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SEC charges Goldman Sachs over packaging of subprime mortgage deal

The SEC has charged Goldman Sachs with fraud over its packaging of a subprime mortgage investment.

By Staff writer / April 16, 2010

As a security guard looks on, people enter the Goldman Sachs headquarters in New York on Friday. The government has accused Goldman Sachs of defrauding investors by failing to disclose conflicts of interest in mortgage investments it sold as the housing market was faltering.

Diane Bondareff/AP


Securities regulators charged Goldman Sachs with fraud Friday, in a case that could hold Wall Street's most prominent firm legally accountable in the collapse of subprime-mortgage investments.

The Securities and Exchange Commission charged the firm and one of its vice presidents with failing to disclosure key information to investors in one supbrime-mortgage deal.

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Specifically, the SEC says that Goldman failed to tell investors that it had allowed a hedge fund that was betting against the housing market to help structure the portfolio.

The civil lawsuit focuses on a single allegation, rather than a broader case against Goldman's mortgage-product activities. But it amplifies a long-running debate regarding the financial crisis: Did illegal and fraudulent activities on Wall Street play a big role in causing the crisis?

Many financial experts say that the main roots of the crisis lie elsewhere -- including in behavior that was reckless and greedy but not illegal. But federal investigators implied that more lawsuits could come.

"The SEC continues to investigate the practices of investment banks and others involved in the securitization of complex financial products tied to the US housing market as it was beginning to show signs of distress," said Kenneth Lench, chief of the agency's unit focused on so-called "structured products," in a statement accompanying the charges.Goldman's stock fell about 12 percent Friday, while an index of financial stocks was down 3 percent.

Some industry analysts say that the sharp reaction in lower share values reflects the possibility that legal troubles will reach deeper at Goldman and throughout the industry. "I think this is going to be the first of many" cases involving US banks and the crisis, Matt McCormick, a banking analyst at Bahl & Gaynor, said on CNBC.

Goldman, America's largest investment bank, issued a statement saying it would "vigorously contest [the charges] and defend the firm and its reputation."

Short seller influenced collateralized debt obligation, SEC charges

The case in question involves a Goldman client, the big hedge fund run by investor John Paulson. The SEC alleges that in 2007, as a bubble in US housing markets was showing signs of weakness, the hedge fund "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."

In other words, the design of this investment product was influenced by someone betting against its success (a "short seller," in Wall Street jargon), and other investors in the product were not told.