The Securities and Exchange Commission on Friday charged Goldman Sachs Group Inc. and one of its vice presidents for defrauding investors. The complaint alleges that the company misstated and omitted key facts about a financial product tied to subprime mortgages as the U.S. housing bubble was beginning to burst in 2007.
Goldman Sachs did not immediately respond to calls for comment.
The SEC said Goldman Sachs marketed a financial product, called collateralized debt obligation or CDO, to investors without telling them that a major hedge fund that was betting against the mortgage market had played a key role in selecting the portfolio.
The hedge fund, Paulson & Co., paid Goldman Sachs about $15 million to structure a transaction in which Paulson could take short positions against mortgage securities which it helped choose. While investors lost about $1 billion on the CDO, Paulson earned about $1 billion by betting against it, the complaint states.
The SEC alleges that Goldman Sachs Vice President Fabrice Tourre was principally responsible by structuring the transaction, preparing the marketing materials and communicating directly with investors. Tourre knew that Paulson's interest in the CDO directly conflicted with the interest of investors, the complaint says.
"The product was new and complex but the deception and conflicts are old and simple," said Robert Khuzami, director of the SEC's division of enforcement, in a statement. "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."
And Tourre knew that the housing market was tanking at the time.
The complaint quotes two e-mails in early 2007. Tourre wrote on to a friend in January, saying, "More and more leverage in the system. The whole building is about to collapse anytime now ... Only potential survivor, the fabulous Fab[rice Tourre] ... standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities!!!" [sic]
Another e-mail in February, to Tourre from the head of the Goldman's structured product correlation trading desk stated in part, "the cdo biz is dead we don't have a lot of time left."
The SEC complaint, filed in U.S. District Court in Manhattan, seeks injunctive relief, disgorgement of profits by Goldman, prejudgment interest, and financial penalties.
The agency's probes into subprime mortgage scandals will go on. Kenneth Lench, chief of the agency's structured and new products unit, added, "The SEC continues to investigate the practices of investment banks and others involved in the securitization of complex financial products tied to the U.S. housing market as it was beginning to show signs of distress."