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The Securities & Exchange Commission is investigating Deutsche Bank’s role in packaging collateralized debt obligations (CDOs) for John Paulson—which allowed the hedge fund manager to short subprime mortgages during the financial crisis—and misleading other investors about the transactions, German paper Der Spiegel reported over the weekend.News of the SEC investigation was buried at the end of a Der Spiegel article about a series of lawsuits the German bank was facing [via Naked Capitalism]:
Meanwhile, the US Securities and Exchange Commission is also investigating Deutsche Bank, SPIEGEL reports. According to financial regulatory sources, the bank launched one CDO transaction called “START” in which it allegedly allowed the hedge fund of US speculator John Paulson to choose junk mortgage securities against which he could speculate — without the other investors knowing about it.
If this lawsuit sounds familiar, that’s because it is essentially the same legal trouble that Goldman Sachs got into with the SEC over the ABACUS deal. The SEC claimed that Paulson was involved in the creation of the CDOs, but Goldman didn’t inform the counterparties and those insuring the deal that Paulson had planned on shorting the mortgage bonds. (Reuters has a great factbox of what went down with ABACUS here.)
Now, what’s outrageous about the Deutsche Bank START investigation is not its possible allegations—it’s the timing. The SEC charged Goldman with fraud concerning ABACUS in April 2010, and Goldman settled the suit for $550 million in July 2010.
Yves Smith at Naked Capitalism points out that it is common knowledge Paulson approached Deutsche Bank, Goldman Sachs and Bear Sterns. Both Goldman and Deutsche packaged CDOs for Paulson, so why the long wait with Deutsche Bank? Does the answer have to something to do with the fact that the SEC’s head enforcement chief, Robert Khuzami, worked as Deutsche Bank’s general counsel for the Americas from 2004 to 2009?
When Khuzami took his job at the SEC, he publicly stated he would recuse himself from any investigation involving Deutsche Bank, but Smith doesn’t seem to believe it:
It would not be sufficient for Khuzami to recuse himself from this investigation. Staff would still be concerned about how the probe might affect their ultimate boss.
Deutsche Bank said its CDOs that were similar to Abacus 2007-AC1, the subject of the SEC’s suit against Goldman, didn’t rely on outside firms to help choose the underlying portfolio. That “eliminated the potential for deception with respect to the role of such a manager,” said Ted Meyer, a spokesman for Deutsche Bank.
The suspicions against Khuzami isn’t new [Zerohedge has two critical posts about Khuzami’s role Deutsche’s CDOs in 2010], and Deutsche Bank has faced lawsuits regarding misleading investors about CDOs in the past. But this could be the first time that the German bank would be facing an SEC lawsuit over the matter, and the pressure could be even heavier on Khuzami, who has recently been thrust into the spotlight when he was named to President Obama’s new five-man mortgage fraud unit to investigate any misconduct that may have led to the financial crisis.