• A CDO Goes Moo: Three Email Guidelines Goldman Players Should Have Followed
  • May 11, 2010 | Author: Michael M. Krauss
  • Law Firm: Faegre & Benson LLP - Minneapolis Office
  • "I think that's very unfortunate to have on email." So responded Goldman Sachs' CFO to a message highlighted at an April 27 Senate hearing. This hearing was in response to an SEC civil complaint against Goldman, alleging fraud in the marketing of a synthetic collateralized debt obligation (CDO) that the firm had structured.

    Which email elicited this expression of regret? Was it the boastings of the "fabulous Fab" who—while he was marketing CDOs to investors—predicted that "the whole building is about to collapse" and described himself as "standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities!!!"? Or was it the caution from a senior trader of CDOs that "the cdo biz is dead we don't have a lot of time left"?

    While the SEC featured both of these emails prominently in its complaint, it was neither. The CFO was reacting to yet another message—this time using vulgar language to describe a CDO that Goldman had structured and marketed just months earlier. Sen. Carl Levin, the committee chairman, repeated the offending phrase 11 times in questioning top executives.

    Rating Agency Communications Also Scrutinized

    Goldman is far from the only sophisticated financial player whose internal emails have been grist for the mills of litigation and investigation in the wake of credit crisis. Rating agencies are under fire for assigning triple-A ratings to CDOs that they later downgraded to junk, particularly where their fees were paid by the same firms that structured and sold the products.

    Their cause was not helped by an instant-message conversation between two analysts at one rating agency. When one questioned whether the agency should even rate a deal the analyst deemed "ridiculous," the other responded: "We rate every deal. It could be structured by cows and we would rate it." Bovine attributes are many, of course, but acumen in packaging investment-grade debt securities is not among them.

    Investment Bank Emails Constitute Probable Cause for Fraud

    Meanwhile, a court last fall relied on internal emails in finding probable cause that an investment bank committed fraud in selling CDOs to a hedge fund even as the bank knew the CDOs were about to be downgraded. In one, an employee of the investment bank wrote that he had "sold more crap to [the hedge fund]." In another, a different employee referred to a supposed "investment grade" rated CDO and asked: "OK still have this vomit?"

    The court left no doubt as to the impact of these emails on its decision to allow the hedge fund to attach nearly $36 million of the investment bank's assets. "The court takes [the] employees at their word when they referenced their Notes, these purported ‘investment grade' securities which they sold, as ‘crap' and ‘vomit,' for [the investment bank] alone possessed the knowledge of what their product, their inventory, was truly worth."

    Emails Are Forever, Particularly When Deals Go Bad

    Time and again, people write in email what they would never say in public—much less write on business letterhead. Experienced executives, traders, and analysts at top financial firms are no exception. Many consider email to be the same as a phone call or stopping by a colleague's office. But email—and now texting or tweeting—is no substitute for speaking and meeting. Email provides a verbatim record of what was said, but without context, and without allowing for facial expressions or modulation of tone and expression. And email, unlike conversation, can last forever. Email resurfaces in court years later, scrutinized in the hindsight of a deal gone bad, even as context is forgotten and only the text remains.

    Following Basic Guidelines Could Keep Emails Out of Court

    What can financial institutions and firms do to reduce the risk of "unfortunate" emails? While emails are an efficient and effective means of communication, employees should treat them like any business memo or letter—even when emailing each other. Specifically, they should include only information and language that they would use on any document on company letterhead.

    The analysts, executives, and traders who wrote their now-infamous messages may not have kept in mind three basic email "don'ts."

    • Don't disparage your firm's products or services. The investment banks ridiculed the CDOs they were marketing to clients, and the rating agency apparently belittled its entire approach to determining the ratings on which investors relied. Constructive and thoughtful evaluation of products and services is one thing, but flip one-liners are another—particularly when they may be seen as at odds with statements made outside the firm
    • Don't write something that you do not believe to be accurate or true. Testifying before the Senate, Fabrice Tourre distanced himself from one of his emails by saying, "With a view to typing fast, I wrote something that was not accurate." Employees should do their best to write in email only statements they are prepared to stand behind later—and ideally should proof and allow time to pass before sending an email
    • Don't use humor or sarcasm. Business email is not an outlet for creativity. What seems witty today may appear less so tomorrow—especially after the financial transaction in question has gone south and a droll remark assumes unintended meaning under the glare of litigation or government investigation (or both)

    If the analysts and investment bankers had considered these guidelines, their firms would have been better-positioned to address the substantive issues surrounding their business practices and explain their decision-making without having to rationalize "unfortunate" emails.