On April 16, the Securities and Exchange Commission announced they had filed a complaint against Goldman Sachs & Co. and one of its vice-presidents, Fabrice Tourre, for defrauding investors with a sub-prime mortgage related financial product structured and offered by the company just as the U.S. housing market was beginning to fail. The SEC is seeking injunctive relief, disgorgement of profits, prejudgment interest, and financial penalties from Goldman Sachs and from Tourre.
According to the SEC press release, although the financial products offered were exotic and complicated, the alleged underlying illegal acts were not. The SEC claims that Tourre and Goldman Sachs simply withheld from investors the fact that the portfolio underlying the product, a synthetic collateralized debt obligation under-pinned by the performance of sub-prime residential mortgage-backed securities, was significantly influenced by a hedge fund whose interests were diametrically opposed to those of the investors.
As SEC Director of the Division of Enforcement, Robert Khuzami said, "The product was new and complex but the deception and conflicts are old and simple."
Marketing materials for the product, known as ABACUS 2007-AC1, stated that a third-party independent risk management analyst, ACA Management LLC (ACA), was responsible for selecting the portfolio of mortgage-backed securities at the heart of the product. As alleged by the SEC, however, a hedge fund client of Goldman Sachs, Paulson & Co., played a significant role in portfolio selection.
Paulson & Co. also allegedly paid Goldman Sachs to structure a transaction in which the hedge fund took short positions against the same mortgage-backed securities it selected for inclusion in the portfolio underneath the ABACUS 2007-AC1 product Goldman Sachs sold to investors.
The SEC claims that Tourre was principally responsible for the ABACUS marketing materials produced by Goldman Sachs. According to the SEC's complaint, the independent third party risk analyst (ACA Management) and investors were unaware that Paulson & Co. had bet against the portfolio. The SEC alleges that the hedge fund stood to profit hugely and its interests were completely opposed to those of the investors, who had a long-term equity stake.
According to the complaint, the deal closed on April 26, 2007, and Paulson paid Goldman Sachs approximately $15 million for structuring and marketing ABACUS. By Oct. 24, 2007, 83% of the RMBS in the ABACUS portfolio had been downgraded and 17% was on negative watch. By Jan. 29, 2008, 99% of the portfolio had been downgraded. Investors in ABACUS are alleged to have lost more than $1 billion. The complaint also alleges that Paulson's profit was $1 billion.
The SEC is charging Goldman Sachs and Tourre with violations of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Exchange Act Rule 10b-5, and is seeking an unnamed amount of damages, penalties and disgorgement from Goldman Sachs and Tourre.
View a copy of the complaint below.