SEC Charges Goldman Sachs with Fraud

The Securities and Exchange Commission (SEC) charged Goldman Sachs & Co. and one of its vice presidents for defrauding investors by "misstating and omitting key facts about a financial product tied to subprime mortgages" as the U.S. housing market was beginning to falter, the commission announced.

That financial product was a structured collateralized debt obligation (CDO) that hinged on the performance of subprime residential mortgage-backed securities (RMBS), the SEC alleges in its complaint. Goldman Sachs failed to disclose to investors vital information about the CDO, in particular 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 agency said.

"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, Director of the Division of Enforcement.

Investors in the purported scheme are alleged to have lost more than $1 billion.

The SEC alleges that one of the world's largest hedge funds, Paulson & Co., paid Goldman Sachs to structure a transaction in which Paulson & Co. could take short positions against mortgage securities chosen by Paulson & Co. based on a belief that the securities would experience credit events.

The SEC's complaint alleges that after participating in the portfolio selection, Paulson & Co. effectively shorted the portfolio it helped select by entering into credit default swaps (CDS) with Goldman Sachs to buy protection on specific layers of the ABACUS capital structure.

The SEC alleges that Goldman Sachs Vice President Fabrice Tourre was principally responsible for ABACUS 2007-AC1. Tourre structured the transaction, prepared the marketing materials, and communicated directly with investors. Tourre allegedly knew of Paulson & Co.'s undisclosed short interest and role in the collateral selection process. In addition, he misled ACA into believing that Paulson & Co. invested approximately $200 million in the equity of ABACUS, indicating that Paulson & Co.'s interests in the collateral selection process were closely aligned with ACA's interests. In reality, however, their interests were sharply conflicting, the SEC said.