Confirming that the buy-side knows about Wall Street's informational advantage is important because the buy-side is on strike and won't buy structured finance securities until this informational advantage is eliminated.
The only way to eliminate this informational advantage is to require all structured finance securities to disclose on an observable event basis all activity that occurs with the underlying collateral on the business day after the observable event occurs.
It is only with this reporting, that the buy-side always has current information on the underlying collateral's performance and can know what it owns.
It is one of the few cases to reach the appellate court level in which a sophisticated investor has accused a bank of profiting unjustly by being negligent in marketing and selling the product.
Landesbank also accused Goldman of betting against its own derivative product that was riddled with risky residential mortgage-backed securities.
In dismissing the case, U.S. District Judge William Pauley in New York had said the allegations against Goldman and TCW were "sparse and lack particulars" and speculated on events occurring long after Davis Square closed.
Judges on the 2nd U.S. Circuit Court of Appeals also zeroed in on whether Landesbank should have more carefully scrutinized what it was buying.
"What does the record show about your client's diligence in the housing market during this period?" Judge Susan Carney asked Landesbank lawyer Arthur Miller.
Miller responded that there was "no way of having equal information to Goldman," describing the investment bank as the "emperor" of financial institutions.
Miller told the panel that Goldman knew what information the ratings agencies and the top market regulator, the U.S. Securities and Exchange Commission, had about the quality of the underlying mortgages in the investment pool.In addition, through its investment in sub-prime mortgage servicers, Goldman had current information that was not available to investors on how similar types of loans were performing. As a result, it has insights into which RMBS deals were highly likely to lose value.
"They know that representing them as triple-A securities is false," Miller said, referring to the highest debt rating for a security.
The judges also queried Goldman's lawyer about what it knew at the time about the securities and the risks to its client.
Goldman lawyer Theodore Edelman told the panel that the firm's disclosures were "extremely clear and specific" and that the SEC website had timely information on loan delinquencies.Actually, all of the data on loan delinquencies was out of date, particularly when compared to the data Goldman had access to.
"All of this is available by a click of the mouse," Edelman said.
In court papers, Goldman said Landesbank relied on a late 2007 report by Clayton Holdings, a provider of due diligence services to the mortgage industry. The report referred to loans that Clayton examined in 2006 and 2007, but the loans backing Davis Square were originated primarily in 2004 and 2005....Excuse me, but Clayton Holdings did not look at the loans underlying the securities bought by the German bank.
Goldman had an informational advantage that it could have used (and, at least in the Abacus deal, was suspected by the SEC of having used). It had insight into the current performance of the loans backing the security that was not available to the German bank.
Landesbank accused Goldman of profiting unjustly from Davis Square by charging an excessively high purchase price and fees. It said Goldman also bet against the product by buying billions of dollars in credit default swaps that insured Goldman against the collapse of the mortgage securities collateral it sold to Landesbank.