Securities Law Blog

The Securities and Exchange Commission (SEC) filed civil fraud charges against Goldman Sachs & Co. and one of its vice presidents in federal court in Manhattan on April 16, 2010. The SEC alleges that Goldman Sachs defrauded investors by misstating and failing to disclose key information about a financial product tied to subprime mortgages.

The claim alleges that Goldman Sachs was paid $15 million by one of the world’s largest hedge funds, Paulson & Co., for structuring and marketing a synthetic collateralized debt obligation (CDO), known as ABACUS 2007-AC1 (ABACUS). This complex investment vehicle was based on the performance of subprime residential mortgage-backed securities (RMBS).

According to the complaint, Paulson “played a significant role” in picking which RMBS should make up the portfolio. Allegedly “Paulson effectively shorted the RMBS portfolio it helped select by entering into credit default swaps (CDS) with Goldman Sachs & Co. to buy protection on specific layers of the ABACUS 2007-AC1 capital structure. Given its financial short interest, Paulson had an economic incentive to choose RMBS that it expected to experience credit events in the near future.”

The SEC alleges that marketing materials for ABACUS represented that the RMBS portfolio underlying the CDO was selected by ACA Management LLC (ACA), a third party with expertise in analyzing credit risk in RMBS. Goldman Sachs allegedly failed to disclose to investors that Paulson, which was in-line to benefit should the RMBS default, played a considerable role in the makeup of the portfolio.

The industry regulator alleges that Goldman Sachs Vice President Fabrice Tourre, 31, was “principally responsible” for ABACUS. It claims that Tourre structured the transaction, prepared the marketing materials and communicated directly with investors.

The $15 million deal between Paulson and Goldman Sachs to begin the structuring and marketing of ABACUS allegedly began April 26, 2007. According to the complaint, by October 2007, 83% of the RMBS in the portfolio had been downgraded, and by Jan 2008, 99% had been downgraded.

Investors in the mortgage securities are alleged to have lost more than $1 billion, while the sinking market gave Paulson a profit of about $1 billion.