Goldman On Trial

The Securities and Exchange Commission filed a civil suit against Goldman Sachs accusing Goldman of “defrauding investors by misstating and omitting key facts" about a financial product based on subprime mortgage-backed securities. As everyone knows by now, this type of security was a major contributor to the financial crisis of 2008.

The charges are believed to be the first brought against a Wall Street firm for speculating on the collapse of the housing market, which is still struggling to emerge from one of the steepest declines in history. The SEC is accusing Goldman of failing to tell investors that a major hedge fund, Paulson & Co, had helped put together the controversial financial product known as collateralized debt obligation (CDO), and was at the same time betting against it.The transaction occurred in 2007. CDO's are sophisticated financial tools that repackage loans into a product that can be sold on the secondary market. They are called mortgage-backed securities if the loans are mortgages. If the mortgages are made to those with a less than prime credit history, they are called subprime mortgages.

Goldman claimed it lost 90 Million dollars for its own investment in the security and said it would "vigorously contest them (the SEC) and defend the firm and its reputation." The lawsuit also named Fabrice Tourre, then a vice-president at Goldman who allegedly knew of Paulson & Co.'s undisclosed short interest and role in the collateral selection process, according to the SEC. He was said to be the creator and salesman of the product, which caused investors to lose about one billion dollars. Analysts said a long courtroom battle could now be expected.

Goldman is also facing a potential backlash in Europe; Britain's Prime Minister Gordon Brown called for authorities there to investigate and accuse the investment bank of "moral bankruptcy." In Germany, the Welt am Sonntag newspaper quoted Chancellor Angela Merkel's spokesman, UIrich Wilhelm, as saying that German regulator BaFin will ask the U.S. Securities and Exchange Commission for detailed information.

Although Goldman reported strong earnings this week, nearly double from the same period a year ago, investors focused on the charges, and sold off the stock by two percent, with a decline of $13 billion over a three day period.

Goldman’s gain from the alleged fraud was $15 Million - not a huge figure for this financial giant. However, SEC fines could be $70 Million plus $1.20 for each share, which could bring the total penalty to near $700 Million, a significant dent into Goldman’s capital. Furthermore, many large institutions, as we know, were involved with transactions of this type, and this could just be the tip of the iceberg.

C. Cohn
Cohn-Reilly Report