March 29, 2023

DealBook: S.E.C. Hopes for Validation in Goldman Sachs Trader Case

Fabrice Tourre, a former Goldman Sachs trader, is accused of misleading clients.Mike Segar/ReutersFabrice Tourre, a former Goldman Sachs trader, is accused of misleading clients.

Three years ago, in the shadow of the financial crisis, some of the biggest banks on Wall Street slipped into the government’s cross hairs.

Now, after striking nine-figure settlements with firms like Goldman Sachs and JPMorgan Chase, the government’s campaign to punish Wall Street over risky investments sold before the crisis will culminate in an unlikely way — with the civil trial of a 34-year-old Frenchman, Fabrice P. Tourre.

In a federal courtroom in Lower Manhattan next week, the former midlevel Goldman employee will fight the Securities and Exchange Commission’s claim that he was part of a conspiracy to mislead investors when selling a mortgage security that ultimately failed. Mr. Tourre, a trader stationed in the bowels of Goldman’s mortgage machine when the S.E.C. thrust him into the spotlight, is one of only a handful of employees at big Wall Street firms to land in court over the crisis.

The rarity of the trial underpins its importance. For Mr. Tourre, who is now enrolled in a doctoral economics program at the University of Chicago, an unfavorable verdict could yield a fine, or worse, a ban from the securities industry. A victory in court, however, would offer only belated consolation to Goldman, which is paying for his defense. For the S.E.C., an agency still dogged by its failure to thwart the crisis, the trial is a defining moment that follows one courtroom disappointment after another.

When a jury cleared a midlevel Citigroup employee in a mortgage-bond trial, the S.E.C. took measures to buoy its case against Mr. Tourre. For one, it talked to a private jury consultant, people briefed on the matter said, though it is unclear whether the agency hired the firm. The head of the agency’s trial team is also leading the Goldman case himself, a surprising move.

“Their reputation for trying cases hangs in the balance,” said Thomas A. Sporkin, who was a senior S.E.C. enforcement official until last year when he departed for the law firm Buckley Sandler. “This is their opportunity to show Wall Street that they can prevail against an individual at trial.”

Both sides were in court Tuesday sparring over what the jury should — and shouldn’t hear. The judge, Katherine B. Forrest, ruled that the defense can question a crucial S.E.C. witness, a woman who was an executive of a company that helped arrange the mortgage security, about the agency’s eve-of-trial decision to drop an unrelated investigation against her, a reprieve Mr. Tourre’s lawyers have argued might color her testimony.

The S.E.C. also walked away with a major victory: Judge Forrest permitted the agency to argue that Mr. Tourre was part of larger conspiracy at Goldman, a move that will allow evidence beyond Mr. Tourre’s actions.

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Yet even if it secures a victory at trial, the S.E.C. will probably face scrutiny all the same, as critics question why the agency chose to make Mr. Tourre the face of the financial crisis. Rather than take aim at a high-flying executive, the agency filed its most prominent crisis-era case against someone barely known on Wall Street, a concern that also hampered the Citigroup case, when the foreman of the jury asked, “Why didn’t they go after the higher-ups rather than a fall guy?”

An S.E.C. spokeswoman declined to comment. But in the past, the agency has defended its actions tied to the crisis, noting that it has sued 66 C.E.O.’s and other senior officers in such cases, including a few executives from Wall Street and major mortgage lenders.

When the S.E.C. filed its case against Goldman and Mr. Tourre in April 2010, the allegations shook the bank. Within months, it agreed to pay a $550 million fine, without admitting or denying guilt, then the largest penalty ever levied on Wall Street.

Mr. Tourre, however, rejected a deal on the eve of Goldman’s settlement, people briefed on the matter said. The deal, the people said, would have required Mr. Tourre to face a lifetime ban from the securities industry and a cash penalty — virtually the same punishment he would face if found liable at trial. The agency has not offered to settle since.

At the heart of the agency’s case is the contention that in 2007 Mr. Tourre and Goldman sold investors a mortgage security, known as Abacus, without disclosing a crucial fact: a hedge fund run by the billionaire John A. Paulson helped construct Abacus and then bet against it. The S.E.C. cited Goldman for “misstating and omitting key facts” about Mr. Paulson’s involvement. When the mortgage market soured, a German bank and a handful of other sophisticated investors lost more than $1 billion on the deal.

“The S.E.C. essentially argues that Tourre handed Little Red Riding Hood an invitation to grandmother’s house while concealing the fact that it was written by the Big Bad Wolf,” Judge Forrest explained in a recent ruling.

To win its case, the S.E.C. must show by a preponderance of the evidence that Mr. Tourre “committed a fraudulent act that was material.” The verdict is likely to hinge on whether the S.E.C. can prove what it called two basic acts of “deception” stemming from January 2007, when Mr. Paulson’s hedge fund asked Goldman to create an investment worth betting against.

What led to the first misstep, according to the S.E.C., was Goldman’s decision to use ACA Management to pick the underlying mortgage bonds for the investment. ACA worked closely with Mr. Paulson’s hedge fund in the selection process, the S.E.C. said.

But in a marketing document that Goldman submitted to investors, the bank said the portfolio was “selected by ACA,” with no mention of Mr. Paulson.

Mr. Tourre’s lawyers, however, are expected to note that it was unheard-of for any Wall Street bank to disclose the name of the hedge fund betting against an investment. And e-mails reviewed by The New York Times suggest that the main investor in Abacus, the German bank IKB Deutsche Industriebank, knew the contents of the deal and possibly even removed certain bonds from its makeup. In the two March 2007 e-mails, Goldman employees sent three “replacement” bonds to an IKB executive, saying “hopefully these will work.”

In turn, the S.E.C. is expected to outline a second possible misstep by Mr. Tourre tied to his dealing with ACA. Mr. Tourre, the S.E.C. said, misled ACA into thinking that Mr. Paulson was investing in the bonds rather than betting against it. In a January 2007 e-mail, Mr. Tourre falsely told ACA that one chunk of Abacus was “pre-committed,” meaning that an unnamed investor already agreed to buy it. In a deposition, he later acknowledged that his e-mail “could have been more accurate.”

ACA, the S.E.C. said, interpreted Mr. Toure’s e-mail to mean that Mr. Paulson was the unnamed investor. And when that impression was conveyed to Mr. Tourre in an e-mail, according to the S.E.C., he failed to immediately correct it.

ACA’s chief executive later told the S.E.C. that he “would not have voted to approve” his company’s involvement in Abacus had he known of Mr. Paulson’s strategy.

Yet Mr. Tourre’s lawyers will argue that if ACA did not know of Mr. Paulson’s bet against Abacus, it should have. ACA, the lawyers note, was a sophisticated player and met separately with Mr. Paulson’s team to discuss the Abacus deal. Goldman, the lawyers argue, also sent ACA “a steady stream” of documents correcting Mr. Tourre’s misstatement.

“Fabrice Tourre has done nothing wrong. He is confident that when all the evidence is considered, the jury will soundly reject the S.E.C.’s charge,” his lawyers, Pamela Chepiga and Sean Coffey, said in a statement.

The defense received additional ammunition on Tuesday when Judge Forrest ruled that the S.E.C. could not fully block mention of newspaper articles from 2007 that discussed Mr. Paulson’s penchant for betting against the mortgage market.

The judge has yet to rule on whether to allow the S.E.C. to introduce some of the case’s most colorful e-mails, notably one where Mr. Tourre says a friend had nicknamed him “Fabulous Fab,” and jokes that he sold toxic real estate bonds to widows and orphans.

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I.M.F. Says Euro Zone Remains Vulnerable

In its first official assessment of the European Union financial system, the I.M.F. urged political leaders to show resolve in addressing the remaining weaknesses in the structure of the euro zone. Unfinished tasks include creation of a mechanism for winding down failed banks, and a system to guarantee customer deposits in order to prevent runs on banks, the I.M.F. said.

The fund praised the decision by euro zone leaders last year to concentrate bank supervision in the hands of the European Central Bank, rather than solely with national regulators who have sometimes been reluctant to impose tough measures on their home banks. But, in a 60-page report, the fund also said that a lot of work remained to be done.

“More forceful action is warranted to cement recent gains in market confidence and end the crisis,” the I.M.F. said.

The fund was once known primarily for dealing with financial and debt crises in poor nations, but in recent years has focused more of its resources on Europe and the crisis in the euro zone. As the report Friday illustrated, the I.M.F. and its president, Christine Lagarde, have been increasingly willing to lecture European leaders on how they should combat the crisis.

Many of the weaknesses pointed out by the I.M.F. in the report were familiar. Among them was a dependence by banks on wholesale funding from money markets, which experience has shown can dry up quickly in a crisis.

The I.M.F. also expressed concern that some banks may not have fully disclosed possible losses from bad loans or risky investments. The organization urged banks to continue raising capital, so that they are better able to absorb losses.

“Legacy assets remain a problem in many E.U. countries,” the report said. The I.M.F. did not specify which kinds of assets it meant, but some of the well-known categories include real estate mortgages in countries like Spain or loans to the depressed shipping industry by German, British and Scandinavian banks.

To be an effective bank regulator, the fund said, the E.C.B. needs to have a means to shut down banks in an orderly way, without creating a burden for taxpayers. But European leaders are still discussing how this so-called resolution authority would work. As long as there is no such body, the E.C.B. would be limited in its ability to deal with sick banks, the fund said.

The I.M.F. also highlighted dangers to the insurance industry, which constitutes a large part of the European financial system but has received far less attention than banks. Years of slow growth and low interest rates have become a threat to life insurance policies or pension plans that promised fixed returns.

“A weak economic environment, if it persists, can threaten the financial health of the life insurance and the pensions industries,” the I.M.F. said.

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DealBook: After Huge Loss, JPMorgan Rearranges Top Officials

Matthew Zames was promoted to co-chief operating officer of JPMorgan Chase.Matthew Zames was promoted to co-chief operating officer of JPMorgan Chase.

Adjusting to a shifting banking landscape, JPMorgan Chase broadly reshuffled its management ranks on Friday and united some of its business operations.

The moves, coming months after the bank announced a multibillion-dollar loss on a soured trade, are intended to strengthen JPMorgan’s focus on its clients, especially as profits in other areas are threatened by regulatory changes and the gloom in Europe.

Much of the change centers on combining the bank’s central businesses. Under the new organization, JPMorgan’s consumer businesses will be under one awning, and its investment banking and treasury operations will be under another. “It’s a natural progression,” said Jamie Dimon, the bank’s chief executive.

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By making such a clear delineation, some bank analysts said, JPMorgan is also implicitly mounting a defense against calls for the big banks to be broken up. Those cries gathered steam earlier this week, when Sanford I. Weill, who forced Mr. Dimon, his former lieutenant, out of Citigroup in 1998, said that behemoth financial institutions should split their investment banking businesses from their deposit-taking operations. As the executive who built Citigroup, Mr. Weill had earlier led a charge to lift the Depression-era ban on commercial banks doing investment banking.

Mike Mayo, an analyst with Crédit Agricole Securities, said JPMorgan’s moves were aimed at showing that plain-vanilla banking operations are entirely cordoned off from the bank’s potentially risky investments.

As part of the realignment, JPMorgan promoted a number of younger executives, including Matthew E. Zames and Michael J. Cavanagh, generating new speculation about who may succeed Mr. Dimon. Still, people close to the bank say Mr. Dimon, who is 56, does not have plans to hand over the reins for at least five years.

Frank Bisignano was promoted to co-chief operating officer of JPMorgan Chase.Frank Bisignano was promoted to co-chief operating officer of JPMorgan Chase.James Staley will become chairman of JPMorgan Chase's corporate and investment bank.Scott Eells/Bloomberg NewsJames Staley will become chairman of JPMorgan Chase’s corporate and investment bank.Michael Cavanagh will become co-chief executive of JPMorgan Chase's corporate and investment bank.Michael Cavanagh will become co-chief executive of JPMorgan Chase’s corporate and investment bank.

Both Mr. Cavanagh and Mr. Zames have been in the spotlight over the last three months as JPMorgan works to contain the damages from the trading debacle — a rare black eye for Mr. Dimon, once considered among the most deft risk managers on Wall Street.

In May, Mr. Zames, 41, took over the bank’s chief investment office, the powerful unit at the center of the losing trade. He succeeded Ina Drew, who was one of the more notable casualties of the trade, which has grown to $5.8 billion in losses. Mr. Zames will become JPMorgan’s chief operating officer, a role he will share with Frank Bisignano. Under the realignment announced on Friday, Mr. Zames will still oversee the chief investment office and mortgage capital markets.

Like Mr. Zames, Mr. Bisignano, 52, was tapped last year to be a kind of fix-it man. In his case, it was JPMorgan’s struggling mortgage business.

One little noticed element of the reorganization is its impact on Douglas L. Braunstein, the bank’s chief financial officer. Although Mr. Braunstein, 51, will keep his position, he will no longer report to Mr. Dimon, but instead to Mr. Zames.

Bank executives are split on how to interpret the moves. Some see the change as simply a long-planned promotion for Mr. Zames. But others, who did not want to be named because of the sensitivity of the issues, wondered whether the move was a demotion for Mr. Braunstein.

Just weeks before the trading error, Mr. Braunstein dismissed concerns about the trading that would later blow up in the bank’s chief investment office. In an interview, Mr. Braunstein said he was “very comfortable with the positions we have.”

Under the management changes, Mr. Cavanagh, 46, who used to be the bank’s chief financial officer and now leads the treasury and securities services, will become co-chief executive of the corporate and investment bank. Daniel E. Pinto, 49, who heads the bank’s business in Europe, the Middle East and Africa as well as its global fixed-income business, will oversee all trading businesses and become co-chief executive with Mr. Cavanagh.

Signs of the latest shifts appeared when JPMorgan announced second-quarter earnings this month. On a conference call with analysts, Mr. Cavanagh, who was deputized by Mr. Dimon to lead a kind of financial autopsy of the chief investment unit, described what went wrong at the unit, pointing to fundamental flaws in risk management.

Mr. Cavanagh has long been a valuable lieutenant for Mr. Dimon, senior executives said. As head of strategy and planning at Bank One, he worked closely with Mr. Dimon, a camaraderie he maintained as JPMorgan’s chief financial officer in 2004.

As a result of the shake-up, however, James Staley, 55, who currently is chief executive of JPMorgan’s investment bank, is partly sidelined, some senior executives said Friday. Although Mr. Staley will take on a new role as head of the newly formed corporate and investment bank, some viewed the position as more symbolic than substantial.

“In this role, he will head a group of senior executives who will work together to develop a view of what global banking will look like in the years ahead,” the bank said in a statement. He will continue to serve on the bank’s operating committee.

During Mr. Dimon’s nearly six-year reign, the bank has undergone a number of management revamps. Few of the executives who made up Mr. Dimon’s inner circle during the financial crisis — including Bill Winters, Steve Black and Heidi Miller — remain.

Driving the latest organizational changes, Mr. Cavanagh said, is an overarching desire to improve services for clients and recruit more business. “We can do things that few of our competitors can,” he said in an interview on Friday. He added that the moves allowed JPMorgan to leverage “our size for our clients.”

Although JPMorgan, unlike its rivals, safely navigated the storm of the financial crisis, it is now grappling with the same problems affecting the entire industry. Across the banking sector, revenue from securities and banking are still lackluster as deal volume stays around record lows. As a result, a focus on client services is paramount, banking analysts said. Banks like JPMorgan, they say, cannot depend on profits from trading.

“These companies will live and die on their ability to serve the clients,” said Jason Goldberg, an analyst with Barclays.

JPMorgan is trying to reassure investors that its risk management practices are strong and that the losses are contained. Since disclosing the trading losses in May, the bank has been under close scrutiny. The Justice Department and the Securities and Exchange Commission are investigating the loss. In Washington, some lawmakers have seized upon the losses as further evidence that banks need to scale back their riskiest activities.

In a memo circulated to employees on Friday, Mr. Dimon said: “Periodically, all businesses need to reorganize to set themselves up for continued success.”

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