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Tourre Ruling Should Guide SEC in Fiduciary Rulemaking, Expert Says

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The jury verdict Thursday afternoon that found former Goldman Sachs’ trader Fabrice Tourre liable for fraud for his role in a failed $1 billion subprime mortgage investment is seen as a critical victory for the Securities and Exchange Commission, and the details of the case should be analyzed as the agency writes its fiduciary rule, industry officials say.

“This was a particularly high-profile case for the SEC, so getting a win was critical for them,” Steve Crimmins, a partner with K&L Gates in Washington, who served for eight years as the SEC’s Deputy Chief Litigation Counsel, told ThinkAdvisor on Monday.

The case against Tourre stems from the 2010 case in which the SEC charged Goldman Sachs with defrauding investors in a 2007 deal known as Abacus, a collaterlized debt obligation. The SEC said that Goldman misstated and omitted key facts about the CDO tied to subprime mortgages as the U.S. housing market was beginning to falter. Goldman agreed to pay a record $550 million settlement and reform its business practices.

On Thursday, a jury decided that Tourre, a former Goldman vice president, should be held accountable for his role in hiding the role played by John Paulson’s hedge fund, Paulson & Co., in the Abacus deal. The SEC claimed Tourre hid that Paulson helped choose the portfolio of subprime mortgage-backed securities underlying Abacus while betting it would fail.

At a time when the agency has been criticized for its poor record in taking cases to trial, Crimmins says that the verdict “demonstrates the SEC Trial Unit’s ability to present very complex cases involving technical terms and concepts to a jury of laypeople.” The Tourre verdict, he says, “will be important to the SEC as it resolves its remaining financial crisis cases and takes on new non-vanilla matters.”

Indeed, the SEC released a statement after the verdict was given stating that the agency “will continue to vigorously seek to hold accountable, and bring to trial when necessary, those who commit fraud on Wall Street.” As shown by this verdict, the SEC said, “we proved that Mr. Tourre, as a Goldman Sachs vice president, put together a complicated financial product that was secretly designed to maximize the likelihood that it would fail, and marketed and sold it to investors without appropriate disclosure.”

U.S. District Judge Katherine Forrest said after the verdict that she would consider possible penalties, disgorgement and other measures Tourre could face as a result of being found liable, according to Bloomberg.

“We should talk about the next phase of this matter, which requires some scheduling,” she said, telling lawyers that she expects to see court papers filed by Aug. 23, Bloomberg reported.

Knut RostadKnut Rostad (left), president of the Institute for the Fiduciary Standard who has blogged for ThinkAdvisor, notes that while the Tourre case addresses the fact that a trader/broker has an obligation to disclose a material conflict in a transaction to an experienced institutional investor, the SEC should review the case as it pens its fiduciary standard providing “guidance on this same issue for brokers advising retail investors.”

The Tourre case “matters” to the current debate over how the SEC should write a rule to put brokers under a fiduciary mandate, Rostad argues, “because it is about what is required in meeting the lower (as compared to the fiduciary standard) commercial sales suitability standard when it comes to disclosure,” in this case of a synthetic CDO.

The SEC was successfully able to argue that material information was needed about the CDO, including Paulson’s role. “Leading ACA [Management] executives to believe Paulson would be making a long investment in Abacus was misleading, and the burden is placed on Tourre to effectively disclosing this fact,” Rostad says. “It’s not placed on ACA executives to figure it out. When ACA executives testified under oath they were unaware of Paulson’s position in the deal, the die seemed to be cast.”

The verdict “clearly suggests that ACA reasonably misunderstood the role of Paulson, and the responsibility for this misunderstanding was placed squarely on Tourre,” Rostad says.

In this respect, the Tourre case focuses on his failure “to fulfill his responsibility to an experienced institutional investor in the rough and tumble of a sales transaction regarding a very material conflict of interest,” Rostad notes.

“Let us hope this fairly stringent requirement required of a trader dealing with an institutional investor in the civil court case is recalled as the SEC (or if the SEC) considers appropriate guidance for brokers advising retail investors when similar conflicts of interest are present.”


Check out Knut Rostad’s latest ThinkAdvisor blog, Four More Years? Fiduciary Proponents Need to Regroup.


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