Qui Tam

SEC Charges Goldman Sachs With Fraud in CDO Tied to Subprime Mortgages

By Finch McCranie, Esq.

As Congress finally works to establish a more meaningful SEC whistleblower program, the SEC has just announced that it has charged Goldman Sachs and one of its vice presidents with fraud, in connection with a "financial product tied to subprime mortgages, as the U.S. housing market was beginning to falter."

Often maligned for failing to protect investors before the recent financial crisis, the SEC now charges that Goldman structured and marketed a "synthetic collateralized debt obligation" (CDO) like those that "contributed to the recent financial crisis by magnifying losses associated with the downturn in the United States housing market."

The SEC's Complaint alleges a "securities fraud action against Goldman, Sachs & Co. (?GS&Co?) and a GS&Co employee, Fabrice Tourre (?Tourre?), for making materially misleading statements and omissions in connection with a synthetic collateralized debt obligation (?CDO?) GS&Co structured and marketed to investors. This synthetic CDO, ABACUS 2007AC1,
was tied to the performance of subprime residential mortgage-backed securities (?RMBS?) and was structured and marketed by GS&Co in early 2007 when the United States housing market and related securities were beginning to show signs of distress. Synthetic CDOs like ABACUS 2007-AC1 contributed to the recent financial crisis by magnifying losses associated with the downturn in the United States housing market."

The Complaint further charges:

Undisclosed in the marketing materials and unbeknownst to investors, a large hedge fund, Paulson & Co. Inc. (?Paulson?), with economic interests directly adverse to investors in the ABACUS 2007-AC1 CDO, played a significant role in the portfolio selection process. After participating in the selection of the reference portfolio, Paulson effectively shorted the RMBS portfolio it helped select by entering into credit default swaps (?CDS?) with GS&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. GS&Co did not disclose Paulson?s adverse economic interests or its role in the portfolio selection process in the term sheet, flip book, offering memorandum or other marketing materials provided to investors.

In sum, GS&Co arranged a transaction at Paulson?s request in which Paulson heavily influenced the selection of the portfolio to suit its economic interests, but failed to disclose to investors, as part of the description of the portfolio selection process contained in the marketing materials used to promote the transaction, Paulson?s role in the portfolio selection process or its adverse economic interests.

The full SEC anouncement is reprinted below.

Full post as published by Whistleblower Lawyer Blog on April 16, 2010 (boomark / email).