Goldman Sachs was accused by the US Securities and Exchange Commission on Friday of defrauding investors by misleading them about subprime mortgage products.
In filing civil charges, the SEC alleged Goldman and one of its vice-presidents failed to disclose crucial information about a synthetic collateralised debt obligation (CDO) product that it structured to reflect the performance of the residential mortgage-backed securities (RMBS) market.
The regulator said that Goldman allowed Paulson & Co, a hedge fund, to influence the portfolio selection process while betting against the CDO.
??The product was new and complex but the deception and conflicts are old and simple,? said Robert Khuzami, director of the SEC??s 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 SEC said that Paulson shorted the RMBS portfolio that it helped create by entering into credit default swaps with the bank to buy protection against specific layers of the CDOs. It said that Goldman misled investors because it did not divulge Paulson & Co??s role in the ??term sheet, flip book, offering memorandum, or other marketing materials provided to investors?. Paulson has not been charged by the SEC.
The SEC alleged that Fabrice Tourre, a Goldman vice-president, who was responsible for the CDO, known as Abacus, prepared the marketing materials and told investors that the underlying RMBS portfolio was selected by ACA Management, a third-party RMBS expert.
According to the regulator, Paulson & Co. paid Goldman approximately $15m for structuring and marketing Abacus. By October 24 2007, 83 per cent of the RMBS in the Abacus portfolio had been downgraded and 17 per cent were on negative watch. By January 29 2008, 99 per cent of the portfolio had been downgraded.
Investors in the liabilities of Abacus are alleged to have lost more than $1bn, the SEC said.
In February, the SEC asked Paulson & Co, which is run by John Paulson, for information relating to its CDO probe.
Shares of Goldman Sachs fell by more than 13 per cent to $160 after the SEC made the announcement.
In a statement, Goldman said: ??The SEC??s charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation.??
