The Securities and Exchange Commission filed fraud charges against Goldman Sachs on Friday, alleging that the famously successful but vilified Wall Street bank sold investors a subprime-mortgage investment that was secretly designed to lose value.
In filing the civil suit, the agency targets one of the few banks that, with the help of taxpayer bailouts, emerged from the financial crisis stronger than before. The case strikes at a main cause of the financial crisis: the creation of investments derived from home loans made to borrowers who couldn’t afford the houses they were buying.
But the suit, which alleges that Goldman Sachs misled its clients, goes further, raising the possibility that the bankers who devised these investments knew they were selling toxic financial products that could endanger the financial system, but were concerned only with the fees they would earn by doing so.
The SEC suit comes against the backdrop of a escalating battle on Capitol Hill over how best to overhaul the regulation of financial firms and prevent the kind of abusive practices that contributed to the worst financial crisis in decades.
Months before the mortgage investment was marketed, a senior Goldman Sachs executive recognized in an e-mail that the implosion of the housing market was imminent. “The whole building is about to collapse anytime now,” concluded Goldman Sachs Vice President Fabrice Tourre, who allegedly created the investment at the core of the case.
Goldman Sachs denied the SEC’s allegations. “The SEC’s charges are completely unfounded in law and fact, and we will vigorously contest them and defend the firm and its reputation,” the bank said in a statement.
A lawyer for Tourre, 31, who also faces civil charges, did not respond to requests for comment.
The SEC suit also drags into a legal maelstrom the legendary hedge fund manager John Paulson, who personally earned billions of dollars as his firm Paulson & Co. bet against the housing market as it went bust. The fund was a central actor in the alleged fraud, but officials say Paulson did nothing wrong.
A Paulson spokesman said his firm did nothing improper. He “is not the subject of this complaint, made no misrepresentations and is not the subject of any charges,” according to the statement.
In its case, the SEC alleges that Goldman Sachs created and marketed a financial product known as a collateralized debt obligation, often referred to as a CDO, whose value was linked to that of home loans. The agency claims that Goldman Sachs didn’t tell investors that Paulson & Co. helped the bank assemble the CDO while the hedge fund at the same time placed bets that it would lose value.
“The product was new and complex, but the deception and conflicts are old and simple,” SEC enforcement director Robert Khuzami said in a statement. “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.”
Both Goldman Sachs and Tourre, who is still employed by the firm, could face penalties including fines, repayment of gains and limits on the business they can do. The SEC does not have criminal authority and would not comment on whether the Justice Department is conducting a criminal probe.