How the Vampire Squid Gambled – And Lost $1.2 Billion in Sovereign Wealth

18 | By Shah Gilani

On March 18, 2016, the Libyan Investment Authority (LIA), a sovereign wealth fund set up by dictator Colonel Muammar Gaddafi 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 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.

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 Moammar 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 twelve team members had “no legal expertise and no background in, or experience of complex derivative products.”

Enter the Dragon

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 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 $200,000,000 bet on Citi going up.

An investment decision that seems damning to Goldman, and to me, is revealed in the suits “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 February 19, 2008, it’s equity direct investment team bought $73,768,695 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 $73,768,695 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.

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 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, 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 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 salesman still a viable business tool?

Sound off in the comments below.



18 Responses to How the Vampire Squid Gambled – And Lost $1.2 Billion in Sovereign Wealth

  1. Bob Krone says:

    Fining corporations is totally meaningless. Jailing the Banksters and all the other corporate Gangsters, for a minimum sentence of 50 years without parole is the only way to eradicate those seeking, and GETTING, “Golden Parachutes!” Lock ’em up! Throw away the key!

  2. Mike says:

    As in any purchase or investor decision it is always prudent to prescribe to the old latin phrase – “caveat emptor”. (Buyer Beware!).

    It is plainly evident that this commandment was ignored or at the very least entered into extremely naively. I would be surprised if the courts would side with LIA.

    If they had been rewarded 1.2Billion, would LIA feel guilty and give it back? There are winners and losers in every trade!

  3. James Timmons says:

    Goldman exerted undue influence. LIA entered trades without adequate advice or due diligence. This should be a classic set-up for a decision based on contributory negligence. For how much of the bad outcome was each party responsible? It is hard to predict the result without knowing the contributory negligence rules for the court with jurisdiction. However, since Goldman was clearly giving risky advice, it is hiding behind the fact that its agent was a salesman without any fiduciary duty to the client. LIA chose nepotism and cronyism over expert management. I believe Goldman will be held less responsible than LIA based on a stronger position in law. Since both sides were sleazy, it is A rare case where justice will be served regardless of the outcome. My bet is that the undue influence charge will fail but the unconscionable bargain charge will succeed. The payout will likely be tiny compated to $1.2 billion.

  4. Bob Schubring says:

    A friend who studies the Mossad closely, was dubious of US claims that Libyan agents blew up Pan Am Flight 103, siding with the view that the dictator of Syria, Assad, had more to gain from the attack. Apparently this was quite a strong suspicion at Mossad, as Israel left open the door to charge Syria later if proof of complicity emerged, and stopped short of fully agreeing with the US that the Libyan dictator was 100% at fault for the blast.

    Given that bit of background, I wonder whether the LIA simply gave money to Goldman Sachs, in the belief that it was buying lobbying support in Washington. They didn’t seem to inquire whether the investment was safe or profitable…they wanted to do business with Goldman Sachs.

  5. jlr says:

    P.T. Barnum’s famous quip fits here.

    However, the welfare of sharks hardly merits concern. Likewise, how much must we be troubled by the mistakes of stupid people?

    We can hate sharks, but the stupid can often be seriously damaging to civilization.

    In other words, perhaps the blame and the judgment should cut both ways in the case at hand.

    The LIA may only be entitled to half in refund from GS. The high stupidity on the one part may just balance the high greed on the other.

  6. fallingman says:

    Aaaaand, it’s gone!

    Why anybody would deal with Goldman is beyond me. The sucker at the table is YOU, by definition.

    I guess that’s why they try to find rubes … uh, I mean. muppets… to face rip. Scum.

    I guess it’s safe to say those speeches Hillary gave to GS for hundreds of thousands contained a lot of really valuable insights and advice, just not all that much about business ethics.

  7. Dean C Brunel says:

    During the 19th century, American bankers, including J.P. Morgan set up elaborate transactions, some of which were “legitimised ” by such noble persons as Daniel Webster, the great lawyer and statesman who was in the pocket of Morgan.The U.S. government then passed legislation that delegitimized large complex trusts and anti competitive agglomerates.The number of bankruptcies went through the ceiling,eventually causing the great depression, where everyone gambled on the prediction (faith) that the markets would continue to expand for ever and ever.The poor, stupid , ignorant Lybians never stood a chance against the firebrands of the West.What can be done? Did the defendants break American laws? Defendants will introduce exculpatory documents and witnesses who will will testfy against the small traders whose lifestyles were corrupted by G.S.I hope that the court considers the fact that the Libyans and those in GS, breached and twisted the norms of the strict Islamic code, which , if followed, would have prevented much of the chaos.No wonder our reputation is so devalued in the Middle East. What country is next?

  8. HR says:

    I think that both parties are st fault
    However GS is certainly sophisticated at taking money in any manner they can
    So with no more facts, If I were the judge I would award against GS

  9. Kent says:

    If Lybia “lost” 1.2B (- $350M for fees, of course…), someone(s) made $850M, no??!! Any “bets” on how much the right hand of GoldmanSacs &/or close friends kept in their pockets (I’ll reserve the left hand for the salesperson), yes??!!

  10. Rick Yearout says:

    Maybe they will get fined a heavy .00125% like last time.
    Like they admit it is just “the cost of doing business”

    Guilty as charged, but Goldman’s generals will skate
    free once again.

  11. Alexander Vago says:

    Dear Shah Gilani, i am new to your [intro “public commentations”, and “M.M.”] and have only taken a quick glance at some of your headlines; though I look forward to following your work seriously soon. Thank you for great reporting/observations on a matter of such importance (in the category), which I was unaware of. It is unbiased objective analysis like yours, that gives some hope for the “little guy” that there may yet still be “truth” and integrity in the investment world…with individuals as yourself (who “give a damn”, pardon the strong language, enough to make the efforts to uncover it, and share it in conscience. God Bless you in these tumultous times! ~Alex Vago

  12. Paul says:

    First Doc Brown hi-jacks their plutonium to soup up his DeLorean and now this.
    Those poor Libyans can’t catch a break.

  13. Herman Sudholz says:

    Why do I smell a Clinton connection here? No reason to attack Lybia, speech to Goldman not made public, Undue Influence?? Smells to me

  14. BrianRemer says:

    The bank had a fiduciary duty to its client. Of course banks often ignore their duty without recourse. Ethics is just a course in college and has no meaning and holds no value. Corporations are legally persons but immune from the consequences of their illegal behavior that real persons would face. Wonderfully lopsided.

  15. Spark says:

    So, is the super salesman retired with millions in some bank (better be careful what bank these days)? Where does one get a job that consists of wining and dining and hiring ladies of the evening. In my sales position I actually have to know something.

  16. Alan Steinbronn says:

    There’s a common sense approach whenever one does ANY transaction.

    The approach is known as ‘BUYER BEWARE’.

    Sorry, LIA – you lose due to your own lack of ‘common sense’.

    And I wouldn’t be surprised at all to know the judge laughed out loud seeing the LIA dragging their STUPIDITY into the public eye.

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