Goldman Sachs Group Inc.’s $2 billion Hudson Mezzanine collateralized debt obligation, sold in 2006, is the target of a probe by the Securities and Exchange Commission, according to a person with knowledge of the matter.
The inquiry into the CDO may not lead to any additional actions against the New York-based securities firm, said the person, who declined to be identified because the investigation isn’t public. Michael DuVally, a spokesman for Goldman Sachs, declined to comment, as did SEC spokesman John Nester. The Financial Times reported the probe yesterday.
Goldman Sachs shares have fallen 26 percent since the SEC filed a fraud lawsuit against the firm on April 16 that related to its 2007 sale of a CDO called Abacus. Senator Carl Levin, a Michigan Democrat, said in April that Goldman Sachs’s sales of CDOs such as Hudson raised “a real ethical issue.”
“The ethical issue is valid, but Goldman isn’t the only investment bank” that sold CDOs, said Ambrose Chang, a Hong Kong-based fund manager at Daiwa SB Investments HK Ltd. “After the financial crisis, all Wall Street banks’ reputations have been fundamentally damaged.”
In the Abacus suit, the SEC said Goldman Sachs and one of its employees, Fabrice Tourre, didn’t disclose to investors the role played by hedge fund Paulson & Co. in devising and betting against the securities. Goldman Sachs has denied wrongdoing on the Abacus CDO and said it will fight the SEC’s case.
Hedge Fund Suit
CDOs parcel fixed-income assets such as bonds or loans and slice them into new securities of varying risks, providing higher returns than other investments of the same rating.
In a separate case, Goldman Sachs was sued by Australian hedge fund Basis Capital for $1 billion. In the suit, filed yesterday in Manhattan federal court, Basis claims it was forced into insolvency after buying mortgage-linked securities that the firm created and one of its executives termed “one shi**y deal.”
“The lawsuit is a misguided attempt by Basis, a hedge fund that was one of the world’s most experienced CDO investors, to shift its investment losses to Goldman Sachs,” Goldman Sachs said in a statement.
The U.S. Senate’s Permanent Subcommittee on Investigations, led by Levin, released e-mails in April related to Goldman Sachs’s mortgage-linked deals, including the Hudson Mezzanine transaction. In one October 2006 e-mail, a Goldman Sachs employee describes how the Hudson deal might be viewed by investors as “junk.”
The Hudson Mezzanine 2006-1 CDO contained credit default swaps that referenced $2 billion in subprime, BBB-rated residential mortgage-backed securities, according to the documents released by Levin’s committee. While Goldman Sachs selected the assets in the deal, the firm was also the only investor buying credit protection on the entire transaction, the documents show.
Goldman Sachs created and sold the Hudson CDO in late 2006, near the time documents released by Levin show senior executives wanted to reduce the firm’s exposure to subprime mortgages.
“The CDO imploded within two years. Your clients lost; Goldman profited,” Levin said in an April 27 hearing during which he questioned Goldman Sachs Chief Executive Officer Lloyd Blankfein about the Hudson deal and other CDOs. “To go out and sell these securities to people and then bet against those same securities, it seems to me, is a fundamental conflict of interest and is -- raises a real ethical issue.”
Blankfein responded that “we are one of the largest client franchises in market-making in these kinds of activities we’re talking about” and that “they know our activities, and they understand what market-making is.”
While Goldman Sachs was short on the Hudson Mezzanine CDO, meaning it stood to gain from a collapse because of the credit protection it had purchased, a marketing document for the deal released by Levin’s committee states that “Goldman Sachs has aligned incentives with the Hudson program.”
In a short sale, an investor bets the value of a security will decline.