Fabrice Tourre, a 2001 Stanford University graduate who is allegedly the principal architect in a "toxic" sub-prime mortgage scheme that cost investors more than $1 billion, appeared for the first time before Congress Monday. He denied allegations of wrongdoing.
Tourre, 31, who described himself in an e-mail as the "Fabulous Fab" and the "only potential survivor" of the Goldman Sachs and Co. mortgage-backed securities debacle, is the only individual named in a federal civil lawsuit filed April 16 by the Securities Exchange Commission (SEC).
Tourre is being sued along with broker-dealer Goldman Sachs and Co. for securities fraud in developing a financial "instrument" that was tied to the performance of sub-prime residential mortgage-backed securities.
The "synthetic collateralized debt obligation" (CDO), a particular type of financial instrument, was designed to crash spectacularly for the benefit of Goldman Sachs and one investor, the SEC claims.
Tourre, a native of France, graduated from Stanford's Department of Management Science and Engineering with a specialty in operations research -- developing and using mathematical and computational methods statistics, supply-chain management, pricing and financial engineering, according to the department's website.
He is alleged to have created ABACUS 2007-AC1, a portfolio of investments in sub-prime residential mortgage-backed securities. Investors receive payments out of the interest and principal on the underlying mortgages.
But while investors expected a positive return on a portfolio of mortgages, Tourre and Goldman Sachs allegedly did not divulge that the company was allowing a large hedge fund, Paulson and Co. Inc., to pick the portfolio's selection.
Paulson wasn't interested in the portfolio's success; rather, the company picked securities it expected to fail, according to the SEC complaint.
By betting on failure rather than success -- known as "shorting" -- Paulson made nearly $1 billion in profit while Goldman's investors lost more than $1 billion, according to the lawsuit. Shorting is not illegal, but failing to disclose Paulson's role is fraud, the SEC noted.
Paulson identified 100 bonds it expected to experience "credit events" in the near future. The selection favored sub-prime residential mortgage-backed securities with a high percentage having adjustable-rate mortgages.
The borrowers had relatively low FICO scores, a measure of credit trustworthiness. A high concentration of mortgages were in states such as Arizona, California, Florida and Nevada, which had high rates of home-price appreciation, according to the complaint.
Tourre allegedly devised the ABACUS 2007 portfolio, prepared the marketing materials and communicated directly with investors, according to the complaint.
At the time, he worked as a vice president on the structured-product-correlation trading desk at Goldman Sachs headquarters in New York.
To attract big investors, Goldman Sachs and Tourre allegedly convinced a third-party collateral manager, ACA Capital, to attach its name to the portfolio. Neither ACA Capital nor the investing banks were told of Paulson's role in portfolio selection or its investments in the portfolio's failure.
ACA Capital put up $909 million to protect the credit risk associated with a significant part of the portfolio. One of Europe's largest banks, ABN AMRO Bank N.V., covered ACA Capital's risk.
Tourre allegedly told ABN AMRO Bank in e-mails that ACA Capital had selected the portfolio and never mentioned Paulson's role, according to the suit. ACA Capital's finances collapsed.
A consortium of banks, including the Royal Bank of Scotland, which had purchased ABN AMRO Bank in late 2007, invested more than $840 million. That money was paid to Goldman Sachs, and most was subsequently paid by Goldman to Paulson, according to the complaint.
Another major investor, IKB -- a commercial bank in Dusseldorf, Germany, that specializes in lending to small and medium-sized companies -- bought $150 million worth of notes in the portfolio.
"Within months of closing on the deal, ABACUS 2007 notes were nearly worthless and IKB lost nearly all of its $150 million investment," the complaint notes.
Just months after the deals with Paulson and IKB were closed, 83 percent of the sub-prime residential mortgage-backed securities in the portfolio had been downgraded and 17 percent were on "negative watch." By Jan. 29, 2008, 99 percent of the portfolio had been downgraded, according to the SEC.
Tourre wrote to a friend on Jan. 23, 2007: "More and more leverage in the system. The whole building is about to collapse anytime now ... Only potential survivor, the fabulous Fab ... standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities!!!" the lawsuit states.
A Paulson employee said in January 2007 that the market wasn't pricing the "wipeout" scenario of sub-prime residential mortgage-backed securities, according to the complaint.
"In my opinion this situation is due to the fact that rating agencies, (collateralized-debt obligation) managers and underwriters have all the incentives to keep the game going, while 'real money' investors have neither the analytical tools nor the institutional framework to take action before the losses that one could anticipate based (on) the 'news' available everywhere are actually realized," the employee said.
Goldman Sachs has put Tourre, who was working in London, on paid leave, according to the Wall Street Journal. The company recently announced it has unregistered Tourre with the Financial Services Authority in London, effectively ending his ability to speak with clients or conduct financial business, the Journal reported.
Financial pundits are debating if Tourre is a villain, a fall-guy or a hero. So far, he is the lone individual identified in the SEC suit, which seeks a restraining order against similar activities and repayment to investors of all profits made from the transactions, plus interest and penalties.
Pamela Chepiga, an attorney with Allen and Overy LLP and Tourre's legal counsel, did not return a phone call seeking comment.
Darrell Duffie, a professor in the Stanford Graduate School of Business and an authority on collateralized debt obligation markets (CDOs), described ABACUS 2007-AC1 as "a complicated deal."
But it's not unusual in its structure. There have been many such deals (constructed) in the last 10 years, he said.
"The allegations are the sort of thing that can happen at any time when a bank misstates the product," he said, emphasizing that he does not know if the SEC's allegations are true.
It's much like getting a used car and finding out it's a lemon and not as advertised, he said.
Duffie and Stanford Law School Professor Joseph Grundfest, a former SEC commissioner, will speak during a panel discussion, "SEC v. Goldman Sachs: Analyzing the SEC's Complaint," today (April 27).
More information is available at www.law.stanford.edu/calendar.
The venue has been moved to Bishop Auditorium, located at the Stanford Graduate School of Business, 518 Memorial Way.