Euromoney: Goldman Must Open its Books on Libya

Euromoney, January 2015

The various cases between the Libyan Investment Authority, Goldman Sachs and Societe Generale are rife with sub-plots, and an interesting new one arose in a case management hearing in London in November. As part of the preparation for trial, Goldman Sachs will be required to explain how it calculates profits on the derivatives trades it sells to clients, and specifically, what profit it made on trades that cost the LIA more than a billion dollars in 2007-8.

In one sense, the profits are something of a footnote to the trial. The LIA is seeking damages – the billion dollars or so of premiums it paid to enter a series of derivatives which were then wiped out by the financial crisis – and, as Euromoney has frequently reported, the LIA’s argument will be that Goldman abused the Libyans’ lack of sophistication and sold them transactions that they just didn’t understand. Profitability only matters insofar as it supports the sense of a banker abusing a bamboozled client, and Goldman’s lawyers – Herbert Smith and Robert Miles QC – have tried to argue that the profits are irrelevant.

But Justice Vivian Rose, the high court judge who will hear the case, has decided they should be disclosed. “Goldman Sachs should at this stage provide an explanation backed up by the relevant documents about how it calculates its profits on these kinds of transactions generally, how it calculated the profits on the disputed trades, and what those profits were,” she said.

She did this apparently not with the intent of making it a central point of the case, but to avoid that. “I do not want this profit issue to engulf the rest of the case and at the moment it looks as if it might,” she said. But the outcome will be an uncomfortable level of clarity for the American bank about just how much it made out of managing to lose a billion dollars of someone else’s money.

From the outset of litigation, the LIA and its lawyers – Enyo Law and Roger Masefield QC – have tried to stress that Goldman was exceptionally well remunerated for the devastating trades it put in place. The figure they have put about has always been $350 million, though it has never previously been explained just where that number comes from, and what it actually represents: the fee for putting the trades on, or profitability derived from a proprietary position that Goldman might have taken. Judging from documents seen by Euromoney, it seems to be the disparity between some month-end valuations the LIA received after entering trades, and the price that Goldman charged them, after considering any price movements in the meantime. “We deduced from that,” Masefield said, “that most of that is going to be Goldman’s upfront profit on the transactions.” The November ruling means Goldman will have to explain if that number is right, and if not, just how the bank books its profits, and what it made from the Libyans.

What Goldman had wanted to provide was a document from its product control department, which records a series of metrics about a trade on the day it is entered into, including the P&L. The LIA’s lawyers, in response, call that “only the beginning”, and it may well be that Goldman has to disclose later documents that would reveal any further profit the bank made from the trades.

Responding to the ruling, Miles, representing Goldman, shed some light on the complexity of explaining just what the profitability of a derivative is. “It may turn out that there is no such thing as a usual profit,” he said. “There is [sic] all sorts of adjustments that are made by banks in relation to trades when arriving at the so-called profit,” such as size, liquidity and counterparty. One of the most interesting elements of the case may therefore prove to be its explanation of just how banks go about pricing and accounting for the derivatives they sell to their clients.

Also, disclosure of profits may not be the end of their discussion when the case is finally heard in early 2016. “The point is that profit goes wider than the impact on price,” said Masefield, for the LIA. “If Goldmans was pursuing these transactions because it was more motivated by profit than ensuring that the suitability of the product was properly flagged up to my client, that would constitute … an abuse, even if the price is a fair one.” Which, in the LIA’s view, it wasn’t. “We believe there was substantial over-charging of premium in this case and they were taking advantage of my client’s naivety.”

The hearing also revealed just how many existing and former Goldman people will have their records searched in the disclosure exercise. A total of 28 people will have their emails scanned – some for 144 keywords over a 20-month period ending in September 2008, others for a shorter four-month period. While some names, notably Driss Ben-Brahim who now works for hedge fund GLG, have long been connected with the case, it is interesting to learn that Michael Sherwood, the co-chief executive officer of Goldman Sachs International, and Michael Daffey, global co-chief operating officer of the equities franchise, will also have their past correspondence studied.