U.S. charges Goldman with subprime fraud
Goldman Sachs: Charges ‘unfounded’ and it will ‘defend the firm’
By Jonathan Stempel and Steve Eder
updated 1 hour, 32 minutes ago
WASHINGTON - Goldman Sachs Group Inc was charged with fraud by the Securities and Exchange Commission over its marketing of a subprime mortgage product designed to fail.
The civil lawsuit is the biggest crisis in years for Goldman, which emerged from the global financial meltdown as Wall Street's most influential bank.
It is also a huge test for Chief Executive Lloyd Blankfein, who has faced a firestorm of criticism over the bank's pay and business practices, and it comes as lawmakers in Washington debate sweeping reform of financial industry regulation.
The case has also ensnared John Paulson, a hedge fund investor whose firm Paulson & Co made billions of dollars by betting the nation's housing market would crash. This included an estimated $1 billion from the transaction detailed in the SEC lawsuit, which the agency said cost other investors more than $1 billion.
Fabrice Tourre, a Goldman vice president who the SEC said was mainly responsible for creating the questionable mortgage product, known as ABACUS, was also charged with fraud.
Goldman vowed to defend itself.
"The SEC's charges are completely unfounded in law and fact," it said. "We will vigorously contest them and defend the firm and its reputation."
In its lawsuit, the SEC alleged that Goldman structured and marketed ABACUS, a synthetic collateralized debt obligation that hinged on the performance of subprime residential mortgage-backed securities.
It alleged that Goldman did not tell investors "vital information" about ABACUS, including that Paulson & Co was involved in choosing which securities would be part of the portfolio.
It also alleged that Paulson took a short position against the CDO in a bet that its value would fall.
Paulson & Co said it did buy credit protection from Goldman on securities issued in the ABACUS program, but did not market the product. Tourre was not immediately available for comment.
Shares of Goldman fell as much as 15.6 percent, and dragged broad U.S. stock indexes lower.
"These charges are far more severe than anyone had imagined," and suggest Goldman teamed with "the leading short-seller in the industry to design a portfolio of securities that would crash," said John Coffee, a securities law professor at Columbia Law School in New York.
"The greatest penalty for Goldman is not the financial damages -- Goldman is enormously wealthy -- but the reputational damage," he said, adding that "it's not impossible" to contemplate that the case could lead to criminal charges. Coffee spoke on Reuters Insider.
Goldman had not disclosed that the SEC was considering a lawsuit but had known charges were possible and had urged the SEC not to file them, people familiar with the situation said on Friday. The sources requested anonymity because the probe was not public.
Coming out swinging
The lawsuit is a regulatory and public relations nightmare for Blankfein, who has spent 18 months fending off complaints that Goldman is an unfair beneficiary of taxpayer bailouts of Wall Street. He became chief executive less than a year before the product challenged by the SEC was created.
"This could be the beginning of a period where you have a regulatory cloud over Goldman Sachs, and perhaps even the entire investment banking industry," said Hank Smith, chief investment officer at Haverford Trust Co in Philadelphia.
John Paulson is not related to Henry "Hank" Paulson, who was Blankfein's predecessor as Goldman CEO and later become U.S. Treasury secretary.
The SEC lawsuit represents an aggressive expansion of regulatory efforts to hold people and companies responsible for the nation's financial crises. It could help the SEC rehabilitate its reputation after missing other high-profile cases, including Bernard Madoff's Ponzi scheme.
"The SEC has come out swinging," said Cary Leahey, senior managing director of Decision Economics in New York.
Robert Khuzami, head of the SEC's enforcement division, said John Paulson was not charged because it was Goldman that made misrepresentations to investors, not Paulson.
Still, Khuzami called Paulson's firm "a hedge fund that had a particular interest in the securities performing poorly."
It is unlikely that criminal charges will be brought, a person close to the matter said. Representatives for the Justice Department declined to comment.
In afternoon trading, Goldman shares sank $23.82, or 12.9 percent, to $160.45 on the New York Stock Exchange, after earlier falling to $155.57. The perceived risk of owning Goldman debt, as measured by credit default swaps, increased.