On March 18, 2016, the Libyan Investment Authority (LIA), a sovereign wealth fund set up by dictator Colonel Muammar Gadhafi in 2006, filed suit in London at The High Court of Justice's Chancery Division against Goldman Sachs International.
The suit claims the fund paid Goldman approximately $350 million to set up trades the LIA says it didn't understand, which lost the fund $1.2 billion, everything it invested.
Instead of fraud, the LIA claims its "causes of action" are "undue influence" and "unconscionable bargain."
Goldman Sachs
Group Inc. (NYSE: GS) decided not to settle and believes it can beat the charges because, you know, there was never any undue influence and Goldman Sachs is not unconscionable.
The suit will be decided this October.
In short, the LIA claims the Great Vampire Squid's blood-funnel bankers, traders, and especially one junior salesman, cozied up to the "nascent" sovereign wealth fund's managers and traders, who all had "limited legal and financial expertise," by entertaining them lavishly at expensive restaurants and hotels, plying them with gifts and prostitutes, training them enough to claim they should have known what they were buying, employing the deputy executive director of the fund's younger brother, and finally inducing them into putting on leveraged derivatives trades that amounted to an unconscionable bargain.
Here's the inside scoop on the case...
Background Checks
Libya gained its independence from Italy in 1951. Eight years later, massive quantities of oil were discovered and Libya entered the world stage. In 1969, with Libya's king out of the country, an upstart colonel in the Libyan army, Muammar Mohammed Abu Minyar Gaddafi, led a coup and took over the country.
By 2003, the "Mad Dog" dictator was feeling the pinch when fellow strongman, Iraq's Saddam Hussain, was pulled from his hiding hole and paraded as a prisoner of war.
Don't Miss: The Unintended Consequences of These New SEC Rules Could Kill the Rally - or Worse
Gaddafi, only a few weeks later, renounced his country's nuclear and chemical weapons programs and sought to have sanctions against his country lifted.
Twelve countries lifted sanctions in 2003. The United States in 2004, to reward Libya's renunciation of weapons of mass destruction, lifted its sanctions. By 2006, full relations were restored.
Gaddafi established the Libyan Investment Authority, the country's sovereign wealth fund, in 2006. Its operations were primarily conducted by a management committee set up in January 2007, which later became the fund's board of directors.
Gaddafi appointed his friend, a traditional commercial banker, Mohamed Layas, as executive director. Mustafa Mohamed Zarti (38 years old), at the suggestion of Safir Al Islam Gadaffi, Zarti's friend and the son of Muammar Gadaffi, became the fund's deputy executive director. Zarti's banking experience was limited to a stint on OPEC's Fund for International Development. The directors set up two teams at the fund, the equity, or direct investment, team and an alternative investment team.
The LIA claims the fund's 12 team members had "no legal expertise and no background in, or experience of, complex derivative products."
Enter the Dragon
[mmpazkzone name="in-story" network="9794" site="307044" id="137008" type="4"]
In June 2007, Moroccan native Youssef Kabbaj (31 years old), an upstart Goldman securities salesman out of the firm's London offices, who spoke English, French, and Arabic and had an engineering degree from MIT, cold-called the LIA and got a meeting.
The suit claims Goldman, in particular Youssef Kabbaj, befriended LIA managers, especially deputy executive director Zarti, who pulled the trigger on the fund's trades and investments.
Not only did Goldman's Kabbaj lavish gifts on LIA managers and team members, wine and dine them, send them to Goldman University in London for training, and pay for their travel with him to Marrakech, Casablanca, and Rabat in Morocco, he did deputy executive director Zarti the ultimate favor and got his younger brother, Haitem Zarti (25 years old) an internship at Goldman.
With the ball teed-up, Goldman swung at the LIA as hard as it could.
Between January 2008 and April 2008, Goldman suggested and executed nine "disputed trades" on behalf of the LIA.
The LIA itself was interested in an investment in Citigroup, having been told by Gadaffi himself that Qatar had made a $7.5 billion investment in the American bank, and to look into it. Goldman was only too eager to move that trade along.
But, rather than have the fund buy shares in Citi, Goldman created a "cash-settled forward purchase agreement for Citigroup shares with downside protection in the form of a put option at the same price as the forward."
Yeah, that's what I said. And I understand derivatives.
According to a just-published Bloomberg Businessweek article, "More simply, if Citi shares rose, as the LIA was betting, the fund stood to gain many times its initial investment. If the shares fell by a certain amount, the fund could lose everything. The structure was potentially more lucrative than a conventional purchase of equity and also significantly riskier - while resulting in far higher profits for Goldman."
Goldman teed-up two of these trades amounting to a $200 million bet on Citi going up.
An investment decision that seems damning to Goldman, and to me, is revealed in the suit's "Re-Re-Amended Particulars of Claim Dated 18 March 2016."
The LIA wanted to take an equity position in France's Electricite de France, and on Feb. 19, 2008, its equity direct investment team bought $73.76 million worth of EdF stock. But Goldman, on the same day, "restructured" the position into another "cash-settled forward purchase agreement for shares with downside protection in the form of a put option at the same price as the forward."
In other words, Goldman took the LIA's shares and converted it to $73.76 million in premiums to establish a derivative trade that would make more money if EdF went up, but could lose everything if it fell far enough.
Get Our Best Wealth-Building Ideas: Money Morning's top 5 investment reports to grow your money like never before are right here - and they're absolutely free. Read more...
In the end, the LIA lost $1.2 billion on the trades Goldman ushered it into when markets imploded during the fall of 2008. While the derivative contracts had three years to go, by expiration none of the positions had recovered enough to be worth anything.
So the LIA sued.
Undue Influence
What's revealed in the suit is that before the fund's investments were wiped out, in the summer of 2008, the LIA hired the law firm of Allen & Overy to help it understand the Goldman trades.
Catherine McDougall, a 26-year-old Australian lawyer working for Allen & Overy, was assigned to the LIA. She was dismayed, to say the least.
Goldman never had the LIA sign an ISDA master agreement, standard in derivatives transactions, only sent the LIA trade confirmations months after trades were executed (some they never received), didn't provide account statements, and apparently charged the LIA some $350 million in fees which otherwise should have been closer to $111 million.
According to Matthew Campbell and Kit Chellel's excellent Bloomberg Businessweek article, McDougall "was astonished by how little the LIA's junior employees seemed to know. The legal department's level of competence in dealing with complex legal documentation was 'zero,' she wrote later in a witness statement. The problem was compounded by rudimentary English and basic paperwork that was missing. She described the setup as like 'an advertising company having no TVs.'"
"She asked to see the due diligence the LIA had performed before committing to the deals. They responded, she wrote, 'Due what?'"
But lawyer Robert Miles in the Bloomberg article said, "That's not the bank's problem; the Libyans entered commercial transactions, fair and square." The LIA "understood at all times that Mr. Kabbaj was a salesman, and that his job was to sell investments to the LIA from which [Goldman] could make money," Goldman's lawyers said in closing arguments.
The bank's official statement on the lawsuit reads, in part, "We have always disputed the LIA's claim that it was financially illiterate and it is clear that they understood the disputed trades and entered into them of their own volition."
The LIA claims "undue influence" which Campbell and Chellel say is "more commonly used by wives against husbands" - the idea being "that one party to a transaction can have so much power over another that a contract between them isn't valid."
The unconscionable bargain claim stems from the oppressive fees Goldman charged in a mostly one-sided bet the LIA claims they had no idea they were at risk for.
We'll know in October what the court's decision is.
But in the meantime - what do you think?
Did Goldman exert undue influence to make gross profits on an unsophisticated "elephant" client? Or are slickster salesmen still a viable business tool?
Sound off in the comments below.
This Is the Best "Retirement Stock" of 2016... And the good news is, it's trading for "pennies." But it won't be for long... its revenue is set to surge 4,709%. Learn the details of this $5 stock today while it's still "on sale." Read more...
Follow Money Morning on Facebook and Twitter.
About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.
Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.