One of the first cases to come out of the financial crisis involved fraud charges filed by the Securities and Exchange Commission against Goldman Sachs and one of its mid-level executives, Fabrice Tourre.
The case involved a synthetic collateralized debt obligation tied to subprime mortgages that lost most of its value within months of being sold. Goldman settled the case by paying a $550 million penalty, but Mr. Tourre has continued to fight the charges. He faces a trial date of July 15, 2013.
Now, a new Federal District Court judge in Manhattan, Katherine B. Forrest, has been assigned to preside over the case after it was transferred from the docket of Judge Barbara S. Jones. No reason has been given for the transfer. Judge Jones conducted the trial of Bernard Ebbers, former chief executive of WorldCom, sentencing him to 25 years in prison after his conviction.
Judge Forrest has been on the bench for only one year, receiving her judicial commission o n Oct. 17, 2011, but she is no stranger to closely watched cases. Last month, she issued a permanent injunction prohibiting the federal government from enforcing a law authorizing indefinite military detention.
The issues in Mr. Tourre's case are certainly less controversial, but not less difficult in figuring out the reach of the federal securities law.
Last week, Judge Forrest held a hearing after the S.E.C. asked to revisit a ruling of Judge Jones that had dismissed part of the complaint in light of a subsequent decision by the United States Court of Appeals for the Second Circuit. The charges related to the sale of the C.D.O. by Goldman to a German bank. Judge Jones concluded that the transaction took place outside the United States, and therefore did not come within the federal securities laws.
In Morrison v. National Australia Bank, the Supreme Court limited the application of the primary securities fraud provision, Section 10(b) of the Securitie s Exchange Act of 1934, to only those transactions conducted on a stock exchange in this country or “domestic transactions in other securities.†The lower courts have struggled to figure out exactly what comes under that second category.
In dismissing a portion of the S.E.C.'s complaint, Judge Jones interpreted the Morrison opinion to require showing that a party to a transaction had incurred “irrevocable liability†to purchase or sell the security in the United States if the trade was not conducted on a domestic stock exchange. Although Goldman was the underwriter of the C.D.O., a Cayman Islands-based issuer was the actual seller to the German bank, so Judge Jones concluded there was no connection to this country to allow the S.E.C. to pursue its claim.
The S.E.C. claims that a more recent decision by the appeals court expanded the test for what transactions can come under the federal securities laws. In Absolute Activist Value Master Fund Ltd. v. Fic eto, the appeals court said that the transfer of title to securities in the United States could also be sufficient to bring a case in federal court. The S.E.C. argues that the closing on the Goldman C.D.O. transaction took place in New York and that should be sufficient to allow the claims related to the German bank to proceed.
To make things even more complicated, in reaching its decision the appeals court cited with approval Judge Jones's opinion dismissing claims under the “irrevocable liability†test. Whether there really is a broader test from the Absolute Activist decision is something Judge Forrest will have to figure out.
A brief filed by Mr. Tourre's lawyers disputes whether the dismissed charges can be reinstated, and argues that the parties conducted discovery of foreign witnesses on the assumption that the claims related to the German bank would not be litigated. If Judge Forrest finds in favor of the S.E.C. and reinstates the dismissed claims, then there is a chance that discovery will have to be reopened and the trial could be pushed back.
As per its bylaws, Goldman is paying for Mr. Tourre's lawyers, and the prospect of the case going to trial cannot be a pleasant one for the firm. In addition to the rising legal costs, which could run into the millions of dollars, the case will dredge up issues regarding how the firm put together and sold the C.D.O. right before the financial crisis, which will not cast it in a favorable light.
The stakes are even higher for the S.E.C., so any advantage it can gain in the case against Mr. Tourre is important.
An earlier trial on securities fraud charges against a midlevel Citigroup banker for selling a C.D.O tied to subprime mortgages resulted in a finding against the S.E.C.
The defendant's lawyers offered a “Where's Waldo?†defense, claiming he had only a minor role in a questionable securities offering. Mr. Tourre occupied a similar position at Goldman, and is likely to claim that he was only a bit player in putting together and marketing a C.D.O. that was reviewed by a far more senior executives who have not been named in the case.
If the S.E.C. is unable to hold individuals liable for the sales practices of Wall Street firms, it raises questions about whether it can effectively police the financial markets.
As Judge Forrest wades into a Mr. Tourre's case, her rulings are sure to come under the microscope to see how she handles a high-stakes securities fraud case.
