SEC Charges Goldman Sachs With Fraud On Subprime Mortgages, Paulson & Co. Implicated

Tyler Durden's picture

Washington, D.C., April 16, 2010 — The Securities and Exchange Commission today 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 SEC alleges that Goldman Sachs structured and marketed a synthetic collateralized debt obligation (CDO) that hinged on the performance of subprime residential mortgage-backed securities (RMBS). 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 product was new and complex but the deception and conflicts are old and simple," said 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."

Kenneth Lench, Chief of the SEC'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."

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.

According to the SEC's complaint, filed in U.S. District Court for the Southern District of New York, the marketing materials for the CDO known as ABACUS 2007-AC1 (ABACUS) all represented that the RMBS portfolio underlying the CDO was selected by ACA Management LLC (ACA), a third party with expertise in analyzing credit risk in RMBS. The SEC alleges that undisclosed in the marketing materials and unbeknownst to investors, the Paulson & Co. hedge fund, which was poised to benefit if the RMBS defaulted, played a significant role in selecting which RMBS should make up the portfolio.

The SEC's complaint alleges that after participating in the portfolio selection, Paulson & Co. effectively shorted the RMBS 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. Given that financial short interest, Paulson & Co. had an economic incentive to select RMBS that it expected to experience credit events in the near future. Goldman Sachs did not disclose Paulson & Co.'s short position or its role in the collateral selection process in the term sheet, flip book, offering memorandum, or other marketing materials provided to investors.

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.

According to the SEC's complaint, the deal closed on April 26, 2007, and Paulson & Co. paid Goldman Sachs approximately $15 million for structuring and marketing ABACUS. 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 SEC's complaint charges Goldman Sachs and Tourre with violations of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Exchange Act Rule 10b-5. The Commission seeks injunctive relief, disgorgement of profits, prejudgment interest, and financial penalties.

# # #

For more information about this enforcement action, contact:

Lorin L. Reisner
Deputy Director, SEC Enforcement Division
(202) 551-4787

Kenneth R. Lench
Chief, Structured and New Products Unit, SEC Enforcement Division
(202) 551-4938

Reid A. Muoio
Deputy Chief, Structured and New Products Unit, SEC Enforcement Division
(202) 551-4488

Full Lawsuit:

 

SEC GOLDMAN

Fabrice Tourre's FINRA record:

 

Fabrice Tourre

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
bigkahuna's picture

The SEC will not bring any of this down. We all know they are inept and/or impotent at their job. Thats why no one is investing anymore outside of the strange auto-trading that is going on. You hit the nail on the head though--when the crows truly come home to roost, it won't be any federal joke of an organization that causes it--it will be infighting between these insatiable thieves.. 

Miles Kendig's picture

And reintroduce the concept of work that contributes to rather than destroys society.  For the moment I would like to see the perps dressed out in jumpsuits, reflective vests, goggles, hard hat, gloves & boots while working as societies pooper scooper's.  No hiding in prison for 'em.  Make them live, work and do everything else within society dressed out in their uniform at all times.  Perhaps there is still a reason for the Cabrini Green's to exist after all.

Racer's picture

Maybe their IS some justice after all?

sheeple's picture

N. Muntz: HA HA

RockyRacoon's picture

All sorts of sordid comments come to mind, but I'll remain civil until more facts emerge.

GS is short Gold's picture

+1.  GS will pay a fine without admitting any wrongdoing. nothing to see here, move along.

docj's picture

Sweet - but I'm curbing my enthusiasm until I see suits being led-out of 200 West Street in leg-irons.

dumpster's picture

the problem on that one .. is every one wearing suits are up to their eyebrows in muck.

'so a suit has to rat on a suit,

.  some one wearing a suit at the top has to lead the suit people to the calaboose ,,, fat chance , every one would be in jail 

the leg irons will be continually worn by the citizens

john_connor's picture

They'll pay like a $100 million fine, admit no wrongdoing, and be done with it after booking billions on the scheme.  Wash, rinse, repeat.

Hansel's picture

I was thinking it would be closer to $1 million without admitting or denying culpability.  The suit is good for a headline today, but tomorrow it will be out of the news.  GS will get off because the SEC knows its master.

buzzsaw99's picture

exactly. they are connected. they are a gubbermint guaranteed bank holding company with zero deposits and 100% control of the gubmint. The SEC will be disbanded before the squid goes down. Steal a hundred billion, pay a million dollar fine.

Edna R. Rider's picture

GS defense lawyer:  "No we didn't."

SEC lawyer:  "Oh, OK, our bad."

Miles Kendig's picture

Edna, you forgot the judge that will say; "I must defer to the SEC as the courts have no desire or willpower to exercise oversight of this part of society".  See the Rykoff decision in SEC v Bank of America for a recent example of this process of judicial exclusion is action wherein the victims get to pay the perps fine.

Oh regional Indian's picture

:-) Funny! Brevity is indeed the soul of humor!

Alienated Serf's picture

you forgot-

sec lawyer- "ok tell ya what, we'll keep lookin around anyway so you can run up some serious bills.  then when this is over, you hire me as partner"

GS- "Deal!"

Fidel Sarcastro's picture

The SEC won't do a fucking thing!  A small fine - period to keep the surfs from an uprising.

RockyRacoon's picture
Breaking News Alert
The New York Times
Fri, April 16, 2010 -- 10:39 AM ET
-----

S.E.C. Accuses Goldman Sachs of Fraud on Mortgage Deals

Goldman Sachs, which emerged relatively unscathed from the
financial crisis, was accused of securities fraud in a civil
suit filed Friday by the Securities and Exchange Commission,
which claims the bank created and sold a mortgage investment
that was secretly devised to fail.

The move marks the first time that regulators have taken
action against a deal that helped investors capitalize on
collapse of the housing market. Goldman itself profited by
betting against the very mortgage investments that it sold to
its customers.

Read More:
http://www.nytimes.com?emc=na
reading's picture

I actually don't care what the outcome is at this moment -- I am just happy to see SEC, GS and fraud in the same headline for once.

 

 

RockyRacoon's picture

That's what they're hoping for. A large storm cloud but no rain, no lightning. The average person will say, "Great, they're all guilty just as we thought." Then the cloud passes and GS goes back to business as usual. The sun rises and all is well with the world. Why do you think this came out on Friday?

Cognitive Dissonance's picture

Exactly.

Just as Obama was billed as "change you can believe in" this lawsuit will be trumpeted as "change you can believe in". The sad part is that the average Joe (and I suspect some ZH family members) has been so starved for justice that any bloody body thrown to the lions in the coliseum will be deemed a "good start" and the pressure valve will be released.

WE ARE BEING PLAYED AGAIN FOLKS. Keep your focus on the prize, not on the smoke and mirrors on display today. Don't let up and "hope" things have turned. They have not.

Howard_Beale's picture

I totally disagree CD. And Bob Dylan supports me on this, because the times, they are a changing. Mark my words. This is the beginning of something big and no printing press in the world will fix it. It's going to snowball as big as an Iceland Volcano--just might take a little longer.

Cognitive Dissonance's picture

HB

I was simply trying to say that this lawsuit in and of itself will go nowhere if people relax and wait for the system to "change" by itself. The SEC, if it really is serious about prosecuting fraud, must have the popular support of the masses in order to move forward. If most people now go back to sleep assuming the cops are coming, the political will to follow through on this lawsuit will evaporate. This is why I ended my comment by saying everyone must not relax.

Problem Is's picture

I agree with CD.
This has all the potential of Kabuli theater and guess who the bitches are?

If we get another SEC v BofA, $33 million fine and no admission of wrong doing then guess what?

We been had...

If the SEC blows this case...
Civil fraud charges are likely done for Wall Street let alone any criminal fraud.

As I Said in a Previous Post:
Worst of all, betting on the SEC to win is like betting on the Skipper and Gilligan to get that coconut powered radio working...

Clinteastwood's picture

I think something else is going on, and it's much more cynical.  GS and Paulson knew that Congress and Bush had no idea about finance, that the Community Reinvestment Act was the worst piece of legislation to come down since the Great Depression.  All those nincompoops owing a mortgage.......???????? you gotta be kiddin' me. How else you gonna get the word to those Barney Frank Chris Dodd nitwits in Congress drunk half the time that:

 

You can't have 50% of the people on the dole just so you can get votes.  You can't have an sustainable economy that returns interest at greater than 3-5%.  You can't buy votes by creating money outta thin air.

 

So...............if you want to bring some reality into the system, what do you do?  

 

You take all their money.

 

You know the system is unsustainable, so you intentionally set up multiple (not just this measley SEC example, multiple, many times over) CDOs that are DOOMED............. and you buy the CDSs that will make you rich when the whole thing goes to hell in a handbasket.

 

There's nothing to see here, investors should know the risks.  If they don't, tough.  If the SEC doesn't like it, tough.....Goldman Sachs is too big to fail.

 

But look at this:  What's the net result?  GS may have accomplished it's purpose.  No longer are there unsustainable home mortgage loans (you gotta admit, that's a thing of the past).  No longer are there a bunch of nitwits out there creating a bunch of mortgages that cannot be repaid.  No longer are there mortgage backed securities to defraud investors.  No longer are there unsustainable stock prices because of cheap second mortgages.

 

What this country has needed is a wake-up call from cheap credit.  GS has done its part by creating the catastrophe.   Long live GS.  After all, that's what capitalism is all about, right?  Boom and bust.  Caveat emptor.  Come on Zerohedgers........it's high time the baby boomers weren't babies anymore.

cossack55's picture

So then, Can we count on the CFTC indicting all owners of physical PMs as counterrevolutionaries or would that come form the JD or DHS?

ToNYC's picture

Not this time. Death by a thousand pricks...still the best way to draw blood and bust a balloon. Lloyd Blankfein meets Michael Milken.

Won_Over's picture

I'm with you. Happy for now, while at the same time I know its a joke until someone sees jail for minimum 10 years.

thewhigs's picture

Don't worry, the meltup will continue unabated...

percolator's picture

Whoop de do!  GS will get a small fine without admitting wrong doing.

Hugh Janus's picture

news should be positive for the market, next stop 36,000.

Howard_Beale's picture

Right, green shoots and Dow 36000....so last week.

ToNYC's picture

Dow 36000..no worries. Keep your eyes closed again, and do 3:1 reverse split of the Dow. "Numbers on paper"...mose allison's finest.

Advocatus's picture

Lol, it's true. Look at NYT.

Ragnarok's picture

Purely political, WH needs a victory and congress wants to pass the financial"reform" bill.  WH thinks Americans (anyone not on the far left) will rally around this cause.  It's an election year don't cha know.

Carl Spackler's picture

Winner, winner...chicken dinner!

IE's picture

That's what I'm thinking too. 

I wonder how much damage GS would consider doing to the market "in protest"?  How much *could* they do, if they didn't have cooperation from JPM et al?

Ragnarok's picture

1. Scores political points

2. Gets the rest of the PDs in line

3. Ensures sucessful bond auctions

 

One problem though is that public confidence is tied to equties, you wouldn't want to crash those before an election. I thought they would wait until after the election, I think the WH is in a gambling mood.

IE's picture

They're kind of stuck, right?  Need to pass Fin reform & feed the angry mob before the election. 

My guess is they'll allow the market to tank *a bit* if necessary to get these things done... and then announce QE2.0 in a few months to float things again.  They're going to need to prop up housing more anyway - so they might as well get something out of it (the 3 things you mentioned).

Tethys's picture

I would guess GS was given warning of when the announcement would be made and an opportunity to short their own stock (down 10% so far today).  The media will hype this as and administration victory and to appease the masses, GS will profit on their shorts and use the proceeds to pay the fines, no one will go to jail.

There is no way the administration would truly go after such a high-level contributer without forewarning.

http://www.opensecrets.org/parties/contrib.php?cycle=2008&cmte=DNC

 

tip e. canoe's picture

now that's thinking like a Rahm.

WaterWings's picture

Heh. Oh, and for the RNC, hedging?

Goldman Sachs
$221,115

JP Morgan Chase & Co contributed to both as well! LOL! More to the Repubs. LOL!

LOL!

We're so freaking dooOOoomed!

 

Justin Credible's picture

GS lawyers will *crush* anything the SEC can bring.

GS will pay a small 'handslap' fee and all will be forgotten

by dow 15K during June.

I just hope the ZH servers will be able to handle the traffic spike after this news release.

IE's picture

GS lawyers will *crush* anything the SEC can bring.

GS will pay a small 'handslap' fee and all will be forgotten

Not if the administration needs a very big sacrifice to the political gods.