SEC Charges Goldman Sachs With Fraud
The Securities and Exchange Commission on Friday charged Wall Street’s most gilded firm, Goldman Sachs, with defrauding investors in a sale of securities tied to subprime mortgages.
The SEC said it charged New York-based Goldman (GS, Fortune 500) and a vice president, Fabrice Tourre, for their failure to disclose conflicts in a 2007 sale of a so-called collateralized debt obligation. Investors in the CDO ultimately lost $1 billion, the SEC said.
The SEC’s civil fraud complaint alleges that Goldman allowed hedge fund Paulson & Co. — run by John Paulson, who made billions of dollars betting on the subprime collapse — to help select securities in the CDO.
Goldman didn’t tell investors that Paulson was shorting the CDO, or betting its value would fall. When the CDO’s value plunged within months of its issuance, Paulson walked off with $1 billion, the SEC said.
“The product was new and complex but the deception and conflicts are old and simple,” said Robert Khuzami, director of the Division of Enforcement for the SEC.
A Goldman spokesman didn’t immediately return a call seeking comment.
Goldman shares tumbled 10% in midmorning trading on the SEC charge, and the shares of JPMorgan Chase (JPM, Fortune 500), Citigroup (C, Fortune 500), Morgan Stanley (MS, Fortune 500) and other big banks declined between 2% and 3%.
Khuzami said the case was the first brought by a new SEC division investigating the abuses of so-called structured products such as CDOs in the credit crisis. He said the investigation continues but declined to comment further.
“We continue to examine structured products that played a role in the financial crisis,” Khuzami said in a phone call with reporters. “We are moving across the entire spectrum of products, entities and investors that might have been involved.”
The SEC alleged that Paulson & Co. paid Goldman Sachs approximately $15 million for structuring and marketing the deal, known as Abacus 2007-AC1. Paulson & Co. wasn’t immediately available for comment.
A CDO is a financial instrument backed by pool of assets, typically loans or bonds. In this case, the instrument in question is a so-called synthetic CDO — which is backed not by actual loans but by a portfolio of credit default swaps referencing residential mortgage-backed securities.
While many CDO deals performed poorly, particularly in the latter stages of the housing bubble, the Abacus CDO at the center of this case blew up particularly quickly.
Within six months of the deal’s closing, 83% of the residential mortgage-backed securities in the portfolio had been downgraded, the SEC said. Within nine months, 99% had been downgraded.
Khuzami said the SEC is entitled to disgorgement of ill-gotten gains as well as penalties that will be considered “at the appropriate time.”