In the civil lawsuit being pursued since 2010 by the SEC against a lone Goldman Sachs employee, Fabrice Tourre, alleging "intentional and neglectful misrepresentations" in relation to the ABACUS 2007-AC1 CDO that he worked on, District Judge Kathryn Forrest issued an odd ruling last week that warrants some attention from practitioners in securities offerings.
As part of a barrage of motions in limine, the SEC filed a motion to preclude Tourre from "offering evidence or argument at trial that he reasonably relied on advice of counsel, the legal background of his co-worker, David Gerst, or the institutional processes in place at Goldman Sachs & Co." Tourre's counsel responded by noting the obvious:
1) Tourre was not a lawyer, but actually an engineer by training, and had no independent basis to judge what was or wasn't required to be disclosed, or in what particular form something had to be disclosed, for an offering to meet the securities laws;
2) Gerst had been trained as a lawyer, and had joined Goldman from a leading securitization firm, McKee Nelson, where he had worked on other ABACUS transactions;
3) there was a "division of labor" among the Goldman employees working on the trading desk with Gerst, taking responsibility for "documentation and execution of transactions and liaising with internal and external counsel" while Tourre worked on "the risk and economics" of the desk's business;
4) the offering documents were in fact reviewed by numerous individuals at internal and external counsel and Gerst was the person on the desk responsible, as far as Tourre knew, for that process, in which no one has been yet discovered who suggested the disclosure was inadequate; and
5) telling these facts to the jury was useful to enable them to evaluate the SEC's allegations that Tourre had "intentionally and neglectfully" made misrepresentations or omissions in the course of the offering. In other words, the way in which the deal was put together and the roles of Tourre and others was relevant to the SEC's allegations.
Anyone who has worked on securities offerings of any complexity recognizes this paradigm. There are always bankers or traders making high-level business decisions about the material terms of the offering and then there are different people, internal and external lawyers, and sometimes other professionals, whose job it is to prepare the offering documents and make sure they conform to applicable securities laws. That division of labor is customary and, like most divisions of labor, efficient. It matches people's skills to required tasks; lawyers don't do auditors' work or price deals, and the business people don't write legal documents or do other legal tasks for which they are not qualified. In most cases when I worked with "a desk", there was someone on the desk who was a former lawyer who was the main contact for outside counsel on the documents and other legal subjects, and then communicated between the rest of the team on the desk and outside counsel to get major questions or issues resolved in the course of structuring and negotiating the deal. Only occasionally would the former lawyer be joined by his or her business colleagues on calls with lawyers about the documents; the company they all worked for had hired the documentation person to fulfill that task more effectively.
In the lawsuit against Tourre, the SEC seems to disagree with that practice. It alleged that Tourre was "principally responsible" for the CDO, an allegation that is somewhere between vague and simplistic, on the one hand, and utterly absurd, given the size of Goldman Sachs, its internal processes for doing a deal, and the number of outside lawyers involved in the CDO. The SEC goes on to argue that "a corporate executive has ‘an independent duty to ensure compliance with disclosure obligations.’”. Tourre pointed out that he was hardly a "corporate executive" at Goldman and the legal authority for that proposition was a case against a CEO and CFO concerning proxy statements they had signed -- a very different, Sarbanes-Oxleyish level of responsibility compared to a guy working on a desk who has a lawyer next to him who he thinks is responsible for documentation.
In my view, Judge Forrest should have denied the SEC's motion to preclude Tourre from telling the jury these facts. They are clearly relevant to the allegation that Tourre was "principally responsible" for the transaction and also the allegations about Tourre's "intent" and "neglect"; simply put Tourre thought someone else, more qualified than him, was responsible for disclosure documents, which, in my experience, is an incredibly reasonable understanding. And how reasonable what he thought was seems quite relevant to the jury evaluating his intent and neglect.
Instead, Judge Forrest seems to have become confused and mistakenly framed the issue as whether Tourre was claiming to invoke an "advice of counsel" defense: "Much of that testimony would be irrelevant, given Tourre's intention not to present a reliance on counsel defense". He admitted he wasn't claiming that defense. The elements of that defense are several-fold and mostly inapplicable to the ongoing, multi-day process of constructing a complex deal; they are geared to a situation in which someone expressly poses a very specific discrete question to a lawyer to get advice. But that was not the correct way to frame the question. It's not a "defense" that Tourre has "to present"; how a transaction gets put together and who does what on it are evidence relevant to the plaintiff's allegations about his personal role in the transaction and his intent or neglect. It bears on the case in chief, and thus should not be boxed into an affirmative defense. The judge seemed not to get that. Instead, she expressed concern that explaining "the presence and involvement of lawyers - who are presumably paid to ensure that any disclosures comply with the relevant legal requirements" might confuse the jury into thinking that lawyers "blessed" the documents. But that wouldn't be confusion at all, since that is exactly what the lawyers were supposed to do!
It's a surprisingly confused ruling, considering the judge was a partner at Cravath for 10 years at one point in her career ( I have no idea how often she actually went to trial, though).
I raise it not only for the injustice it does to a junior banker like Tourre in this specific lawsuit but also because it sets a terrible precedent for non-lawyers working on securities deals in the future. If it stands, a banker "primarily responsible" for the transaction, even though not a lawyer, or CEO, director or CFO covered by Sarbox, can be sued personally for any misrepresentations or omissions in an offering, and precluded from defending himself or herself by saying the responsibility for preventing those tasks was delegated to the lawyers. That would keep a lot of bankers up at night and make for very inefficient expenditures of time and money making an explicit record that the lead banker actually had detailed conversations with outside counsel and was told the documents were OK, when everyone knows that is their job in the first place.
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