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Goldman Sachs accused of defrauding investors in mortgage securities

April 16, 2010
  • Goldman Sachs & Co. Chief Executive Officer Lloyd Blankfein testifies on Capitol Hill in Washington before the House Financial Services Committee in February 2009. The government has accused Goldman Sachs of defrauding investors by failing to disclose conflicts of interest in mortgage investments it sold as the housing market was faltering.
Associated Press,

WASHINGTON (AP) -- The government has accused Goldman Sachs & Co. of defrauding investors by failing to disclose conflicts of interest in mortgage investments it sold as the housing market was collapsing.

The Securities and Exchange Commission said in a civil complaint Friday that Goldman failed to disclose that one of its clients helped create -- and then bet against -- subprime mortgage securities that Goldman sold to other investors.

The SEC said the fraud, a blow to the reputation of Wall Street's most powerful firm, was orchestrated in 2007 by a Goldman vice president then in his late 20's. The employee, Fabrice Tourre, has since been promoted to executive director of Goldman Sachs International in London.

Tourre, the SEC said, boasted to a friend that he was able to put such deals together as the mortgage market was unraveling in early 2007.

In an email to the friend, he described himself as "the fabulous Fab standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstrosities!!!"

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A call to a lawyer for Tourre, Pamela Chepiga at Allen & Overy LLP, wasn't returned.

Two European banks that bought the securities lost nearly $1 billion, the SEC said. The agency is seeking to recoup profits reaped on the deal

Goldman Sachs denied the allegations. In a statement, it called the SEC's charges "completely unfounded in law and fact" and said it will contest them.

Goldman, founded more than 140 years ago, built a reputation as a trusted adviser to its investment banking clients. In recent years, it shifted toward taking more risks with its clients' money and its own. Goldman's trading allowed the firm to weather the financial crisis better than most other big banks.

It earned a record $4.79 billion in the last quarter of 2009.

The SEC's enforcement chief said the agency is investigating a wide range of practices related to the crisis. The prospect of possible legal jeopardy for other major financial players roiled the stock market.

Goldman Sachs shares fell more than 12 percent. The Dow Jones industrial average sank more than 120 points in late-day trading.

The charges come as lawmakers seek to crack down on Wall Street practices that helped cause the financial crisis. Among proposals Congress is weighing are tougher rules for complex investments like those involved in the alleged Goldman fraud.

The Goldman client implicated in the fraud is one of the world's largest hedge funds, Paulson & Co. The SEC said it paid Goldman roughly $15 million in 2007 to put together an investment offering that was tied to mortgage-related securities the hedge fund viewed as likely to decline in value.

Separately, Paulson took out a form of insurance that allowed it to make a huge profit when those securities became nearly worthless.

ABN Amro, a major Dutch bank, was the biggest loser in the securities, having paid Goldman $841 million, according to the SEC. And IKB Deutsche Industriebank AG, a German commercial bank, lost nearly all its $150 million investment, the agency said. Most of the money they lost went to Paulson in a series of transactions between Goldman and the hedge fund, the SEC said.

The civil lawsuit filed by the SEC in federal court in Manhattan was the government's most significant legal action related to the mortgage meltdown that ignited the financial crisis and helped plunge the country into recession. Financial analysts said it's dealt a setback to Goldman's standing.

"It undermines their brand," said Simon Johnson, a professor at the Massachusetts Institute of Technology and a Goldman critic. "It undermines their political clout. I don't think anybody really values being connected to Goldman at this point."

He continued: "There are many people who -- until this morning -- thought Goldman Sachs was well-run."

The SEC is seeking unspecified fines and restitution from Goldman Sachs and Tourre.

Asked why the SEC did not also pursue a case against Paulson, Enforcement Director Robert Khuzami said: "It was Goldman that made the representations to investors. Paulson did not."

Paulson & Co. is run by John Paulson, who reaped billions by betting against subprime mortgage securities. He is not related to former Treasury Secretary Henry Paulson.

In a statement, Paulson & Co. said: "As the SEC said at its press conference, Paulson is not the subject of this complaint, made no misrepresentations and is not the subject of any charges."

Goldman told investors that a third party, ACA Management LLC, had selected the pools of subprime mortgages it used to create what are known as synthetic collateralized debt obligations. But, the SEC alleges, Goldman misled investors by failing to disclose that Paulson & Co. also played a role in selecting the mortgage pools and stood to profit from their decline in value.

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