SEC accuses Goldman Sachs of civil fraud

SEC accuses Goldman Sachs of civil fraud

By Zachary A. Goldfarb
Washington Post Staff Writer
Friday, April 16, 2010; 2:36 PM

The Securities and Exchange Commission filed fraud charges Friday against Goldman Sachs, one of the most successful but vilified banks on Wall Street, for allegedly selling investors a financial product based on subprime mortgages that was secretly designed to lose value.

In filing the civil suit against Goldman Sachs, the agency is targeting one of the banks that largely escaped the wreckage of the financial crisis, and with the help of taxpayer bailouts, emerged stronger.

The SEC's suit strikes at a practice that was one of the main causes of the financial crisis: the creation of poisonous investments derived from home loans made to borrowers who couldn't afford the houses they were buying.

The suit also drags into a legal maelstrom Paulson & Co., the firm of legendary hedge fund manager John Paulson, who made billions of dollars by betting against the housing market in the years before it went bust. He and his firm have not been accused of wrongdoing.

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

Paulson & Co. also had no immediate comment.

In this case, the SEC alleges that Goldman Sachs created and marketed a financial product known as a collateralized debt obligation, often referred to as a CDO, whose value was linked to that of home loans. The SEC says the bank failed to tell investors important information about the investment -- in particular that Paulson & Co. played a central role in helping Goldman assemble the CDO while the hedge fund at the same time placed bets that the CDO would lose value.

"The product was new and complex but the deception and conflicts are old and simple," said Robert Khuzami, director of the Division of Enforcement. "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."

The suit, filed in federal court in Southern District of New York, alleges that Paulson & Co. paid Goldman Sachs to create a product which would allow the firm to bet against subprime mortgage securities it believed would lose value.

The bank created the CDO, which was known as ABACUS 2007-AC1, and began to market it to investors who wanted to bet that the housing and subprime mortgage would continue to boom.

But, according to the SEC, the bank didn't tell investors that Paulson & Co. had helped formulate the CDO by encouraging the purchase of subprime mortgages that would likely lose value.

The SEC alleges that a Goldman Sachs vice president, Fabrice Tourre, was principally responsible for putting together the CDO. He also faces civil charges.

According to the SEC, the CDO was created on April 26, 2007, just as the housing market began to falter. Paulson & Co. paid Goldman Sachs $15 million for structuring and marketing the CDO. Investors in the CDO lost more than $1 billion, according to the agency.

If the conduct alleged by the SEC went beyond this specific instance and was common on Wall Street, this could upend a popular notion about the causes of the financial crisis. It would mean bankers may have been intentionally creating toxic assets, only looking to generate fees for their employers and bonuses for themselves without worrying about whether it would cost their investors or clients or pose a risk to the nation's financial markets.

The prevailing view about the roots of the financial crisis has been that Wall Street's biggest banks, perhaps ignoring common sense, bought into the widespread notion that housing prices would continue to rise for the foreseeable future, and that these firms were as surprised as anyone at the sudden collapse in the housing market. Banks and other financial firms ended up in peril because of all the toxic mortgage-related assets on their books.

But according to the SEC, Goldman knew that it was creating a toxic investment.