Photographer: Ben Baker
Photographer: Ben Baker

Almost three years ago, when Goldman Sachs Group Inc. paid $550 million to settle fraud accusations by the Securities and Exchange Commission, one of the claims was that Goldman misled the bond-insurer ACA Financial Guaranty Corp. in a horribly complex deal named Abacus.

Goldman settled without admitting to the accusations. The terms also prohibited Goldman from denying the SEC’s allegations in its public statements. Then, this week, a funny thing happened. A New York state appeals court, in a 3-2 ruling, dismissed ACA’s lawsuit against Goldman. ACA said Goldman misled it. The court said the insurer’s claims didn’t hold up.

The case captures perfectly why much of the public detests “neither admit nor deny” regulatory settlements. We don’t know whose facts to believe. Without trials or admissions of liability, the government’s allegations remain unproven. Sure, Goldman paid a big fine. That doesn’t establish anything. For all we know it paid the money just to make the SEC go away.

The result is surreal: Goldman still isn’t allowed to deny the agency’s claims that it misled ACA. However, a court has thrown out ACA’s claims that Goldman did, in fact, mislead it.

To make matters more confusing, there may not be anything factually inconsistent between this week’s court ruling and the SEC’s earlier allegations. To win a fraud suit as a private litigant, ACA needed to show that it justifiably relied on Goldman’s misrepresentations. (The court said the insurer failed this test.) The SEC, by contrast, doesn’t have to prove that an investor relied on a defendant’s misstatements. Plus, the SEC said Goldman defrauded multiple parties, not just ACA.

SEC Accusations

Let’s back up a bit. Abacus was a financial product known as a synthetic collateralized debt obligation. The SEC’s suit accused Goldman and a junior executive, Fabrice Tourre, of making false and misleading statements to investors about the deal, which the SEC said was designed to fail.

Goldman’s main offense, allegedly, was telling a German bank that ACA had picked the mortgage-related investments underlying the deal -- when actually the selection process was heavily influenced by a hedge fund, Paulson & Co., which later made $1 billion betting against Abacus. As part of its SEC accord, Goldman said it was “a mistake” not to disclose Paulson’s role, but it didn’t admit violating the law.

Echoing the agency’s allegations, ACA accused Goldman of misleading it into believing that Paulson would take a long, or bullish, position in the equity portion of Abacus, aligning it with ACA’s interests. In its majority opinion, the appeals court said it dismissed ACA’s claims because “such misrepresentations were specifically contradicted by the offering circular’s disclosure that no such equity position was being taken.”

In other words, ACA should have known Paulson wasn’t long when the insurer sold credit protection on a $909 million slice of the deal in 2007. ACA had acknowledged in writing that it wasn’t relying on any representations other than those in the circular and in written agreements, the court said. ACA said it will appeal this week’s ruling. The company is being wound down and isn’t writing new policies.

Although Goldman settled with the SEC, Tourre, 34, is still fighting the agency. He’s now pursuing a doctorate in economics at the University of Chicago. Should his case ever go to trial, we may find out what really happened here.

The usual criticism of “no admit” settlements is that they suggest the government is soft on corporate crooks. No doubt this is often true. But there is also a flip side. Settling without admissions of liability may tempt regulators to pursue weak cases, knowing that some defendants would rather write a check than spend years battling in court.

Warren’s Query

This week, U.S. Senator Elizabeth Warren asked this question in a letter to SEC Chairman Mary Jo White, Federal Reserve Chairman Ben Bernanke and Attorney General Eric Holder: “Have you conducted any internal research or analysis on trade-offs to the public between settling an enforcement action without admission of guilt and going forward with litigation as necessary to obtain such admission and, if so, can you provide that analysis to my office?”

Back in February, Warren put the same question to Comptroller of the Currency Thomas Curry. His agency, which regulates the country’s largest banks, replied last week that it had no such research or analysis.

Warren, a Massachusetts Democrat and former Harvard Law School professor, wrote in her May 14 letter: “I believe strongly that if a regulator reveals itself to be unwilling to take large financial institutions all the way to trial -- either because it is too timid or because it lacks resources -- the regulator has a lot less leverage in settlement negotiations and will be forced to settle on terms that are much more favorable to the wrongdoer.”

Perhaps, too, the regulator would try harder to make sure it brings only strong cases if its goal were to actually prove its allegations. As for the SEC’s claims in the Abacus suit, we can only wonder. Did Goldman rip off ACA? This week a court ruled no.

(Jonathan Weil is a Bloomberg View columnist. The opinions expressed are his own.)

To contact the writer of this article: Jonathan Weil in New York at jweil6@bloomberg.net.

To contact the editor responsible for this article: James Greiff at jgreiff@bloomberg.net.