Goldman Sachs Accused of Fraud: God's Work or the Devil's Bu

by Derek Loosvelt | April 19, 2010

According to Goldman, it was simply doing the former, but the crew over at the SEC believes the bank was very much engaged in the latter.

Although we won't discover who's right from some time (that is, who either proves or successfully defends the case in a court of law) it's becoming clear the case against Goldman won't be the last one of its kind the SEC will be filing. As the case inches along to the courtroom (there's little chance the SEC will settle something this juicy) expect similar investment vehicles created by other banks to receive the fraudulent treatment.

Already, Deutsche Bank, UBS and Merrill Lynch are names being tossed aroundlegal circles as banks that may have structured similar vehicles and failed to disclose material information about said vehicles to investors (at issue in the Goldman case is whether or not it let investors know that a client of theirs, John Paulson, had handpicked the securities to be bundled and then bet against them*).

Of course, this is yet another monstrous blow to Goldman Sachs' public image, an image that was tarnishing and now seems to be blackening. It will certainly cause would-be Goldmanites (undergrads, MBA students and others) to question whether or not they should automatically reply with a roaring YES if offered a slot on Team Goldman. With the firm (who's been likened to a vampire squid) now facing a headline-topping investigation, the Goldman name will surely become a less attractive one to have on your resume (albeit merely a touch less unless a guilty verdict or more suits come Goldman's way; here's Goldman's most recent response, which, depending on how you read it, might appear to be setting up Fab Fab as this).

The case will also certainly help the cause of those in Washington looking to pass some serious (rather than softball) financial regulatory reform. In the past couple of weeks it appeared that initiatives against fancy derivative instruments (instruments that few, even on Wall Street, understand) were slowing, but Goldman on the receiving end of court papers, as well as other cases likely on the way, will significantly help those on the left side of the line when it comes time to pull the lever.

*More on the complaint from the SEC website:

"Goldman Sachs failed to disclose to investors vital information about the CDO, in particular the role that a major hedge fund played in the portfolio selection process and the fact that the hedge fund had taken a short position against the CDO.

The SEC alleges that one of the world's largest hedge funds, Paulson & Co., paid Goldman Sachs to structure a transaction in which Paulson & Co. could take short positions against mortgage securities chosen by Paulson & Co. based on a belief that the securities would experience credit events.

The SEC's complaint alleges that after participating in the portfolio selection, Paulson & Co. effectively shorted the RMBS portfolio it helped select by entering into credit default swaps (CDS) with Goldman Sachs to buy protection on specific layers of the ABACUS capital structure. Given that financial short interest, Paulson & Co. had an economic incentive to select RMBS that it expected to experience credit events in the near future. Goldman Sachs did not disclose Paulson & Co.'s short position or its role in the collateral selection process in the term sheet, flip book, offering memorandum, or other marketing materials provided to investors.

Filed Under: Finance


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