By Grant McCool
NEW YORK, March 30 A U.S. appeals court was
asked on Friday to decide whether Goldman Sachs Group Inc
and TCW Asset Management Co should have foreseen the housing
market implosion that caused a $37 million loss for German
state-owned Landesbank Baden-Wurttemberg.
A three-judge panel on Friday did not make an immediate
ruling on a trial judge's decision last September to dismiss the
German bank's lawsuit claiming fraud against Goldman and
TCW, an investment advisor.
The lawsuit was brought over a collateralized debt
obligation (CDO) named Davis Square Funding VI, which was
managed and marketed by Goldman and TCW at the height of the
housing bubble when profits were potentially lucrative. The
lawsuit was filed in October 2010, about four years after Davis
It is one of the few cases to reach the appellate court
level in which a sophisticated investor has accused a bank of
profiting unjustly by being negligent in marketing and selling
the product. Landesbank also accused Goldman of betting against
its own derivative product that was riddled with risky
residential mortgage-backed securities.
In dismissing the case, U.S. District Judge William Pauley
in New York had said the allegations against Goldman and TCW
were "sparse and lack particulars" and speculated on events
occurring long after Davis Square closed.
Judges on the 2nd U.S. Circuit Court of Appeals also zeroed
in on whether Landesbank should have more carefully scrutinized
what it was buying.
"What does the record show about your client's diligence in
the housing market during this period?" Judge Susan Carney asked
Landesbank lawyer Arthur Miller.
Miller responded that there was "no way of having equal
information to Goldman," describing the investment bank as the
"emperor" of financial institutions.
Miller told the panel that Goldman knew what information the
ratings agencies and the top market regulator, the U.S.
Securities and Exchange Commission, had about the quality of the
underlying mortgages in the investment pool.
HOUSING MARKET CRASH
The CDO's underlying portfolio comprised about 95 percent
RMBS, which went on to lose value as the housing market crashed
in 2007 and 2008, contributing to a global economic crisis. The
German bank's lawsuit said it lost its investment of $37
"They know that representing them as triple-A securities is
false," Miller said, referring to the highest debt rating for a
The judges also queried Goldman's lawyer about what it knew
at the time about the securities and the risks to its client.
Goldman lawyer Theodore Edelman told the panel that the
firm's disclosures were "extremely clear and specific" and that
the SEC website had timely information on loan delinquencies.
"All of this is available by a click of the mouse," Edelman
In court papers, Goldman said Landesbank relied on a late
2007 report by Clayton Holdings, a provider of due diligence
services to the mortgage industry. The report referred to loans
that Clayton examined in 2006 and 2007, but the loans backing
Davis Square were originated primarily in 2004 and 2005.
One legal expert said that since the mortgages at issue were
dated several years before the housing crisis, Goldman should be
able to successfully defend the appeal.
"Back then, securitization was going great guns and we were
a good 18 months away from the meltdown in the market," said
Tony Plath, law professor at the University of North Carolina in
Landesbank accused Goldman of profiting unjustly from Davis
Square by charging an excessively high purchase price and fees.
It said Goldman also bet against the product by buying billions
of dollars in credit default swaps that insured Goldman against
the collapse of the mortgage securities collateral it sold to
In 2010, the SEC sued Goldman and a vice president of the
firm over another CDO, called Abacus 2007-AC1, accusing them of
failing to tell investors the Paulson & Co hedge fund helped
choose and bet against the subprime RMBS underlying Abacus.
Goldman settled with the SEC for $550 million without
admitting wrongdoing. The case against the executive, Fabrice
Tourre, is ongoing.
The case is Landesbank Baden-Wurttemberg vs Goldman Sachs
and TCW Asset Management Co, 2nd Circuit U.S. Court of Appeals
in New York No. 11-4443.