CASE STUDY OF GOLDMAN SACHS AND DEUTSCHE BANK

¶A key factor in the recent financial crisis was the role played by complex financial instruments, often referred to as structured finance products, such as residential mortgage backed securities (RMBS), collateralized debt obligations (CDOs), and credit default swaps (CDS), including CDS contracts linked to the ABX Index. These financial products were envisioned, engineered, sold, and traded by major U.S. investment banks.

¶From 2004 to 2008, U.S. financial institutions issued nearly $2.5 trillion in RMBS securities and over $1.4 trillion in CDOs securitizing primarily mortgage related products.1237 Investment banks charged fees ranging from $1 to $8 million to act as the underwriter of an RMBS securitization,1238 and from $5 to $10 million to act as the placement agent for a CDO securitization.1239 Those fees contributed substantial revenues to the investment banks which set up structured finance groups, and a variety of RMBS and CDO origination and trading desks within those groups, to handle mortgage related securitizations. Investment banks placed these securities with investors around the world, and helped develop a secondary market where private RMBS and CDO securities could be bought and sold. The investment banks' trading desks participated in those secondary markets, buying and selling RMBS and CDO securities either for their customers or for themselves.

¶Some of these financial products allowed investors to profit, not only from the success of an RMBS or CDO securitization, but also from its failure. CDS contracts, for example, allowed counterparties to wager on the rise or fall in the value of a specific RMBS security or on a collection of RMBS and other assets contained or referenced in a CDO. Major investment banks also developed standardized CDS contracts that could be traded on a secondary market. In addition, they established the ABX Index which allowed counterparties to wager on the rise or fall in the value of a basket of subprime RMBS securities, and which could be used to reflect the state of the subprime mortgage market as a whole.

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¶Investment banks sometimes matched up parties who wanted to take opposite sides in a structured finance transaction, and other times took one or the other side of a transaction to accommodate a client. At still other times, investment banks used these financial instruments to make their own proprietary wagers. In extreme cases, some investments banks set up structured finance transactions which enabled them to profit at the expense of their clients.

¶Two case studies, involving Goldman Sachs and Deutsche Bank, illustrate a variety of troubling and sometimes abusive practices involving the origination or use of RMBS, CDO, CDS, and ABX financial instruments. Those practices included at times constructing RMBS or CDOs with assets that senior employees within the investment banks knew were of poor quality; underwriting securitizations for lenders known within the industry for issuing high risk, poor quality mortgages or RMBS securities; selling RMBS or CDO securities without full disclosure of the investment bank's own adverse interests; and causing investors to whom they sold the securities to incur substantial losses.

¶In the case of Goldman Sachs, the practices included exploiting conflicts of interest with the firm's clients. For example, Goldman used CDS and ABX contracts to place billions of dollars of bets that specific RMBS securities, baskets of RMBS securities, or collections of assets in CDOs would fall in value, while at the same time convincing customers to invest in new RMBS and CDO securities. In one instance, Goldman took the entire short side of a $2 billion CDO known as Hudson 1, selected assets for the CDO to transfer risk from Goldman's own holdings, allowed investors to buy the CDO securities without fully disclosing its own short position, and when the CDO lost value, made a $1.7 billion gain at the expense of the clients to whom it had sold the securities. While Goldman sometimes told customers that it might take an adverse investment position to the RMBS or CDO securities it was selling them, Goldman did not disclose that, in fact, it already had significant proprietary investments that would pay off if the particular security it was selling or if RMBS and CDO securities in general fell in value. In another instance, Goldman marketed a CDO known as Abacus 2007-AC1 to clients without disclosing that it had allowed the sole short party in the CDO, a hedge fund, to play a major role in selecting the assets. The Abacus securities quickly lost value, and the three long investors together lost $1 billion, while the hedge fund profited by about the same amount. In still other instances, Goldman took on the role of a collateral put provider or liquidation agent in a CDO, and leveraged that role to obtain added financial benefits to the fiscal detriment of the clients to whom it sold the CDO securities.

¶In the case of Deutsche Bank, during 2006 and 2007, the bank's top CDO trader, Greg Lippmann, repeatedly warned and advised his Deutsche Bank colleagues and some of his clients seeking to buy short positions about the poor quality of the RMBS securities underlying many CDOs, describing some of those securities as "crap" and "pigs." At one point, Mr. Lippmann was asked to buy a specific CDO security and responded that it "rarely trades," but he "would take it and try to dupe someone" into buying it. He also disparaged RMBS securities that, at the same time, were being included in Gemstone 7, a CDO being assembled by the bank for sale to investors. Gemstone 7 included or referenced 115 RMBS securities, many of which carried BBB, BBB-, or even BB credit ratings, making them among the highest risk RMBS securities sold to the public, yet received AAA ratings for its top three tranches. Deutsche Bank sold $700 million in Gemstone securities to eight investors who saw their investments rapidly incur delinquencies, rating downgrades, and losses. Mr. Lippmann at times referred to the industry's ongoing CDO marketing efforts as a "CDO machine" or "ponzi scheme," and predicted that the U.S. mortgage market as a whole would eventually plummet in value. Deutsche Bank's senior management disagreed with his negative views, and used the bank's own funds to make large proprietary investments in mortgage related securities that, in 2007, had a notional or face value of $128 billion and a market value of more than $25 billion. At the same time, Deutsche Bank allowed Mr. Lippmann to develop for the bank a $5 billion proprietary short position in the RMBS market, which it later cashed in for a profit of approximately $1.5 billion. Despite that gain, in 2007, due to its substantial long investments, Deutsche Bank incurred an overall loss of about $4.5 billion from its mortgage related proprietary investments.

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¶The two case studies illustrate how investment banks engaged in high intensity sales efforts to market new CDOs in 2007, even as U.S. mortgage delinquencies climbed, RMBS securities incurred losses, the U.S. mortgage market as a whole deteriorated, and investors lost confidence. They demonstrate how these investment banks benefitted from structured finance fees, and had little incentive to stop producing and selling high risk, poor quality structured finance products. They also illustrate how the development of complex structured finance products, such as synthetic CDOs and naked credit default swaps, amplified market risk by allowing investors with no ownership interest in the "reference obligations" to place unlimited side bets on their performance. Finally, the two case histories demonstrate how proprietary trading led to dramatic losses in the case of Deutsche Bank and to conflicts of interest in the case of Goldman Sachs.

¶Investment banks were a major driving force behind the structured finance products that provided a steady stream of funding for lenders to originate high risk, poor quality loans and that magnified risk throughout the U.S. financial system. The investment banks that engineered, sold, traded, and profited from mortgage related structured finance products were a major cause of the financial crisis.

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¶A. Background

¶(1) Investment Banks In General

¶Historically, investment banks helped raise capital for business and other endeavors by helping to design, finance, and sell financial products like stocks or bonds. When a corporation needed capital to fund a large construction project, for example, it often hired an investment bank either to arrange a bank loan or to raise capital by designing, financing, and marketing an issue of shares or corporate bonds for sale to investors. Investment banks performed these services in exchange for fees.

¶Today, investment banks also participate in a wide range of other financial activities, including providing broker-dealer and investment advisory services, and trading commodities and derivatives. Investment banks also often engage in proprietary trading, meaning trading with their own money and not on behalf of a customer. Many investment banks are structured today as affiliates of one or more banks.

¶Under the Glass-Steagall Act of 1933, certain types of financial institutions had been prohibited from commingling their services. For example, with limited exceptions, only broker- dealers could provide brokerage services; only banks could offer banking; and only insurers could offer insurance. Each financial sector had its own primary regulator who was generally prohibited from regulating services outside of its jurisdiction.1240 Glass-Steagall also contained prohibitions against proprietary trading.1241 One reason for keeping the sectors separate was to ensure that banks with federally insured deposits did not engage in the type of high risk activities that might be the bread and butter of a broker-dealer or commodities trader. Another reason was to avoid the conflicts of interest that might arise, for example, from a financial institution pressuring its clients to obtain all of its financial services from the same firm. A third reason was to avoid the conflicts of interest that arise when a financial institution is allowed to act for its own benefit in a proprietary capacity, while at the same time acting on behalf of customers in an agency or fiduciary capacity.

¶Glass-Steagall was repealed in 1999, after which the barriers between banks, broker- dealers, and insurance firms fell. U.S. financial institutions not only began offering a mix of financial services, but also intensified their proprietary trading activities. The resulting changes in the way financial institutions were organized and operated made it more difficult for regulators to distinguish between activities intended to benefit customers versus the financial institution itself. The expanded set of financial services investment banks were allowed to offer also contributed to the multiple and significant conflicts of interest that arose between some investment banks and their clients during the financial crisis.

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(2) Roles and Duties of an Investment Bank: Market Maker, Underwriter, Placement Agent, Broker-Dealer

¶Investment banks typically play a variety of significant roles when dealing with their clients, including that of market maker, underwriter, placement agent, and broker-dealer. Each role brings different legal obligations under federal securities law.

¶Market Maker. A "market maker" is typically a dealer in financial instruments that stands ready to buy and sell for its own account a particular financial instrument on a regular and continuous basis at a publicly quoted price.1242 A major responsibility of a market maker is filling orders on behalf of customers. Market markers do not solicit customers; instead they maintain, buy, and sell quotes in a public setting, demonstrating their readiness to either buy or sell the specified security, and customers come to them. For example, a market maker in a particular stock typically posts the prices at which it is willing to buy or sell that stock, attracting customers based on the competitiveness of its prices. This activity by market makers helps provide liquidity and efficiency in the trading market for the security.1243 It is common for a particular security to have multiple market makers who competitively quote the security.

¶Market makers generally use the same inventory of assets to carry out both their market- making and proprietary trading activities. Market makers are allowed, in certain circumstances specified by the SEC, to sell securities short in situations to satisfy market demand when they do not have the securities in their inventory in order to provide liquidity. Market makers have among the most narrow disclosure obligations under federal securities law, since they do not actively solicit clients or make investment recommendations to them. Their disclosure obligations are generally limited to providing fair and accurate information related to the execution of a particular trade.1244 Market makers are also subject to the securities laws' prohibitions against fraud and market manipulation. In addition, they are subject to legal requirements relating to the handling of customer orders, for example using best execution efforts when placing a client's buy or sell order.1245

¶Underwriter and Placement Agent. If an investment bank agrees to act as an "underwriter" for the issuance of a new security to the public, such as an RMBS, it typically purchases the securities from the issuer, holds them on its books, conducts the public offering, and bears the financial risk until the securities are sold to the public. By law, securities sold to the public must be registered with the SEC. Underwriters help issuers prepare and file the registration statements filed with the SEC, which explain to potential investors the purpose of a proposed public offering, the issuer's operations and management, key financial data, and other important facts. Any offering document, or prospectus, given to the investing public in connection with a registered security must also be filed with the SEC. If a security is not offered to the general public, it can still be offered to investors through a "private placement." Investment banks often act as the "placement agent," performing intermediary services between those seeking to raise money and investors. Placement agents often help issuers design the securities, produce the offering materials, and market the new securities to investors. Offering documents in connection with private placements are exempt from SEC registration and are not filed with the SEC. In the years leading up to the financial crisis, RMBS securities were registered with the SEC, while CDOs were sold to investors through private placements. Both of these securities were also traded in a secondary market by market makers. Investment banks sold both types of securities primarily to large institutional investors, such as other banks, pension funds, insurance companies, municipalities, university endowments, and hedge funds.

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¶Whether acting as an underwriter or placement agent, a major part of the investment bank's responsibility is to solicit customers to buy the new securities being offered. Under the securities laws, investment banks that act as an underwriter or placement agent for new securities are liable for any material misrepresentation or omission of a material fact made in connection with a solicitation or sale of those securities to investors.1246

¶The obligation of an underwriter and placement agent to disclose material facts to every investor it solicits comes from two sources: the duties as an underwriter specifically, and the duties as a broker-dealer generally. With respect to duties relating to being an underwriter, the U.S. Court of Appeals for the First Circuit observed that underwriters have a "unique position" in the securities industry:

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"[T]he relationship between the underwriter and its customer implicitly involves a favorable recommendation of the issued security. … Although the underwriter cannot be a guarantor of the soundness of any issue, he may not give it his implied stamp of approval without having a reasonable basis for concluding that the issue is sound."1247

¶In addition, Section 11 of the Securities Act of 1933 makes underwriters liable to any investor in any registered security if any part of the registration statement "contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading."1248

¶Broker-Dealer. Broker-dealers also have affirmative disclosure obligations to their clients. With respect to the duties of a broker-dealer, the SEC has held:

"[W]hen a securities dealer recommends a stock to a customer, it is not only obligated to avoid affirmative misstatements, but also must disclose material adverse facts to which it is aware. That includes disclosure of 'adverse interests' such as 'economic self interest' that could have influenced its recommendation."1249

¶To help broker-dealers understand when they are obligated to disclose material adverse facts to investors, the Financial Industry Regulatory Authority (FINRA) has further defined the term "recommendation":

"[A] broad range of circumstances may cause a transaction to be considered recommended, and this determination does not depend on the classification of the transaction by a particular member as 'solicited' or 'unsolicited.' In particular a transaction will be considered to be recommended when the member or its associated person brings a specific security to the attention of the customer through any means, including, but not limited to, direct telephone communication, the delivery of promotional material through the mail, or the transmission of electronic messages."1250

¶There is no indication in any law or regulation that the obligation to disclose material adverse facts is diminished or waived in relation to the level of sophistication of the potential investor.1251

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¶(3) Structured Finance Products

¶Over time, investment banks have devised, marketed, and sold increasingly complex financial instruments to investors, often referred to as "structured finance" products. These products include residential mortgage backed securities (RMBS), collateralized debt obligations (CDOs), and credit default swaps (CDS), including CDS contracts linked to the ABX Index, all of which played a central role in the financial crisis.

¶RMBS and CDO Securities. RMBS and CDO securities are two common types of structured finance products. RMBS securities contain pools of mortgage loans, while CDOs contain or reference pools of RMBS securities and other assets. RMBS concentrate risk by including thousands of subprime and other high risk home loans, with similar characteristics and risks, in a single financial instrument. Mortgage related CDOs concentrate risk even more by including hundreds or thousands of RMBS securities, with similar characteristics and risks, in a single financial instrument. In addition, while some CDOs included only AAA rated RMBS securities, others known as "mezzanine" CDOs contained RMBS securities that carried the riskier BBB, BBB-, and even BB credit ratings and were more susceptible to losses if the underlying mortgages began to incur delinquencies or defaults.

¶Some investment banks went a step farther and assembled CDO securities into pools and resecuritized them as so-called "CDO squared" instruments, which further concentrated the risk in the underlying CDOs.1252 Some investment banks also assembled "synthetic CDOs," which did not contain any actual RMBS securities or other assets, but merely referenced them. Some devised "hybrid CDOs," which contained a mix of cash and synthetic assets.

¶The securitization process generated billions of dollars in funds that allowed investment banks to supply financing to lenders to issue still more high risk mortgages and securities, which investment banks and others then sold or securitized in exchange for still more fees. This cycle was repeated again and again, introducing more and more risk to a wider and wider range of investors.

¶Credit Default Swaps. Some investment banks modified still another structured finance product, a derivative known as a credit default swap (CDS), for use in the mortgage market. Much like an insurance contract, a CDS is a contract between two parties in which one party guarantees payment to the other if the assets referenced in the contract lose value or experience a negative credit event. The party selling the insurance is referred to as the "long" party, since it profits if the referenced asset performs well. The party buying the insurance protection is referred to as the "short" party, because it profits if the referenced asset performs poorly.³³ See U.S. Census Bureau, "Statistical Abstract of the United States 2011," at 735, http://www.census.gov/compendia/statab/2011/tables/11s1175.pdf. (suitability obligation to institutional customers).

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¶The short party, or CDS buyer, typically pays periodic premiums, similar to insurance premiums, to the long party or CDS seller, who has guaranteed the referenced assets against a loss in value or a negative credit event such as a credit rating downgrade, default, or bankruptcy. If the loss or negative credit event occurs, the CDS seller is required to pay an agreed upon amount to the CDS buyer. Many CDS contracts also tracked the changing value of the referenced assets over time, and required the long and short parties to post cash collateral with each other to secure payment of their respective contractual obligations.

¶CDS contracts that reference a single, specific security or bond for protection against a loss in value or negative credit event have become known as "single name" CDS contracts. Other CDS contracts have been designed to protect a broader basket of securities, bonds, or other assets.

¶By 2005, investment banks had standardized CDS contracts that referred to a "single name" RMBS or CDO security. Some investment banks and investors, which held large inventories of RMBS and CDO securities, purchased those single name CDS contracts as a hedge against possible losses in the value of their holdings. Other investors, including investment banks, began to purchase single name CDS contracts, not as a hedge to offset losses from the RMBS or CDO securities they owned, but as a way to profit from particular RMBS or CDO securities they predicted would lose value or fail. CDS contracts that paid off on securities that were not owned by the CDS buyer became known as "naked credit default swaps." Naked CDS contracts enabled investors to bet against mortgage related assets, using the minimal capital needed to make the periodic premium payments and collateral calls required by a CDS contract.

¶The key significance of the CDS product for the mortgage market was that it offered an alternative to investing in RMBS and CDO securities that would perform well. Single name CDS contracts instead enabled investors to place their dollars in financial instruments that would pay off if specific RMBS or CDO securities lost value or failed.

¶ABX Index. In January 2006, a consortium of investment banks, led by Goldman Sachs and Deutsche Bank, launched still another type of structured finance product, linked to a newly created "ABX Index," to enable investors to bet on multiple subprime RMBS securities at once. The ABX Index was administered by a private company called the Markit Group and consisted of five separate indices, each of which tracked the performance of a different basket of 20 designated subprime RMBS securities.1253 The values of the securities in each basket were aggregated into a single composite value that rose and fell over time. Investors could then arrange, through a broker-dealer, to enter into a CDS contract with another party using the ABX basket of subprime RMBS securities as the "reference obligation" and the relevant ABX Index value as the agreed upon value of that basket. For a fee, investors could take either the "long" position, betting on the rise of the index, or the "short" position, betting on the fall of the index, without having to physically purchase or hold any of the referenced securities or raise the capital needed to pay for the full face value of those referenced securities. The index also used standardized CDS contracts that remained in effect for a standard period of time, making it easier for investors to participate in the market, and buy and sell ABX-linked CDS contracts.

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¶The ABX Index allowed investors to place unlimited bets on the performance of one or more of the subprime RMBS baskets. It also made it easier and cheaper for investors, including some investment banks, to short the subprime mortgage market in bulk.1254 Investment banks not only helped establish the ABX Index, they encouraged their clients to enter into CDS contracts based upon the ABX Index, and used it themselves to bet on the mortgage market as a whole. The ABX Index expanded the risks inherent in the subprime mortgage market by providing investors with a way to make unlimited investments in RMBS securities.

¶Synthetic CDOs. By mid-2006, there was a large demand for RMBS and CDO securities as well as a growing demand for CDS contracts to short the mortgage market. To meet this demand, investment banks and others began to make greater use of synthetic CDOs, which could be assembled more quickly, since they did not require the CDO arranger to find and purchase actual RMBS securities or other assets. The increasing use of synthetic CDOs injected even greater risk into the mortgage market by enabling investors to make unlimited wagers on various groups of mortgage related assets and, if those assets performed poorly, expanding the number of investors who would realize losses.

¶Synthetic CDOs did not depend upon actual RMBS securities or other assets to bring in cash to pay investors. Instead, the CDO simply developed a list of existing RMBS or CDO securities or other assets that would be used as its "reference obligations." The parties to the CDO were not required to possess an ownership interest in any of those reference obligations; the CDO simply tracked their performance over time. The performance of the underlying reference obligations, in the aggregate, determined the performance of the synthetic CDO.

¶The synthetic CDO made or lost money for its investors by establishing a contractual agreement that they would make payments to each other, based upon the aggregate performance of the underlying referenced assets, using CDS contracts. The "short" party essentially agreed to make periodic payments, similar to insurance premiums, to the other party in exchange for an agreement that the "long" party would pay the full face value of the synthetic CDO if the underlying assets lost value or experienced a defined credit event such as a ratings downgrade. In essence, then, the synthetic CDO set up a wager in which the short party bet that its underlying assets would perform poorly, while the long party bet that they would perform well.

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¶Synthetic CDOs provided still another vehicle for investors looking to short the mortgage market in bulk. The synthetic CDO typically referenced a variety of RMBS securities. One or more investors could then take the "short" position and wager that the referenced securities as a whole would fall in value or otherwise perform poorly. Synthetic CDOs became a way for investors to short multiple specific RMBS securities that they expected to incur delinquencies, defaults, and losses.

¶Synthetic CDOs magnified the risk in the mortgage market because arrangers had no limit on the number of synthetic CDOs they could create. In addition, multiple synthetic CDOs could reference the same RMBS and CDO securities in various combinations, and sell financial instruments dependent upon the same sets of high risk, poor quality loans over and over again to various investors. Since every synthetic CDO had to have a "short" party betting on the failure of the referenced assets, at least some poor quality RMBS and CDO securities could be included in each transaction to attract those investors. When some of the high risk, poor quality loans later incurred delinquencies or defaults, they caused losses, not in a single RMBS, but in multiple cash, synthetic, and hybrid CDOs whose securities had been sold to a wide circle of investors.1255

¶Conflicts of Interest. Investment banks that designed, obtained credit ratings for, underwrote, sold, managed, and serviced CDO securities, made money from the fees they charged for these and other services. Investment banks reportedly netted from $5 to $10 million in fees per CDO.1256 Some also constructed CDOs to transfer the financial risk of poorly performing RMBS and CDO securities from their own holdings to the investors they were soliciting to buy the CDO securities.1257 By selling the CDO securities to investors, the investment banks profited not only from the CDO sales, but also eliminated possible losses from the assets removed from their warehouse accounts. In some instances, unbeknownst to the customers and investors, the investment banks that sold them CDO securities bet against those instruments by taking short positions through single name CDS contracts. Some even took the short side of the CDO they constructed, and profited when the referenced assets lost value, and the investors to whom they had sold the long side of the CDO were required to make substantial payments to the CDO.

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¶The following two case studies examine how two investment banks active in the U.S. mortgage market constructed, marketed, and sold RMBS and CDO securities; how their activities magnified risk in the mortgage market; and how conflicts of interest negatively impacted investors and contributed to the financial crisis. The Deutsche Bank case history provides an insider's view of what one senior CDO trader described as Wall Street's "CDO machine." It reveals the trader's negative view of the mortgage market in general, the poor quality RMBS assets placed in a CDO that Deutsche Bank marketed to clients, and the fees that made it difficult for investment banks like Deutsche Bank to stop selling CDOs. The Goldman Sachs case history shows how one investment bank was able to profit from the collapse of the mortgage market, and ignored substantial conflicts of interest to profit at the expense of its clients in the sale of RMBS and CDO securities.

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B. Running the CDO Machine: Case Study of Deutsche Bank

¶This case history examines the role of Deutsche Bank USA in the design, marketing, and sale of collateralized debt obligations (CDOs) that incorporated or referenced residential mortgage backed securities (RMBS).

¶From 2004 to 2008, U.S. financial institutions issued over $1.4 trillion worth of CDO securities. At first, this complex structured finance product proved highly profitable for investment banks which established CDO departments and trading desks to create and market the securities. By early 2007, however, due to declining housing prices, accelerating mortgage delinquencies, and RMBS losses, investor interest in CDOs began to drop off sharply. In July 2007, the major credit rating agencies began lowering credit ratings for many CDO securities, at times eliminating the investment grade ratings that had supported CDO sales. Despite waning investor interest, U.S. investment banks continued to issue new mortgage related CDOs throughout 2007, in an apparent effort to sustain their fees and CDO departments. Some investment banks supported the CDO market by purchasing existing CDO securities for inclusion in new, even more complex CDOs, seeking customers in Europe and Asia, or retaining risky CDO securities on their own books.

¶Deutsche Bank was a major player in the CDO market, both in creating new CDO issues and trading these securities in the secondary market. Deutsche Bank's top global CDO trader, Greg Lippmann, began to express concerns that the CDO market was unsustainable. By the middle of 2006, Mr. Lippmann repeatedly warned and advised his Deutsche Bank colleagues and some of his clients seeking to buy short positions about the poor quality of the assets underlying many CDOs. He described some of those assets as "crap" and "pigs," and predicted the assets and the CDO securities would lose value.

¶At one point, Mr. Lippmann was asked to buy a specific CDO security and responded that it "rarely trades," but he "would take it and try to dupe someone" into buying it. He also at times referred to the industry's ongoing CDO marketing efforts as a "CDO machine" or "ponzi scheme." Deutsche Bank's senior management disagreed with his negative views, and used the bank's own funds to make large proprietary investments in mortgage related securities that, in 2007, had a notional or face value of $128 billion and a market value of more than $25 billion.

¶Despite disagreeing with his negative views on the mortgage market, Deutsche Bank allowed Mr. Lippmann, in 2005, to develop a large proprietary short position for the bank in the RMBS market. Since carrying that short position required the bank to pay millions of dollars in premiums, senior management also required Mr. Lippmann to defray or eliminate those costs by convincing others to take short positions in the mortgage market, thereby generating fees for the bank from arranging those shorts. In 2006, Mr. Lippmann generated an estimated $200 million in fees by encouraging his clients, such as hedge funds, to buy short positions. Simultaneously, Mr. Lippmann increased the size of the bank's short position by taking the short side of credit default swaps (CDS) referencing individual RMBS securities, an investment strategy often referred to as investing in "single name CDS" contracts. Over a two-year period from 2005 to 2007, Mr. Lippmann built a massive short position in single name CDS contracts totaling $5 billion. From 2007 to 2008, at the direction of the bank's senior management, he cashed in that position, generating a profit for his trading desk of approximately $1.5 billion, which he claims made more money on a single position than any other trade had ever made for Deutsche Bank in its history. Despite that gain, due to its substantial long investments, Deutsche Bank incurred an overall loss of about $4.5 billion from its mortgage related proprietary investments.¹²⁵⁸¹²⁵⁸ Subcommittee interview of Greg Lippmann (10/18/2010); Net Revenues from ABS Products Backed by U.S. Residential Mortgages, DB_PSI_C00000003.

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¶To understand how Deutsche Bank continued to issue and market CDO securities even as the market for mortgage related securities began collapsing, the Subcommittee examined a specific CDO in detail, called Gemstone CDO VII Ltd. (Gemstone 7). In October 2006, Deutsche Bank began assisting in the gathering of assets for Gemstone 7, which issued its securities in March 2007. It was the last in a series of CDOs sponsored by HBK Capital Management (HBK), a large hedge fund which acted as the collateral manager for the CDO. Deutsche Bank made $4.7 million in fees from the deal, while HBK was slated to receive $3.3 million. It was not the last CDO issued by Deutsche Bank. Even after Gemstone 7 was issued in March of 2007, Deutsche Bank issued 9 additional CDOs.

¶Gemstone 7 was a hybrid CDO containing or referencing a variety of high risk, subprime RMBS securities initially valued at $1.1 billion when issued. Deutsche Bank's head global trader, Mr. Lippmann, recognized that these RMBS securities were high risk and likely to lose value, but did not object to their inclusion in Gemstone 7. Deutsche Bank, the sole placement agent, marketed the initial offering of Gemstone 7 in the first quarter of 2007. Its top tranches received AAA ratings from Standard & Poor's and Moody's, despite signs that the CDO market was failing and the CDO itself contained many poor quality assets.

¶Nearly a third of Gemstone's assets consisted of high risk subprime loans originated by Fremont, Long Beach, and New Century, three lenders known at the time within the financial industry for issuing poor quality loans and RMBS securities. Although HBK directed the selection of assets for Gemstone 7, Mr. Lippmann's CDO Trading Desk was involved in the process and did not object to including certain RMBS securities in Gemstone 7, even though Mr. Lippmann was simultaneously referring to them as "crap" or "pigs." Mr. Lippmann was also at the same time advising some of his clients to short some of those same RMBS securities. In addition, Deutsche Bank sold five RMBS securities directly from its inventory to Gemstone 7, several of which were also contemporaneously disparaged by Mr. Lippmann.

¶The Deutsche Bank sales force aggressively sought purchasers for the CDO securities, while certain executives expressed concerns about the financial risk of retaining Gemstone 7 assets as the market was deteriorating in early 2007. In its struggle to sell Gemstone 7, Deutsche Bank motivated its sales force with special financial incentives, and sought out buyers in Europe and Asia because the U.S. market had dried up. Deutsche Bank also talked of providing HBK's marks, instead of its own, to clients asking about the value of Gemstone 7's assets, since HBK's marks showed the CDO's assets performing better. Deutsche Bank was ultimately unable to sell $400 million, or 36%, of the Gemstone 7 securities, and agreed with HBK to split the unsold securities, each taking $200 million onto its own books. Deutsche Bank did not disclose to the eight investors whom it had solicited and convinced to buy Gemstone 7, that its global head trader of CDOs had an extremely negative view of a third of the assets in the CDO or that the bank's internal valuations showed that the assets had lost over $19 million in value since purchased.¹²⁵⁹¹²⁵⁹ See Sections 11 and 12 of Securities Act of 1933. See also Rule 10b-5 of the Securities Exchange Act of 1934. For a more detailed discussion of the legal obligations of underwriters, placement agents, and broker-dealers, see Section C(6) on conflicts of interest analysis, below.

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¶Gemstone 7 also demonstrated how CDOs magnified risk by including or referencing within itself 115 different RMBS securities containing thousands of high risk, poor quality subprime loans. Many of those RMBS securities carried BB ratings, which are non-investment grade credit ratings and were among the highest risk securities in the CDO. Gemstone 7 also included CDO securities that, in themselves, concentrated the risk of their underlying assets. Over 75% of Gemstone's assets consisted of RMBS securities with ratings of BBB or lower, including approximately 33% with non-investment grade ratings, yet Gemstone's top three tranches were given AAA ratings by the credit rating agencies. The next three tranches were given investment grade ratings as well. Those investment grade ratings enabled investors like pension funds, insurance companies, university endowments, and municipalities, some of which were required by law, regulation, or their investment plans to put their funds in safe investments, to consider buying Gemstone securities. Eight investors actually purchased them. Within eight months, the Gemstone securities began incurring rating downgrades. By July 2008, all seven tranches in the CDO had been downgraded to junk status, and the long investors were almost completely wiped out. Today, the Gemstone 7 securities are nearly worthless.

¶Deutsche Bank was, in Mr. Lippmann's words, part of a "CDO machine" run by investment banks that produced hundreds of billions of high risk CDO securities. Because the fees to design and market CDOs ranged from $5 to $10 million per CDO, investment bankers had a strong financial incentive to continue issuing them, even in the face of waning investor interest and poor quality assets, since reduced CDO activity would have led to less income for structured finance units, smaller bonuses for executives, and even the disappearance of CDO departments, which is eventually what occurred. The Deutsche Bank case history provides a cautionary tale for both market participants and regulators about how complex structured finance products gain advocates within an organization committed to pushing the products through the pipeline to maintain revenues and jobs, regardless of the financial risks or possible impact on the marketplace.

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¶(1) Subcommittee Investigation and Findings of Fact

¶As part of its investigation into the CDO market and the Deutsche Bank case study, the Subcommittee collected and reviewed hundreds of thousands of Deutsche Bank documents including reports, analyses, memoranda, correspondence, transcripts, spreadsheets, and email. The Subcommittee also collected and reviewed documents from HBK Capital Management, several financial institutions that purchased Deutsche Bank CDO securities, and the Securities and Exchange Commission (SEC). In addition, the Subcommittee conducted 14 interviews, including interviews with current and former Deutsche Bank and HBK executives, managers, sales representatives, and traders; spoke with personnel from the financial institutions that invested in Gemstone 7; and consulted with a number of experts from the SEC, academia, and industry.

¶Based upon the Subcommittee's review, the Report makes the following findings of fact.

CDO Machine. From late 2006 through 2007, despite increasing mortgage delinquencies, RMBS losses, and investor flight from the U.S. mortgage market, U.S. investment banks continued to issue new CDOs, including Deutsche Bank which issued 15 new CDOs securitizing nearly $11.5 billion of primarily mortgage related assets from December 2006 to December 2007.

Fee Incentives. Because the fees charged to design and market CDOs were in the range of $5 to $10 million per CDO, investment banks had strong incentives to continue issuing CDOs despite increasing risks and waning investor interest, since reduced CDO activity meant less revenues for structured finance units and even the disappearance of CDO departments and trading desks, which is eventually what occurred.

Deutsche Bank's $5 Billion Short. Although Deutsche Bank as a whole and through an affiliated hedge fund, Winchester Capital, made proprietary investments in long mortgage related assets, the bank also permitted its head CDO trader to make a $5 billion short investment that bet against the mortgage market and produced bank profits totaling approximately $1.5 billion.

Proprietary Loss. By 2007, Deutsche Bank, through its mortgage department and an affiliated hedge fund, had substantial proprietary holdings in the mortgage market, including more than $25 billion in long investments and a $5 billion short position, which together resulted in 2007 losses to the bank of about $4.5 billion.

Gemstone 7. In the face of a deteriorating market, Deutsche Bank aggressively sold a $1.1 billion CDO, Gemstone 7, which included RMBS securities that the bank's top CDO trader had disparaged as "crap" and "pigs," and which produced $1.1 billion of high risk, poor quality securities that are now virtually worthless.

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¶(2) Deutsche Bank Background

¶CDOs In General. According to the Securities Industry and Financial Markets Association, $1.4 trillion worth of CDOs were issued in the United States from 2004 through the end of 2007.¹²⁶⁰¹²⁶⁰ 10/15/2010 "Global CDO Issuance," Securities Industry and Financial Markets Association, http://www.sifma.org/research/statistics.aspx. The following chart depicts the dramatic rise and fall of the U.S. CDO market over the last ten years, with total CDO issuance reaching its peak in 2006 at $520 billion, and then falling to a low of $4 billion in 2009.¹²⁶¹¹²⁶¹ Chart prepared by the Subcommittee using data from 10/15/2010 "Global CDO Issuance," Securities Industry and Financial Markets Association, http://www.sifma.org/research/statistics.aspx. By 2004, most, but not all, CDOs relied primarily on mortgage related assets such as RMBS securities. Subcommittee interview of Gary Witt, former Managing Director of Moody's RMBS Group (10/29/2009).

Total Annual CDO Issuance 2000-2009 Total CDO Issuance Year ($ in billions)²⁰⁰⁰²⁰⁰⁰ 4/7/2010 Blankfein & Cohn, Letter to Shareholders (quoted in Hearing Exhibit 4/27-161 at 12). 67.99 2001 78.45 2002 83.07 2003 86.63 2004 157.82 2005 251.27 2006 520.64 2007 481.60 2008 61.89 2009 4.34

¶In 2006 and 2007, investment banks created around half a trillion dollars in CDO securities each year, even as U.S. housing prices began to stagnate and decline, subprime mortgages began to default at record rates, and RMBS securities began to incur dramatic losses. By the middle of 2007, due to the increasing risks, U.S. institutional investors like pension funds, hedge funds, and others began to purchase fewer CDO securities, and investment banks turned their attention increasingly to European and Asian investors as well as the issuers of new CDOs who became the primary buyers of CDO securities.¹²⁶²¹²⁶² See 7/12/2007 email from Michael Lamont to Boaz Weinstein at Deutsche Bank, DBSI_01201843; "Banks' Self-Dealing Super Charged Financial Crisis," ProPublica (8/26/2010), http://www.propublica.org/article/banks- self-dealing-super-charged-financial-crisis; and "Mortgage-Bond Pioneer Dislikes What He Sees," Wall Street Journal (2/24/2007). In 2007, U.S. investment banks kept issuing and selling CDOs despite slowed sales, which meant that investment banks had to retain an increasing portion of the unsold assets on their own balance sheets.¹²⁶³¹²⁶³ "Banks' Self-Dealing Super Charged Financial Crisis," ProPublica (8/26/2010).

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¶The credit rating agencies marked a "sea change" in the CDO market in 2007, in which investment banks issued CDOs at near record levels in the first half of the year, but then sharply reined in their efforts after the mass rating downgrades of RMBS and CDO securities began in July 2007:

"[The CDO] market in the U.S. was very active in terms of issuance throughout the first half of 2007. … The year 2007 saw a sea change for the CDO market. Moody's rated more than 100 SF [structured finance] CDO transactions in each of the first two quarters, but the number fell sharply to 40 in the third quarter and to just eight in the fourth quarter as the sheer speed and magnitude of the subprime mortgage fallout significantly weakened investors' confidence."¹²⁶⁴¹²⁶⁴ Moody's 2008 Global CDO Review (3/3/2008).

¶In the years leading up to the financial crisis, the typical size of a CDO deal was between $1 and $1.5 billion,¹²⁶⁵¹²⁶⁵ "Wall Street's money machine breaks down," CNNMoney.com (11/12/2007), http://money.cnn.com/magazines/fortune/fortune_archive/2007/11/26/101232838/index.htm. and generated large fees for investment banks in the range of $5 to $10 million per CDO.¹²⁶⁶¹²⁶⁶ See "Banks' Self-Dealing Super-Charged Financial Crisis," ProPublica (8/26/2010), http://www.propublica.org/article/banks-self-dealing-super-charged-financial-crisis ("A typical CDO could net the bank that created it between $5 million and $10 million – about half of which usually ended up as employee bonuses. Indeed, Wall Street awarded record bonuses in 2006, a hefty chunk of which came from the CDO business."). Fee information obtained by the Subcommittee is consistent with this range of CDO fees. For example, Deutsche Bank received nearly $5 million in fees for Gemstone 7, and the head of its CDO Group said that Deutsche Bank received typically between $5 and 10 million in fees per CDO, while Goldman Sachs charged a range of $5 to $30 million in fees for its Camber 7, Fort Denison, and Hudson Mezzanine 1 and 2 CDOs. 12/20/2006 Gemstone 7 Securitization Credit Report, DB_PSI_00237655-71; undated Gemstone 7 Securitization Credit Report, MTSS000011-13; 3/15/2007 Gemstone CDO VII Ltd. Closing Memorandum, DB_PSI_00133536-41; Subcommittee interview of Michael Lamont (Deutsche Bank) (9/29/2010); 3/21/2011 letter from Deutsche Bank's counsel to the Subcommittee, PSI-Deutsche_Bank-0001-04; Goldman Sachs response to Subcommittee QFRs at PSI-QFR-GS0249.Show full note To handle these transactions, a number of large investment banks established CDO departments and trading desks charged with designing, underwriting, selling, or trading CDO securities. The CDO origination desks typically worked with the investment banks' structured finance sales force to sell the resulting CDO securities. This structure meant that stopping the issuance of CDO securities would require the investment banks to lose out on the fees, prestige, and market share tied to CDO sales. In addition, whole CDO departments, with their dedicated bankers, traders, and supervisors, would have to disappear, which is eventually what happened after the CDO market crashed.

¶CDOs at Deutsche Bank. From 2004 to 2008, Deutsche Bank issued 47 asset backed CDOs for a total securitization of $32.2 billion.1267 According to analysts, in both 2006 and 2007, Deutsche Bank ranked fourth globally in issuing asset backed CDOs, behind Merrill Lynch, JPMorgan Chase, and Citigroup.¹²⁶⁸¹²⁶⁸ See "Global ABS CDO Issuance" chart, Reuters (4/20/2010), http://graphics.thomsonreuters.com/10/04/GLB_GCDOV0410.gif; "Banks in Talks to End Bond Probe," Wall Street Journal (12/2/2010),

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¶At Deutsche Bank, five different parts of the Securitized Product Group played key roles in its CDO business. They were the CDO Group (North America); the CDO sales force, formally called Securitized Products; the CDO Syndication Desk which helped promote and track CDO sales; the mortgage department; and the CDO Trading Desk, formally called ABS (Asset Backed Security) Trading, CDO Trading, and ABS Correlation Trading.

¶The CDO Group had two co-heads, Michael Lamont and Michael Herzig, and approximately 20 employees. The heads of the group reported to Richard D'Albert, Global Head of Deutsche Bank's Securitized Product Group. The CDO Group designed and structured the bank's CDOs, analyzed the assets that went into the CDOs, monitored the purchasing and warehousing of those assets, obtained CDO credit ratings, prepared CDO legal documentation, acted as the CDO underwriter or placement agent on behalf of Deutsche Bank, and oversaw the issuance of the CDO securities.¹²⁶⁹¹²⁶⁹ Subcommittee interview of Michael Lamont (9/29/2010).

¶The CDO sales force sold the resulting CDO securities for Deutsche Bank. It received assistance from the CDO Syndication, sometimes called the "syndicate," which helped promote the deals with investors and tracked CDO sales. The CDO sales force was headed by Sean Whelan and Michael Jones. They reported to Munir D'auhajre, overall head of sales, who reported, in turn, to Fred Brettschneider, the head of the Institutional Client Group of Deutsche Bank Americas. The CDO sales force had approximately 20 employees. In the United States, the CDO Syndication had about seven employees, and was headed by Anthony Pawlowski, who reported to Mr. Lamont and Mr. Herzig, who headed the CDO Group.

¶The Deutsche Bank mortgage department was responsible for purchasing residential mortgages from a variety of sources, warehousing those mortgages, and securitizing the mortgages into RMBS securities for which Deutsche Bank acted as the underwriter or placement agent. Some of those RMBS securities were later included or referenced in CDOs issued by the bank.

¶The CDO Trading Desk was headed by Greg Lippmann, who served as global head of Deutsche Bank's CDO, ABS, and ABS Correlation Trading Desks.¹²⁷⁰¹²⁷⁰ Organizational Chart for Deutsche Bank Global CDO Group, DB_PSI_C00000001. Those desks were responsible for trading a variety of RMBS, CDO, and other asset backed securities on the secondary market. Mr. Lippmann had a staff of approximately 30 employees,²⁰²⁰ To develop FICO scores, Fair Isaac uses proprietary mathematical models that draw upon databases of actual credit information to identify factors that can reliably be used to predict whether an individual will repay outstanding debt. Key factors in the FICO score include an individual's overall level of debt, payment history, types of credit extensions, and use of available credit lines. See "What's in Your FICO Score," Fair Isaac Corporation, http://www.myfico.com/CreditEducation/WhatsInYourScore.aspx. Other types of credit scores have also been developed, including the VantageScore developed jointly by the three major credit bureaus, Equifax Inc., Experian Group Ltd., and TransUnion LLC, but the FICO score remains the most widely used credit score in U.S. financial markets. AAA rated RMBS securities; the second a basket of AA rated RMBS securities; and the remaining indices tracked baskets of A, BBB, and BBB- rated RMBS securities. Every six months, a new set of RM BS securities was selected for each index. See 3/2008 Federal Reserve Bank of New York Staff Report No. 318, "Understanding the Securitization of Subprime Mortgage Credit," at 26. Markit Group Ltd. administered the ABX Index which issued indices in 2006 and 2007, but has not issued any new indices since then.Show full note in the United States and 10 in London. Like the head of the CDO Group, Mr. Lippmann reported to Mr. D'Albert, the head of the bank's Securitized Product Group. Mr. Lippmann was also the head of risk management for all new issue CDOs and described himself as "involved in underwriting, structuring, marketing and hedging our warehouse risk for new issue cdos."¹²⁷¹¹²⁷¹ 7/14/2006 email from Greg Lippmann to Melissa Goldsmith at Deutsche Bank, DBSI_PSI_EMAIL01400135- 37. http://online.wsj.com/article/SB10001424052748704594804575649170454587534.html?KEYWORDS=Banks+in+ Talks+to+End+Bond+Probe. See also 10/2006, "CDO Primary Update Progress Report," prepared by Deutsche Bank, DBSI_PSI_EMAIL03970167-72, at 68 (ranking Deutsche Bank as third in CDO issuances as of October 2006).

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¶The CDO Trading Desk conducted trades for both clients and other Deutsche Bank entities. It was further divided into three trading desks, designated the CDO, ABS, and ABS Correlation Desks. Each traded certain structured finance products, tracked relevant market news and developed expertise in its assigned products, and served as a source of asset and market information for other branches of Deutsche Bank. The CDO Desk focused on buying and selling CDO securities; the ABS Desk concentrated on trading RMBS and other asset backed securities as well as short trading strategies involving credit default swap (CDS) contracts in single name RMBS; and the ABS Correlation Desk acted primarily in a market making capacity for Deutsche Bank clients, trading both long and short RMBS and CDO securities and CDS contracts with the objective of taking offsetting positions that minimized the bank's risk.¹²⁷²¹²⁷² Subcommittee interview of Greg Lippmann (10/18/2010).

¶Mr. Lippmann was well known in the CDO marketplace as a trader. He had joined Deutsche Bank in 2000, after a stint at Credit Suisse trading bonds. One publication noted that Mr. Lippmann "made his name with big bets on a housing bust," continuing: "Mr. Lippmann emerged as a Cassandra of the financial crisis, spotting cracks in the mortgage market as early as 2006. His warnings helped Deutsche brace for the crisis. He also helped investors – and himself – land huge profits as big bets that the housing market would collapse materialized."¹²⁷³¹²⁷³ "Lippmann, Deutsche Trader, Steps Down," New York Times (4/21/2010), http://dealbook.nytimes.com/2010/04/21/lippmann-deutsche-trader-steps-down/. See also Michael Lewis, The Big Short (2010), at 64.

¶(3) Deutsche Bank's $5 Billion Short

¶In 2006 and 2007, Deutsche Bank's top CDO trader, Greg Lippmann, repeatedly warned his Deutsche Bank colleagues and some clients outside of the bank about the poor quality of the assets underlying many RMBS and CDO securities. Although senior management within the bank did not agree with his views, they allowed Mr. Lippmann, in 2005, to establish a large short position on behalf of the bank, essentially betting that mortgage related securities would fall in value. From 2005 to 2007, Mr. Lippmann built that position into a $5 billion short.

¶(a) Lippmann's Negative Views of Mortgage Related Assets

¶Emails produced to the Subcommittee provide repeated examples of Mr. Lippmann's negative views of mortgage related assets, particularly those involving subprime mortgages. At times, he expressed his views to colleagues within the bank; at other times he expressed them in connection with advising a client to bet against an RMBS security by taking a short position. At times, Mr. Lippmann recommended that his clients short poor quality RMBS assets, even while his trading desk was participating in a selection process that included those same assets in Gemstone 7. The following emails by Mr. Lippmann, written during 2006 and 2007, provide examples of his negative views.

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Emails regarding LBMLT 2004-3 M8, a subprime RMBS security issued by Long Beach: "[T]his bond blows."¹²⁷⁴¹²⁷⁴ 2/24/2006 emails between Greg Lippmann and Rocky Kurita at Deutsche Bank, DBSI_PSI_EMAIL00966290. Mr. Lippmann's negative comments did not begin in 2006; as early as May 2005, he wrote that the "real money flows are buying protection." 5/11/2005 email from Greg Lippmann to Rocky Kurita at Deutsche Bank, DBSI_PSI_EMAIL00048683. (2/24/2006)

Email providing Deutsche Bank trader his opinion regarding RMBS shelves: ["[Y]ikes didn't see that[.] … [H]alf of these are crap and rest are ok[.] …[C]rap-heat pchlt sail tmts."¹²⁷⁵¹²⁷⁵ 4/5/2006 email from Greg Lippmann to Deutsche Bank employee, DBSI_PSI_EMAIL01073270. The acronyms in the email refer to the following lenders: Home Equity Asset Trust ("heat"), People's Choice Home Loan Securities Trust ("pchlt"), Structured Asset Investment Loan ("sail"), and Terwin Mortgage Trust ("tmts"). (4/5/2006)

Email advising an investment banker at JPMorgan Chase regarding subprime RMBS securities issued by Aegis Asset Backed Securities Trust ("aabst"), Bay View Financial Acquisition Trust ("bayv"), Home Equity Mortgage Loan Asset Based Trust ("inabs"), Park Place Securities Inc. ("ppsi"), and Structured Asset Investment Loan ("sail"): "This is a good pool for you because it has a fair number of weak names but not so many that investors should balk (I wouldn't add more of these) and also has only a few names that are very good."¹²⁷⁶¹²⁷⁶ 6/23/2006 email from Greg Lippmann to Derek Kaufman at JPMorgan, DBSI_PSI_EMAIL01344930-33. (6/23/2006)

Email advising an investment banker at Oppenheimer Funds: "[Y]ou can certainly build a portfolio by picking only bad names and you have largely done that as Rasc ahl is considered bad as is Fremont (bsabs fr, fhlt, jpmac fre, sabr fr, nheli fm deals) ace, arsi and lbmlt."¹²⁷⁷¹²⁷⁷ 8/4/2006 email from Greg Lippmann to Michelle Borre at Oppenheimer Funds, DBSI_PSI_EMAIL01528941- 43. The acronyms in the email refer to the following lenders: Residential Asset Securities Corp. ("Rasc"), American Home Loans ("ahl"), Fremont ("fr," "fre," "fm," and "fhlt"), Bear Stearns Asset Backed Securities (bsabs), JPMorgan Acquisition Trust ("jpmac"), Securitized Asset Backed Receivables Trust ("sabr"), Nomura Home Equity Loan, Inc. ("nheli"), ACE Securities Corp. ("ace"), Argent Securities Inc. ("arsi"), and Long Beach Mortgage Trust ("lbmlt").Show full note Mr. Lippmann listed ACE Securities Corp. as a "bad name" even though it was created by and associated with Deutsche Bank itself.¹²⁷⁸¹²⁷⁸ Subcommittee interview of Greg Lippmann (10/18/2010); Subcommittee interview with Deutsche Bank's counsel (3/7/2011); 3/21/2011 letter from Deutsche Bank's counsel to the Subcommittee (ACE is one of "Deutsche Bank's own shelf offerings."), PSI-Deutsche_Bank-32-0001-04. See also 3/2/2011 letter from Deutsche Bank's counsel to the Subcommittee ("Deutsche Bank has no ownership interest in ACE Securities Corp. ('ACE'). All shares of ACE are held by Altamont Holdings Corp, a Delaware corporation. Deutsche Bank Securities, Inc. ('DBSI'), however, is an administrative agent for ACE and in that role has authority to act on behalf of ACE in connection with offerings of asset-backed securities, including RMBS offerings. … Deutsche Bank hired the AMACAR Group, LLC ('AMACAR') to assist in the creation of ACE to act as a registrant and depositor in connection with RMBS offerings sponsored and/or underwritten by Deutsche Bank."), PSI-DeutscheBank-31-0004- 06.Show full note (8/4/2006)

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Email to co-head of the Deutsche Bank CDO Group and to Global Head of Deutsche Bank's Securitized Product Group: "I was going to reject this [long purchase of a synthetic CDO] because it seems to be a pig cdo position dump 60^ but then I noticed winchester [Deutsche Bank affiliated hedge fund] is the portfolio selector……any idea???"1279 (8/4/2006)

Email responding to a hedge fund trader at Spinnaker Capital asking about a subprime RMBS security issued by Credit Based Asset Servicing and Securitization, LLC ("cbass"): "That said I can probably short this name to some CDO fool."¹²⁸⁰¹²⁸⁰ 8/30/2006 email from Greg Lippmann to Bradley Wickens at Spinnaker Capital, DBSI_PSI_EMAIL01634802. (8/30/2006)

Email responding to a hedge fund trader at Spinnaker Capital asking about MABS 2006-FRE1, a subprime RMBS security that contained Fremont loans and was issued by Mortgage Asset Securitization Transactions Asset-Backed Securities Trust: "This kind of stuff rarely trades in the synthetic market and will be tough for us to cover i.e. short to a CDO fool. That said if u gave us an order at 260 we would take it and try to dupe someone."¹²⁸¹¹²⁸¹ 9/1/2006 email from Greg Lippmann to Bradley Wickens at Spinnaker Capital, DBSI_PSI_EMAIL02228884. (9/1/2006)

Email describing MABS 2006-FRE1, a subprime RMBS security that contained Fremont loans and was issued by Mortgage Asset Securitization Transactions Asset- Backed Securities Trust, as a "crap bond."¹²⁸²¹²⁸² 9/1/2006 email from Greg Lippmann to Bradley Wickens at Spinnaker Capital, DBSI_PSI_EMAIL01645016. (9/01/2006)

Email describing MSHEL 2006-1 B3, an RMBS security issued by Morgan Stanley as "crap we shorted"; referring to GSAMP 2006-HE3 M9, an RMBS security issued by Goldman Sachs, as "this bond sucks but we are short 20MM"; and noting with regard to ACE, which was created by and associated with Deutsche Bank, that "ace is generally horrible."¹²⁸³¹²⁸³ 9/21/2006 email from Greg Lippmann to Deutsche Bank employee, DBSI_PSI_EMAIL01689001-02. In an October 2006 email, a Deutsche Bank employee wrote to Mr. Lippmann and others that a number of RMBS such as LBMLT, HEAT, INABS, AMSI/ARSI, RAMP/RASC, and CWL "would be impossible to sell to the public" due to their poor quality. 10/2/2006 email from Axel Kunde at Deutsche Bank to Sean Whelan with copy to Mr. Lippmann, DBSI_PSI_EMAIL02255361.Show full note (9/21/2006)

Email responding to a hedge fund trader at Mast Capital: "Long Beach is one of the weakest names in the market."¹²⁸⁴¹²⁸⁴ 10/20/2006 email from Greg Lippmann to Craig Carlozzi at Mast Capital, DBSI_PSI_EMAIL01774820-21. (10/20/2006)

Email to a client selecting bonds to short: "u have picked some crap right away so u have figured it out."¹²⁸⁵¹²⁸⁵ 12/4/2006 email from Greg Lippmann to Mark Lee at Contrarian Capital, DBSI_PSI_EMAIL01866336. The acronyms in the email refer to the following lenders: Bear Stearns Asset Backed Securities ("bsabs"), Option One Mortgage Loan Trust ("omlt"), and Ameriquest Mortgage Securities, Inc. ("amsi"). (12/04/2006)

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Email regarding GSAMP 06-NC2 M8, an RMBS security that contained New Century loans and was issued by Goldman Sachs: "[T]his is an absolute pig."¹²⁸⁶¹²⁸⁶ 12/8/2006 email from Greg Lippmann to Peter Faulkner at PSAM LLC, DBSI_PSI_EMAIL01882188. (12/8/2006)

Email describing ABSHE 2006-HE1 M7, a subprime RMBS security issued by Asset Backed Securities Corporation Home Equity Loan Trust, as a "crap deal"; and describing ACE 2006 HE2 M7, a subprime RMBS securitization issued by ACE Securities Corp., as: "[D]eal is a pig!"¹²⁸⁷¹²⁸⁷ 3/1/2007 email from Greg Lippmann to Joris Hoedemaekers at Oasis Capital UK, DBSI_PSI_EMAIL02033845. (3/1/2007)

¶When asked about these emails, Mr. Lippmann told the Subcommittee that he generally thought all assets in CDOs were weak, and that his descriptions were often a form of posturing while negotiating prices with his clients. In a number of cases, however, Mr. Lippmann was assisting his clients in devising short strategies or communicating with Deutsche Bank colleagues, rather than negotiating with clients over prices. As will be seen later in this Report, some of the RMBS securities he criticized were, at virtually the same time, being included by his trading desk in Gemstone 7, which was later sold by Deutsche Bank's CDO Group.

¶In addition to disparaging individual RMBS securities, Mr. Lippmann expressed repeated negative views about the CDO market as a whole. At times during 2006 and 2007, he referred to CDO underwriting activity by investment banks as the workings of a "CDO machine" or "ponzi scheme."¹²⁸⁸¹²⁸⁸ In the 1920s, Charles Ponzi defrauded thousands of investors in a speculation scheme that "involves the payment of purported returns to existing investors from funds contributed by new investors." "Ponzi Schemes – Frequently Asked Questions," SEC, http://www.sec.gov/answers/ponzi.htm. In June 2006, for example, a year before CDO credit ratings began to be downgraded en masse, Mr. Lippmann sent an email to a hedge fund trader warning about the state of the CDO market: "[S]tuff is flat b/c [because] the cdo machine has not slowed but I am fielding 2-4 new guys a day that are kicking the tires so we probably don't go tighter."¹²⁸⁹¹²⁸⁹ 6/8/2006 email from Greg Lippmann to Bradley Wickens at Spinnaker Capital, DBSI_PSI_EMAIL01282551. A few months later, in August 2006, Mr. Lippmann wrote about the coming market crash: "I don't care what some trained seal bull market research person says this stuff has a real chance of massively blowing up."¹²⁹⁰¹²⁹⁰ 8/29/2006 email from Greg Lippmann to Bradley Wickens at Spinnaker Capital, DBSI_PSI_EMAIL01628496.

¶When asked about his comments, Mr. Lippmann told the Subcommittee that the CDO market was not really a ponzi scheme, because people did receive an investment return, and asserted that he had used the term because he was "grasping at things" to prove he was right in his short position.1291 Mr. Lippmann also told the Subcommittee that while he knew that the major credit rating agencies had given AAA ratings to an unusually large number of RMBS and CDO securities and most people believed in the ratings, he did not. He also told the

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¶Subcommittee that he "told his views to anyone who would listen" but most CDO investors disagreed with him.¹²⁹²¹²⁹² Subcommittee interview of Greg Lippmann (10/18/2010).

¶In March 2007, Mr. Lippmann again expressed his view that mortgage related assets were "blowing up":

"I remain firm in my belief that these are blowing up whether people like it or not and that hpa [housing price appreciation] is far less relevant than these bulls think. Can't blame them because if this blows up lots of people lose their jobs so they must deny in hope that that will help prevent the collapse. At this price I'm nearly just as short as I've ever been."¹²⁹³¹²⁹³ 3/4/2007 email from Greg Lippmann to Harvey Allon at Braddock Financial, DBSI_PSI_EMAIL02041351-53. On June 23, 2007, Mr. Lippmann wrote to a Deutsche Bank colleague, "Yup this is the beginning of phase 2 (the bulls still can't see it), sales by the longs and how do you think the foreign banks will feel when they see that the true mark for what they have is … this could be the end of the cdo biz." 6/23/2007 email from Greg Lippmann to Michael George, DBSI_PSI_EMAIL02584591.Show full note

¶(b) Building and Cashing in the $5 Billion Short

¶Mr. Lippmann did not just express negative views of RMBS and CDO securities to his colleagues and clients, he also acquired a significant short position on those assets on behalf of Deutsche Bank. Despite the views of virtually all other senior executives at the bank that RMBS and CDO securities would gain in value over time, Mr. Lippmann convinced the bank to allow him to initiate and build a substantial proprietary short position that would pay off only if mortgage related securities lost value.

¶Initiating the Short Position. In 2005, Deutsche Bank was heavily invested in the U.S. mortgage market and, by 2007, had accumulated a long position in mortgage related assets that, according to Deutsche Bank, had a notional or face value of $128 billion and a market value of more than $25 billion.¹²⁹⁴¹²⁹⁴ According to Deutsche Bank, as of March 31, 2007, it held a total long position in mortgage related securities whose notional or face value totaled $127.8 billion, including $4.3 billion at "ABS Correlation London"; $5 billion at "CDO Primary Issue/New York"; $102 billion at "RMBS/New York"; $7.6 billion at "SPG-Asset Finance/New York"; and $8.9 billion at "Winchester Capital/London." 3/2/2011 letter from Deutsche Bank's counsel to the Subcommittee, PSI-DeutscheBank-31-0004-06. The market value of those positions was substantially lower. For example, according to Deutsche Bank, the $102 billion long investment held by its RMBS/New York office had a market value of about $24 billion. 3/21/2011 letter from Deutsche Bank's counsel to the Subcommittee, PSI- Deutsche_Bank-32-0001-04.Show full note These positions had been accumulated and were held primarily by the Deutsche Bank mortgage department, the ABS Trading Desk, and a Deutsche Bank affiliated hedge fund, Winchester Capital, which was based in London.¹²⁹⁵¹²⁹⁵ Id.

¶Mr. Lippmann told the Subcommittee that, despite the bank's positive view of the mortgage market, in the fall of 2005, he requested permission to establish a proprietary trading position that would short RMBS securities.¹²⁹⁶¹²⁹⁶ Subcommittee interview of Greg Lippmann (10/18/2010). When asked if the position was a proprietary investment by the bank, Mr. Lippmann told the Subcommittee that it was. Id. Deutsche Bank acknowledges in a 20-F filing with the U.S. Securities and Exchange Commission that it conducts proprietary trading, in addition to trading activity that facilitates customer business. Deutsche Bank stated that it trades for its own account (i.e., uses its capital) to exploit market opportunities. See Deutsche Bank Aktiengesellschaft's Form 20-F filed with the Securities and Exchange Commission on March 26, 2008, at 24.Show full note He explained that he made this request after reviewing data he received from a Deutsche Bank quantitative analyst, Eugene Xu. He said that this data showed that, in regions of the United States where housing prices had increased by 13%, the default rates for subprime mortgages had increased to 7%.¹²⁹⁷¹²⁹⁷ Subcommittee interview of Greg Lippmann (10/18/2010). At the same time, he said, in other regions where housing prices had increased only 4%, the subprime mortgage default rates had quadrupled to 28%.¹²⁹⁸¹²⁹⁸ Id. Mr. Lippmann explained that he had concluded that even a moderate slow down in rising housing prices would result in significant subprime mortgage defaults, that there was considerable correlation among these subprime mortgages, and that the defaults would affect BBB rated RMBS securities. Mr. Lippmann stressed that his negative view of RMBS securities was based primarily on his view that moderating home prices would cause subprime mortgage defaults and was not dependent upon the quality of the subprime loans.¹²⁹⁹¹²⁹⁹ Id.

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¶In the fall of 2005, Mr. Lippmann said that he approached his supervisor Richard D'Albert, Global Head of the Structured Products Group, for permission to enter into CDS agreements to short RMBS securities totaling $1 billion.1300 He said that he explained at the time that a cost benefit analysis favored a short RMBS position, because the bank would pay a relatively small amount of CDS premiums per year in exchange for a potentially huge payout. Mr. Lippmann said that he estimated at the time that, when the costs were compared to the potential payout if the BBB securities defaulted, the proposed short position offered a potential payout ratio of 8 to 1.

¶Mr. Lippmann also developed a presentation supporting his position entitled, "Shorting Home Equity Mezzanine Tranches." It made the following points:

"Over 50% of outstanding subprime mortgages are located in MSAs [metropolitan statistical areas] with double digit 5 year average of annual home price growth rates.

There is a strong negative correlation between home price appreciation and loss severity.

Default of subprime mortgages are also strongly negatively correlated with home price growth rates.

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Nearly $440 billion subprime mortgages will experience payment shocks in the next 3 years.

Products that may be riskier than traditional home equity/subprime mortgages have become popular."¹³⁰¹¹³⁰¹ 9/2005 "Shorting Home Equity Mezzanine Tranches, A Strategy to Cash in on a Slowing Housing Market," DBSI_PSI_EMAIL00502892-29.

¶Mr. Lippmann told the Subcommittee that Mr. D'Albert approved his taking the short position in or around November 2005, but said the trade was so big and controversial that Mr. Lippmann also had to get the approval of Rajeev Misra, Global Head of Credit Trading, Securitization and Commodities, who was based in London.¹³⁰²¹³⁰² Subcommittee interview of Greg Lippmann (10/18/2010). Mr. Lippmann said that, in or around November 2005, Mr. Misra reluctantly gave his approval for the short position, even though Mr. Misra believed mortgage related securities would continue to increase in value over time.

¶Building the Short Position. Mr. Lippmann told the Subcommittee that he used some existing short positions that had been undertaken as hedges to begin building his position.¹³⁰³¹³⁰³ Id. He said that, throughout 2006, he gradually accumulated a larger short position, which eventually reached $2 billion. According to Mr. Lippmann, Deutsche Bank senior management reluctantly went along.¹³⁰⁴¹³⁰⁴ Id. He told the Subcommittee that, at one point in 2006, Boaz Weinstein, who reported to Mr. Misra, told him that the carrying costs of his position, which required the bank to pay insurance-like premiums to support the $2 billion short position, had become so large that he had to find a way to pay for them. According to Mr. Lippmann, the bank's senior management asked him to persuade them that he was right by demonstrating that others were willing to "short" the market as well. Mr. Lippmann told the Subcommittee he was then motivated to convince his clients that they ought to short the mortgage market, arrange the shorts for them, and make enough in fees from those transactions to pay for the costs of his multi-billion-dollar short.¹³⁰⁵¹³⁰⁵ Id.

¶Mr. Lippmann told the Subcommittee that he spent much of 2006 pitching his clients to short the mortgage market. He said that he often made presentations to prospective clients sharing with them his "strategy on how to cash in on a slowing housing market."¹³⁰⁶¹³⁰⁶ Id. He said that, in early 2006, he expended approximately 200 hours trying to convince AIG to short single name RMBS, but was unsuccessful. He told the Subcommittee that he also believed that his presentations helped convince AIG to stop buying RMBS and CDO securities and stop selling CDS protection for those deals. In an August 2006 email, Mr. Lippmann wrote: "In 05 for a time, we sold EVERY single one to AIG. They stepped out of the market in March of 06 after speaking with me and our research people (and I don't doubt other dealers)."¹³⁰⁷¹³⁰⁷ 8/26/2006 email from Greg Lippmann to Richard Axilrod at Moore Capital, DBSI_PSI_EMAIL01618236. Mr. Lippmann told the Subcommittee that Mr. Lamont, who co-led Deutsche Bank's CDO Group, was not pleased that Mr. Lippmann had convinced AIG, a very large purchaser of long interest in RMBS and CDO securities, to stop buying them.

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¶The documents indicate that Mr. Lippmann and his trading team were aware at the time that the CDO Trading Desk was expected to promote rather than discourage client interest in purchasing Deutsche Bank's CDO securities. One of Mr. Lippmann's top traders, Rocky Kurita, put it this way in mid-2005: "[W]e have to make money. Customer happiness is a secondary goal but we cannot lose sight of the trading desk[']s other role of supporting new issue and the customer franchise."¹³⁰⁸¹³⁰⁸ 5/12/2005 email from Rocky Kurita to Greg Lippmann, DBSI_PSI_EMAIL00054826. In a 2007 email to a client, Mr. Lippmann wrote: "[P]lease please do not forward these emails outside of your firm. … I do not want to be blamed by the new issue people for destroying their business."¹³⁰⁹¹³⁰⁹ 2/1/2007 email from Greg Lippmann to Wyck Brown at Braddock Financial, DBSI_PSI_EMAIL01969867.

¶Although Mr. Lippmann was unsuccessful in convincing AIG to short RMBS and CDO securities, he did convince some of his other clients, usually hedge funds, to undertake such shorts, primarily by purchasing single name CDS contracts referencing specific RMBS securities. Those trades generated substantial sums for the ABS Correlation Trading Desk which acted as a market maker in the CDS market for those clients. Mr. Lippmann told the Subcommittee that the shorts executed by his clients ultimately generated about $200 million in revenues for his desk in 2006.¹³¹⁰¹³¹⁰ Subcommittee interview of Greg Lippmann (10/18/2010).

¶Defending the Short. According to Mr. Lippmann, in December 2006, he met in London with a senior bank official, Anshu Jain, Head of Global Markets at Deutsche Bank, and suggested that Deutsche Bank's long positions in mortgage related securities created too much exposure for the bank and should be reduced.¹³¹¹¹³¹¹ Id. Mr. Lippmann recommended that the bank hedge its risk using his short strategy. His suggestion was not acted upon, but as the market grew more volatile in late 2006 and early 2007, Mr. Lippmann's short position began to gain in value and caught the attention of senior management at the bank.

¶Mr. Lippmann told the Subcommittee that, in January 2007, he met with Mr. Jain, Mr. Misra, and Mr. D'Albert at a hotel in Lisbon, where all three again challenged him to defend his short position by noting that it had required him to pay out $20 million in CDS premiums during 2006.¹³¹²¹³¹² Id. Mr. Lippmann told the Subcommittee that he countered by pointing out, while he had paid out $20 million, his desk made $200 million from trading in RMBS and CDO shorts for his clients. He said that the three concluded he could keep his short position.¹³¹³¹³¹³ Id. According to Mr. Lippmann, in February 2007, Mr. Jain met with him again to discuss whether or not to keep his short position, because it had gained in value and Deutsche Bank could cash in the position and take the profits at that time. Mr. Lippmann said that the result of the meeting was that, once again, his position was left in place.

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¶While defending his position within the bank, Mr. Lippmann continued to speak with his outside clients about his negative views of the market, continued to make presentations to potential clients about shorting the market,¹³¹⁴¹³¹⁴ See, e.g., 2/2007 presentation, "Shorting Home Equity Mezzanine Tranches," prepared by Mr. Lippmann, DBSI_PSI_EMAIL01988773-845. and continued to execute shorts for them, while building his desk's proprietary short position.

¶According to Mr. Lippmann, in late February or early March 2007, as the ABX Index showed subprime RMBS securities losing value and subprime mortgages continued incurring delinquencies at record rates, an ad hoc meeting of Deutsche Bank's executive committee took place in London to discuss the bank's risk exposure in mortgage related securities. According to Mr. Lippmann, he happened to be in London at the time and was invited to attend. He estimated that ten to twelve persons were at the meeting in person, and another two to four persons participated by telephone. He said that, at the meeting, Deutsche Bank executives discussed whether the recent market volatility reflected short term or longer term trends and whether the bank should make any changes in its holdings.¹³¹⁵¹³¹⁵ Subcommittee interview of Greg Lippmann (10/18/2010). At that time, Mr. Lippmann held the only large short position on behalf of the bank, then about $4 to 5 billion in size.1316 In contrast, the Deutsche Bank mortgage group held $102 billion in long RMBS and CDO securities, and Winchester Capital, Deutsche Bank's hedge fund affiliate, held a net long position of $8.9 billion.1317 Mr. Lippmann told the Subcommittee that he was the only person at the meeting who argued for the bank to increase its short position.¹³¹⁸¹³¹⁸ Subcommittee interview of Greg Lippmann (10/18/2010).

¶At the time of the London meeting, Mr. Lippmann's position was showing a significant profit. Mr. Misra brought up the alternative of cashing in his position while RMBS prices were down, because he thought prices were in a short term dip and the profits might disappear later on. Mr. Lippmann contended that the bank should not only keep his short position, but increase it, but more senior voices disagreed with him. He told the Subcommittee that the decision at the end of the meeting was for all parties to keep their positions unchanged, including Mr. Lippmann.¹³¹⁹¹³¹⁹ Id.

¶Cashing In the Short. In July 2007, the major credit rating agencies began issuing downgrades of RMBS and CDO securities, in particular those that incorporated or referenced subprime mortgages. The value of those securities began to plummet. By the end of the summer of 2007, Deutsche Bank initiated efforts to sell off the long positions held by Winchester Capital and other Deutsche Bank entities, reflecting a shift in the bank's strategy, but its sales force had difficulty due to the lack of customers willing to buy long.¹³²⁰¹³²⁰ Subcommittee interview of Jordan Milman (10/22/2010). Mr. Milman, one of Mr. Lippmann's top traders, stated that the market first weakened in February 2007, stabilized until June or July 2007, and then it was a "one way train" down from then through 2008. Id. During 2007 and 2008, at the direction of senior management, Mr. Lippmann gradually cashed in his short position, obtaining a total return of about $1.5 billion, which Mr. Lippmann told the Subcommittee he believes was the largest profit obtained from a single position in Deutsche Bank history.¹³²¹¹³²¹ Subcommittee interview of Greg Lippmann (10/18/2010). See Net Revenues from ABS Products Backed by U.S. Residential Mortgages, DB_PSI_C00000003.

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¶Despite the gain from Mr. Lippmann's short position, Deutsche Bank told the Subcommittee that, overall in 2007, it had a long position in mortgage related holdings, with a face value of about $128 billion and a market value of more than $25 billion. Deutsche Bank told the Subcommittee that, despite the size of these holdings and their declining value, it lost only about $4.5 billion on those mortgage related holdings for the year.¹³²²¹³²² According to a chart prepared by Deutsche Bank for the Subcommittee, in 2007 and 2008, its RMBS holdings lost about $3.4 billion; the CDO Group lost about $1.0 billion; Winchester Capital lost about $1.1 billion; and two other trading desks lost nearly $650 million. These losses were offset by the $1.5 billion gain from the bank's short position, for total mortgage related losses of about $4.5 billion. Net Revenues from ABS Products Backed by U.S. Residential Mortgages, DB_PSI_C00000003.Show full note Deutsche Bank also filed a 2007 annual report with the SEC claiming a 2007 profit of €7.2 billion.¹³²³¹³²³ Deutsche Bank stated in its annual report filed with the SEC that it ended 2007 in the black, due to gains in other areas of the bank, including its Corporate and Investment Bank which reported a pre-tax profit of €5.1 billion and its Private Clients and Asset Management division which reported a pre-tax profit of €2.1 billion. See Deutsche Bank's When asked why its large long position in mortgage holdings did not lose more value, Deutsche Bank told the Subcommittee that it had placed large hedges, using U.S. Treasury bonds, which reduced its losses.¹³²⁴¹³²⁴ Subcommittee interview with Deutsche Bank's counsel (3/7/2011). See also 3/21/2011 letter and accompanying chart from Deutsche Bank's counsel to the Subcommittee, PSI-Deutsche_Bank-32-0001-04.

¶(4) The "CDO Machine"

¶From 2006 to 2007, Mr. Lippmann repeatedly cautioned his colleagues and clients that the mortgage market was headed for a downfall, convinced a number of his clients to short RMBS and CDO securities, and built his $5 billion short position on behalf of Deutsche Bank. Meanwhile, the "CDO machine," as he described it, continued issuing new CDO securities through the end of 2007. The reasons for this continuing CDO activity, despite a deteriorating mortgage market and waning investor interest, are key to understanding how these complex, high risk, structured finance products ended up in multiple financial portfolios throughout the U.S. financial system.

¶Mr. Lippmann was frequently asked why, given his negative views, the CDO market was continuing to operate. He pointed to investment bank fees, prestige, and pressure to preserve the CDO jobs involved. In August 2006, for example, Mr. Lippmann wrote:

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"Why have we done this? It is not without reluctance and we are looking for ways to get out of this risk, but for now the view has been, we like the fees and the league table credit (and dammit we have a budget to make)."¹³²⁵¹³²⁵ 8/26/2006 email from Greg Lippmann to Richard Axilrod at Moore Capital, DBSI_PSI_EMAIL01618236-42. On August 1, 2006, Mr. Lippmann wrote to Mr. Milman, "who has all this crap and let me know which ones to look at looks like a lot of crappy deals." 8/1/2006 email from Greg Lippmann to Jordan Milman, DBSI_PSI_EMAIL01510643. Mr. Lippmann's negative views were shared by his traders. In an email originally sent by one of the traders on his desk, Rocky Kurita, the CDO business is set to a song, "CDO Oh Baby," by Vanilla Ice with the following lyrics: "Yo vip let's kick it! CDO oh baby, CDO oh baby. All right, stop, collaborate and listen. Spreads are wide with a technical invasion. Home Eq Subs were trading so tightly. Until Hedge Funds Bot Protection daily and nightly. Will they stop? Yo I don't know. Turn up the Arb and let's go. To the extreme Macro Funds do damage like a vandal. Now, BBs are trading with a new handle. Print, even if the housing bubble looms. There are never ends to real estate booms. If there is a problem, yo, we'll solve it. Check out the spreads while my structurer revolves it. CDO oh baby, CDO oh baby." 11/8/2005 email from Jordan Milman to Greg Lippmann, DBSI_PSI_EMAIL00686597-601 (forwarding an 11/8/2005 email from Rocky Kurita at Deutsche Bank).Show full note

¶In January 2007, after a trader asked Mr. Lippmann why the CDO market hadn't imploded, Mr. Lippmann responded: "league table, fees, never has one blown up yet."¹³²⁶¹³²⁶ 1/5/2007 email from Greg Lippmann to Chris Madison at Mast Capital, DBSI_PSI_EMAIL02333467-68. The reference to "league table credit" indicates that investment banks considered it prestigious to be listed as the leading producer of a complex structured finance product like CDOs, and used their standing in the tables that tracked total origination numbers as a way of burnishing their reputations, attracting top talent, and generating new business. An October 2006 "Progress Report" on its CDO business, for example, which was prepared internally by the bank, included a slide entitled, "CDO Primary Revenue Forecast and League Tables," in which a chart ranked Deutsche Bank third in CDO issuance, behind Merrill Lynch and Citigroup.¹³²⁷¹³²⁷ 10/2006, "CDO Primary Update Progress Report," DBSI_PSI_EMAIL03970167-72, at 68. The slide indicated that Deutsche Bank had completed 38 CDOs to date, had a 7% share of the CDO market, and "expected to close 50 deals by year end," with the "pipeline for Q1 and Q2 2007 building." The final page of the presentation, providing a chart listing the top 20 Deutsche Bank CDO salespersons by region, together with their individual sales credits, identifies some of the bank personnel invested in the continuation of the CDO business.

¶On the issue of fees, the head of Deutsche Bank's CDO Group Michael Lamont told the Subcommittee that he estimated the bank received 40-200 basis points for each CDO created, depending upon the complexity of the CDO.¹³²⁸¹³²⁸ Subcommittee interview of Michael Lamont (9/29/2010). He indicated those fees translated into about $5 to $10 million per CDO.¹³²⁹¹³²⁹ Id. When asked what he meant by saying "we have a budget to make," Mr. Lippmann explained that new CDO deals had to be completed continuously to produce the revenues needed to support the budgets of the CDO desks and departments involved with their creation.¹³³⁰¹³³⁰ Subcommittee interview of Greg Lippmann (10/18/2010).

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¶A similar view as to why the CDO business continued to operate despite increasing market risk was expressed by a former executive at the hedge fund Paulson & Co. in a January 2007 email exchange with another investor. The Paulson executive wrote:

"It is true that the market is not pricing the subprime RMBS wipeout scenario. In my opinion this situation is due to the fact that rating agencies, CDO managers and underwriters have all the incentives to keep the game going, while 'real money' investors have neither the analytic tools nor the institutional framework to take action before the losses that one could anticipate based [on] the 'news' available everywhere are actually realized."¹³³¹¹³³¹ 1/14/2007 email from Paolo Pellegrini at Paulson to Ananth Krishnamurthy at 3a Investors, PAULSON ABACUS 0234459.

¶At the end of September 2006, the head of Deutsche Bank's sales force, Sean Whelan, wrote to Mr. Lippmann expressing concern that some CDO tranches were getting increasingly difficult to sell: "[T]he equity and the AAA were the parts we found difficult to place."¹³³²¹³³² 9/27/2006 email from Sean Whelan to Greg Lippmann, DBSI_PSI_EMAIL02255361-63. Mr. Lippmann told the Subcommittee that once firms could not sell an entire CDO to investors, it was a warning that the market was waning, and the investment banks should have stopped structuring new ones.¹³³³¹³³³ Subcommittee interview of Greg Lippmann (10/18/2010). Mr. Lippmann told the Subcommittee that he thought Mr. Lamont's CDO Group at Deutsche Bank had too many CDOs in the pipeline in the spring of 2007, when it could not sell all of its CDO securities. He reported that he told Mr. Lamont that defaults would increase. Instead of getting out of the CDO business, however, he said, a new source of CDO demand was found – when new CDOs started buying old CDO securities to include in their assets. One media report explained how this worked:

"As the housing boom began to slow in mid-2006, investors became skittish about the riskier parts of those investments. So the banks created – and ultimately provided most of the money for – new CDOs. Those new CDOs bought the hard-to-sell pieces of the original CDOs. The result was a daisy chain that solved one problem but created another: Each new CDO had its own risky pieces. Banks created yet other CDOs to buy those."¹³³⁴¹³³⁴ "Banks' Self-Dealing Super Charged Financial Crisis," ProPublica, (8/26/2010), http://www.propublica.org/article/banks-self-dealing-super-charged-financial-crisis.

¶Research conducted by Thetica Systems, at the request of ProPublica, found that in the last years before the financial crisis, CDOs had become the dominant purchaser of high risk CDO securities, largely replacing real money investors like pension funds, insurance companies, and hedge funds. The CDO market analysis found that, by 2007, 67% of the high risk mezzanine CDO securities had been purchased by other CDOs, up from 36% in 2004.¹³³⁵¹³³⁵ Id. ProPublica even found that, from 2006 to 2007, nearly half of all the CDOs sponsored by Merrill Lynch bought significant portions of other Merrill CDOs.

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¶Mr. Lippmann told the Subcommittee that he considered it a "shady" practice when, in 2006, difficult-to-sell BBB CDO tranches began to be placed in new CDOs.¹³³⁶¹³³⁶ Subcommittee interview of Greg Lippmann (10/18/2010). In a June 2007 email to Mr. Lippmann, Richard Kim, a Deutsche Bank Managing Director, described placing unsold CDO tranches into a new CDO to be sold to investors as a "CDO2 balance sheet dump."¹³³⁷¹³³⁷ 6/14/2007 email from Richard Kim at Deutsche Bank to Greg Lippmann, DBSI_PSI_EMAIL02202920.

¶In addition to placing unsold CDO securities in newly issued CDOs, investment banks turned increasingly to non-U.S. investors to keep the CDO machine going. In August 2006, Mr. Lippmann noted that European and Asian banks were being targeted to buy CDOs:

"Hear what you are saying and in a normal market your logic would be inarguable, but the demand for this crap is virtually entirely technically driven, all cdos. And each person at the cdo table thinks someone else is the fool- cdo equity, ostensibly only two buyers one mutual fund in Australia, and one hedge fund in Chicago, who is actually putting on a bearish correlation trade: bbb sold mostly ponzi-like to other cdos with limited distribution in Europe. AA and Junior AAA sold mostly to high grade cdos and to a certain extent European and Asian banks and lastly the senior AAA, this may ultimately break the cdo market."¹³³⁸¹³³⁸ 8/26/2006 email from Greg Lippmann to Richard Axilrod at Moore Capital, DBSI_PSI_EMAIL01618236.

¶In a December 2006 email, Mr. Lippmann wrote to a client: "[W]ho owns the cdos…insurance company and german and asian banks…and high grade cdos (can you say ponzi scheme)[?]"¹³³⁹¹³³⁹ 12/4/2006 email from Greg Lippmann to Deutsche Bank employee, DBSI_PSI_EMAIL01867147-49. In early 2007, he wrote:

"[T]he other side is all cdos..so it is the cdo investors who r on the other side who buys cdos: aaa-reinsurance, ws [Wall Street] conduits, European and Asian banks, aa-high grade cdos, European and Asian banks and insurers..some US insurers, bbb other mezz [mezzanine] abs [asset-backed security] cdos (i.e. ponzi scheme), European banks and insurers, equity some US hedge funds, Asian insurance companies, Australian and Japanese retail investors through mutual funds."¹³⁴⁰¹³⁴⁰ 2/27/2007 email from Greg Lippmann to Fabrizio Wittenburg at Deutsche Bank, DBSI_PSI_EMAIL02027053- 55.

¶In February 2007, when an investor wrote to Mr. Lippmann inquiring about the status of the "CDO machine," Mr. Lippmann responded: "[G]etting slower but not dead yet[.] … 2-5 ramping a day instead of 10-15[.] … [H]earing of many investors in [A]sia especially shutting down … but the window is not completely shut yet."¹³⁴¹¹³⁴¹ 2/20/2007 email from Greg Lippmann to David Homan at Moore Capital, DBSI_PSI_EMAIL02006853-54. Deutsche Bank emails demonstrate that, in 2007, like other investment banks, it was actively trying to sell CDOs in Asia.¹³⁴²¹³⁴² See, e.g., "I would like these guys to push Asia sales on this…, but also as Ilinca said, the question arises why weren't they working on this thus far?" 2/21/2007 email from Abhayad Kamat at Deutsche Bank to Michael Lamont and others at Deutsche Bank, DBSI_PSI_EMAIL04056326-36.

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¶Mr. Lippmann had an unrelentingly negative view of the RMBS and CDO securities he traded. He believed the securities would ultimately lose value, but he also believed investment banks would do all they could to sustain the CDO market for as long as possible due to the CDO fees, prestige, market share, and jobs at stake.

¶(5) Gemstone

¶To understand how one investment bank, Deutsche Bank, continued to develop and aggressively solicit its clients to purchase CDO securities even as mortgage related securities lost value and the CDO market began collapsing, the Subcommittee examined in detail Gemstone 7, a $1.1 billion CDO. Gemstone 7 was assembled and marketed by Deutsche Bank, as sole placement agent, from October 2006 to March 2007.¹³⁴³¹³⁴³ In the Gemstone 7 offering circular, Deutsche Bank is described as the placement agent: "The Notes purchased by the Initial Purchaser, if any, will be privately placed with eligible investors by the Initial Purchaser" where the Initial Purchaser was Deutsche Bank. Gemstone 7 Offering Circular, GEM7-00000427-816 at GEM7-00000640. In contrast, other documents produced by Deutsche Bank indicate that the bank was acting as an underwriter in the Gemstone 7 transaction. See, e.g., 12/20/2006 Gemstone 7 Securitization Credit Report, DB_PSI_00237655-71 and undated Gemstone 7 Securitization Credit Report, MTSS000011-13. For ease of reference but without making a judgment on the matter, this Report uses the term "placement agent" when describing Deutsche Bank's role in Gemstone 7.Show full note Gemstone 7 was the last in a series of CDOs sponsored by HBK Capital Management (HBK), a large hedge fund.¹³⁴⁴¹³⁴⁴ Subcommittee interview of HBK Managing Director Jamiel Akhtar (9/15/2010).

¶Deutsche Bank issued the Gemstone 7 securities in March 2007. Six out of Gemstone's seven tranches received investment grade ratings, including AAA ratings for the top three tranches. Two months later, in July 2007, the major credit rating agencies issued mass rating downgrades of RMBS and CDO securities, including 19 of the 115 RMBS securities included or referenced in Gemstone 7. In November 2007, the credit rating agencies began to downgrade the Gemstone 7 securities. Today, all seven tranches have been downgraded to junk status, and the Gemstone 7 securities are nearly worthless.

¶(a) Background on Gemstone

¶Gemstone 7 was a $1.1 billion hybrid CDO whose assets consisted predominantly of high risk subprime RMBS securities. Nearly 90% of its assets were mid and subprime RMBS securities with 33% carrying non-investment grade ratings.¹³⁴⁵¹³⁴⁵ The intended portfolio composition of Gemstone 7 was disclosed to investors in a Debt Investor Presentation. See 2/2007 Gemstone 7 Debt Investor Presentation, GEM7-00001687-1747 at 1695. Of the remaining assets, 4.5% were CDO securities; 3.3% were commercial mortgage backed securities; and 3.5% were securities backed by pools of student loans.¹³⁴⁶¹³⁴⁶ Id. at 1691. When the deal closed in March 2007, Gemstone 7 had about $476 million in cash RMBS assets as well as $625 million in synthetic assets.¹³⁴⁷¹³⁴⁷ 9/14/2010 Gemstone 7 Asset Chart, PSI-Deutsche Bank-17-Gemstone7-0001-03. Gemstone 7 was constructed as a "partially static" CDO, meaning that while some of its assets were set and could not change, others could be replaced by the collateral manager, HBK.

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¶HBK is a Dallas based hedge fund that was founded in October 1991, and by 2007, managed approximately $12 billion in capital.¹³⁴⁸¹³⁴⁸ 1/2007 Gemstone 7 Debt Investor Presentation, at 17, DBSI_PSI_EMAIL01980000-60. According to HBK, its Structured Products Group, one of its 21 business units, was "one of the leading purchasers and long-term investors in credit sensitive mortgages … including RMBS and ABS, a component in HBK's overall strategy since 2002."¹³⁴⁹¹³⁴⁹ Id. Deutsche Bank told the Subcommittee that HBK had a reputation as a competent manager of mortgage related assets.¹³⁵⁰¹³⁵⁰ Subcommittee interview of Sean Whelan, co-head of Deutsche Bank sales force (9/22/2010). HBK had acted as the collateral manager for seven previous CDO deals (six named Gemstone), choosing to alternate the mandate for the deals between Lehman Brothers and Deutsche Bank.

¶In October 2006, HBK retained Deutsche Bank to act as the placement agent for Gemstone 7. Under the agreement, HBK was to receive 30 basis points, or 0.3%, per year of the notional amount of Gemstone 7 (approximately $3.3 million) in return for serving as the collateral manager. Deutsche Bank was slated to receive $6.79 million in "underwriting fees," but because the deal did not sell completely, Deutsche Bank ultimately received a lesser amount of $4.7 million.¹³⁵¹¹³⁵¹ See 12/20/2006 Gemstone 7 Securitization Credit Report, DB_PSI_00237655-71; undated Gemstone 7 Securitization Credit Report, MTSS000011-13; 3/15/2007 Gemstone CDO VII Ltd. Closing Memorandum, DB_PSI_00133536-41. According to the Gemstone Offering Circular, HBK was to receive "0.30% per annum on the Quarterly Amount payable in arrears on each distribution date." 3/15/2007 Offering Circular for Gemstone CDO VII, Ltd., GEM7-00000427-816, "The Management Agreement," at 168. As opposed to an upfront fee, which Deutsche Bank received, the fee to HBK was paid quarterly. Thus, 0.30% of $1.1 billion translates to a fee of approximately $3.3 million for HBK. See 7/11/2007 email from Chehao Lu at Deutsche Bank to Marco Lukesch at HBK, GEM7-00003568. See also email noting HBK's quarterly collateral management fee of $826,067.88 as of September 11, 2007. 9/11/2007 email from Eric Martel at HBK to Jamiel Akhtar at HBK, GEM7-00006900.Show full note

¶On October 25, 2006, HBK and Deutsche Bank signed an agreement outlining the terms of Gemstone 7. HBK told the Subcommittee:

"The collateral purchased under the warehouse arrangement was selected by HBK and subject to Deutsche Bank's right of approval. The warehouse documents originally contemplated a total collateral pool of $750 million, which was increased to $1.1 billion in late December 2006."¹³⁵²¹³⁵² 8/20/2010 letter from HBK's counsel to the Subcommittee, at 2.

¶On October 24, 2006, Deutsche Bank opened a warehouse account to store the assets that would serve as the collateral for the CDO when it closed.¹³⁵³¹³⁵³ See chart, "Assets Purchased by Gemstone VII CDO during Warehouse Period," GEM7-00001831-33 (showing assets purchased during the warehouse period). According to Credit magazine, "The financial press will often make its first mention of a 'new' CDO on or around the time of its closing – with the closing date generally the day on which the CDO issues tranches of debt and equity to investors. Prior to that day, however, there will have been a so- called pre-closing or 'warehousing' period, typically lasting between three and six months. During that period the asset manager will have acquired (or 'warehoused') assets to act as collateral for the securities to be issued by the CDO … on the closing day." See "CDO Guide: recovery rates," Credit magazine (May 2004), http://db.riskwaters.com/public/showPage.html?page=133193.Show full note Deutsche Bank and HBK shared the risk for any change in value of the warehoused assets if the deal failed to close. Pursuant to the risk sharing agreement, if the deal failed to close, HBK would incur the risk for the first $80 million in losses, and Deutsche Bank would bear the remaining risk.¹³⁵⁴¹³⁵⁴ 12/20/2006 Gemstone 7 Securitization Credit Report, DB_PSI_00237655-71.

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¶Deutsche Bank CDO Group. Several departments and desks at Deutsche Bank were involved in designing, marketing, and selling the Gemstone 7 securities. The CDO Group, co- headed by Michael Lamont and Michael Herzig, was responsible for designing its structure, monitoring the purchasing and warehousing of its assets, obtaining its credit ratings, preparing the legal documentation, establishing its administrative structure, obtaining underwriting approval of the deal, designing the marketing materials, and overseeing the issuance of the CDO securities.¹³⁵⁵¹³⁵⁵ Subcommittee interview of Michael Lamont (9/29/2010). Abhayad Kamat within the CDO Group was assigned lead responsibility for structuring Gemstone 7.¹³⁵⁶¹³⁵⁶ Subcommittee interview of Abhayad Kamat (10/8/2010). The CDO Trading Desk, headed by Greg Lippmann, participated in the CDO approval process once HBK selected assets. The CDO sales force, headed by Sean Whelan and Michael Jones, was responsible for selling the Gemstone 7 CDO securities.

¶To issue the CDO securities, Deutsche Bank established an offshore corporation in the Cayman Islands called Gemstone CDO VII, Ltd.¹³⁵⁷¹³⁵⁷ Gemstone CDO VII Ltd. Certificate of Incorporation and Memorandum and Articles of Association of Gemstone CDO VII Ltd., DB_PSI_00236844. To administer the corporation, Deutsche Bank appointed its Cayman Island affiliate, Deutsche Bank Cayman, which is a licensed trust company.¹³⁵⁸¹³⁵⁸ Deutsche Bank International Limited is a wholly owned subsidiary of Deutsche Bank AG. It currently has several offices around the world, including one in the Cayman Islands, Deutsche Bank (Cayman) Limited ("DB Cayman"), that was opened in 1983. "Deutsche Bank International Ltd.," Bloomberg Businessweek, http://investing.businessweek.com/research/stocks/private/snapshot.asp?privcapId=884191; "Deutsche Bank in the Cayman Islands," Deutsche Bank, http://www.dboffshore.com/page.php?title=cayman_islands. DB Cayman is a licensed trust company incorporated in the Cayman Islands. Preference Share Paying Agency Agreement, GEM7- 00001089-1030, at 1092.Show full note As administrator, Deutsche Bank Cayman provided Gemstone 7 with the administrative services needed to operate the CDO securitization, including but not limited to, providing office facilities and secretarial staff, maintaining the books and records required by Cayman law, naming at least two Cayman directors, and acting as the Share Registrar for Gemstone shares.¹³⁵⁹¹³⁵⁹ Amended and Restated Administrative Agreement, GEM7-00001223-31; Preference Share Paying Agency Agreement, GEM7-00001089-1130 at 1095-96.

¶HBK's Long Investment in Gemstone. HBK routinely purchased the equity tranche,¹³⁶⁰¹³⁶⁰ An equity tranche is the tranche in an RMBS or CDO structure that is designed to be the first to incur any losses from the securitization. Since it is expected to incur at least some level of losses, the equity tranche is usually not given a credit rating and is often retained by the originator of the securitization. See American Banker definition, http://www.americanbanker.com/glossary/e.html. also known as the residual interest, in all of its Gemstone deals, including Gemstone 7.¹³⁶¹¹³⁶¹ According to HBK, "HBK's investment process integrates expertise in capital markets, structural analysis, collateral and loan level analysis, due diligence, and in house surveillance. HBK is seen as not as a trader but as a HBK told investors in its sales presentation that "HBK has retained 100% of the equity from CDO transactions resulting in strong alignment of interests between HBK and investors."¹³⁶²¹³⁶² Id. According to Kevin Jenks, HBK's collateral manager, HBK had a "buy and hold" approach to all of its Gemstone CDOs.¹³⁶³¹³⁶³ Subcommittee interview of Kevin Jenks (10/13/2010). Also see 1/2007 Gemstone 7 Debt Investor Presentation, DBSI_PSI_EMAIL01980000-60 at 25. HBK also told the Subcommittee that it participated in Gemstone 7 with "the objective of obtaining long exposure to the CDO's collateral, on a leveraged basis, through ownership of the Residual interest."¹³⁶⁴¹³⁶⁴ 8/20/2010 letter from HBK's counsel to the Subcommittee.

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¶HBK deals were known for containing above average concentrations of BB or lower rated assets, but HBK prided itself on its ability to run in-depth analysis and accurate stress tests on assets it selected for its CDOs.¹³⁶⁵¹³⁶⁵ Subcommittee interview of Abhayad Kamat (10/8/2010). Mr. Kamat was the individual at Deutsche Bank who was primarily responsible for structuring Gemstone 7. HBK expected to receive a 15% return on its investment in the equity tranche.¹³⁶⁶¹³⁶⁶ Subcommittee interview of Jamiel Akhtar (9/15/2010). In its investor presentation, HBK stated: "The firm strives to provide superior risk-adjusted rates of return with relatively low volatility and relatively low correlation to most major market indices."¹³⁶⁷¹³⁶⁷ 1/2007 Gemstone 7 Debt Investor Presentation, DBSI_PSI_EMAIL01980000-60 at 17. HBK's presentation also claimed that, as of January 2007, it had only three downgrades in its asset backed security portfolio, and that its upgrade to downgrade ratio was 23 to 3.¹³⁶⁸¹³⁶⁸ Id. at 25. Investor M&T Bank, who later purchased Gemstone 7 securities, told the Subcommittee that it had relied on HBK's assertions when choosing what it thought was an investment with "minimal risk."¹³⁶⁹¹³⁶⁹ Subcommittee interview of M&T (9/20/2010).

¶HBK informed the Subcommittee that it had never shorted any of the assets in its seven Gemstone CDOs, that its CDO trade book was evenly matched with long and short CDO assets during the 2006-2007 period,¹³⁷⁰¹³⁷⁰ According to HBK, "HBK never had a short position in any securities issued by the Gemstone 7 CDO." HBK also told the Subcommittee staff that it had approximately $350 million of long exposure in Gemstone 7 and another $800 million of "additional long exposure to the same assets underlying collateral outside the CDO." 8/20/2010 letter from HBK's counsel to the Subcommittee. HBK told the Subcommittee that it did at times take short positions in certain mortgage backed securities unrelated to the Gemstone transactions.Show full note and that it lost over $700 million in its Structured Credit business unit during 2007.¹³⁷¹¹³⁷¹ 8/20/2010 letter from HBK's counsel to the Subcommittee, and exhibit to letter, HBK's exposure to Gemstone VII Notes, GEM7-00000001-10.

¶(b) Gemstone Asset Selection

¶As the collateral manager, HBK selected the assets for Gemstone 7, subject to approval by Deutsche Bank's structuring and trading groups before each asset could be placed in the Deutsche Bank warehouse account for the CDO.¹³⁷²¹³⁷² Subcommittee interview of Abhayad Kamat (10/8/2010). According to HBK and Deutsche Bank vigilant investor that maximizes value through intensive analysis and surveillance." 1/2007 Gemstone 7 Debt Investor Presentation, DBSI_PSI_EMAIL01980000-60 at 23.

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¶personnel, the approval process worked in the following manner. First, HBK identified the RMBS, CDO, and other securities it wanted to include or reference in the CDO. HBK then sent an email to Mr. Lippmann or his traders at Deutsche Bank requesting that the identified assets be placed in the warehouse account for Gemstone 7. Deutsche Bank traders, sometimes in consultation with Mr. Lamont's structuring group, would then either approve or voice concerns regarding the proposed assets. If they had concerns, the traders would work with HBK personnel to resolve them. For example, on January 9, 2007, HBK's Jason Lowry sent an email to Mr. Lippmann and his trader, Jordan Milman, with a list of RMBS securities proposed for inclusion in Gemstone 7, and asked: "This is the last BB list for approval. Could you take a look?" On the same day, Mr. Milman wrote back: "approved contingent upon first pay defaults getting bought back on the 2 heat bonds."¹³⁷³¹³⁷³ See, e.g., 1/9/2007 email from Jason Lowry to Greg Lippmann, GEM7-00002154; and 12/11/2006 email from Greg Lippmann to Kevin Jenks, GEM7-00002805. The term "heat" refers to an RMBS security issued by Home Equity Asset Trust.

¶Although the Gemstone 7 offering circular did not describe Deutsche Bank's role in the asset selection process, the private engagement agreement between HBK and Deutsche Bank did.¹³⁷⁴¹³⁷⁴ The Gemstone 7 offering circular states that with regard to the purchase of underlying assets: "The Issuer [Gemstone 7] will acquire Underlying Assets from a warehouse facility (the 'Warehouse Facility') provided by an affiliate of DBSI [Deutsche Bank Securities, Inc.], which provides for the purchase of Asset-Backed Securities at the direction of the Collateral Manager [HBK] on behalf of the Issuer prior to the Closing Date." Gemstone 7 Offering Circular, GEM7-00000427-816 at 494.Show full note According to the terms of the engagement agreement, Deutsche Bank agreed to provide, among other items, the following service: "advising the Issuer [Gemstone 7] and the Company [HBK] on the selection and acquisition of the Underlying Assets" and "the scope of due diligence for the Underlying Assets."¹³⁷⁵¹³⁷⁵ 10/25/2006 signed letter agreement between HBK and Deutsche Bank, GEM7-00000071-89 at 72. Under both the engagement agreement and a separate risk sharing agreement, Deutsche Bank also had the right to reject assets selected by HBK for the Gemstone warehouse account.¹³⁷⁶¹³⁷⁶ Id.; 10/24/2006 Risk Sharing Agreement, GEM7-00000090-99 at 91. When asked about Deutsche Bank's obligations under these agreements, Mr. Lippmann told the Subcommittee that he viewed Deutsche Bank as having an obligation to the entity, Gemstone 7, to price the assets accurately as they were purchased, which included comparing the price of each security or CDS contract on the date it went into the warehouse account to its market price and ensuring that the CDO did not overpay for the assets it purchased.¹³⁷⁷¹³⁷⁷ Subcommittee interview of Greg Lippmann (10/18/2010). Mr. Lippmann's trader, Mr. Milman, and Mr. Kamat, of Mr. Lamont's CDO Group, agreed with that assessment.¹³⁷⁸¹³⁷⁸ Subcommittee interview of Jordan Milman (10/22/2010) and Abhayad Kamat (10/8/2010). All three also stated that the engagement agreement did not require Deutsche Bank to analyze the quality of the assets being purchased or how those assets were expected to perform.

¶On the other hand, documents reviewed by the Subcommittee indicate, in at least a few instances, that Deutsche Bank personnel voiced concerns about an RMBS security being placed in the deal due to performance concerns in addition to price. For example, Mr. Kamat, who also assisted Mr. Lippmann's trading desks, wrote to Mr. Jenks about the quality of an asset being considered for Gemstone 7. Mr. Kamat wrote: "MLMI 2005-HE1 B3 [is] on credit watch – do you want to move this out of the portfolio – investors might question/resist[.]" Mr. Jenks responded: "[N]o let's leave it in[.]"1379

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¶On another occasion, Mr. Jenks from HBK exchanged several emails with Mr. Lippmann about several RMBS securities that Mr. Jenks wanted to include in the Gemstone 7 warehouse account. Mr. Jenks sent the list to Mr. Lippmann and wrote: "please approve." Mr. Lippmann responded: "ok approved but would like to lower these 2 pts each given recent press on fhlt and significant widening in the baa3 cds. Is that cool?" The term "fhlt" referred to RMBS securities issued by Fremont; by saying he wanted to "lower these 2 pts," Mr. Lippman indicated he wanted to assign them a lower value for warehouse purposes. Mr. Jenks replied: "Greg, Fremont overall is really not trading badly just the ones on downgrade watch," to which Mr. Lippmann responded: "we have seen the fhlt 05-d bbb-trade wide …. please work with me on this. … I am trying to work with you." Mr. Jenks replied:

"Greg, I have been trying to work with you. Doing trades just with you and not on bid lists. But we play in the higher quality part of the market, I really expected you to approve the list as is. We still have several hundred million of bonds to do in cds form to do [sic]."1380

¶This exchange shows that Mr. Lippmann was cognizant of the quality of the assets being included in the CDO, and pushed for lower prices when he thought the assets were of poor quality.

¶HBK told the Subcommittee that it selected good quality bonds using a very complex model to analyze them.¹³⁸¹¹³⁸¹ See 1/2007 Gemstone 7 Debt Investor Presentation, DBSI_PSI_EMAIL01980000-60 ("HBK's investment model utilizes proprietary default, prepay and severity loan level models to make investments in the residential market. ... Transaction performance is tracked monthly via trustee surveillance reports and ongoing loan level information to monitor and analyze parameters such as collateral yields, delinquency and default trends, recoveries, prepayments, and available credit enhancement.").Show full note It told investors that it "analyze[d] every bond in the market, providing for a vast range of data …. [F]rom this data, trends can be observed early regarding the bonds themselves as well as the general economy and the implications on future issuance."¹³⁸²¹³⁸² Id. at 42. HBK provided this description for the Subcommittee regarding the tools it used in the asset selection process:

"HBK used a statistically driven mortgage behavior model to help make trading decisions and select assets for inclusion in the Gemstone VII CDO. Three separate database tools were utilized in this process. First, HBK licensed a commercial database called LP Database, which contained detailed information and performance history for millions of non-agency mortgages. The LP Database was a robust dataset comprising close to 80% of the market, back to the 1996 vintage. Utilizing the data acquired from the LP

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Database, HBK then developed a proprietary system called the Loss Model that forecasted the likelihood of default, prepayment, delinquency, or timely payment for an individual mortgage monthly over a ten-year time horizon. The Loss Model made these forecasts based on a series of 50 loan characteristics, including whether the mortgage was a first or second lien mortgage, the type of mortgage (e.g., fixed or ARM), its geographic location, FICO score, loan-to-value ratio, and level of documentation, and projections of home price appreciation and unemployment rates.

Finally, HBK merged the information from the Loss Model into a Bond Evaluation Engine, which was based on software licensed from Intex Solutions. The Bond Evaluation Engine provided information that assisted HBK traders in pricing mortgage bonds and evaluating how the bonds might perform under certain stresses. … This portion of the analysis focused on the structure and enhancements of the RMBS and how those structures would contribute to bond performance."¹³⁸³¹³⁸³ 10/12/2010 letter from HBK's counsel to the Subcommittee.

¶Mr. Jenks of HBK told the Subcommittee that HBK "never had a bond that we thought was bad that was put in a CDO."¹³⁸⁴¹³⁸⁴ Subcommittee interview of Kevin Jenks (10/13/2010). Mr. Jenks also told the Subcommittee that he had frequent conversations with Mr. Lippmann, was aware of his "negative housing view," but disagreed with the magnitude of Mr. Lippmann's negative views.¹³⁸⁵¹³⁸⁵ Id. Mr. Lippmann told the Subcommittee that although he occasionally suggested bonds to Mr. Jenks for Gemstone 7, and Mr. Jenks at times purchased them, Mr. Jenks had strong views on the assets that should be included in the CDO and was not required to listen to him. HBK and Deutsche Bank emails confirm that Mr. Lippmann or his traders offered at times to sell certain bonds to HBK, which occasionally purchased them.¹³⁸⁶¹³⁸⁶ See, e.g., 12/8/2006 email from Greg Lippmann to Kevin Jenks, DBSI_PSI_EMAIL01883072 (discussing trade they agreed to). See also 2/23/2007 email from Jordan Milman to Greg Lippmann, DBSI_PSI_EMAIL02022054 ("I'd rather just have Ilinca show hbk, he loves bonds like this."). Deutsche Bank sold five bonds from its inventory, with a value of more than $27 million, to HBK for inclusion in Gemstone 7.¹³⁸⁷¹³⁸⁷ Assets Purchased by Gemstone VII CDO during Warehouse Period, GEM7-00001831-33. According to Mr. Lamont, his CDO Group was "agnostic" towards the quality of the assets that HBK purchased for Gemstone 7, and told the Subcommittee that investors had relied on HBK, the collateral manager, to analyze their quality.¹³⁸⁸¹³⁸⁸ Subcommittee interview of Michael Lamont (9/29/2010). Mr. Kamat also agreed that Deutsche Bank was agnostic with regard to the quality of the assets. Subcommittee interview of Abhayad Kamat (10/8/2010). Mr. Lamont said that the role of the CDO Group was, not to select the CDO's assets, but to structure the deal and then use models to conduct stress tests on it.¹³⁸⁹¹³⁸⁹ Subcommittee interview of Michael Lamont (9/29/2010).

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¶(c) Gemstone Risks and Poor Quality Assets

¶Gemstone 7's assets were assembled in late 2006 and early 2007, when the mortgage market was deteriorating and subprime mortgages were experiencing record delinquency rates. The CDO posed a host of risks due to both the state of the market and the poor quality of many of its underlying assets.

¶Credit Report. In December 2006, Mr. Lamont's CDO Group prepared a Credit Report for Deutsche Bank's credit risk management group to obtain internal approval for the securitization of Gemstone 7.¹³⁹⁰¹³⁹⁰ Id. See undated Gemstone 7 Securitization Credit Report, MTSS000011-13 and 12/20/2006 Gemstone 7 Securitization Credit Report, DB_PSI_00237655-71. The 12/20/2006 Credit Report appears to be an earlier version of the document. The Credit Report noted the following business risks for Deutsche Bank regarding Gemstone 7, including the possibility that the bank would be unable to sell $400 million of the Gemstone securities, which carried "significant" risk:

"The portfolio is concentrated on RMBS obligations, with 67.6%, 20.2% and 1.9% of the RMBS exposure represented by 2005, 2006, and 2007 vintages, respectively, which results in significant vintage risk."

"RMBS accounts for ~90.0% of the initial collateral portfolio."

"All unsold tranches have been taken back by HBK except for the Class A-1B ($400mm). Currently, we are working with [redacted] to see if they will be interested in taking the tranche. The plan for distribution if [redacted] decides not to take the tranche, will be a senior sequential repack. The Class A-1B will be broken into two tranches. DB will take the senior part (Class A-1B(i) $200mm) and HBK will take the bottom part (Class A-1B(i) $200mm). Once the repack is setup, then DB will try to syndicate the Class A-1B(i)."¹³⁹¹¹³⁹¹ Gemstone 7 Securitization Credit Report, MTSS000011-13.

¶The business risks described in the internal Deutsche Bank credit report relating to "significant vintage risk" for the 2005, 2006, and 2007 vintage RMBS securities 1392were not disclosed in the Gemstone 7 offering materials given to investors. Although the March 15,²⁰⁰⁷²⁰⁰⁷ "Home Loans Product Strategy," WaMu presentation at JPM_WM03097203, Hearing Exhibit 4/13-60a (only Countrywide ranked higher). WaMu Home Loans Product Strategy, "Strategy and Business Initiatives Update," JPM_WM03097217, Hearing Exhibit 4/13-60a [emphasis in original]. Performance Evaluation for Peter D'Erchia, S&P SEN-PSI 0007442; See also April 23, 2010 Subcommittee Hearing at 74-75. annual report filed with the SEC, in particular the Executive Summary of Deutsche Bank's Annual Report and the letter from the Chairman of the Board. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0252, at 0262.Show full note Offering Circular contained a "Risk Factor" section describing multiple risks associated with an investment in Gemstone 7, including those associated with residential asset backed securities, the Offering Circular was silent with respect to the above risks identified in the Credit Report, which were highlighted for Deutsche Bank management.

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¶The Offering Circular did, however, describe in detail a number of significant risks associated with RMBS securities. For example, it stated:

"The risk of losses on residential mortgage loans is particularly relevant now. While there is always a risk of defaults or delinquencies in payment, recently losses on residential mortgage loans have been increasing and may continue to increase in the future. The losses have been most significant in respect of subprime mortgage loans but all are affected.

A number of factors are contributing to the increase in losses. Residential property values that increased for many years are now declining. … Declining property values also exacerbate the losses due to a failure to apply adequate standards to potential borrowers. Failures to properly screen borrowers may include failures to do adequate due diligence on a borrower (including employment and income history) or the relevant property (including valuation) or failures to follow predatory lending and the other borrower-protection statutes. Increases in interest rates may also contribute to higher rates of loss. ...

The increase in delinquencies and defaults has contributed to a declining market for mortgage loans. The declining market has, in turn, seriously impacted mortgage originators and servicers. … The financial difficulties of servicers in particular are likely to result in losses in respect of securities backed by residential mortgage loans. … At any one time, the portfolio of Residential ABS Securities may be backed by residential loans with disproportionately large aggregate principal amounts secured by properties in only a few states or regions."¹³⁹³¹³⁹³ 3/15/2007 Offering Circular for Gemstone CDO VII, Ltd., GEM7-00000427-816 at 483-84. While an earlier offering circular for Gemstone 7, dated February 14, 2007, identifies some risks associated with the CDO, the March offering circular contains additional language, quoted above, on the risks associated with the deteriorating mortgage market. 2/14/2007 Offering Circular for Gemstone CDO VII, Ltd., PSI-M&T_Bank-02-0001-370.Show full note

¶These disclosures demonstrate that both HBK and Deutsche Bank were well aware of the deteriorating mortgage market and increased risks associated with RMBS and CDO securities, even as they were marketing the Gemstone 7 securities and claiming HBK had applied careful analysis in the asset selection process to ensure good quality CDO securities.

¶Long Beach-Fremont-New Century Bonds. A substantial portion of the cash and synthetic assets included in Gemstone 7, 30% in all, involved subprime residential mortgages issued by three subprime lenders, Long Beach, Fremont, and New Century, all known for issuing poor quality loans and securities.¹³⁹⁴¹³⁹⁴ For more information on these three lenders, see sections D(3)(d) and E(2)(c)-(d) of Chapter IV. Mr. Jenks of HBK told the Subcommittee that he saw data showing that Long Beach and Fremont were poor performers, but he thought the performance varied depending upon the tranche, and he believed he could pick the better tranches. He thought he could buy low, structure the deal well, and make money. Subcommittee interview of Kevin Jenks (10/13/2010).Show full note Loans by these lenders were among the first to collapse. According to Moody's, these three originators, plus WMC Corporation, accounted for 31% of the subprime RMBS securities issued in 2006, but 63% of the rating downgrades issued in the second week of July 2007, when the mass rating downgrades began.¹³⁹⁵¹³⁹⁵ 7/12/2007 Moody's Structured Finance Teleconference and Web Cast: RMBS and CDO Rating Actions, at Moody's SI 2010-0046902, Hearing Exhibit 4/23-106.

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¶During the period when securities were being assembled for the Gemstone 7 warehouse in late 2006 and early 2007, Mr. Lippmann frequently disparaged many of the same assets he and his traders allowed to be included in Gemstone 7. About $27 million of these assets came from Deutsche Bank's own inventory. In emails to colleagues and his clients, Mr. Lippmann used words like "crap" and "pig" to describe the assets. Mr. Lippmann brought some of the assets of Gemstone 7 to the attention of some of his clients that shorted these assets.¹³⁹⁶¹³⁹⁶ Subcommittee interview of counsel for Deutsche Bank (2/1/2011).

¶On October 20, 2006, for example, one of Mr. Lippmann's clients sent him an email seeking advice about certain subprime bonds issued by Long Beach Mortgage Loan and Trust (LBMLT) and other originators. Mr. Lippmann responded:

"LBMLT-06-5 M9-375. Long Beach is one of the weakest names in the market. We shorted this bond to a CDO in the mid-300s on October 13[.] Deal was done before S&P changed their criteria on July 1. Lots of 40 year mortgages …. Less than half the loans have full documentation and 10% are investor properties. This is a real pig.

LBMLT -06-2 M9 350. See above on Long Beach. This one is already performing poorly with substantial delinquencies .… Further the FICO is less than the 06-05 and there are fewer full doc loans. This seems a better short than the 06-5. Only reason I can think for my guys showing you a tighter level is that we are short this one and that the June 06 deals have a taint that earlier months don[']t due to the theory that late June deals were crammed with bad stuff in order to beat the S & P revisions."¹³⁹⁷¹³⁹⁷ 10/20/2006 email from Greg Lippmann to Craig Carlozzi at Mast Capital, DBSI_PSI_EMAIL01774820-21.

¶Despite these negative views of Long Beach, Mr. Lippmann's group raised no concerns when $25 million in LBMLT 2006-5 M9 securities was purchased by HBK for Gemstone 7's warehouse account, $20 million of which was purchased on October 24, 2006, four days after Mr. Lippmann's email. Altogether, a total of $79.5 million in Long Beach bonds went into Gemstone 7.¹³⁹⁸¹³⁹⁸ 9/14/2010 Gemstone 7 Asset Chart, PSI-DeutscheBank-17-Gemstone7-0001-03.

¶Mr. Lippmann had similar negative views of RMBS securities containing subprime loans originated by Fremont, yet his group did not object to including Fremont securities in Gemstone 7. For instance, on December 6, 2006, Mr. Lippmann's traders did not object to including $20 million of an RMBS known as SABR 2005-FR4 B3, which contained Fremont loans, in Gemstone 7.¹³⁹⁹¹³⁹⁹ Id. One week earlier, on November 29, 2006, when asked by a bank colleague about the same RMBS security, Mr. Lippmann labeled it a "pig."¹⁴⁰⁰¹⁴⁰⁰ With regard to the asset, Mr. Lippmann wrote: "pig probably a 400-525 market." 11/29/2006 email from Greg Lippmann to Francis Blair at Deutsche Bank, DBSI_PSI_EMAIL01853153. Two days later, on December 1, 2006, Mr. Lippmann declared in an email to a client that the security was "blowing up."¹⁴⁰¹¹⁴⁰¹ See 12/1/2006 email from Greg Lippmann to Tyler Duncan at Wayzata Investment Partners, DBSI_PSI_EMAIL01864446 (Mr. Lippmann wrote: "sabr 05-fr4 b3 another Fremont blowing up we traded in august at 260"). Later in January 2007, Greg Lippmann wrote: "SABR Fr [Fremont] blows." 1/25/2007 email from Greg Lippmann to Mark Lee at Contrarian Capital, DBSI_PSI_EMAIL01961580.

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¶In addition, on November 29, 2006, Mr. Lippmann called still another RMBS security with Fremont loans, FHLT 2005-A M9, a "pig."¹⁴⁰²¹⁴⁰² 11/29/2006 email from Greg Lippmann to Jashin Patel at Deutsche Bank, "Where is this pig marked?," DBSI_PSI_EMAIL01854608. Yet a month earlier, on October 30, 2006, approximately $1 million of FHLT 2005-A M9 had been purchased for Gemstone 7, with no objection from Mr. Lippmann's trading desk.¹⁴⁰³¹⁴⁰³ See 9/14/2010 Gemstone 7 Asset Chart, PSI-DeutscheBank-17-Gemstone7-0001-03.

¶Mr. Lippmann made similar negative remarks about RMBS securities containing subprime loans originated by New Century. On November 28, 2006, Mr. Lippmann wrote: "MABS 2005-NC2 M9 … huge payment shock coming."¹⁴⁰⁴¹⁴⁰⁴ 11/28/2006 email from Greg Lippmann to Rocky Kurita, DBSI_PSI_EMAIL01846000. Yet six weeks later, on January 17, 2007, $10 million of this exact asset, MABS 2005-NC2 M9, was purchased by Gemstone 7, without objection from Mr. Lippmann's traders.¹⁴⁰⁵¹⁴⁰⁵ See 9/14/2010 Gemstone 7 Asset Chart, PSI-DeutscheBank-17-Gemstone7-0001-03. On December 8, 2006, Mr. Lippmann wrote about another New Century security underwritten by Goldman Sachs: "GSAMP 06-nc2 m8 this is an absolute pig."¹⁴⁰⁶¹⁴⁰⁶ 12/8/2006 email from Greg Lippmann to Peter Faulkner at PSAM, LLC, DBSI_PSI_EMAIL01882188. Although Gemstone 7 did not purchase the M8 securities, it did purchase a total of $30 million in GSAMP 2006-NC2 M9 securities – from a lower tranche in the same securitization with less subordination. It purchased those securities over a month-long period, with $10 million of the securities on November 13, 2006; another $10 million on December 8, 2006; and still another $10 million on December 21, 2006.¹⁴⁰⁷¹⁴⁰⁷ See 9/14/2010 Gemstone 7 Asset Chart, PSI-DeutscheBank-17-Gemstone7-0001-03. In addition, on December 18, 2006, Gemstone 7 purchased $8.8 million worth of a similar security, GSAMP 2006-NC2 B2.¹⁴⁰⁸¹⁴⁰⁸ Id.

¶Mr. Lippmann was equally critical of New Century loans securitized by ACE, an entity created by and associated with Deutsche Bank. On September 21, 2006, for example, when asked by a Deutsche Bank salesperson for his opinion of ACE 2006-NC1 M9, an RMBS issued by ACE with New Century subprime loans, Mr. Lippmann responded that ACE was "generally horrible."¹⁴⁰⁹¹⁴⁰⁹ 9/21/2006 email from Greg Lippmann to Melissa Goldsmith at Deutsche Bank, DBSI_PSI_EMAIL01689001- 02. Mr. Lippmann confirmed to the Subcommittee that he believed ACE was "horrible." Subcommittee interview of Greg Lippmann (10/18/2010). On May 19, 2006, Mr. Lippmann wrote to a Deutsche Bank colleague, "We traded that ACE piece of crap with Ike at 380." 5/19/2006 email from Greg Lippmann to Rocky Kurita at Deutsche Bank, DBSI_PSI_EMAIL0120552. On May 29, 2007, Mr. Lippmann wrote with regard to ACE 2006-ASP3 M7,Show full note On March 2, 2007, a client sent an email to Mr. Lippmann stating: "[T]hey are claiming that DB [Deutsche Bank] was one of the last ones to tighten standards on buying loans to securitize. [Y]ou were right - ACE is crap." Mr. Lippmann responded: "INDEED … IT IS."¹⁴¹⁰¹⁴¹⁰ 3/2/2007 email from Greg Lippmann to Clark Baker at Harbinger Capital, DBSI_PSI_EMAIL02038599. Yet on December 19, 2006, Mr. Lippmann's traders did not object to the purchase of $10 million of ACE 2006-NC1 M9 for Gemstone 7.¹⁴¹¹¹⁴¹¹ 9/14/2010 Gemstone 7 Asset Chart, PSI-DeutscheBank-17-Gemstone7-0001-03.

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¶Mr. Lippmann also had negative opinions about other securities purchased for Gemstone 7. On March 1, 2007, for example, Mr. Lippmann wrote that ABSHE 2006-HE1 M7 was "crap."¹⁴¹²¹⁴¹² 3/1/2007 email from Greg Lippmann to Joris Hoedemaekers at Oasis Capital, DBSI_PSI_EMAIL02033845. But $5 million of this same security had been purchased three months earlier by Gemstone 7, on November 16, 2006, without objection from Mr. Lippmann's trading desk.¹⁴¹³¹⁴¹³ 9/14/2010 Gemstone 7 Asset Chart, PSI-DeutscheBank-17-Gemstone7-0001-03. In still another instance, on March 19, 2007, Mr. Milman described FFML 2006-FF13 as "a piece of crap."¹⁴¹⁴¹⁴¹⁴ 3/19/2007 email from Jordan Milman to Greg Lippmann, DBSI_PSI_EMAIL02412084. Yet over the prior five months, the Lippmann trading desk had approved the purchase of a total of $38.5 million of this exact bond, FFML 2006-FF13, for inclusion in Gemstone 7: $11.7 million of the class B1 securities on October 30, 2006; $16.2 million of the class B2 securities on November 17,²⁰⁰⁶²⁰⁰⁶ and 2007, but has not issued any new indices since then. Fremont 10-K Statement with the SEC. and January 9, 2007; and $10.6 million of the class M9 securities on March 15, 2007.¹⁴¹⁵¹⁴¹⁵ 9/14/2010 Gemstone 7 Asset Chart, PSI-Deutsche Bank-17-Gemstone7-0001-03.

¶Securities from Deutsche Bank's Inventory. Gemstone 7 purchased five securities totaling $27 million directly from Deutsche Bank's inventory.¹⁴¹⁶¹⁴¹⁶ These five securities were: (1) ACE 2006-HE1 M10, (2) Securitized Asset Backed Receivables (SABR) 2005- OP1 B4, (3) Ameriquest Mortgage Securities Inc. (AMSI) 2005-R11 M10, (4) Deutsche Bank Alt-A Securities, Inc. (DBALT) 2006-AR6 M10, and (5) First Franklin Mtg Loan Asset Backed Certificate (FFML) 2005-1 B4. See Assets Purchased by Gemstone VII CDO during Warehouse Period, GEM7-00001831-33. See also 9/14/2010 Gemstone 7 Asset Chart, PSI-Deutsche Bank-17-Gemstone7-0001-03.Show full note Mr. Lippmann, and his trader Jordan Milman, shared negative views of one of the bonds, ACE 2006-HE1 M10, a security in which over 75% of the loans had been originated by Fremont.¹⁴¹⁷¹⁴¹⁷ 9/14/2010 Gemstone 7 Asset Chart, PSI-Deutsche Bank-17-Gemstone7-0001-03. In an instant message conversation in December 2006, Mr. Lippmann asked Mr. Milman his thoughts on ACE 2006- HE1 M10. Mr. Lippmann asked: "DOESNT THIS DEAL BLOW," to which Mr. Milman replied: "yes it blows I am seeing 20-40% writedowns."¹⁴¹⁸¹⁴¹⁸ 12/1/2006 instant message conversation between Greg Lippmann and Jordan Milman, DBSI_PSI_EMAIL01863636. Not only did HBK include $10 million of this asset in the Gemstone 7 warehouse account, HBK purchased it from Deutsche Bank that same month through one of Mr. Lippmann's traders.¹⁴¹⁹¹⁴¹⁹ 12/19/2006 email from Jason Lowry at HBK to Greg Lippmann and others at Deutsche Bank, DBSI_PSI_EMAIL01910568; 12/19/2006 email from Greg Lippmann to Jordan Milman and others at Deutsche Bank, DBSI_PSI_EMAIL01910580. Thus, Deutsche Bank allowed Gemstone 7 to acquire a $10 million asset that its traders believed would perform poorly, and effectively removed the financial risk of this asset from its own inventory, shifting it to its customers.

¶"this stinks though I didn't mention it." 5/29/2007 email from Greg Lippmann to Danielle Pluthero at Deutsche Bank, DBSI_PSI_EMAIL02532365.

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¶Mr. Lippmann expressed a negative outlook for other assets as well, including SABR 2005-OP1, that was taken from Deutsche Bank's inventory and sold to Gemstone 7. On August 26, 2006, Mr. Lippmann wrote to a client about more securities "blowing up," including SABR 2005-OP1:

"I am encouraged that in spite of the virility of the cdo bid, there are numerous examples of bonds blowing up … the tripling of serious delinq [delinquencies] in sabr 05-opl to over 6.5% since feb even though the avg [average] mortgage age is now only 21 months i.e. hasn't reset yet .… What I'm saying is there is plenty of fundamental evidence that bonds are blowing up even as the new issue and index market are remaining buoyant."¹⁴²⁰¹⁴²⁰ 8/26/2006 email from Greg Lippmann to Richard Axilrod, DBSI_PSI_EMAIL01618236.

¶On December 12, 2006, with no objection from Mr. Lippmann's desk, Gemstone 7 purchased $5.5 million of SABR 2005-OP1 B4 from Deutsche Bank, the same asset that he had described months earlier as incurring "serious delinquencies."¹⁴²¹¹⁴²¹ Assets Purchased by Gemstone VII CDO during Warehouse Period, GEM7-00001831-33.

¶A third example involved securities issued by Ameriquest Mortgage Securities Inc. (AMSI), which Gemstone purchased from Deutsche Bank's inventory. On April 6, 2006, Mr. Lippmann called AMSI 2005-R7 M8 a "crap name."¹⁴²²¹⁴²² 4/6/2006 email from Greg Lippmann to himself, DBSI_PSI_EMAIL01075218. In a June 16,²⁰⁰⁶²⁰⁰⁶ and 2007, but has not issued any new indices since then. Fremont 10-K Statement with the SEC. email, Mr. Lippmann called AMSI generally a "weakish name."¹⁴²³¹⁴²³ 6/16/2006 email from Greg Lippmann to Rocky Kurita, DBSI_PSI_EMAIL01314036. On December 12, 2006, Gemstone 7 purchased $5 million of another RMBS, AMSI 2005-R11 M10, with no objection from the Lippmann trading desk.¹⁴²⁴¹⁴²⁴ Assets Purchased by Gemstone VII CDO during Warehouse Period. GEM7-00001831-33.

¶In still another instance, Deutsche Bank praised its sales force for placing a security it was having difficulty selling as the underwriter, Deutsche Alt-A Securities Inc. (DBALT) 2006- AR6, in Gemstone 7. On November 17, 2006, the Deutsche Bank Option Arms Desk sent the following email, "The Arms Desk would like to express its sincere appreciation to the sales force for an outstanding job in helping us place the bonds off DBALT 06-AR6. Thanks a lot!!"¹⁴²⁵¹⁴²⁵ 11/17/2006 email from Deutsche Arms to Deutsche Bank employees, DBSI_PSI_EMAIL01831021; 11/14/2006 email from Deutsche Arms to Deutsche Bank employees, DBSI_PSI_EMAIL01822045. DBALT was "one of Deutsche Bank's own shelf offerings." 3/21/2011 letter from Deutsche Bank's counsel to the Subcommittee, PSI- Deutsche_Bank-32-0001-04. Less than two weeks later, on November 29, 2006, a member of the Deutsche Bank sales force wrote: "Some success in CMO [collateralized mortgage obligation] land today: Sold 9 mm [million] DBALT 06-AR6 M10 (Ba2/BBB-) to HBK. This class was never sold in the new issue marketing."¹⁴²⁶¹⁴²⁶ 11/29/2006 email from Larry Pike to Eleanny Pichardo and others, DB_PSI_01731794. HBK records indicate that, the next day, it agreed to purchase $8.8 million of DBALT 2006-AR6 M10.¹⁴²⁷¹⁴²⁷ 11/30/2006 email from Jason Lowry at HBK to Abhayad Kamat and others, GEM7-00005480. See also Assets Purchased by Gemstone VII CDO during Warehouse Period, GEM7-00001831-33.

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¶Many investors would likely have found the negative views of Mr. Lippmann, Deutsche Bank's top CDO trader, important to their decision as to whether or not to buy Gemstone 7, but his views, as described above, were not disclosed to them. At the time, the traders on his desk as well as other Deutsche Bank CDO personnel knew that many clients valued and relied on Mr. Lippmann's opinion when making investment decisions, yet did not disclose his views of the specific assets included in Gemstone 7.¹⁴²⁸¹⁴²⁸ See 7/6/2006 email from Axel Kunde to Greg Lippmann, DBSI_PSI_EMAIL01374694 ("If you tell the sales guy the bond is really bad his investor will use that as an argument against us and demand we buy back his note, because he trusted DB [Deutsche Bank] to pick a good portfolio etc, etc."). M&T Bank told the Subcommittee that had it known about Mr. Lippmann's views, it might have "thought twice" before purchasing Gemstone 7 securities.¹⁴²⁹¹⁴²⁹ Subcommittee Interview of M&T (9/20/2010).

¶(d) Gemstone Sales Effort

¶Deutsche Bank began aggressively marketing Gemstone 7 to investors beginning in January 2007.¹⁴³⁰¹⁴³⁰ See, e.g., 1/25/2007 Deutsche Bank internal email chain, DB_PSI_00346491-99, at 99. The bank communicated with potential investors about Gemstone 7 in a variety of ways, including through emails, telephone calls, face to face meetings, and at conferences. Deutsche Bank personnel also went on what they called "road shows" to cities around the world, to meet investors and pitch the CDO to them.¹⁴³¹¹⁴³¹ Subcommittee interview of Sean Whelan (9/22/2010). Sean Whelan, co-head of the Deutsche Bank CDO sales force, and Ilinca Bogza, a vice president in the Deutsche Bank syndicate group, worked to market Gemstone 7 to investors, including by scheduling road shows and personal meetings with potential investors.

¶Investors were typically shown a "Debt Investor Presentation" that had been prepared by HBK and Deutsche Bank.¹⁴³²¹⁴³² See, e.g., 1/2007 Gemstone 7 Debt Investor Presentation, DBSI_PSI_EMAIL01980000-60 and 2/8/2007 Gemstone 7 Debt Investor Presentation, GEM7-00001687-1747. That presentation provided an overview of the transaction, a description of HBK's organization, and its investment strategy. The presentation highlighted investment considerations, including HBK's expertise in the capital markets, how its structured products exhibit relatively stable performance, and their low default history. The presentation also contained a description of HBK's analytical systems and surveillance capabilities, and included an appendix describing the risk factors for the deal. HBK told the Subcommittee that its employees attended investor meetings, and were at times called upon to answer questions, but did not always participate in the Gemstone 7 sales efforts which were led by Deutsche Bank.¹⁴³³¹⁴³³ Subcommittee interview of Kevin Jenks (10/13/2010).

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¶One Gemstone investor, M&T Bank, told the Subcommittee that, after observing a presentation made by Mr. Jenks and receiving Deutsche Bank's assurances in connection with its solicitation efforts, it believed that Gemstone 7 securities posed minimal investment risk.¹⁴³⁴¹⁴³⁴ Subcommittee interview of M&T (9/20/2010). According to the transcript of a telephone call on February 5, 2007, Sean Whelan of Deutsche Bank's sales force pitched the Gemstone 7 deal to M&T Bank and stated in part: "If you indicate early, like Gemstone deals go very well, and this deal will all go very well and it will get oversubscribed."¹⁴³⁵¹⁴³⁵ 2/5/2007 telephone transcript between Sean Whelan and Alex Craig of M&T, MTSS000920-25, at 22. The following day, February 6, 2007, Mr. Whelan again pitched the deal to M&T and stated that Gemstone 7 "was like a lay up."¹⁴³⁶¹⁴³⁶ 2/6/2007 telephone transcript between Sean Whelan, Alex Craig, and David Borchard of M&T, MTSS000929- 31, at 31. When asked about these comments, Mr. Whelan told the Subcommittee that what he meant was that working with a quality hedge fund like HBK was a "lay up," not that the Gemstone 7 deal itself was a "lay up."¹⁴³⁷¹⁴³⁷ Subcommittee interview of Sean Whelan (9/22/2010). With regards to his comment about oversubscription, he said he was referring to the tranches that M&T Bank was considering purchasing, which ultimately were fully subscribed.¹⁴³⁸¹⁴³⁸ Id.

¶In early 2007, as the closing date for Gemstone 7 neared, the Deutsche Bank sales force was having difficulty getting commitments from investors to buy Gemstone securities. Many investors who were solicited declined to invest because of concerns about the high concentration in subprime RMBS with BBB or BB ratings.¹⁴³⁹¹⁴³⁹ See spreadsheet containing potential investor feedback regarding Gemstone 7, DBSI_PSI00117568. In the beginning of 2007, there was a general lack of buyer interest in mortgage related securities in the United States, other than from new CDOs purchasing CDO securities from prior deals. It was not the first time, however, that a Gemstone deal involving Deutsche Bank and HBK could not be fully sold. HBK had conditioned Deutsche Bank's participation in Gemstone 7 on its purchasing unsold securities from Gemstone 4 and 5, BB rated securities that HBK still had on its books for $13.1 million. In an email sent to a colleague, an HBK Managing Director Jamiel Akhtar wrote:

"As a condition for receiving the underwriting mandate, Kevin [Jenks] and I insisted that DB [Deutsche Bank] buy from us the $13.1mm of BB rated CDO liabilities HBK retained on its own books from Gemstone IV and V. This was a fairly sharp-elbowed tactic on our part, as the BB bonds are the worst part of the capital structure, but I felt like we should be sharp-elbowed with DB right now."¹⁴⁴⁰¹⁴⁴⁰ 10/5/2006 email from Jamiel Akhtar at HBK to Jon Mosle at HBK, GEM7-00006353.

¶The head of Deutsche Bank's CDO Group, Michael Lamont, sent an email to the CDO Group banker assigned lead responsibility for structuring Gemstone 7, acknowledging the risk the bank took on by purchasing the earlier unsold securities, but also noting the "nice" fee being paid to the bank: "[T]hat is part of the risk we took when we were awarded the mandate and we are still making a nice all in fee."¹⁴⁴¹¹⁴⁴¹ 2/8/2007 email from Michael Lamont to Abhayad Kamat, DBSI_PSI_EMAIL04045219-24. When Deutsche Bank told HBK that it intended to resell the Gemstone 4 and 5 securities, the HBK official indicated it was "ok with that as long as it is not blasted out to everyone so as not to affect his current deal [Gemstone 7] in the market."¹⁴⁴²¹⁴⁴² Id. at 24. Deutsche Bank and HBK did not disclose in the Gemstone 7 offering materials both the bank's purchase of the Gemstone 4 and 5 securities as a precondition to the deal and the bank's plan to sell the Gemstone 4 and 5 securities contemporaneously with the Gemstone 7 securities.

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¶Struggle to Sell Gemstone. Evidence obtained by the Subcommittee shows that both HBK and Deutsche Bank were concerned about their exposure should Gemstone 7 not be fully subscribed and worked hard to sell the deal in the face of U.S. investor disinterest.¹⁴⁴³¹⁴⁴³ Subcommittee interview of Kevin Jenks (10/13/2010). Mr. Jenks recalled that there were more non U.S. investors in CDOs in 2007, but he believed that was because there was not much of a CDO market in Europe. Subcommittee interview of Kevin Jenks (10/13/2010). Mr. Whelan told the Subcommittee that in 2006 and 2007, CDO subscription was "spotty." Subcommittee interview of Sean Whelan (9/22/2010). According to the terms of the Gemstone deal, if the securities were not fully sold, the risk of the first $80 million in losses would fall on HBK, while all remaining losses would fall on Deutsche Bank.¹⁴⁴⁴¹⁴⁴⁴ 12/20/2006 Gemstone 7 Securitization Credit Report, DB_PSI_00237655-71. On February 27, 2007, Mr. Kamat of Deutsche Bank wrote to Mr. Jenks of HBK about selling the Gemstone 4 and 5 securities and brought up the CDO Group's need to reduce risk: "[W]e are trying to reduce our exposure right now given internal very senior mgmt review of our business." Mr. Jenks responded: "We are also trying to reduce exposure."¹⁴⁴⁵¹⁴⁴⁵ 2/27/2007 email between Abhayad Kamat and Kevin Jenks, DB_PSI_00421609 (discussing potential exposure due to purchase of earlier Gemstone 4 and 5 tranches in Gemstone 7).

¶In January 2007, Michael Lamont, head of Deutsche Bank's CDO Group, and Mr. Jenks, the HBK collateral manager, discussed the urgency of selling Gemstone 7 in the face of a deteriorating market. On January 9, 2007, Mr. Jenks wrote to Mr. Lamont: "[W]ith this market this way and probably going to get worse we would like to really move on the cdo. Please allocate the resources to expedite this." Four minutes later Mr. Lamont responded: "[W]e are focused on this as well. We don't have a deal in the market and you will be first."¹⁴⁴⁶¹⁴⁴⁶ 1/9/2007 email chain between Michael Lamont and Kevin Jenks, GEM7-00002156.

¶Several developments in early 2007 signaled problems in the mortgage industry. On January 29, 2007, subprime lender Fremont Investment & Loan announced that it had "severed ties" with 8,000 brokers whose loans had high delinquency rates.¹⁴⁴⁷¹⁴⁴⁷ 2/1/2007 S&P internal email, "Defaults cause Fremont to end ties to 8,000 brokers," Hearing Exhibit 4/23-93d. The following week on February 7, 2007, New Century, another major subprime lender, disclosed in a conference call with investors that "the level of early-payment defaults and loan repurchases [had] led to tighter underwriting guidelines," that its nonprime loan production would be declining, and that it would be restating its earnings.¹⁴⁴⁸¹⁴⁴⁸ "New Century plunges on loan production," MarketWatch (2/8/2007), http://www.marketwatch.com/story/new- centurys-shares-punished-over-loan-production-warning. On the day before the New Century conference call, Deutsche Bank received a request from HBK to approve a New Century asset purchase for the Gemstone 7 deal and approved this request on February 9. See 2/9/2007 email from Jordan Milman to Ashley Bonilla at HBK, DB_PSI_00845552.Show full note An additional warning to the market that occurred as Gemstone was being marketed to investors was the plunge in the ABX Index that tracked the value of subprime RMBS securities. In February 2007, the ABX Index fell from a high of $0.90 early in the month to $0.69 by the end of the month, indicating a drop of more than 23% in the value of subprime RMBS securities.¹⁴⁴⁹¹⁴⁴⁹ On Feb. 23, 2007, MarketWatch announced: "The ABX.HE index that tracks CDS on the riskiest subprime loans, rated BBB-, that were sold in the second half of 2006 fell to $0.69 on Friday, according to Markit.com, which administers the indexes. That's down from $0.72 on Thursday and $0.79 at the beginning of the week. In early February, this index was above 90." "Subprime mortgage derivatives index plunges; Bankruptcies, losses in subprime home loan industry spark drop," MarketWatch (2/23/2007), http://www.marketwatch.com/story/index-of- subprime-mortgage-derivatives-plunges-on-sector-woes.Show full note These and other events affected both the RMBS and CDO markets, since so many CDOs included or referenced subprime RMBS securities.

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¶Emails reviewed by the Subcommittee show that CDO personnel at Deutsche Bank were well aware of the worsening CDO market and were rushing to sell Gemstone 7 before the market collapsed. On February 7, 2007, Mr. Lippmann, reacting to the New Century developments, raised concerns with Mr. Lamont about the ability of Deutsche Bank to continue to sell CDO securities: "I was calling about warehouse marks and distribution risk b/c [because] hearing rumors about other dealers having big trouble placing this stuff."¹⁴⁵⁰¹⁴⁵⁰ 2/7/2007 email from Greg Lippmann to Michael Lamont, DBSI_PSI_EMAIL02366193-96, at 94. When Mr. Lamont heard about the New Century developments he wrote: "yikes. I think we will stay short a while." 2/7/2007 email from Michael Lamont to Greg Lippmann, DBSI_PSI_EMAIL02366194. The next day, February 8, 2007, Mr. Lamont told Abhayad Kamat, the CDO Group employee structuring Gemstone 7: "[R]egardless we need to sell it [Gemstone 7] now while we still can."¹⁴⁵¹¹⁴⁵¹ 2/8/2007 email from Michael Lamont to Abhayad Kamat, DBSI_PSI_EMAIL04045219-24. The same day, Mr. Lamont wrote to Mr. Jenks at HBK: "Keep your fingers crossed but I think we will price this just before the market falls off a cliff."¹⁴⁵²¹⁴⁵² 2/8/2007 email from Michael Lamont to Kevin Jenks, DBSI_PSI_EMAIL04045360. The next day, February 9, 2007, Ilinca Bogza, of the Deutsche Bank syndicate group, wrote to Mr. Lamont: "Jenks just called me. … He is frightened that accounts will pull their orders given the widening in abx today. … He mentioned he was going to give you a call. He is very nervous."¹⁴⁵³¹⁴⁵³ 2/9/2007 email from Ilinca Bogza to Michael Lamont, DBSI_PSI_EMAIL04047421-23.

¶On February 13, 2007, the head of Deutsche Bank's syndicate group, Anthony Pawlowski, wrote to Mr. Lamont: "I am not sure how to push guys upstairs without having them crack. Everyone wants to price this deal asap (Sean Whelan [co-head of Deutsche Bank's CDO sales force] is pushing for Friday to lock up his guys on the AAA and AA)[.] Let me know."¹⁴⁵⁴¹⁴⁵⁴ 2/13/2007 email from Anthony Pawlowski at Deutsche Bank to Michael Lamont, DBSI_PSI_EMAIL04049521. A week later, on February 20, 2007, Mr. Lamont wrote to Deutsche Bank syndicate to ask:

"[O]n our managed mezz[anine] abs [asset backed security] CDOs last year what was the split by risk tranche across deals between real money and cdo warehouses. The street may be pulling back so this would be good info to have as we think about how we are going to place risk."¹⁴⁵⁵¹⁴⁵⁵ 2/20/2007 email from Michael Lamont to Ilinca Bogza, DBSI_PSI_EMAIL04054492. On February 20, 2007, a client of Mr. Lippmann's who was looking to short more RMBS commented in an email to him about the negative news concerning Novastar Financial Inc., which announced losses that day. His client described the situation in the market "like the plague." 2/20/2007 email from Steven Eisman at Frontpoint Partners to Greg Lippmann, DBSI_PSI_EMAIL02008182.Show full note

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¶In one odd instance, Ms. Bogza, from the CDO syndicate, sent an email to the Deutsche Bank sales force suggesting that Gemstone 7 was experiencing greater investor interest than it really was. The February 20,²⁰⁰⁷²⁰⁰⁷ "Home Loans Product Strategy," WaMu presentation at JPM_WM03097203, Hearing Exhibit 4/13-60a (only Countrywide ranked higher). WaMu Home Loans Product Strategy, "Strategy and Business Initiatives Update," JPM_WM03097217, Hearing Exhibit 4/13-60a [emphasis in original]. Performance Evaluation for Peter D'Erchia, S&P SEN-PSI 0007442; See also April 23, 2010 Subcommittee Hearing at 74-75. annual report filed with the SEC, in particular the Executive Summary of Deutsche Bank's Annual Report and the letter from the Chairman of the Board. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0252, at 0262.Show full note email by Ms. Bogza stated that the bank had received an "indication of [investor] interest" in 75% of the BBB securities in Gemstone 7.¹⁴⁵⁶¹⁴⁵⁶ 2/20/2007 email from Ilinca Bogza to sales force, DBSI_PSI_EMAIL02007608. After receiving this email, Mr. Lippmann wrote to Ms. Bogza: "[W]ow that much interest in the bbb? Is that real?? We would take as much as you can oversell."¹⁴⁵⁷¹⁴⁵⁷ 2/20/2007 email from Greg Lippmann to Ilinca Bogza, DBSI_PSI_EMAIL02007608. Ms. Bogza responded: "no. that is def[initely] not real .. it is at 50%.; cant oversell any tranche to be honest," to which Mr. Lippmann responded: "very sneaky."¹⁴⁵⁸¹⁴⁵⁸ 2/20/2007 email between Greg Lippmann and Ilinca Bogza, DBSI_PSI_EMAIL02007794.

¶In late February, as the market continued to deteriorate, Deutsche Bank attempted to motivate its employees to sell Gemstone 7 by providing special incentives to its sales force for selling the deal. On February 21, 2007, Mr. Kamat wrote to Ms. Bogza: "[W]e need help on selling the As and BBBs in the Gemstone CDO 7 transaction – we have nearly 50% unsold on both tranches in the transaction."¹⁴⁵⁹¹⁴⁵⁹ 2/21/2007 email from Abhayad Kamat to Ilinca Bogza, DBSI_PSI_EMAIL04055827. In another email the same day, he wrote: "[S]hould we offer more PCs for Gemstone 7 CDO given the market?"¹⁴⁶⁰¹⁴⁶⁰ Id. "PCs" refers to Production Credits, which were used to boost a salesperson's compensation including through an end-of-year bonus. Later the same night, Mr. Kamat sent an email to the co-head of the CDO Group seeking to increase the Production Credits that could be awarded for selling Gemstone 7: "[D]ouble digit PCs? I guess my original offer of 300 on single-As and 600 on triple-Bs is too low … what can we offer?"¹⁴⁶¹¹⁴⁶¹ 2/21/2007 email from Abhayad Kamat at Deutsche Bank to Michael Lamont and others at Deutsche Bank, DBSI_PSI_EMAIL04056326-36.

¶Showing Investors Higher Marks. As the value of mortgage related assets grew more volatile, some potential investors in Gemstone 7 inquired about the mark to market (MTM) value of the CDO's underlying assets. MTM is a valuation method by which the current value of an asset is recorded on a firm's books at the price it would sell in the marketplace on the day it is marked. Investors at times inquire about MTM values to determine if the underlying assets of a CDO have dropped in value since their inclusion in the warehouse account. Traders who closely follow buy and sell activity for a particular class of assets are generally best able to provide the most accurate current valuation. At Deutsche Bank, the CDO Trading Desk marked the value of assets monthly as a service to its clients and at times provided this service to HBK for the assets underlying Gemstone 7.¹⁴⁶²¹⁴⁶² 3/27/2007 email from Richard Leclezio at Deutsche Bank to Jordan Milman noting that HBK has requested marks from Deutsche Bank, DB_PSI_00423053-61. HBK also prepared its own internal marks valuing Gemstone's assets. According to both Deutsche Bank and HBK, assigning a mark is a very complicated process that involves credit analysis of the securities at issue. Both explained it was not unusual for different entities to mark an asset differently.¹⁴⁶³¹⁴⁶³ Subcommittee interview of Jordan Milman (10/22/2010). Subcommittee interview of Kevin Jenks (10/13/2010).

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¶During the marketing phase of Gemstone 7, documents indicate several potential investors asked Deutsche Bank to provide MTM values for the underlying assets in the CDO. In response, those potential investors were given HBK's marks, rather than the generally lower valuations assigned to the assets by Deutsche Bank's CDO Trading Desk. On January 23, 2007, Mr. Kamat sent an email to HBK explaining that some potential investors had requested marks for the Gemstone 7 assets:

"Some investors are asking for current marks on the Gemstone 7 CDO portfolio. The attached file has the purchase price and the current marks that we got from our desk. There are many bonds where the price difference between purchase price and current mark is more than 4% .… I have asked Jordan [Milman, a Deutsche Bank trader] to review the marks but it would be great if you could have someone at HBK review also to check if the current marks seem correct. It seems as if the entire portfolio price has dropped since purchase by 1.74% which does not show well to investors."¹⁴⁶⁴¹⁴⁶⁴ 1/23/2007 email from Abhayad Kamat to HBK, GEM7-00003101. This document has HBK showing a loss of $9.4 million in the value of the Gemstone assets, whereas Deutsche Bank showed a loss of $19 million. In interviews with the Subcommittee, both Mr. Milman and Mr. Lippmann said that a 1.74% drop would not have concerned them because of the relative small dollars involved compared to the $1.1 billion deal.Show full note

¶Before he heard back from HBK, Mr. Kamat sent a very similar request to Mr. Milman to review the marks to verify them. He wrote:

"There are many [Gemstone 7] bonds where the price difference between purchase price and the current mark is more than 4% .… Before we send these over to CDO investors, pls could you review to check if the current marks are correct. It seems as if the entire portfolio price has dropped since purchase by 1.74% which does not show well to investors."¹⁴⁶⁵¹⁴⁶⁵ 1/23/2007 email from Abhayad Kamat to Jordan Milman, DB_PSI_00465462.

¶The next day, a Deutsche Bank trader verified the marks: "I checked the names that Abhayad [Kamat] highlighted [and] most are marked within the recent color[.] [T]here are 4 which should be tightened."¹⁴⁶⁶¹⁴⁶⁶ 1/24/2007 email from Jashin Patel to Jordan Milman, DB_PSI_00843917.

¶On January 23, 2007, Mr. Kamat learned that HBK's marks showed a loss of 0.9% or $9.4 million in the Gemstone 7 portfolio, while Deutsche Bank's marks showed a greater loss of 1.7% or $19 million.¹⁴⁶⁷¹⁴⁶⁷ 1/23/2007 email from Abhayad Kamat to HBK, GEM7-00003101. On January 24, 2007, Mr. Kamat directed Deutsche Bank's syndicate group to share HBK's marks with investors instead of Deutsche Bank's. He wrote: "[F]or investors who have asked for current marks on the Gemstone CDO 7 portfolio, tell them: HBK says that the overall current portfolio is down USD 9 million."¹⁴⁶⁸¹⁴⁶⁸ 1/24/2007 email from Abhayad Kamat to Chehao Lu and others at Deutsche Bank, DB_PSI_00741750-52.

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¶A couple weeks later, a question arose about using Deutsche Bank marks for Gemstone 7. On February 7, 2007, Ms. Bogza from the syndicate group wrote to Mr. Kamat: "Why can we not show a priced [marked] portfolio?? We need to show this [to investors]." Mr. Kamat responded: "[T]he marks we got from Jordan are too low … and it will take quite some time if we try to take on an exercise where we try to get kevin and jordan to agree on the correct marks."¹⁴⁶⁹¹⁴⁶⁹ 2/7/2007 emails between Abhayad Kamat and Ilinca Bogza, DB_PSI_00434692-96. Mr. Kamat wrote to another colleague later that day: "[U]se this for the current prices to be sent to investors, but please note to investors that this is from HBK."¹⁴⁷⁰¹⁴⁷⁰ 2/7/2007 email from Abhayad Kamat to Chehao Lu, DB_PSI_00711486. HBK also appeared to want to show higher marks to investors. When Mr. Kamat emailed Mr. Jenks seeking marks for the Gemstone 7 portfolio on February 7, Mr. Jenks sent an internal email to an HBK assistant trader. Mr. Jenks wrote: "Need line item marks for cdo portfolio[.] use dec or jan depending on which is better[.] 1471

¶When asked about these documents, Mr. Kamat stated that he advised using HBK's marks instead of Deutsche Bank's marks, because HBK's marks were better due to the collateral manager's familiarity with the assets.¹⁴⁷²¹⁴⁷² Subcommittee interview of Abhayad Kamat (10/8/2010). However, Deutsche Bank's trading desk was one of the biggest traders in RMBS and CDOs on Wall Street, making it unlikely that the desk could not adequately price the assets that it traded. Deutsche Bank also chose not to share both sets of marks with investors; it shared only the HBK marks showing higher asset values.

¶When HBK was asked about this matter, Mr. Jenks told the Subcommittee that he did not authorize Deutsche Bank to give out HBK's marks to investors and would be "surprised" if Deutsche Bank had given out HBK's marks.¹⁴⁷³¹⁴⁷³ Subcommittee interview of Kevin Jenks (10/13/2010). Mr. Jenks only recalled one time when an investor asked Deutsche Bank for Gemstone 7 marks. When the Subcommittee asked several of the investors who ultimately purchased Gemstone securities if they had asked for marks showing the current value of the underlying assets, M&T Bank told the Subcommittee that it did not know to ask for marks.¹⁴⁷⁴¹⁴⁷⁴ Subcommittee interview of M&T (9/20/2010). Standard Chartered, Wachovia, and Commerzbank told the Subcommittee that they did not ask for the marks and it would have been unusual for them to do so. Eight days before the Gemstone CDO closed and its securities issued, HBK estimated that its portfolio marks were down approximately $30 million.¹⁴⁷⁵¹⁴⁷⁵ 3/7/2007 email from Kevin Jenks to Abhayad Kamat, GEM7-00001958.

¶$400 Million of Unsold Securities. The mortgage market continued to worsen in March as Deutsche Bank continued to market the Gemstone securities. On March 8, 2007, one week before the Gemstone 7 deal closed, New Century – the subprime lender whose RMBS securities made up part of Gemstone – filed an 8-K with the SEC which said: "The Company has only been able to fund a portion of its loans this week. In addition, its capacity to fund new originations is substantially limited due to its lenders' restrictions or refusals to allow the

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¶Company to access their financing arrangements."¹⁴⁷⁶¹⁴⁷⁶ 3/8/2007 New Century Financial Corporation 8-K filing with the SEC. Even senior Deutsche Bank management was aware of the problems involving New Century and Fremont during this time period. On March 2, 2007, Mr. Lippmann sent an email to Mr. Misra, copying Mr. D'Albert, with a subject line: "Fremont Shut Down Sub-Prime business" that contained a number of negative news headlines concerning New Century including, "New Century says U.S. attorney conducting criminal probe … New Century says NYSE reviewing transactions in its securities … New Century says SEC requested meeting on restatement." The next day Mr. Misra replied to Mr. Lippmann, "Well, no regrets. Let's hold tight on our shorts now. It will be a bumpy market to market ride but we will prevail." 3/2/2007 and 3/3/2007 email chain between Mr. Lippmann and Mr. Misra, DBSI_PSI_EMAIL02392659-61.Show full note New Century's financial troubles were prominently reported in the financial press on March 11, 2007.¹⁴⁷⁷¹⁴⁷⁷ See, e.g., "Crisis Looms In Market for Mortgages," The New York Times (3/11/2007), http://www.nytimes.com/ 2007/03/11/business/11mortgage.html. ("On March 1, a Wall Street analyst at Bear Stearns wrote an upbeat report on a company that specializes in making mortgages to cash-poor homebuyers. The company, New Century Financial, had already disclosed that a growing number of borrowers were defaulting, and its stock, at around $15, had lost half its value in three weeks. What happened next seems all too familiar to investors who bought technology stocks in 2000 at the breathless urging of Wall Street analysts. Last week, New Century said it would stop making loans and needed emergency financing to survive. The stock collapsed to $3.21.")Show full note On March 15, 2007, the day Gemstone 7 closed, Bear Stearns said that "residential mortgage-related revenue decreased from the prior year period, reflecting weakness in the U.S. residential mortgage-backed securities market. … New Century Financial Corp., which had been a major provider of loans to people with risky credit, said it has lost support from its financial backers and is being delisted from the NYSE."¹⁴⁷⁸¹⁴⁷⁸ "Bear Stearns 1Q profit rises 8 percent on strong results in bonds, credit," Associated Press Financial Wire (3/15/2007). Also see "New Century Understated Debt; Faces SEC Probe, Stock Delisting," Associated Press (3/13/2007), http://www.cnbc.com/id/17590171/New_Century_Understated_Debt_Faces_SEC_Probe_Stock_Delisting; "New Century Subpoenaed, Faces Delisting," Washington Post (3/13/2007), http://www.washingtonpost.com/wp-dyn/content/article/2007/03/13/AR2007031300603.html.Show full note New Century comprised 15% of Gemstone 7.

¶Ultimately $400 million of Gemstone 7 was unsold. Although not contractually obligated to do so, Deutsche Bank agreed to split the unsold $400 million of Gemstone 7 securities between itself and HBK.¹⁴⁷⁹¹⁴⁷⁹ On 3/14/2007, Fred Brettschneider, head of Deutsche Bank institutional sales, wrote: "We believe that we have reached an acceptable compromise with HBK. We will be restructuring the unsold mezz AAA and we will underwrite the senior portion leaving them [HBK] with the junior piece." 3/14/2007 email from Fred Brettschneider to Anshu Jain and others, DBSI_PSI_EMAIL02064810-12. On 3/27/2007, Larry Pike of Deutsche Bank wrote with regard to Gemstone 7, "400mm of the unsold bonds were a middle (mezz) AAA class that were expected to be purchased by an investor who backed out at a late stage due to a deteriorating market. HBK was upset about this and wanted DB to take these bonds down, threatening to curtail business globally with HBK if we didn't." 3/27/2007 email from Larry Pike to Sean Whelan and others, DB_PSI_00859611.Show full note Meetings concerning taking back the $400 million were held at the highest levels of both Deutsche Bank and HBK.¹⁴⁸⁰¹⁴⁸⁰ Subcommittee interview of Michael Lamont (9/29/2010). As Mr. Lippmann put it: "[W]e don't have much choice … either we repo for them or we take it down."¹⁴⁸¹¹⁴⁸¹ Apparently, Mr. Lippmann was explaining that either Deutsche Bank could "repo" or loan money to HBK in order for HBK to purchase the unsold Gemstone 7 securities or Deutsche Bank would have to "take it down" – either purchase the securities itself or liquidate the CDO. 2/20/2007 email from Greg Lippmann to Rich Rizzo at Deutsche Bank, DBSI_PSI_EMAIL02377303.

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¶Deutsche Bank and HBK were unable to sell 36% of the securities and instead kept those securities on their books. Mr. Jenks of HBK told the Subcommittee that he always wanted to know if unsold portions of a CDO he was interested in investing in would be bought back by the underwriter, but he did not know if everyone asked about this.¹⁴⁸²¹⁴⁸² Subcommittee interview of Kevin Jenks (10/13/2010). M&T Bank told the Subcommittee that it would have been useful information, though it would have been more concerned if the tranches it was purchasing were not fully subscribed.¹⁴⁸³¹⁴⁸³ Subcommittee interview of M&T (9/20/2010). In addition, Standard Chartered reported that it didn't know that a portion of the CDO was unsold, and that it would have been information worth knowing but that it wouldn't have ultimately impacted its decision to invest in Gemstone 7. Subcommittee interview of counsel for Standard Chartered (10/14/2010).

¶(e) Gemstone Losses

¶Gemstone 7 closed on March 15, 2007, and received credit ratings from S&P and Moody's on the same day.¹⁴⁸⁴¹⁴⁸⁴ 3/15/2007 letter from S&P to Gemstone CDO VII Ltd, GEM7-00001658-61; 3/15/2007 letter from Moody's to Gemstone CDO VII Ltd., GEM7-00001657. The top three tranches, representing 73% of the value of the CDO, received AAA ratings. The next three tranches received investment grade ratings of AA, A, and BBB.¹⁴⁸⁵¹⁴⁸⁵ Gemstone 7 ratings from S&P's RatingsDirect on the Global Credit Portal, https://www.globalcreditportal.com/ratingsdirect/Login.do, with subscription. The CDO received these ratings even though one third of its underlying assets carried non-investment grade ratings.

¶Eight months later, in November 2007, five of its seven tranches were downgraded, including one of its AAA rated tranches. By July 2008, all seven tranches had been downgraded to junk status, and the Gemstone securities were nearly worthless. This chart, using S&P data, displays the downgrades.¹⁴⁸⁶¹⁴⁸⁶ Chart prepared by the Subcommittee using data from S&P's RatingsDirect on the Global Credit Portal, https://www.globalcreditportal.com/ratingsdirect/Login.do, with subscription.

¶Gemstone VII Ratings by Tranche

¶Tranche Initial Rating: Date 1st Downgrade: Date 2nd Downgrade: Date 3rd Downgrade: Date Class A-1a AAA: March 15,²⁰⁰⁷²⁰⁰⁷ "Home Loans Product Strategy," WaMu presentation at JPM_WM03097203, Hearing Exhibit 4/13-60a (only Countrywide ranked higher). WaMu Home Loans Product Strategy, "Strategy and Business Initiatives Update," JPM_WM03097217, Hearing Exhibit 4/13-60a [emphasis in original]. Performance Evaluation for Peter D'Erchia, S&P SEN-PSI 0007442; See also April 23, 2010 Subcommittee Hearing at 74-75. annual report filed with the SEC, in particular the Executive Summary of Deutsche Bank's Annual Report and the letter from the Chairman of the Board. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0252, at 0262.Show full note A+: Feb. 5,²⁰⁰⁸²⁰⁰⁸ SEC Examination Report for Moody's Investor Services Inc., PSI-SEC (Moodys Exam Report)-14-0001- 16, at 4. SEC Examination Report for Standard and Poor's Ratings Services, Inc., PSI-SEC (S&P Exam Report)- 14-0001-24, at 3. For a detailed discussion of these obligations under federal securities laws, see Section (6)(a), below. BB+: July 11,²⁰⁰⁸²⁰⁰⁸ SEC Examination Report for Moody's Investor Services Inc., PSI-SEC (Moodys Exam Report)-14-0001- 16, at 4. SEC Examination Report for Standard and Poor's Ratings Services, Inc., PSI-SEC (S&P Exam Report)- 14-0001-24, at 3. For a detailed discussion of these obligations under federal securities laws, see Section (6)(a), below. CC: August 19,²⁰⁰⁹²⁰⁰⁹ OTS Annual Report, "Agency Profile," http://www.ots.treas.gov/_files/482096.pdf. See 12/7/2006 email from Daniel Sparks to Tom Montag, "Subprime Volatility," GS MBS-E-010931233. Class A-1b AAA: March 15,²⁰⁰⁷²⁰⁰⁷ "Home Loans Product Strategy," WaMu presentation at JPM_WM03097203, Hearing Exhibit 4/13-60a (only Countrywide ranked higher). WaMu Home Loans Product Strategy, "Strategy and Business Initiatives Update," JPM_WM03097217, Hearing Exhibit 4/13-60a [emphasis in original]. Performance Evaluation for Peter D'Erchia, S&P SEN-PSI 0007442; See also April 23, 2010 Subcommittee Hearing at 74-75. annual report filed with the SEC, in particular the Executive Summary of Deutsche Bank's Annual Report and the letter from the Chairman of the Board. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0252, at 0262.Show full note B-: Feb. 5,²⁰⁰⁸²⁰⁰⁸ SEC Examination Report for Moody's Investor Services Inc., PSI-SEC (Moodys Exam Report)-14-0001- 16, at 4. SEC Examination Report for Standard and Poor's Ratings Services, Inc., PSI-SEC (S&P Exam Report)- 14-0001-24, at 3. For a detailed discussion of these obligations under federal securities laws, see Section (6)(a), below. CC: July 11,²⁰⁰⁸²⁰⁰⁸ SEC Examination Report for Moody's Investor Services Inc., PSI-SEC (Moodys Exam Report)-14-0001- 16, at 4. SEC Examination Report for Standard and Poor's Ratings Services, Inc., PSI-SEC (S&P Exam Report)- 14-0001-24, at 3. For a detailed discussion of these obligations under federal securities laws, see Section (6)(a), below. n/a Class A-2 AAA: March 15,²⁰⁰⁷²⁰⁰⁷ "Home Loans Product Strategy," WaMu presentation at JPM_WM03097203, Hearing Exhibit 4/13-60a (only Countrywide ranked higher). WaMu Home Loans Product Strategy, "Strategy and Business Initiatives Update," JPM_WM03097217, Hearing Exhibit 4/13-60a [emphasis in original]. Performance Evaluation for Peter D'Erchia, S&P SEN-PSI 0007442; See also April 23, 2010 Subcommittee Hearing at 74-75. annual report filed with the SEC, in particular the Executive Summary of Deutsche Bank's Annual Report and the letter from the Chairman of the Board. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0252, at 0262.Show full note AA-: Nov. 21,²⁰⁰⁷²⁰⁰⁷ "Home Loans Product Strategy," WaMu presentation at JPM_WM03097203, Hearing Exhibit 4/13-60a (only Countrywide ranked higher). WaMu Home Loans Product Strategy, "Strategy and Business Initiatives Update," JPM_WM03097217, Hearing Exhibit 4/13-60a [emphasis in original]. Performance Evaluation for Peter D'Erchia, S&P SEN-PSI 0007442; See also April 23, 2010 Subcommittee Hearing at 74-75. annual report filed with the SEC, in particular the Executive Summary of Deutsche Bank's Annual Report and the letter from the Chairman of the Board. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0252, at 0262.Show full note CCC-: Feb. 5,²⁰⁰⁸²⁰⁰⁸ SEC Examination Report for Moody's Investor Services Inc., PSI-SEC (Moodys Exam Report)-14-0001- 16, at 4. SEC Examination Report for Standard and Poor's Ratings Services, Inc., PSI-SEC (S&P Exam Report)- 14-0001-24, at 3. For a detailed discussion of these obligations under federal securities laws, see Section (6)(a), below. CC: July 11,²⁰⁰⁸²⁰⁰⁸ SEC Examination Report for Moody's Investor Services Inc., PSI-SEC (Moodys Exam Report)-14-0001- 16, at 4. SEC Examination Report for Standard and Poor's Ratings Services, Inc., PSI-SEC (S&P Exam Report)- 14-0001-24, at 3. For a detailed discussion of these obligations under federal securities laws, see Section (6)(a), below. Class B AA: March 15,²⁰⁰⁷²⁰⁰⁷ "Home Loans Product Strategy," WaMu presentation at JPM_WM03097203, Hearing Exhibit 4/13-60a (only Countrywide ranked higher). WaMu Home Loans Product Strategy, "Strategy and Business Initiatives Update," JPM_WM03097217, Hearing Exhibit 4/13-60a [emphasis in original]. Performance Evaluation for Peter D'Erchia, S&P SEN-PSI 0007442; See also April 23, 2010 Subcommittee Hearing at 74-75. annual report filed with the SEC, in particular the Executive Summary of Deutsche Bank's Annual Report and the letter from the Chairman of the Board. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0252, at 0262.Show full note BBB: Nov. 21,²⁰⁰⁷²⁰⁰⁷ "Home Loans Product Strategy," WaMu presentation at JPM_WM03097203, Hearing Exhibit 4/13-60a (only Countrywide ranked higher). WaMu Home Loans Product Strategy, "Strategy and Business Initiatives Update," JPM_WM03097217, Hearing Exhibit 4/13-60a [emphasis in original]. Performance Evaluation for Peter D'Erchia, S&P SEN-PSI 0007442; See also April 23, 2010 Subcommittee Hearing at 74-75. annual report filed with the SEC, in particular the Executive Summary of Deutsche Bank's Annual Report and the letter from the Chairman of the Board. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0252, at 0262.Show full note CC: Feb. 5,²⁰⁰⁸²⁰⁰⁸ SEC Examination Report for Moody's Investor Services Inc., PSI-SEC (Moodys Exam Report)-14-0001- 16, at 4. SEC Examination Report for Standard and Poor's Ratings Services, Inc., PSI-SEC (S&P Exam Report)- 14-0001-24, at 3. For a detailed discussion of these obligations under federal securities laws, see Section (6)(a), below. n/a Class C A: March 15,²⁰⁰⁷²⁰⁰⁷ "Home Loans Product Strategy," WaMu presentation at JPM_WM03097203, Hearing Exhibit 4/13-60a (only Countrywide ranked higher). WaMu Home Loans Product Strategy, "Strategy and Business Initiatives Update," JPM_WM03097217, Hearing Exhibit 4/13-60a [emphasis in original]. Performance Evaluation for Peter D'Erchia, S&P SEN-PSI 0007442; See also April 23, 2010 Subcommittee Hearing at 74-75. annual report filed with the SEC, in particular the Executive Summary of Deutsche Bank's Annual Report and the letter from the Chairman of the Board. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0252, at 0262.Show full note B-: Nov. 21,²⁰⁰⁷²⁰⁰⁷ "Home Loans Product Strategy," WaMu presentation at JPM_WM03097203, Hearing Exhibit 4/13-60a (only Countrywide ranked higher). WaMu Home Loans Product Strategy, "Strategy and Business Initiatives Update," JPM_WM03097217, Hearing Exhibit 4/13-60a [emphasis in original]. Performance Evaluation for Peter D'Erchia, S&P SEN-PSI 0007442; See also April 23, 2010 Subcommittee Hearing at 74-75. annual report filed with the SEC, in particular the Executive Summary of Deutsche Bank's Annual Report and the letter from the Chairman of the Board. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0252, at 0262.Show full note CC: Feb. 5,²⁰⁰⁸²⁰⁰⁸ SEC Examination Report for Moody's Investor Services Inc., PSI-SEC (Moodys Exam Report)-14-0001- 16, at 4. SEC Examination Report for Standard and Poor's Ratings Services, Inc., PSI-SEC (S&P Exam Report)- 14-0001-24, at 3. For a detailed discussion of these obligations under federal securities laws, see Section (6)(a), below. n/a Class D BBB: March 15,²⁰⁰⁷²⁰⁰⁷ "Home Loans Product Strategy," WaMu presentation at JPM_WM03097203, Hearing Exhibit 4/13-60a (only Countrywide ranked higher). WaMu Home Loans Product Strategy, "Strategy and Business Initiatives Update," JPM_WM03097217, Hearing Exhibit 4/13-60a [emphasis in original]. Performance Evaluation for Peter D'Erchia, S&P SEN-PSI 0007442; See also April 23, 2010 Subcommittee Hearing at 74-75. annual report filed with the SEC, in particular the Executive Summary of Deutsche Bank's Annual Report and the letter from the Chairman of the Board. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0252, at 0262.Show full note CCC+: Nov. 21,²⁰⁰⁷²⁰⁰⁷ "Home Loans Product Strategy," WaMu presentation at JPM_WM03097203, Hearing Exhibit 4/13-60a (only Countrywide ranked higher). WaMu Home Loans Product Strategy, "Strategy and Business Initiatives Update," JPM_WM03097217, Hearing Exhibit 4/13-60a [emphasis in original]. Performance Evaluation for Peter D'Erchia, S&P SEN-PSI 0007442; See also April 23, 2010 Subcommittee Hearing at 74-75. annual report filed with the SEC, in particular the Executive Summary of Deutsche Bank's Annual Report and the letter from the Chairman of the Board. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0252, at 0262.Show full note CC: Feb. 5,²⁰⁰⁸²⁰⁰⁸ SEC Examination Report for Moody's Investor Services Inc., PSI-SEC (Moodys Exam Report)-14-0001- 16, at 4. SEC Examination Report for Standard and Poor's Ratings Services, Inc., PSI-SEC (S&P Exam Report)- 14-0001-24, at 3. For a detailed discussion of these obligations under federal securities laws, see Section (6)(a), below. n/a Class E BB+: March 15,²⁰⁰⁷²⁰⁰⁷ "Home Loans Product Strategy," WaMu presentation at JPM_WM03097203, Hearing Exhibit 4/13-60a (only Countrywide ranked higher). WaMu Home Loans Product Strategy, "Strategy and Business Initiatives Update," JPM_WM03097217, Hearing Exhibit 4/13-60a [emphasis in original]. Performance Evaluation for Peter D'Erchia, S&P SEN-PSI 0007442; See also April 23, 2010 Subcommittee Hearing at 74-75. annual report filed with the SEC, in particular the Executive Summary of Deutsche Bank's Annual Report and the letter from the Chairman of the Board. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0252, at 0262.Show full note CCC: Nov. 21,²⁰⁰⁷²⁰⁰⁷ "Home Loans Product Strategy," WaMu presentation at JPM_WM03097203, Hearing Exhibit 4/13-60a (only Countrywide ranked higher). WaMu Home Loans Product Strategy, "Strategy and Business Initiatives Update," JPM_WM03097217, Hearing Exhibit 4/13-60a [emphasis in original]. Performance Evaluation for Peter D'Erchia, S&P SEN-PSI 0007442; See also April 23, 2010 Subcommittee Hearing at 74-75. annual report filed with the SEC, in particular the Executive Summary of Deutsche Bank's Annual Report and the letter from the Chairman of the Board. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0252, at 0262.Show full note CC: Feb. 5,²⁰⁰⁸²⁰⁰⁸ SEC Examination Report for Moody's Investor Services Inc., PSI-SEC (Moodys Exam Report)-14-0001- 16, at 4. SEC Examination Report for Standard and Poor's Ratings Services, Inc., PSI-SEC (S&P Exam Report)- 14-0001-24, at 3. For a detailed discussion of these obligations under federal securities laws, see Section (6)(a), below. n/a Preference Shares Not rated Source: S&P

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¶Investors contacted by the Subcommittee reported that they had lost all or most of their investments. In June 2008, M&T Bank wrote down the value of its Gemstone 7 securities to about 2% of their original value – from $82 million to $1.87 million.1487 Wachovia Bank told the Subcommittee that its $40 million investment in Gemstone paid out approximately $3 million from 2007-2010, but is currently worth nothing.¹⁴⁸⁸¹⁴⁸⁸ 11/19/2010, 11/23/2010 emails from counsel of Wachovia to Subcommittee staff. Standard Chartered Bank told the Subcommittee that, in 2008, it liquidated its Gemstone investment and received approximately 25-30% of its initial $224 million investment.1489 Commerzbank told the Subcommittee that its initial $16 million investment in Gemstone is currently worth nothing.¹⁴⁹⁰¹⁴⁹⁰ 12/7/2010 email from counsel of Commerzbank to Subcommittee staff.

¶(6) Other Deutsche Bank CDOs

¶Gemstone 7 was only one of many CDOs that Deutsche Bank assembled and underwrote as the mortgage market deteriorated in 2007. From December 2006 through December 2007, Deutsche Bank issued 15 new CDOs with assets totaling $11.5 billion.¹⁴⁹¹¹⁴⁹¹ ABS CDOs Issued by DBSI (between 2004 and 2008), PSI-Deutsche_Bank-02-0005-23. The Subcommittee did not examine these CDOs, but a brief discussion of a few shows that the bank's issuance of high risk mortgage related assets was not confined to Gemstone 7.

¶Magnetar CDOs. Magnetar is a Chicago based hedge fund that, according to press reports, worked with several financial institutions to create CDOs with riskier assets and then bet on those CDOs to fail.¹⁴⁹²¹⁴⁹² See, e.g., "The Magnetar Trade: How One Hedge Fund Helped Keep the Bubble Going," ProPublica (4/9/2010), http://www.propublica.org/article/the-magnetar-trade-how-one-hedge-fund-helped-keep-the-housing-bubble-going. Deutsche Bank underwrote one of those CDOs and served as trustee for two other Magnetar CDOs.

¶According to press reports, Magnetar's investment strategy was to purchase the riskiest portion of a CDO – the equity – and, at the same time, to purchase short positions on other tranches of the same CDO.¹⁴⁹³¹⁴⁹³ Id. Thus, Magnetar would receive a large return on the equity if the security did well, but would also receive a substantial payment from its short positions if the securities lost value. This strategy was dubbed by some as the "Magnetar Trade." It apparently generated large profits for Magnetar. By the end of 2007, when the market was in turmoil, Magnetar's Constellation Fund was up 76% and its Capital Fund was up 26%.¹⁴⁹⁴¹⁴⁹⁴ "Magnetar's Exit: A Deal So Bad Even a Credit-Rating Agency Balked," ProPublica (4/9/2010), http://www.propublica.org/article/magnetars-exit-a-deal-so-bad-even-a-credit-rating-agency-balked.

¶Mr. Lippmann disapproved of the Magnetar CDOs.¹⁴⁹⁵¹⁴⁹⁵ Subcommittee interview of Greg Lippmann (10/18/2010). In August 2006, when an investor asked Mr. Lippmann about Magnetar, he responded that it was a "Chicago based hedge fund that is buying tons of cdo equity and shorting the single names .… [T]hey are buying equity and shorting the single names … a bit devious."¹⁴⁹⁶¹⁴⁹⁶ 8/23/2006 email from Jeremy Coon at Passport Management to Greg Lippmann, DBSI_PSI_EMAIL01603121. In another email, when asked how Magnetar distorted the market, Mr. Lippmann responded, "easy but lengthy answer get him on the phone and call me." 8/31/2006 email from Warren Dowd at Deutsche Bank to Greg Lippmann, DBSI_PSI_EMAIL01641089.

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¶In May 2006, Magnetar created its first CDO, Orion 2006-1 Ltd., a $1.3 billion hybrid CDO with cash and synthetic assets.¹⁴⁹⁷¹⁴⁹⁷ See Loreley Financing v. Credit Agricole Corporate and Investment Bank, (N.Y. Sup.), (10/29/2010). Orion 2006-1 is one of two Magnetar CDOs that are the subjects of this lawsuit filed by Loreley Financing, a European- based investment fund, and Crédit Agricole, a French bank. See also "Magnetar Deals at Center of New Lawsuit," ProPublica (10/25/2010), http://www.propublica.org/article/magnetar-deals-at-center-of-new-lawsuit.Show full note The CDO closed on May 26, 2006, and was underwritten by Calyon and managed by NIBC Credit Management, Inc.¹⁴⁹⁸¹⁴⁹⁸ See Loreley Financing v. Credit Agricole Corporate and Investment Bank, (N.Y, Sup.), (10/29/2010) (alleging Calyon permitted Magnetar to select poor assets for the two Magnetar CDOs and fraudulently induced investors to purchase the securities). Deutsche Bank's Special Situations Group purchased equity in Orion, and helped create the CDO.¹⁴⁹⁹¹⁴⁹⁹ "Magnetar Gets Started," ProPublica (4/9/2010), http://www.propublica.org/article/magnetar-gets-started; Loreley Financing v. Credit Agricole Corporate and Investment Bank, (N.Y. Sup.), (10/29/2010). A Deutsche Bank employee, Michael Henriques, who worked on Orion as managing director of the Special Situations Group, left Deutsche Bank and ultimately went to work for Magnetar.¹⁵⁰⁰¹⁵⁰⁰ Loreley Financing v. Credit Agricole Corporate and Investment Bank, (N.Y. Sup.), (10/29/2010).

¶Although Orion received investment grade ratings from Fitch and Moody's in June 2006,¹⁵⁰¹¹⁵⁰¹ "Fitch Rates Orion 2006-1, Ltd./LLC.," BusinessWire (5/26/2006), http://www.thefreelibrary.com/Fitch+Rates+Orion+2006-1,+Ltd.%2FLLC.-a0146274727; 6/9/2006 "$292.5 Million of Debt Securities Rated, $936 Million of Senior Credit Swap Risk Rated," Moody's, http://v3.moodys.com/viewresearchdoc.aspx?docid=PR_109282. a little over a year later, on August 21, 2007, Fitch issued the first of several rating downgrades.¹⁵⁰²¹⁵⁰² Fitch downgraded the CDO's Class A notes from AAA to AA, the Class B notes from AA to A-, the Class C notes from A to BB, and the Class D notes from BBB to B+. "Fitch Downgrades $289MM of Orion 2006-1, Ltd.," BusinessWire (8/21/2007), http://www.highbeam.com/doc/1G1-167859601.html. In November 2007, Moody's downgraded the Class A notes six notches and the Class B notes seven notches.¹⁵⁰³¹⁵⁰³ 11/1/2007 "Moody's takes neg action on Orion 2006-1," Moody's, http://v3.moodys.com/viewresearchdoc.aspx?docid=PR_143474. By May 2008, every class of Orion's securities had been downgraded to junk status.¹⁵⁰⁴¹⁵⁰⁴ 10/28/2010 "Moody's lowers ratings of 95 Notes issued by 56 structured finance CDO transactions," Moody's, http://v3.moodys.com/viewresearchdoc.aspx?docid=PR_208444.

¶START CDOs. Deutsche Bank also underwrote six START CDOs with a combined value of $5.25 billion from June 2005 to December 2006.¹⁵⁰⁵¹⁵⁰⁵ They included Static Residential 2005-A for $1 billion; Static Residential 2005-B for $1 billion; Static Residential 2005-C for $500 million; Static Residential 2006-A for $1 billion; Static Residential 2006-B for $1 billion; and Static Residential 2006-C for $750 million. Chart, ABS CDOs Issued by DBSI (between 2004 and 2008), PSI-Deutsche_Bank-02-0005-23. In one of the deals, Deutsche Bank worked with Elliot Advisors, a hedge fund that bought the equity tranche in the CDO and simultaneously bought CDS protection against the entire structure, essentially shorting the deal and betting that the value of its assets would fall.¹⁵⁰⁶¹⁵⁰⁶ Subcommittee interview of Michael Lamont (9/29/2010). On four of the deals, Deutsche Bank worked with Paulson Advisors, a hedge fund that bought the equity tranche and apparently shorted the rest of the CDO, while Deutsche Bank sold the rest of the securities.¹⁵⁰⁷¹⁵⁰⁷ Subcommittee interview of Greg Lippmann (10/18/2010). An internal Deutsche Bank email explained one of the 2005 START CDOs as follows:

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"The $1 billion START 2005-B trade was backed by a static pool of CDS on mezzanine RMBS for Paulson Advisors ($4 bln risk arb hedge fund). Paulson retained the bottom 6% of the trade and we sold the rest of the capital structure. Paulson, who came to us with the strong desire to short the U.S. housing market, wrote CDS on underlying ABS (over 100 names) to DB [Deutsche Bank] and DB intermediated them into the deal."¹⁵⁰⁸¹⁵⁰⁸ 10/10/2005 email from Michael Raynes at Deutsche Bank to Greg Lippmann, DBSI_PSI_EMAIL00574452.

¶Mr. Lamont told the Subcommittee that Mr. Paulson shorted the START deals, and he believed investors were aware of that fact. Mr. Lamont told the Subcommittee that Mr. Lippmann's ABS desk shorted the START CDOs only in its role as an intermediary for other clients, which was confirmed by Mr. Lippmann. In an email discussing START with a Deutsche Bank colleague, Mr. Lippmann advised him to buy protection for the bank against START. He wrote: "Start is crap you should short because I bet we'll have to … buyback cash ones next year."¹⁵⁰⁹¹⁵⁰⁹ 12/14/2006 email from Greg Lippmann to Taranjit Sabharwal at Deutsche Bank, DBSI_PSI_EMAIL01895617.

¶Mr. Lippmann told the Subcommittee that Deutsche Bank ended up losing a great deal of money on the START deals. One Deutsche Bank employee wrote to Mr. Lippmann regarding one of the deals in June 2007: "This along with our remaining held inventory if we can't sell away we repack into a CDO 2 balance sheet dump later this summer. Worst case we hold it but it is probably the lesser of two evils (the greater evil being our held START position)."¹⁵¹⁰¹⁵¹⁰ 6/14/2007 email from Richard Kim at Deutsche Bank to Greg Lippmann, DBSI_PSI_EMAIL02202920.

¶(7) Analysis

¶Deutsche Bank was the fourth largest issuer of CDOs in the United States. It continued to issue CDOs after mortgages began losing money at record rates, investor interest waned, and its most senior CDO trader concluded that the mortgage market in general and the specific RMBS securities being included in the bank's own CDOs were going to lose value. Mr. Lippmann derided specific RMBS securities and advised his clients to short them, at the same time his desk was allowing the very same securities to be included or referenced in Gemstone 7, a CDO that the bank was assembling for sale to its clients. In fact, the bank was selling some assets that Mr. Lippmann believed contained "crap." While the Gemstone CDO was constructed and marketed by the bank's CDO Desk, which is separate from the trading desk controlled by Mr. Lippmann, both desks knew of Mr. Lippmann's negative views. The bank managed to sell

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¶$700 million in Gemstone 7 securities which then failed within months, leaving the bank's clients with worthless investments.

¶This case history raises several concerns. The first is that Deutsche Bank allowed the inclusion of Gemstone 7 assets which its most senior CDO trader was asked to review and saw as likely to lose value. Second, the bank sold poor quality assets from its own inventory to the CDO. Third, the bank aggressively marketed the CDO securities to clients despite the negative views of its most senior CDO trader, falling values, and the deteriorating market. Fourth, the bank failed to inform potential investors of Mr. Lippmann's negative views of the underlying assets and its inability to sell over a third of Gemstone's securities. Each of these issues focuses on the poor quality of the financial product that Deutsche Bank helped assemble and sell. Still another concern raised by this case history is the fact that the bank made large proprietary investments in the mortgage market that resulted in multi-billion-dollar losses – losses that, in this instance, did not require taxpayer relief but, due to their size, could have caused material damage to both U.S. investors and the U.S. economy.

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C. Failing to Manage Conflicts of Interest: Case Study of Goldman Sachs

¶The Goldman Sachs case study shows how one investment bank profited from the collapse of the mortgage market and engaged in troubling and sometimes abusive practices that raise multiple conflict of interest concerns. The first part of this case study shows how Goldman used structured finance products, including CDO, CDS, and ABX instruments, to take a proprietary net short position against the subprime mortgage market. Reaching its peak at $13.9 billion, Goldman's net short investments realized record gains for the Structured Products Group in 2007 of over $3.7 billion which, when combined with other mortgage losses, resulted in overall net revenues for Goldman's Mortgage Department of $1.1 billion. The second half of the case study shows how Goldman engaged in securitization practices that magnified risk in the market by selling high risk, poor quality mortgage products to investors around the world. The Hudson, Anderson, Timberwolf, and Abacus CDOs show how Goldman used these financial instruments to transfer risk associated with its high risk assets, assist a favored client make a $1 billion gain, and profit at the direct expense of the clients that invested in the Goldman CDOs. In addition, the case study shows how conflicts of interest related to proprietary investments led Goldman to conceal its adverse financial interests from potential investors, sell investors poor quality investments, and place its financial interests before those of its clients.

¶(1) Subcommittee Investigation and Findings of Fact

¶During the course of its investigation into the Goldman Sachs case study, the Subcommittee issued 13 document subpoenas as well as multiple document request letters to financial institutions, government agencies, hedge funds, due diligence firms, insurance companies, individuals, and others. The Subcommittee obtained tens of millions of pages of documents, including internal reports, memoranda, correspondence, spreadsheets, and email. The Subcommittee conducted over 55 interviews and one deposition, including interviews with a variety of senior executives and Mortgage Department personnel at Goldman Sachs. The Subcommittee also spoke with agency officials, law enforcement, and industry and academic experts in financial products and securities law. On April 27, 2010, the Subcommittee held a hearing which took testimony from Goldman senior executives and current and former employees of its Mortgage Department, and released 173 hearing exhibits.1511 After that hearing, the Subcommittee gathered additional information in post-hearing interviews and through post- hearing questions for the record.1512

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¶In connection with the hearing, the Subcommittee released a joint memorandum from Chairman Levin and Ranking Member Coburn summarizing the investigation to date into the role of the investment banks in the financial crisis. The memorandum contained the following findings of fact, which this Report reaffirms, regarding the Goldman Sachs case study.

Securitizing High Risk Mortgages. From 2004 to 2007, in exchange for lucrative fees, Goldman Sachs helped lenders like Long Beach, Fremont, and New Century, securitize high risk, poor quality loans, obtain favorable credit ratings for the resulting residential mortgage backed securities (RMBS), and sell the RMBS securities to investors, pushing billions of dollars of risky mortgages into the financial system.

Magnifying Risk. Goldman Sachs magnified the impact of toxic mortgages on financial markets by re-securitizing RMBS securities in collateralized debt obligations (CDOs), referencing them in synthetic CDOs, selling the CDO securities to investors, and using credit default swaps and index trading to profit from the failure of the same RMBS and CDO securities it sold.

Shorting the Mortgage Market. As high risk mortgage delinquencies increased, and RMBS and CDO securities began to lose value, Goldman Sachs took a net short position on the mortgage market, remaining net short throughout 2007, and cashed in very large short positions, generating billions of dollars in gain.

Conflict Between Client Interests and Proprietary Trading. In 2007, Goldman

Sachs went beyond its role as market maker for clients seeking to buy or sell mortgage related securities, traded billions of dollars in mortgage related assets for the benefit of the firm without disclosing its proprietary positions to clients, and instructed its sales force to sell mortgage related assets, including high risk RMBS and CDO securities that Goldman Sachs wanted to get off its books, and utilizing key roles in CDO transactions to promote its own interests at the expense of investors, creating a conflict between the firm's proprietary interests and the interests of its clients.

Abacus Transaction. Goldman Sachs structured, underwrote, and sold a synthetic CDO called Abacus 2007-AC1, did not disclose to the Moody's analyst overseeing the rating of the CDO that a hedge fund client taking a short position in the CDO had helped to select the referenced assets, and also did not disclose that fact to other investors.