The Securities and Exchange Commission today charged Goldman Sachs (GS) with defrauding investors by misstating and omitting key facts about securities tied to subprime mortgages as the housing bubble was bursting. The major averages swooned on the news. The blue-chip Dow Jones Industrial Average ($INDU) plunged to a triple-digit loss, while shares in Goldman slumped more than 10%.
The SEC alleges that Wall Street's most illustrious and powerful investment bank structured and marketed a synthetic collateralized debt obligation (CDO) tied to the performance of subprime residential mortgage-backed securities (RMBS). The SEC says Goldman "failed to disclose to investors vital information about the CDO," most notably the role that "a major hedge fund played in the portfolio selection process and the fact that the hedge fund had taken a short position against the CDO."
The SEC alleges that billionaire John Paulson's Paulson & Co., one of the world's largest hedge funds, paid Goldman to structure that portfolio so that it was doomed to fail -- and then bet against it. Paulson was not named in the SEC suit.
"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," said Robert Khuzami, the director of the SEC's Division of Enforcement, in a press release.
The SEC alleges that after participating in the portfolio selection of a financial product called Abacus, Paulson & Co. shorted parts of it by entering into credit default swaps (CDS) with Goldman. CDS are a kind of insurance that pays off when a debt security fails.
Paulson & Co. paid Goldman Sachs approximately $15 million for structuring and marketing the CDO, according to the SEC complaint. By Jan. 29, 2008, 99% of the portfolio had been downgraded, the SEC says, and investors in the liabilities of Abacus are alleged to have lost more than $1 billion. The SEC charged Goldman VP Fabrice Tourre for alleged structuring the transaction.
Goldman issued a statement calling the SEC's charges unfounded and said it will "vigorously contest them and defend the firm and its reputation."
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