Goldman Sachs Group Inc. was sued by U.S. regulators for fraud tied to collateralized debt obligations that contributed to the worst financial crisis since the Great Depression. The firm’s shares tumbled 13 percent and financial stocks slumped.
Goldman Sachs created and sold CDOs linked to subprime mortgages in early 2007, as the U.S. housing market faltered, without disclosing that hedge fund Paulson & Co. helped pick the underlying securities and bet against the vehicles, the Securities and Exchange Commission said today. Billionaire John Paulson’s firm earned $1 billion on the trade and wasn’t accused of wrongdoing. The SEC also sued Fabrice Tourre, a Goldman Sachs vice president who helped create the CDOs, known as Abacus.
“The product was new and complex but the deception and conflicts are old and simple,” SEC Enforcement Director Robert Khuzami said. “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 became emblematic of public outrage at the banking industry after posting a record $13.4 billion profit in 2009, a year after receiving $10 billion in taxpayer aid during the financial crisis. It repaid the funds in June. The company, led by Chief Executive Officer Lloyd Blankfein, 55, has been criticized by lawmakers and pundits for issues from its pay practices to its role in helping Greece mask the size of its debts. It called the SEC’s claims “unfounded.”
Financial Stocks Slump
“Civil charges and the disgorgement are not the issue -- the threat to Goldman is reputational,” said Brad Hintz, an analyst at Sanford C. Bernstein & Co. in New York. The danger is to “ultimately its market share with its prized institutional and corporate clients.”
Shares of Goldman Sachs, based in New York, dropped $23.57, or 13 percent, to $160.70 as of 4:02 p.m. in New York Stock Exchange trading. It marked the biggest one-day decline since Jan. 20, 2009, and pushed the value of Warren Buffett’s options to buy Goldman Sachs shares down by $950 million.
Buffett, Berkshire Hathaway Inc.’s chief executive officer, got the warrants on $5 billion of Goldman Sachs stock as part of an agreement that extended financing to the bank during the depths of the 2008 credit crisis. The deal reflected Buffett’s belief in “not just the strength of Goldman but its integrity,” Ronald Olson, a Berkshire director said this week in an interview.
The cost to protect against a default on Goldman Sachs’s debt jumped 30.5 basis points, or 0.305 percentage point, to 120.5 basis points.
“The SEC’s charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation,” Goldman Sachs said in a statement today.
The firm put together the Abacus deal in 2007, a year in which Goldman Sachs earned a then-record $11.6 billion, a figure it surpassed in 2009, when it earned $13.4 billion. Goldman Sachs paid Blankfein $68.5 million for 2007 -- $600,000 in salary, plus a $67.9 million bonus.
According to the SEC’s complaint, Tourre, now 31, 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.
“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!!!” Tourre wrote in the e-mail, according to the SEC. The agency didn’t identify the recipient of the note.
Reached at his London office today, Tourre declined to comment. “I need to jump, thank you, goodbye,” he told Bloomberg News before hanging up. A call to Pamela Chepiga, a lawyer for Tourre at Allen & Overy LLP, wasn’t returned. Tourre, a graduate of Ecole Centrale Paris, one of France’s top engineering schools, and Stanford University, joined Goldman Sachs in July 2001, according to his LinkedIn profile.
Goldman Sachs and Tourre knew it would be difficult, if not impossible, to sell the CDO if they disclosed to investors that Paulson played a significant role in selecting the collateral and was also betting against it, the SEC said.
‘Surreal’ ACA Meeting
The bank also knew that at least one potential investor, Dusseldorf, Germany-based IKB Deutsche Industriebank AG, wasn’t likely to invest in a CDO that didn’t have a collateral manager to analyze and select the portfolio, according to the complaint.
In January 2007, Goldman Sachs approached ACA Management LLC, a firm that analyzes credit risk, to select the portfolio for a CDO transaction sponsored by Paulson. In an internal memo on March 12, 2007, Goldman said it would “leverage ACA’s credibility and franchise” to help distribute the transaction, the SEC said.
Paulson, Tourre and a representative from ACA met in February 2007 to discuss assets that would be included in the residential-mortgage backed security, the SEC said. While Paulson and Tourre knew Paulson intended to short the security, ACA wasn’t in the loop.
“I am at this ACA meeting,” Tourre wrote in an e-mail to an unidentified Goldman Sachs employee during the meeting. “This is surreal.”
Goldman’s ‘Extensive Disclosure’
Goldman Sachs also said that it lost more than $90 million because it had an investment in the deal, overwhelming the $15 million it made in fees. The firm said it provided “extensive disclosure” to IKB and ACA about the risk of the underlying mortgage securities. Goldman Sachs never told ACA that Paulson was going to be a “long” investor in Abacus, and ACA selected the underlying securities, the firm said.
Paulson & Co., which oversees $32 billion, said in a statement that the fund didn’t make any misrepresentations connected to the Abacus deal.
“While Paulson purchased credit protection from Goldman Sachs on securities issued under the Abacus ABS CDO program we were not involved in the marketing of any Abacus products to any third parties,” the New York-based firm said. “ACA as collateral manager had sole authority over the selection of all collateral in the CDO.”
Paulson could be the target of investor lawsuits now that the SEC is investigating how Abacus was put together, said Thomas Adams, who worked in the CDO groups for two bond insurers and is now a partner at New York-based Paykin Krieg & Adams LLP.
“There haven’t been many investor lawsuits on these kinds of deals,” Adams said. “This opens the door to civil claims across a number of transactions.”
Bank of America Corp. and JPMorgan Chase & Co. lost at least 4 percent today as all 27 companies in the S&P 500 Diversified Financial Index declined. In Europe, Deutsche Bank AG dropped 8 percent.
The case is Securities and Exchange Commission v. Goldman Sachs, 10-cv-03229, U.S. District Court, Southern District of New York (Manhattan).