When the SEC announced its fraud complaint against Goldman Sachs, people noted that the penalties involved would involve money, not jail time. But an attorney writing for seekingalpha.com argued over the weekend that John Paulson, the hedge fund manager who worked with GS to create “synthetic derivatives,” accessed FICO scores to create his financial product and therefore violated the Fair Credit Reporting Act (FCRA)–which could mean a penalty as high as $1 billion, and even jail time if the FTC or Justice Department decides to go after him.
Avery Goodman says that the FCRA “allows people to obtain credit information in order to purchase or sell mortgages,” but because these derivatives were “synthetic” they never directly involved the mortgages in question. If his interpretation is accurate, that would mean that accessing FICO scores–even in aggregate, and even if provided by a third party and bundled with the mortgages that made up the asset backed securities–would be in violation of the Act.
The key to understanding this is to realize that a synthetic derivative is outside the chain of contract. It has no effect upon the existing credit obligation. The original borrower has no obligation at all on the derivative. It is solely a contract between two third parties. The only connection is that bets are being taken for or against the existing loans. Derivatives, in the abstract, are gambling contracts that were immune to state anti-gambling laws by virtue of various acts of Congress, obtained by bankers years ago.
However, the bankers made a mistake because they probably never forsaw the creation of synthetic debt related derivatives. They failed to obtain an exemption for violation of the Fair Credit Reporting Act. Therefore, the use of credit reports to structure or create synthetic derivatives is blatantly illegal.
“Jail Time for Wall Street’s Derivatives Writers?” [seekingalpha.com]