Posted on 16 Apr 2010
The Securities and Exchange Commission on Friday charged Goldman Sachs Group Inc. with defrauding investors by misstating and omitting key facts about a financial product tied to subprime mortgages, in a civil lawsuit that is one of the biggest moves by authorities in response to the financial crisis of 2007-08.
Goldman's stock price fell sharply after the news. The Wall Street firm's share price was down more than 14% in midday trading.
The SEC said Goldman Sachs structured and marketed a synthetic collateralized debt obligation, or CDO, that hinged on the performance of subprime residential mortgage-backed securities.
The CDO was structured and marketed by Goldman in early 2007 when the U.S. housing market and related securities were beginning to show signs of distress, the SEC complaint said.
Goldman Sachs said that the SEC's charges are completely unfounded.
According to the SEC, Goldman Sachs failed to disclose to investors vital information about the CDO, in particular the role that a major hedge fund played in the portfolio selection process and the fact that the hedge fund had taken a short position against the CDO.
"Undisclosed in the marketing materials and unbeknownst to investors, a large hedge fund, Paulson & Co. Inc., with economic interests directly adverse to investors in the [CDO], played a significant role in the portfolio selection process," the complaint said.
Paulson didn't respond to a request for comment.
"The product was new and complex but the deception and conflicts are old and simple," said SEC enforcement chief Robert Khuzami.
"Goldman wrongly permitted a client that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio, while telling other investors that the securities were selected by an independent, objective third party," Mr. Khuzami said.
The SEC also named Goldman employee Fabrice Tourre in the complaint, saying he was "principally responsible" for creating the CDO.
The Goldman complaint is part of the SEC's investigation into investment banks and others that securitized complex financial products tied to the U.S. housing market as it was beginning to show signs of distress, according to Kenneth Lench, chief of the SEC's Structured and New Products Unit.
U.S. investigators have said they are pursuing cases connected to the collapse of the subprime-mortgage market and the broader problems that engulfed Wall Street in 2008, resulting in the bankruptcy of Lehman Brothers and the government takeover of some leading financial institutions.
Until now, relatively few major figures or companies have been hit with civil or criminal charges. The SEC filed civil fraud charges last June against former Countrywide Financial Corp. Chief Executive Angelo Mozilo, saying he hid information that the company was facing dangers from high-risk lending practices.
Mr. Mozilo has mounted a vigorous defense. His lawyers say he did nothing wrong and accused the SEC of taking statements by Mr. Mozilo out of context.
In February, the SEC settled with State Street Corp. on charges that the bank misled investors about its exposure to subprime mortgages. In that case, the SEC said the bank selectively disclosed information about its subprime mortgage investments to specific investors.