The government has accused Goldman Sachs & Co. of defrauding investors by failing to disclose conflicts of interest in mortgage investments it sold as the housing market was collapsing.
The Securities and Exchange Commission said in a civil complaint Friday that Goldman failed to disclose that one of its clients helped create — and then bet against — subprime mortgage securities that Goldman sold to other investors.
We have a small fall today, one that we were expecting for some time but just would never come. Financial stocks on the whole sold off.
This is the kind of event why you would want to diversify accross sectors but if you are legging into Citigroup thinking it will go to 8 dollars adding it over the last 3 days was a bad move.
Is this a buying opportunity? I think it is. The market is taking this opportunity to correct and we would expect SP500 at 1145 to be the support.
Here is the rest of the BusinessWeek reporting:
The Goldman client implicated in the fraud is one of the world’s largest hedge funds, Paulson & Co. The SEC said it paid Goldman roughly $15 million in 2007 to put together an investment offering that was tied to mortgage-related securities the hedge fund viewed as likely to decline in value.
Separately, Paulson took out a form of insurance that allowed it to make a huge profit when those securities became nearly worthless.
ABN Amro, a major Dutch bank, was the biggest loser in the securities, having paid Goldman $841 million, according to the SEC. And IKB Deutsche Industriebank AG, a German commercial bank, lost nearly all its $150 million investment, the agency said. Most of the money they lost went to Paulson in a series of transactions between Goldman and the hedge fund, the SEC said.
The civil lawsuit filed by the SEC in federal court in Manhattan was the government’s most significant legal action related to the mortgage meltdown that ignited the financial crisis and helped plunge the country into recession. Financial analysts said it’s dealt a setback to Goldman’s standing.
“It undermines their brand,” said Simon Johnson, a professor at the Massachusetts Institute of Technology and a Goldman critic. “It undermines their political clout. I don’t think anybody really values being connected to Goldman at this point.”
He continued: “There are many people who — until this morning — thought Goldman Sachs was well-run.”
The SEC is seeking unspecified fines and restitution from Goldman Sachs and Tourre.
Asked why the SEC did not also pursue a case against Paulson, Enforcement Director Robert Khuzami said: “It was Goldman that made the representations to investors. Paulson did not.”
Paulson & Co. is run by John Paulson, who reaped billions by betting against subprime mortgage securities. He is not related to former Treasury Secretary Henry Paulson.
In a statement, Paulson & Co. said: “As the SEC said at its press conference, Paulson is not the subject of this complaint, made no misrepresentations and is not the subject of any charges.”
Goldman told investors that a third party, ACA Management LLC, had selected the pools of subprime mortgages it used to create what are known as synthetic collateralized debt obligations. But, the SEC alleges, Goldman misled investors by failing to disclose that Paulson & Co. also played a role in selecting the mortgage pools and stood to profit from their decline in value.
“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,” Khuzami said in a statement.
IKB was an early casualty of the financial crisis. It issued a profit warning in 2007 saying it had been hurt by U.S. subprime mortgage investments. IKB was sold in 2008 to Dallas-based Lone Star Funds.
Ed Trissel, a spokesman for Lone Star Funds, declined to comment on the case.
Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, is “pleased that the SEC is departing from the lax enforcement of the Bush administration and is returning to the SEC’s proper role of protecting investors in the marketplace,” spokesman Steven Adamske said.
The SEC charges come after Goldman Sachs denied last week it bet against clients by selling them mortgage-backed securities while reducing its own exposure to them.
In an annual letter to shareholders, Goldman said it began reducing its exposure to the U.S. mortgage market in late 2006. It said it did so by selling mortgage investments or buying credit default swaps. The swaps are a form of insurance that pays out if the value of the underlying asset declines.
Those hedges, also known as short positions, served Goldman well. As the housing market began cratering and losses piled up for other big banks, Goldman suffered less damage. That led to criticism that the bank benefited at the expense of clients who bought mortgage-backed securities that became toxic. Goldman denied that.
“Our short positions were not a ‘bet against our clients,'” Goldman said in the letter. “Rather, they served to offset our long positions. Our goal was, and is, to be in a position to make markets for our clients while managing our risk within prescribed limits.”
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