Anger at Goldman Still Simmers
By Gretchen Morgenson
New York Times
March 26, 2012
Just before the financial crisis began in September 2008, a prominent hedge fund appeared well positioned to take advantage of any turmoil in the markets. That fund, Copper River Partners, had made sizable bets months earlier against companies whose stocks it expected to suffer.
Within weeks, however, Copper River, once a successful $1.5 billion hedge fund, was out of business, having unexpectedly absorbed losses on the very bets it thought would be profitable.
While the market turmoil contributed to its problems, Marc Cohodes, head of Copper River, says that a significant force behind the failure was Goldman Sachs, which for years had been the firm's broker.
Testifying recently in a lawsuit that is unrelated to Copper River's closing, Mr. Cohodes maintained that actions taken in the fall of 2008 by Goldman in the handling of trades for Copper River had done irreparable damage to the fund. His testimony, which has not been made public, was obtained by The New York Times.
Copper River relied on Goldman to handle its negative bets, known as short sales, in compliance with securities laws. These regulations require that before a short sale can be made, the shares must be borrowed; Mr. Cohodes said his fund had paid Goldman approximately $100 million to borrow shares over many years.
In his testimony, Mr. Cohodes said he and his partners at Copper River had even come to wonder if Goldman had in fact borrowed the shares for the firm. Without the shares, Copper River faced losses, while Goldman could have come under regulatory scrutiny.
When asked whether Goldman had borrowed the shares, Michael DuVally, a Goldman spokesman, said: "Mr. Cohodes is wrong. We met our obligations under applicable law." He added that Copper River's problems were the result of the extreme stress in the financial markets at the time.
Goldman has sought to seal the transcript of Mr. Cohodes's deposition, which is part of a case brought by Overstock.com, an Internet retailer, against two of the biggest Wall Street firms.
Overstock contends that the firms -- Goldman Sachs and Merrill Lynch -- failed to borrow company shares that they or their clients sold short, a practice known as naked shorting. Overstock says that the firms essentially evaded rules intended to prevent stock manipulations, and that its stock came under outsize selling pressure as a result.
Both of the firms sued by Overstock have denied the company's accusations. They have requested that the judge overseeing the case seal all the documents generated in the discovery process, contending that their release would disclose trade secrets about the business, known as securities lending, which is highly profitable for the firms. The Times has joined three other media companies in asking the court to unseal the documents. Mr. Cohodes's deposition, however, is not subject to the seal.
Earlier this month, John E. Munter, the judge overseeing the case in California state court, ruled that many of the documents should be made public. The firms are expected to appeal the ruling.
Mr. Cohodes declined to comment beyond his deposition or to explain why he had not sued Goldman over his fund's losses. He has left the money management business and now raises chickens on his farm in Northern California. As an investor who often bet against companies, he drew the ire of many of his targets' executives and shareholders. That he is a straight-talking man who enjoys the combat comes through in his testimony.
Mr. Cohodes is not a party in the Overstock lawsuit and has had a longstanding adversarial relationship with the company, whose stock he bet against. When asked in the deposition if he wanted to help Overstock, he replied, "Oh, absolutely not."
Goldman's handling of its clients has been a hot topic since the credit bubble burst. The firm's creation of Abacus, a mortgage security that was meant to fail but was sold to the firm's clients without disclosing that fact, was the subject of a $550 million regulatory settlement and Congressional hearings.
More recently, a Goldman executive named Greg Smith resigned from the firm and wrote a scathing Op-Ed article in The Times.
Mr. Smith contended in his open letter to the firm's top management that its culture had become toxic and that it had placed its own interests ahead of its customers'. Goldman denied the claims and contended that its customers came first.
Mr. Cohodes's testimony in the Overstock case provides new details of his fund's surprising demise in the market rout. At the time Copper River closed, he only alluded to his problems with Goldman. In an early October 2008 letter to investors describing the September turmoil, he said that "counterparties did not provide the level of business support that they have in the past," something that exacerbated losses.
While few investors understand or care about the mechanics of securities lending, the area has come under increased regulatory scrutiny. The Securities and Exchange Commission has brought several cases in recent years accusing market participants of failing to borrow shares they or their customers had sold short, improperly creating a supply of additional stock to sell.
Along with a handful of traders at smallish firms, Goldman's securities lending unit has been cited by regulators for lapses.
In 2010, the S.E.C. sued Goldman on accusations that it "willfully" had failed to preborrow shares as required for its short-selling clients in January 2009, shortly after Copper River went out of business. The improprieties involved 385 short sales in which the firm had not located shares for its brokerage clients to borrow.
Goldman paid $450,000 to settle the case without admitting or denying the accusations.
Failing to borrow shares on behalf of customers is illegal because of concerns about market manipulation. But it can also leave a brokerage firm's client who is short a stock dangerously exposed to an escalating price in the shares. If a stock shorted by an investor began to trade higher and the shares were not borrowed, closing out the transaction would require the fund to buy them in the open market. That could propel the already rising price of the shares even higher, adding to the costs of the trade.
Mr. Cohodes, who worked at the hedge fund for 25 years, testified in the Overstock case because his firm had placed short bets on that Internet company's shares during the mid-2000s. In 2005 Overstock sued Copper River for stock manipulation, seeking $1 billion in damages. Copper River denied the accusations but settled the matter in late 2009, paying $5 million.
In his Overstock testimony, Mr. Cohodes described Goldman's role as the primary brokerage firm used by Copper River from 2004 through October 2008. Goldman conducted many of Copper River's trades and was relied upon to locate all the shares the firm needed to borrow before it bet against companies.
According to Mr. Cohodes's deposition, Copper River often sold short shares that were hard to locate for borrowing purposes and therefore extremely costly. As such, Copper River paid Goldman handsomely to make sure its trades complied with securities laws, Mr. Cohodes testified. He was unhappy about these fees, he said, but assumed that they were the cost of doing business and that Goldman was charging the market rate for following the rules.
"I view stock loan sort of as the Mafia," Mr. Cohodes said in his deposition. "It's a black box where you don't know people's inputs and costs, and it was sort of: 'Here's the rate.
If you want to borrow it, this is the rate.' And it is what it is."
As an investor, Mr. Cohodes had long expected a stock market correction to result when the overheated mortgage market finally cooled. By mid-2008 he had put on sizable bets against companies that he thought would suffer in such a rout, he testified. One was American Capital, an investment company; others were the Open Text Corporation, a company that offers intranet applications, and Jos. A. Bank, a men's clothing store.
When Fannie Mae and Freddie Mac collapsed in early September 2008 and the stock market began to fall, Mr. Cohodes thought that his firm was well positioned to profit from the downturn, he recalled. His troubles began after Lehman Brothers failed; Copper River's funds at the firm were suddenly frozen. Then government regulators changed the rules governing short-selling, banning the practice altogether in shares of roughly 800 financial companies and decreasing the amount of time allowed for such trades to settle.
This caused a violent rally in these shares. But the stocks that made up Copper River's largest short positions were not on the short ban list.
Nevertheless, the stocks climbed, and Goldman began requiring Copper River to unwind its short positions by buying back the shares. This upset Mr. Cohodes, he said, because the firm's account was in compliance with its federal regulatory margin requirement. Moreover, the fund was not leveraged; it had not made its bets using borrowed money.
Instead, he said, he suspected that Goldman had never borrowed the shares for Copper River's short positions and was trying to close out the trades to eliminate the problematic naked short positions. Because Goldman had a duty to borrow the shares, it could have risked regulatory questions about compliance, under Mr. Cohodes's account.
Mr. DuVally rejected this argument. "Significant losses and a drop in position value caused the Copper River accounts to incur risk calls in September 2008, which it did not adequately address," he said. "As a result, we declared an event of default, which entitled us as prime broker to require liquidation of the account."
Desperate to save his firm, Mr. Cohodes said he began working to transfer his account to another bank, BNP Paribas.
Goldman refused to release Copper River's positions, he said.
When he discussed having another fund, Farallon Capital, take over Copper River's short positions, Goldman thwarted that transfer as well, Mr. Cohodes testified. Farallon's chief financial officer had told Copper River that an unnamed trader on Goldman's proprietary desk had warned him not to take the hedge fund's positions because it would "be out of business in a couple of days anyway," the deposition said.
Greg Swart, the chief financial officer at Farallon, declined to comment.
As the stocks continued climbing, Mr. Cohodes came to believe that Goldman was buying the stocks that he was short ahead of him, driving up their prices and making Copper River's short-covering purchases even more costly, he testified.
Mr. Cohodes continued: "The stock market was literally falling apart, going straight down. And our short positions would have benefited hugely by the market falling apart and melting down. But the stocks that we had to cover were all going straight up in violent fashions in a straight-down market." Someone, he said, was driving up his price.
Mr. DuVally of Goldman said in response, "We looked into these front-running allegations, and they are not true." He added, "We conducted the liquidation in a manner designed to limit, to the extent possible in an extremely volatile market, losses in Copper River's accounts." He declined to say why Goldman did not allow Copper River's accounts to be transferred.
It is possible, of course, that other investors knew of Copper River's short trades, figured that the fund was in distress and rushed to buy the stocks the fund was covering. But the warning call to Farallon from Goldman's proprietary desk indicated to Mr. Cohodes that the Wall Street firm was front-running Copper River, he said.
As soon as Copper River's short trades were closed out, the stocks it had focused on began plummeting, charts show. Most of the stocks peaked on Sept. 23 and started falling precipitously.
"I think Goldman Sachs is a racketeering entity that does whatever they can to make a dime without conscience, thought, foresight or care about ramifications," Mr. Cohodes concluded in his testimony. "I think they are cold-blooded and could care less about the law. That's my opinion. I think I can back it up."
Goldman said Mr. Cohodes had been a satisfied Goldman customer who changed his view only after his fund experienced losses.
Copper River closed at the end of September 2008. The stocks it had been short soon collapsed.
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