Goldman Sachs' Problems Continue to Grow
The Securities and Exchange Commission has charged Goldman Sachs with defrauding clients by selling them toxic collateral debt obligations (CDOs) containing residential mortgage-backed securities (RMBS) that were secretly selected by a hedge-fund manager, who stood to benefit if the value of those securities declined. Unfortunately for Goldman, this is just one of several major problems facing the firm.
According to recent article in the Wall Street Journal by Gregory
Zuckerman, Susanne Craig and Serena Ng, the SEC’s civil enforcement action is the strongest attack yet by the government on Wall Street. The overhang of a trillion dollars of toxic CDOs like these has aggravated the world financial crisis. President Obama has vowed to bring the derivatives market out of the dark as part of his financial reform initiative.
The SEC found that Goldman Sachs arranged for Paulson & Co. to help select the RMBS. Paulson then bet against it, while investors in the CDO weren't told of Paulson's role or intentions. The SEC alleges that Paulson set it up to fail, since his hedge fund would benefit if that happened. By mid-2006, Paulson and his hedge fund had purchased credit default swaps on billions of dollar of toxic mortgages, and he wanted to increase his bearish bet.
The SEC did not charge Paulson or his hedge fund with wrongdoing. "Goldman made the representations, Paulson did not," said SEC Enforcement Chief Robert Khuzami.
The SEC also charged Fabrice Tourre, who it said was primarily responsible for structuring the CDO and pitching it to investors. At about the same time, referring to such CDOs, Tourre wrote in an email that "the whole building is about to collapse anytime now." He described himself in the email as the "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 monstruosities!!!"
The deals were approved by senior Goldman executives, the SEC alleged.
Several days ago, the Wall Street Journal reported that prosecutors are investigating Goldman director Rajat Gupta to determine whether he provided inside information to the Galleon Group, a hedge fund founded by Raj Rajaratnam, who is embroiled the largest insider-trading probe in decades, according to the article..
Goldman and other firms were heavily involved in creating and selling complex investments backed by subprime loans at a time when defaults were increasing and the housing bubble was beginning to burst.
Investors in the CDO, known as Abacus 2007-AC1, suffered losses of more than $1 billion, according to the SEC. On the other hand, Paulson made a profit of about $1 billion. Goldman, a major trader of stocks and bonds on behalf of Paulson, received about $15 million for structuring the bonds and pitching them to investors.
Deutsche Bank also sold similar CDOs where Paulson’s hedge fund selected the securities, zeroing in on those it saw as particularly risky, according to the article. In contrast, one senior banker at Bear Stearns Cos. reportedly refused to be part of selling deals to investors that a bearish client was involved in putting together.
The complaint says Goldman sought out an independent mortgage-analysis firm, ACA Management LLC, and told participants that ACA was responsible for designing the product, rather than a hedge fund with a vested interest in seeing the securities fail.
James Cox, a securities-law expert and professor at Duke University Law School, reportedly stated, “That strikes me as plain and simple laundering of the deal.” “To me, it goes directly to the materiality of the omission.”
Senior management at Goldman was aware of the Abacus transaction and Paulson's connection to it, according to the SEC. A 2007 Goldman internal memo reportedly states: "Goldman is effectively working an order for Paulson to buy protection on specific layers of" the deal's "capital structure."
By October 2007, four months after issuance, more than 80% of the underlying mortgage securities in Abacus had been downgraded, and 99% were downgraded by January 2008, according to the SEC.
The U.S. government is not the only sovereign power scrutinizing Goldman Sachs. BusinessWeek’s Christine Harper reported that European governments are following the SEC’s lead and that Goldman’s board may be forced to change management as a result of the revelations. U.K. Prime Minister Gordo Brown called for the U.K. Financial Services Authority to start a probe, and said he was “shocked” at the “moral bankruptcy” reflected in the SEC’s findings against Goldman Sachs. “It is individuals in Goldman Sachs that are going to have to answer questions,” he added, “We are determined to root out any malpractice.”
The European Union is also investigating Goldman Sach’s involvement in swap transactions that may have obscured Greece’s budget deficit. And the U.S. Congress is also scrutinizing Goldman Sach’s swap transactions with AIG, which funneled much of the $182.3 billion in bailout money it received to Goldman Sachs.
Page Perry, LLC 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 35 occasions. Page Perry’s attorneys are actively involved in representing investors who have lost money in CDOs and other structured finance investments. For further information, please contact us.
