SEC Charges Wall Street Behemoth Goldman Sachs With Fraud

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Investment giant Goldman Sachs and one of its vice presidents, Fabrice Tourre, have been charged with defrauding investors. The Securities and Exchange Commission brought the civil fraud complaint, which accuses the firm and Tourre of failing to disclose a conflict of interest during the 2007 sale of a “synthetic” collateralized debt obligation (CDO)–in this case, a portfolio consisting of mortgage-backed securities.

According to the complaint, Goldman let Paulson & Company, a hedge fund run by John Paulson, who made billions of dollars during the subprime mortgage collapse, choose the securities that would be included in the CDO. Yet Paulson, whose company paid Goldman Sachs approximately $15 million for structuring and marketing the deal, had cherry-picked the securities he thought most likely to fail—and fail they did. Within nine months of the deal’s closing, 99 percent of the residential mortgage-backed securities in the portfolio had been downgraded. Goldman and Paulson, who had bought credit default insurance on the mortgage bonds, cashed in, walking off with $1 billion in investor money.

Goldman is being charged because it did not disclose Paulson’s involvement to investors, despite having a legal obligation to do so. Paulson, however, had no obligation to disclose the conflict, and therefore was not charged by the SEC. Paulson & Co. issued a statement in which it emphasized that it “is not the subject of the complaint, made no misrepresentations and is not the subject of any charges.”

This marks the first case brought by a new division within the SEC, which is investigating abuses of structured products like CDOs during the credit crisis. CDOs are typically backed by actual assets, such as bonds or loans, and deals involving them have traditionally performed poorly, especially during the recent housing crisis. Yet the Paulson-Goldman CDO, known as Abacus 2007-AC1, had a particularly spectacular flame-out.

A former SEC enforcement attorney said that proving Goldman Sachs’ liability would depend on a number of factors, including the extent of information provided to the investors, the investors’ own sophistication about CDOs, and the fiduciary duties that Goldman owed them.

Shares of the investment firm fell 13 percent after the announcement, wiping out $12 billion of shareholder value. Other big banks and investment firms such as Deutsche Bank, JPMorgan Chase, Citigroup and Morgan Stanley also saw their stocks drop in the wake of the SEC’s actions.

The director of the Division of Enforcement for the agency, Robert Khuzami, said that the investigation is ongoing. “We continue to examine structured products that played a role in the financial crisis,” said Khuzami.

In a statement, Goldman Sachs claimed that “the SEC’s charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation.”

 

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