Goldman Sachs Accused by SEC of Civil Fraud on Mortgage-Backed CDOs

The government has accused Goldman Sachs of failing to disclose conflicts of interest in mortgage investments it sold as the housing market was waning.

(April 16, 2010) — The U.S. Securities and Exchange Commission (SEC) has accused Goldman Sachs & Co. of fraud in failing to disclose conflicts in mortgage securities, which cost investors more than $1 billion and fueled the worst financial crisis since the Great Depression. While the housing market crumbed, Goldman profited by betting against the mortgage investments it marketed to its customers.

Pension funds were often the purchasers of faulty CDOs, resulting in a trend of pension funds suing financial institutions since the economic crisis. In early January, for example, a Virgin Islands pension fund sued Morgan Stanley over CDO sales, claiming the Wall Street bank marketed $1.2 billion of risky mortgage-related notes that it believed would fail.

Following the SEC’s announcement today, Goldman Sachs shares fell about 13% but gained ground in evening trades after the investment bank continued to respond to its fraud charge.

The SEC’s complaint, filed in the U.S. District Court for the Southern District of New York, states that Goldman failed to disclose that one of its clients — Paulson & Co. — helped create and then bet against subprime mortgage securities that the New York-based firm sold to investors. Paulson & Co., one of the world’s largest hedge funds run by the billionaire John Paulson, paid Goldman about $15 million for structuring the deals in 2007. Paulson has not been charged.

The SEC alleged Goldman, led by CEO Lloyd Blankfein, failed to reveal “vital information” about a synthetic collaterized debt obligation, called ABACUS. The regulator additionally charged Goldman Vice President Fabrice Tourre, a 31-year-old French graduate of Stanford who has worked at Goldman since July 2001. The complaint alleges Tourre was responsible for creating ABACUS with help from Paulson & Co. According to the  SEC complaint, Tourre, who called himself “The Fabulous Fab,” sent an email to a friend on January 23, 2007 warning about the upcoming collapse in the subprime mortgage securities market:

“More and more leverage in the system. The whole building is about to collapse anytime now… Only potential survivor, the fabulous Fab[rice Tourre]… standing in the middle of all these complex, highly leveraged exotic trades he created without necessarily understanding all of the implications of those monstrosities!!!”

“The product was new and complex but the deception and conflicts are old and simple,” SEC Enforcement Director Robert Khuzami said in a statement. “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.”

In response, Goldman Sachs called the SEC’s charges “completely unfounded in law and fact.” “We will vigorously contest them and defend the firm and its reputation,” the Wall Street behemoth said in a statement.

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