Goldman charged with mortgage fraud

A plaque for investment banking giant Goldman Sachs at a press conference in Hong Kong.

It's official: the Securities and Exchange Commission is done playing nice with Wall Street banks. This morning, it accused the investment bank of fraud, dropping its first civil suit against investors who have directly profited off the fallout of the housing market.

The company's stock dropped more than 14 percent in morning trading after the SEC released the charges.

In a court document, the SEC charged Goldman Sachs with "making materially misleading statements and omissions in connection with a synthetic collateralized debt obligation ("CDO") Goldman Sachs & Co. structured and marketed to investors."

SEC Enforcement Director Robert Khuzami explained the decision in a phone conference with the press this morning: "As we've said, we continue to examine structured products and other instruments that contributed to the financial crisis and that remains the case."

Goldman responded to the allegations in a statement. "The SEC's charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation."

In 2007, Goldman sold investors a financial product made up of mortgage-backed securities, which were selected by an outside hedge fund called Paulson & Co. What investors didn't know, but the SEC says the bank did know, is that the hedge fund was shorting those mortgage-backed securities. In other words, they had in interest in those securities losing value, but the investors wanted them to go up in value. In the end, investors lost more than a billion dollars while Paulson & Co. made about that much on the transaction.

"If the facts are as they alleged, this is an egregious conflict of interest and I don't really know how anyone could seriously argue otherwise."
said Boston University School of Law Professor Cornelius Hurley. "The fact that the Goldman Sachs stock plummeted on the revelation of these charges kind of indicates the consensus on that."

Although hedge fund manager Paulson was highlighted in the suit, it was Goldman that was charged.

"It was Goldman that made the representations to investors," said Khuzami. "Paulson did not. We charged those that we felt appropriate based on the evidence in the law."

Khuzami said the SEC will move forward examining questionable products and practices in the financial crisis. "If we find structures or deals or arrangements that share similar profiles to this one as well as other structures or transactions that violate the securities laws," he said, "We will pursue them aggressively."

The accused product: Abacus 2007-AC1

The New York Times reports a focal point of the case was a bond package known as "Abacus 2007-AC1", and named Goldman Vice President Fabrice Tourre as well as notable hedge fund manager John A. Paulson, who made billions in 2007 for his wagers that the housing bubble would burst:

Goldman let Mr. Paulson select mortgage bonds that he wanted to bet against -- the ones he believed were most likely to lose value -- and packaged those bonds into Abacus 2007-AC1, according to the S.E.C. complaint. Goldman then sold the Abacus deal to investors like foreign banks, pension funds, insurance companies and other hedge funds. But the deck was stacked against the Abacus investors, the complaint contends, because the investment was filled with bonds chosen by Mr. Paulson as likely to default. Goldman told investors in Abacus marketing materials reviewed by The Times that the bonds would be chosen by an independent manager.

In November 2008, Paulson discussed the mortgage crisis with the House Committee on Oversight and Government Reform. Paulson made a $15 million contribution to the Center for Responsible Lending for the housing crisis in July 2007.

About the author

Jeremy Hobson is host of Marketplace Morning Report, where he looks at business news from a global perspective to prepare listeners for the day ahead.

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