Remember the case over Goldman Sachs's Hudson CDOs, in which U.S. District Judge Victor Marrero wrote a scalding opinion in March? Marrero refused to dismiss fraud claims against the bank, in a ruling that detailed Goldman Sachs's alleged scheme to shed exposure to subprime mortgages by dumping toxic collateralized debt obligations on an unsuspecting public. This week Goldman had a little something to say about the case, and -- surprise! -- it's not an apology.
On Monday the bank's lawyers at Sullivan & Cromwell filed Goldman's answer and counterclaims to the securities fraud suit brought by the Dodona hedge fund. (Hat tip to Brune & Richard's new must-check website, S.D.N.Y. Blog.) The most interesting part of the filing comes 40 pages in, when the bank outlines why (in its view) Dodona -- and not Goldman -- is the real wrongdoer in the Hudson CDO scenario.
According to Goldman, the hedge fund and its founder, former Salomon Brothers asset-backed trader Alan Brody, knew exactly what they were getting when they bought Hudson CDOs. The fund explicitly marketed itself as an expert in the "structural complexity" of "mortgage-related CDO equity and structured credit products." Dodona told investors it was "uniquely qualified to make informed and sound investment and hedging decisions" about CDOs because Brody and company were savvy about evaluating underlying collateral.
Goldman asserted that when the hedge fund invested in the bank's Hudson products, Dodona specifically represented that it had conducted its own evaluation of the CDOs and was not relying on Goldman's advice. It also expressly acknowledged the risk of the investment. In fact, according to the counterclaims, Goldman relied on Dodona's experience when it permitted the fund to invest in the CDOs.
That's the twist in Goldman's counterclaims: It alleges that it was misled by Dodona, which supposedly engaged in "a cynical 'heads, I win, tails, I sue' strategy -- whereby it seeks retroactively to short its own investment in the Hudson CDOs through meritless litigation." To make the argument, Goldman invoked the magic phrase all CDO defendants rely upon -- "sophisticated investor" -- and the New York state appellate court's two-month-old ruling in HSH Nordbank v. UBS (which has been getting as vigorous a workout as I thought it would). In HSH Nordbank, the state appellate division's First Department concluded that the German bank, as a sophisticated investor, received abundant warnings and disclaimers about a UBS CDO, so it couldn't turn around and make a $500 million fraud claim.
But Goldman didn't cite the ruling in its own defense. Instead, it argued that the decision supports its fraudulent inducement counterclaim against Dodona, which allegedly duped Goldman when it lied about its independent analysis of the CDO risk as part of a "calculated strategy" of hedging the investment. "Dodona made the misleading statements as part of a fraudulent scheme to create a risk-free option pursuant to which it sought to benefit from any gain in the value of its investment, but to sue defendants in the event of any decline and to fraudulently induce Goldman Sachs to sell the Hudson CDO Securities," the counterclaim said.
The bank also accused the hedge fund of breaching the investment contract it signed and demanded that the hedge fund repay its costs and legal fees.
Goldman has had mixed early results in these mortgage-referenced CDO cases. A suit by Germany's Landesbank Baden-Wuerttemberg over its investment in Goldman's Davis Square CDOs was tossed by U.S. District Judge William Pauley last year, in a decision affirmed by the 2nd Circuit Court of Appeals in April. State Supreme Court Justice Barbara Kapnick in Manhattan, on the other hand, refused to dismiss state-court fraud claims by the bond insurer ACA, which was the portfolio selection agent on Goldman's notorious Abacus CDO. If the Dodona counterclaims are a portent of Goldman's strategy in the Abacus case, ACA may be in line for some nasty accusations as well.
I left phone messages for Goldman counsel Richard Klapper of Sullivan & Cromwell and Dodona counsel Lawrence Lederer of Berger & Montague but didn't hear back.
(Reporting by Alison Frankel)
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