TAG | Paulson & Co.
The Securities and Exchange Commission on Friday, April 16, 2010, charged Goldman Sachs, with defrauding investors in a sale of securities tied to subprime mortgages.
The SEC said it charged New York-based Goldman Sachs and a vice president, Fabrice Tourre, for failure to disclose conflicts in a 2007 sale of a collateralized debt obligation. Investors in the CDO lost over $1 billion, the SEC said.
The SEC’s civil fraud complaint alleges that Goldman Sachs did allow the hedge fund Paulson & Co. — run by John Paulson, who made billions betting on the subprime collapse — to help select securities in the CDO.
Goldman Sachs didn’t tell investors that Paulson was shorting the CDO, or betting its value would fall. The CDO’s value plunged within months of its issuance, and Paulson walked off with $1 billion, the SEC said.
“The product was new and complex but the deception and conflicts are old and simple,” said Robert Khuzami, director of the Division of Enforcement for the SEC.
Goldman Sachs said that “the SEC’s charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation.”
Goldman Sachs shares fell 13% following the announcement, wiping out $12 billion of shareholder value. Shares of Deutsche Bank, another big player in the structured securities markets of the bubble era, slid 8%.
“This litigation exposes the cynical, savage culture of Wall Street that allows a dealer to commit fraud on one customer to benefit another,” Chris Whalen, a bank analyst at Institutional Risk Analytics, said in a note to clients Friday.
Khuzami said the case was the first brought by a new SEC division investigating the abuses of structured products such as CDOs in the credit crisis. He said the investigation continues but declined to comment further.
“We continue to examine structured products that played a role in the financial crisis,” Khuzami said in a phone call with reporters. “We are moving across the entire spectrum of products, entities and investors that might have been involved.”
The SEC alleged that Paulson & Co. paid Goldman Sachs approximately $15 million for structuring and marketing the deal, known as Abacus 2007-AC1.
Khuzami said Paulson wasn’t charged because, unlike Goldman Sachs, which sold the securities to investors, it didn’t have a duty to fully disclose conflicts to other investors.
A CDO is a financial instrument backed by pool of assets, usually loans or bonds. In this case, the instrument in question is a so-called synthetic CDO — which is backed not by actual loans but by a portfolio of credit default swaps referencing residential mortgage-backed securities.
While many CDO deals performed poorly, particularly in the latter stages of the housing bubble, the Abacus CDO at the center of this case blew up particularly quickly.
Within six months of the deal’s closing, 83% of the residential mortgage-backed securities in the portfolio had been downgraded, the SEC said. Within nine months, 99% had been downgraded reported Colin Barr, senior writer for Fortune magazine.
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