The Securities and Exchange Commission has filed a Complaint against Goldman, Sachs & Co. and one of its vice presidents, charging them with defrauding investors by misrepresenting and omitting to disclose material facts about a financial product that was tied to subprime mortgages as the U.S. housing market was beginning to implode.
The financial product at issue was a synthetic collateralized debt obligation (CDO), known as ABACUS 2007-AC1 (ABACUS). ABACUS was linked to the performance of subprime residential mortgage-backed securities (RMBS). ABACUS was structured and marketed by Goldman Sachs.
Goldman Sachs omitted to disclose material information to investors about the CDO, particularly the fact that a major hedge fund had taken a short position against the CDO (i.e., was poised to benefit if the underlying RMBS defaulted) and that this same hedge fund was also involved in the portfolio selection process for the CDO.
The hedge fund is Paulson & Co., one of the world’s largest. 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, according to the SEC.
According to the SEC’s complaint, the marketing materials for ABACUS all represented that the underlying RMBS portfolio was selected by ACA Management LLC (ACA), a third party with expertise in analyzing credit risk in RMBS. But undisclosed in the marketing materials and unbeknownst to investors, Paulson & Co. played a significant role in selecting which RMBS should make up the portfolio.
Paulson & Co.’s short position: After helping to select the RMBS portfolio, Paulson & Co. entered into credit default swaps (CDS) with Goldman Sachs, thereby purchasing rights that would increase in value if certain of the RMBS it selected went into default or experienced a credit event. Goldman Sachs did not disclose Paulson & Co.’s short position or its role in the RMBS selection process in the term sheet, flip book, offering memorandum, or other marketing materials provided to investors.
Fabrice Tourre (Goldman Sach’s VP and a named defendant) sent an e-mail to a friend in January 2007 saying, “The whole building is about to collapse” in reference to CDOs tied to subprime mortgages. The Tourre email continued: “Only potential survivor, the fabulous Fab standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstrousities!!!”
Approximately four months after Tourre’s comments, on April 26, 2007, the ABACUS deal closed. By Oct. 24, 2007, 83 percent of the RMBS in the ABACUS portfolio had been downgraded and 17 percent were on negative watch. By Jan. 29, 2008, 99 percent of the portfolio had been downgraded.
Investors in the liabilities of ABACUS are alleged to have lost more than $1 billion.
“The product was new and complex but the deception and conflicts are old and simple,” observed Robert Khuzami, Director of the Division of Enforcement. “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.”
“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,” Kenneth Lench, Chief of the SEC’s Structured and New Products Unit, warned.
J. Boyd Page, senior partner of Page Perry in Atlanta, noted “There have been a lot of suggestions that Goldman was burning both ends of the candle by actually betting against investments that it was recommending to customers. While Goldman continues to deny such charges, the allegations in the SEC action certainly suggest that Goldman had serious undisclosed conflicts in recommending certain CDOs. Investors will have to ask whether this was just an isolated incident or evidence of a pattern of conduct.”
Goldman Sachs became a target of public outrage when it posted a record $13.4 billion profit in 2009 and paid large bonuses, a year after receiving $10 billion in taxpayer bailout money. Goldman Sachs has also been criticized for its role in helping Greece raise off-balance-sheet funding and report smaller debt.
The case is Securities and Exchange Commission v. Goldman Sachs, 10-cv-03229, U.S. District Court, Southern District of New York (Manhattan).
Page Perry is an Atlanta-based law firm with over 125 years collective experience representing investors in securities-related litigation and arbitration. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 30 occasions. Page Perry’s attorneys are actively involved in representing institutional and corporate investors that sustained losses in CDOs and other structured products. For further information, please contact us.