SEC charges Goldman Sachs with Fraud

"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.

The SEC's civil fraud complaint alleges that Goldman allowed hedge fund Paulson & Co. -- run by John Paulson, who made billions of dollars betting on the subprime collapse -- to help select securities in the CDO.  Goldman didn't tell investors that Paulson was shorting the CDO, or betting its value would fall. When the CDO's value plunged within months of its issuance, 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 Enforcement for the SEC.
 Khuzami said the case was the first brought by a new SEC division investigating the abuses of so-called 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, 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, typically 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.

Khuzami said the SEC is entitled to disgorgement of ill-gotten gains as well as penalties that will be considered "at the appropriate time."




Ron Geffner, a former SEC enforcement attorney who is now a partner with Sadis & Goldberg in New York...said the case would hinge on variables including the objectivity of the portfolio designer, what was communicated to investors, what fiduciary duties Goldman may have had and how sophisticated the investors were.