Posted on 30 Apr 2010
The Securities and Exchange Commission has referred its investigation of Goldman Sachs to the Justice Department for possible criminal prosecution, less than two weeks after filing a civil securities fraud case against the firm, according to a source familiar with the matter.
Any probe by the Justice Department, if underway, would be in a preliminary stage. No Goldman Sachs employees involved in the mortgage-related transactions that are the focus of the SEC case have been interviewed by Justice Department prosecutors or the FBI agents who often conduct probes on behalf of prosecutors, according to a source familiar with the matter. The sources spoke on the condition of anonymity because they were not authorized to discuss the matter publicly.
The Justice Department usually investigates high-profile cases of securities fraud, but the threshold for criminal prosecution is significantly higher than that of civil cases. The SEC files only civil cases.
The Wall Street Journal and Bloomberg News reported Thursday night that the U.S. attorney's office in Manhattan had followed up on the request and opened a criminal probe. The office declined to comment.
"Given the recent focus on the firm, we're not surprised by the report of an inquiry," said Goldman spokesman Lucas Van Praag. "We would cooperate fully with any request for information."
Although the SEC frequently sends its cases to the Justice Department for possible criminal prosecution, the stakes are higher because the Goldman case involves one of Wall Street's most storied firms, a business that had survived the financial crisis with its profitability intact but now faces accusations that it misled clients.
It is rare for the government to indict a company, and even the threat of criminal prosecution can doom a business. A criminal investigation destroyed the Wall Street firm Drexel Burnham Lambert in the 1980s even though the firm settled with authorities.
And although the Supreme Court ultimately overturned the conviction, accounting firm Arthur Andersen collapsed after facing criminal charges in connection with corporate corruption at Enron in 2002.
In that case, the justices said that lower courts had given juries far too broad guidelines by which to decide whether to convict the company. The decision, lawyers at the time said, would make it more difficult for prosecutors to bring criminal cases against corporations.
The SEC says that Goldman and employee Fabrice Tourre broke the law and committed fraud when they sold clients a complex investment linked to the value of home loans that was secretly designed to fail. Another firm, Paulson & Co., a hedge fund, helped Goldman create the investment and planned to bet against it. But the SEC says the relationship was not disclosed to Goldman's clients, ACA Financial Guaranty and the German bank IKB.
Goldman and Tourre have denied any wrongdoing. Goldman says that ACA and IKB were sophisticated investors and that disclosure of Paulson's role was not required.
Proving a criminal case could be challenging given that prosecutors must show "beyond a reasonable doubt" that Goldman and its employees committed fraud, compared with the threshold for a civil case, which requires a "preponderance of evidence."
Under civil law, the SEC does not have to prove that Goldman set out to defraud investors -- only that it did. But criminal law would require prosecutors to show that Goldman maliciously planned to mislead its investors.
Since the SEC filed its lawsuit this month, securities lawyers have debated the merits of the agency's case. Most agree that it represents an ambitious legal theory, saying the bar to show that Paulson's role was relevant would be high because the financial firms involved were big and engaged in speculative betting.
Goldman also says ACA was told about Paulson's role, and the firm has written a letter to its investors strongly suggesting that was the case.
The Justice Department suffered a setback this year when a case against two Bear Stearns hedge fund managers failed. A jury rejected securities fraud charges against the hedge fund managers, who ran funds linked to subprime mortgages, after presenting evidence that the men knew about risks but did not disclose these to investors.
The SEC is still pursuing the Bear Stearns case.