SEC accuses Wall Street giant Goldman Sachs of defrauding investors

WASHINGTON — The Securities and Exchange Commission (SEC) on Friday accused Wall Street giant Goldman Sachs of fraud in a risky offshore deal backed by subprime mortgages that cost investors more than $1 billion.

The SEC says Goldman and one of its vice presidents, Fabrice Tourre, 31, allowed a Wall Street hedge fund to secretly select shaky securities for the deal.

The hedge fund, Paulson & Co., then bet those subprime mortgage securities would fail. When they did, Paulson, which is run by John Paulson, made a $1 billion profit and investors lost nearly all they put in, the complaint charges.

The lawsuit is the first to be filed against Goldman, the prestigious Wall Street investment-banking titan at the center of multiple inquiries into the causes of the global financial meltdown.

It's unclear whether Goldman could face legal exposure for other instances in which it allegedly failed to disclose to investors in 2006 and 2007 that it had secretly bet the housing market would collapse.

Paulson has acknowledged it reaped an overall $3.7 billion profit by betting against the housing market as it nose-dived in 2006 and 2007.

In an e-mail to a friend in January 2007, the lawsuit says, Tourre remarked that "the whole building is about to collapse anytime now," an apparent allusion to a plunge in the housing market that would depress the value of the mortgage securities.

The case suggests a reinvigorated SEC, after a long lull, is pressing to hold Wall Street accountable for its role in the worst financial crisis since the Great Depression. People familiar with the SEC investigation of Goldman said it could expand, and a special Senate investigations panel is preparing to hold a hearing that will put Goldman under another magnifying glass.

The company denounced the allegations Friday as "completely unfounded in law and fact," and vowed to "vigorously contest them and defend the firm and its reputation."

Underscoring Goldman's stature as the world's most prestigious investment bank, the enforcement action triggered a 126-point drop in the Dow Jones industrial average. Shares of Goldman led the way, plummeting nearly 13 percent.

After the market closed, Goldman issued a second statement, saying it lost $90 million on the transaction and that all of the involved parties were "sophisticated" investors such as foreign banks, pension funds and insurance companies that were well aware of the risks.

Goldman said the largest investor, ACA Capital Management, selected the securities "after a series of discussions, including with Paulson & Co." Goldman called the exchange "entirely typical."

The accusations amount to a black eye for the once-untouchable Goldman Sachs, a money machine that is the epicenter of Wall Street power. For decades, its platinum reputation has attracted top investors and stock underwriting deals.

Several of its former chief executives have gone on to high public office, among them Henry Paulson, the former Treasury secretary, and Jon Corzine, the former New Jersey governor. Henry Paulson and John Paulson are not related.

Besides naming the company as a defendant, the lawsuit accuses Tourre of concealing Paulson's role from investors in a synthetic securities deal known as ABACUS, 2007-AC1, in which investors didn't buy securities.

Instead, the investors effectively bet that a specified bundle of home loans to marginally qualified borrowers would perform well — while Paulson took "short" positions, meaning it bet that those bonds would founder.

Paulson profited grandly from the nation's economic collapse, taking in a total of $3.7 billion from its bets. The SEC complaint says the Paulson firm paid Goldman $15 million to assemble the deal, which Tourre was principally responsible for structuring.

The marketing materials for the investment, known as a collateralized debt obligation (CDO), told investors that ACA Management, an independent third party, selected the mortgage-backed securities. The Paulson firm wasn't mentioned.

"The product was new and complex, but the deception and conflicts are old and simple," SEC enforcement chief 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."

The deal, one of about two dozen similar bundles in the ABACUS series, closed on April 26, 2007. Within six months, 83 percent of the mortgage-backed securities in the bundle had been downgraded and 27 percent were placed on negative watch by Wall Street ratings agencies, the complaint says.

By the following Jan. 29, it says, 99 percent of the portfolio had been downgraded, costing investors more than $1 billion.

Khuzami said the Paulson firm wasn't charged because it didn't mislead investors.

However, the lawsuit alleges that Goldman and Tourre "knew that it would be difficult, if not impossible," to find investors for a synthetic CDO if they disclosed that a short player, such as Paulson, had a significant role in selecting the securities. Thus, they sought a third party for that role and approached ACA, calling it "important that we can use ACA's branding" in an internal e-mail.

The complaint quoted Tourre, then 28, as saying in a Jan. 27, 2007, e-mail to a friend that was written in French and English: "More and more leverage in the system, The whole building is about to collapse anytime now. ... Only potential survivor, the fabulous Fab(rice Tourre) ... standing in the middle of all of these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities (sic)!!!"

Tourre has since been promoted to executive director of Goldman Sachs International in London. A call to a lawyer for Tourre wasn't returned.

Material from The New York Times and The Associated Press is included in this report.