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Goldman Fights Back, Denies Fraud Charges and Reaches Out to Clients

Source: WSJ

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Posted on 19 Apr 2010

Goldman Sachs Group Inc. is mobilizing for a counterattack against the U.S. government's fraud accusations amid mounting concerns the firm could lose business to Wall Street rivals.

On Sunday, the New York company again denied the Securities and Exchange Commission's allegations that it duped clients by selling them a financial instrument secretly designed by hedge-fund firm Paulson & Co., which then made a $1 billion profit by betting on the deal's downfall.

Goldman said all three firms that participated in the deal the SEC is probing were sophisticated investors and had a hand in selecting the mortgages they subsequently bet on. Goldman added that it wasn't required to disclose who provided input into the mortgage-selection process or what views their clients were taking on the portfolio.

"As normal business practice, Goldman does not disclose the identities of a buyer to a seller and vice versa, and the suit is unfounded in law and fact," a Goldman spokesman said.

On Sunday, U.K. Prime Minister Gordon Brown said he would instruct the Financial Services Authority to conduct an immediate special investigation into how Goldman's alleged actions affected British banks. "There is a moral bankruptcy reflected in what I am reading about and hearing about," Mr. Brown told the BBC's Andrew Marr show.

There were few signs Sunday the crisis is forcing executives to launch a large-scale damage-control campaign with customers and shareholders, though Goldman on Friday emailed its staff and its sprawling "alumni network," which includes many hedge-fund clients, and was in contact with clients all weekend, trying to dispel any concerns.

The mess is especially awkward for Goldman's powerful chairman and chief executive, Lloyd C. Blankfein, and close friend Gary D. Cohn, president and chief operating officer at the firm. Both men pushed hard as Goldman evolved over roughly the past decade from an elite private partnership with a reputation as a sober adviser on corporate mergers to a take-no-prisoners public company increasingly focused on using its own capital to drive its business for clients and its own accounts.

Mr. Cohn turned the once-sleepy mortgage department into a major trading operation, putting the firm's capital to work for clients, buying assets and reselling them later, often for a tidy profit. By last year, investment banking generated just 11% of Goldman's net revenue of $45.17 billion, down from 33% in 1999, the year the company went public. In 2009, Goldman got nearly 90% of its $19.83 billion in pretax earnings from trading and principal investments.

According to Goldman's latest proxy statement, Messrs. Blankfein and Cohn each had total compensation of more than $50 million in 2007, the year the $2 billion financial instrument called Abacus 2007-AC1 was created. Goldman was paid $15 million to arrange the deal but suffered a $90 million loss after taking a bullish position on it.

Although news of the SEC's allegations wiped more than $12 billion off of Goldman's stock-market value, neither executive's job appears to be jeopardy. Goldman's board has embraced the firm's overhaul under Mr. Blankfein and his predecessors. Messrs. Blankfein and Cohn weren't named in the complaint, and it was unclear whether they knew about the trade. The SEC hasn't alleged that they knew.

In addition, no direct link has surfaced connecting the firm's top two executives to the collateralized debt obligation. Messrs. Blankfein and Cohn weren't part of a Goldman management committee that was sent a company memo in 2007 describing the deal, according to people familiar with the matter.

Still, Mr. Blankfein and other top Goldman executives can expect to be grilled by analysts and lawmakers this week and next. Goldman is scheduled to report first-quarter earnings Tuesday, followed by an analysts' conference call led by Chief Financial Officer David Viniar.

Mr. Blankfein is set to testify in general terms about the financial crisis to the Senate Permanent Subcommittee on Investigations on April 27, people familiar with the matter said. The Democratic-led panel has been hostile territory for financial executives, including former Washington Mutual Inc. CEO Kerry Killinger.

Some financial-services industry experts said the SEC's accusations could be impossible for Goldman to overcome no matter how hard it tries.

"Even if unfounded...the impact is profound," said Dee Soder, an executive coach in New York whose clients include financial executives. Goldman has thousands of clients and counterparties in its role as adviser, asset manager, financier, investor, market maker and trader.Brad Hintz, an analyst at Bernstein Research, estimated Friday that the SEC's lawsuit could cost Goldman as much as $706.5 million in civil fines and investor payments.

"And even at this point, for some new business it might take a little extra dancing," said Robbie Vorhaus, a crisis and reputation adviser in New York.


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