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Wall Street's Hypothetical Mortgage


Despite the enormous attention that’s been given to the SEC’s charges of fraud against Goldman Sachs , the actual case seems to rest on a relatively small point: whether Goldman should have included in the prospectus for the synthetic CDO the fact that the counterparty was involved in choosing some of the portfolio.

Former attorneys with the SEC’s division of enforcement and lawyers at Wall Street firms tell me this will be the central part of any case. It seems a rather picayune point on which to focus such a major action against Wall Street’s most successful firm, but the fact is that if that omission is deemed material it would be a violation of rule 10b5 and therefore count as fraud.

Given the voluminous warnings included in the prospectus for Abacus 2007-AC1, it seems doubtful the fact that Paulson and Co. was party to deciding what was in the portfolio of referenced securities would have hurt appetite for the deal.

In a conference call this morning, Goldman’s general counsel, when asked whether the firm should have included that fact, said he didn’t believe the law required it and didn’t believe it was material. It will be a long time until that point is decided in court. But if it ever gets there, it will be the key legal point in contention.

The larger questions raised by the SEC’s actions are ones I have raised on CNBC and in my book. Namely, why did Wall Street need to create a synthetic market for mortgage securities when there was already a $12 trillion market for actual mortgages.

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Questions? Comments? Write to faberreport@cnbc.com.