SEC Charges Goldman Sachs with Fraud Over Subprime RMBS CDO

The Securities and Exchange Commission (SEC) today charged Goldman Sachs (GS) and one of its vice presidents for allegedly defrauding investors by misstating and omitting key facts about a financial product tied to subprime mortgages, demanding a jury trial for the allegations to be heard. According to a compliant filed in US District Court for the Southern District of New York Friday (download here), the SEC alleges Goldman and Fabrice Tourre made materially misleading statements and omissions in connection with a synthetic collateralized debt obligation (CDO) that Goldman structured and marketed to investors. All told, the investors are said to have lost more than $1bn, the claim states. That CDO, ABACUS 2007-AC1, was tied to the performance of subprime residential mortgage-backed securities (RMBS) and according to the SEC, Goldman failed to disclose to investors 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 SEC 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.” Goldman Sachs did not immediately return HousingWire’s request for comment, but earlier this month, in its 2009 annual report, Goldman CEO Lloyd Blankfein denied allegations that Goldman made billions betting against subprime RMBS and its clients. According to the allegations Paulson & Co., a hedge fund with $32bn under management across merger, event and credit strategies, paid Goldman Sachs $15m to structure a transaction for Paulson to take short positions against MBS it chose, believing the securities would experience credit events. The SEC alleges Goldman marketed the RMBS that comprised the CDO as being selected by ACA Management, a third party with expertise in analyzing credit risk in RMBS, but failed to disclose the Paulson arrangement in those marketing materials. Goldman did not disclose Paulson’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 said. As a result, unbeknownst to investors, the selection of the RMBS for the CDO was impacted by the fact that Paulson would stand to profit if the underlying RMBS defaulted, the SEC claims. The Paulson deal closed on April 26, 2007 and by Oct. 24, 2007, 83% of the RMBS in the ABACUS portfolio had been downgraded and 17% were on negative watch. By Jan. 29, 2008, the SEC said, 99% of the portfolio had been downgraded. 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 to buy protection on specific layers of the ABACUS capital structure. According to the complaint, the SEC claims Tourre was principally responsible for the CDO in question, structuring the transaction, prepared the marketing materials, and communicated directly with investors. He also knew about Paulson’s undisclosed short interests and role in the collateral selection process, the SEC alleges. In addition, Tourre allegedly misled ACA into believing that Paulson invested approximately $200m in the equity of ABACUS, indicating that Paulson interests in the collateral selection process were closely aligned with ACA’s interests, the SEC said, but in reality, their interests were sharply conflicting. Write to Austin Kilgore. The author held no relevant investments.

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