Goldman Sachs Criminal Probe May Use Powerful New York State Law

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The criminal investigation of Goldman Sachs Group Inc. by the Manhattan District Attorney’s Office has at its disposal a 90-year-old New York law that makes it easier for state prosecutors to bring charges than their federal counterparts.

District Attorney Cyrus Vance Jr. subpoenaed Goldman Sachs, the fifth-biggest U.S. bank by assets, for records on its activities leading into the credit crisis, two people familiar with the matter said. Vance may bring charges under the state’s Martin Act, which lawyers call a potent tool for New York prosecutors probing investment frauds, Ponzi schemes and other white-collar crime.

To prove securities fraud in federal court, U.S. prosecutors must show that a defendant intended to defraud victims and that the investors relied on misstatements or omissions. Under the Martin Act, New York prosecutors aren’t required to prove intent, said Michael Perino, a law professor at St. John’s University in New York.

“The reason why New York prosecutors love it so much and Wall Street firms hate it so much is that it is a much, much easier case to bring,” Perino said in an interview. “All a prosecutor has to show under the Martin Act is a material misstatement in connection with a securities offering.”

Vance’s subpoena of New York-based Goldman Sachs related to the U.S. Senate’s Permanent Subcommittee on Investigations report on Wall Street’s role in the collapse of the financial markets, said the people, who spoke on condition of anonymity because the inquiry isn’t public.

Levin Subcommittee

The subcommittee, led by Michigan Democrat Carl M. Levin, released a 640-page report in April that accused the bank of misleading buyers of mortgage-linked investments. Levin said Goldman Sachs also misled Congress about the company’s bets on the housing market. The firm has said its testimony was truthful.

“Subpoenas are a normal part of the information request process,” said David Wells, a spokesman for Goldman Sachs. The bank is cooperating with the investigation, he said.

Vance is far from deciding to charge any individuals with crimes, said John Moscow, a former deputy chief of the investigations division in the Manhattan District Attorney’s Office.

“The big question they’re probably looking to answer is what happened,” said Moscow, now at Baker Hostetler LLP. “When you’ve figured out what happened, then you can figure out if it’s wrongful and it’s criminal. Before you’ve figured out what happened, it’s premature” to predict the outcome.

‘A Smoking Gun’

Peter Henning, a professor at Wayne State University Law School in Detroit, said he doubts that Vance’s investigators will find “a smoking gun” in documents that have already been reviewed by Congress and federal regulators, including the U.S. Securities and Exchange Commission.

By using the Martin Act, Vance may instead be able to build a criminal case based on circumstantial evidence, he said.

“It makes it easier to prove,” Henning said of the state statute.

Last year, Goldman Sachs paid $550 million to settle SEC claims related to its marketing of the complex securities known as collateralized debt obligations. The settlement resolved claims that it failed to disclose that hedge fund Paulson & Co. was betting against, and influenced the selection of, CDOs the company was packaging and selling.

After the SEC settlement, the Vance probe “has the appearance of being political piling on,” said attorney Jacob Frenkel, a former SEC lawyer now with Shulman Rogers Gandal Pordy & Ecker PA in Potomac, Maryland.

Criminal Case

“That has to be balanced by the fact that, regardless of perception, state and local law enforcement have a legitimate place in the investigative process because the applicable laws are different,” Frenkel said. “I do not expect that this investigation will result in a criminal case against Goldman Sachs as a firm.”

The Martin Act was enacted in 1921, and five years later, an appeals court said it applied to “all deceitful practices contrary to the plain rules of common honesty.”

The law imposes a two-year statute of limitations on misdemeanors and five years on felonies.

The New York state attorney general can bring civil or criminal actions under the Martin Act, while district attorneys only use it in criminal cases. Former New York Attorneys General Eliot Spitzer and Andrew Cuomo used the law against investment banks and the mutual-fund industry, while Robert Morgenthau, Vance’s predecessor, used it often during his 34-year tenure to combat boiler rooms, Ponzi schemes, private-placement investment fraud, and corrupt trading practices.

Mortgage Securitization

Goldman Sachs met last month with New York Attorney General Eric Schneiderman’s office as part of his examination of mortgage securitization before the housing collapse, according to a person familiar with the matter. The meeting took place within the past two weeks, said the person, who spoke on the condition of anonymity because the probe isn’t public.

Schneiderman has been conducting a broad examination of mortgage practices and the packaging and sale of loans to investors, according to the person.

JPMorgan Chase & Co., UBS AG, Deutsche Bank AG, Bank of America Corp., Morgan Stanley and the Royal Bank of Scotland Group Plc also are part of that probe, the person said. Four bond insurers have been subpoenaed as well.

Perjury Charges

The Senate report was referred to the U.S. Department of Justice and the SEC, which are also investigating.

Levin said at the time of his report that U.S. prosecutors should review whether to bring perjury charges against Goldman Sachs Chairman and Chief Executive Officer Lloyd Blankfein, 56, and other current and former employees who testified before Congress last year.

Levin said they denied under oath that Goldman Sachs took a financial position against the mortgage market solely for its own profit, statements the senator said were untrue.

“The testimony we gave was truthful and accurate and this is confirmed by the subcommittee’s own report,” Goldman Sachs said in a statement in April after the Levin report was released.

“The report references testimony from Goldman Sachs witnesses who repeatedly and consistently acknowledged that we were intermittently net short during 2007,” Goldman said in that statement. “We did not have a massive net short position because our short positions were largely offset by our long positions, and our financial results clearly demonstrate this point.”

‘Widespread Mistrust’

In a Jan. 25 speech to the New York City Bar Association, Vance, who only has jurisdiction over crimes committed in Manhattan, said “the Martin Act has never been more relevant” as “widespread mistrust infects financial markets.” Still, he said the law is “marred by its overly lenient penalties,” and he called on state lawmakers to stiffen punishment.

Vance said he would seek prison sentences of as long as 8 1/3 years to 25 years for frauds involving more than $1 million. The crime now carries no minimum prison sentence, regardless of the money involved.

“Whether the perpetrator steals $500 or $500 million, the felony penalty is the same -- that reserved for the lowest-level felonies in New York,” two Vance deputies, Adam S. Kaufmann and Marc Frazier Scholl, wrote in Business Crimes Bulletin last September.

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