that it held a long position in the equity tranches and did not disclose its substantial short positions. As the court said:

 "having allegedly affirmatively represented [Goldman] had a particular investment interest in [these synthetic CDOs]—that it was long—in order to be both accurate and complete, Goldman ... had a duty to disclose [it] had a [greater] investment interest [from its] short [position] ... [because that was] a fact that, if disclosed, would significantly alter the ‘total mix’ of available information."

Finding that Plaintiffs established duty, the court turned to the scienter analysis. Scienter could be  inferred when defendants "knew facts or had access to information suggesting that their public statements were not accurate." Here, Defendants allegedly assured shareholders that Goldman complied with the law and that it had "procedures in place to address 'potential conflicts of interest.'" Alternately, Goldman allegedly fostered a conflict of interest in the Abacus CDO and acted against investor interest in Hudson, Anderson and Timberwolf I. The court found that "Goldman knew or should have known that its statements about complying with the letter and spirit of the law, and its disclaimers regarding ‘potential’ conflicts of interest were inaccurate and incomplete." The court agreed with Plaintiffs that a strong inference of scienter could be drawn from Goldman's actions in the four CDO deals.

The court also found that Plaintiffs had sufficiently alleged loss causation and claims against the Individual Defendants.  The Individual Defendants allegedly helped prepare the SEC filings at issue. Moreover, scienter was established through allegations that the Individual Defendants actively monitored the status of the relevant CDO assets and were intimately acquainted with the CDO operations.    

With respect to the Wells Notices, Goldman, according to Plaintiffs, failed to disclose the receipt of the Wells Notices from the SEC in connection with the investigation of the Abacus transaction.  Plaintiffs asserted that Defendants' disclosures about governmental investigations triggered a duty to disclose receipt of Wells Notices, and that by failing to do so caused the public to mistakenly believe that “no significant developments had occurred which made the investigation more likely to result in formal charges." The court noted that the delivery of a Wells Notice, while reflecting the SEC Enforcement Division’s determination on bringing charges, did not necessarily mean that charges would be filed.  The court found that failure to disclose receipt of the Wells Notices did not render Goldman’s statement misleading and that Defendants' violation of FINRA's Wells Notice disclosure requirement was not grounds upon which a section 10(b) or Rule 10b-5 claim could be based.   The court also rejected the argument that a FINRA rule requiring disclosure of a wells notice triggered a duty to disclose under the antifraud provisions. 

The primary materials for this case may be found on the DU Corporate Governance website

David Rodman