LAST UPDATED : April 16, 4:57 p.m.
The Securities Exchange Commission sued for fraud today in connection with mortgage-backed collateralized debt obligations (CDOs) it packaged and sold to investors, securities that have been blamed for 2008-2009 financial collapse.
“Goldman Sachs failed to disclose to investors vital information about the CDO, in particular the role that a major hedge fund played in the portfolio selection process and the fact that the hedge fund had taken a short position against the CDO,” an SEC release said.
"The product was new and complex but the deception and conflicts are old and simple," said Robert Khuzami, Director of the Division of Enforcement, in the release. "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."
The SEC complaint named Fabrice Tourre, a 31-year-old vice president on the structured product correlation trading desk, who was responsible for the CDO in question, ABACUS 2007-AC1.
“I think this is a big attention grabbing type thing the SEC did,” said Aite Group senior analyst John Jay. “First let’s not forget these investors are not retail investors. Number two, it is not unusual for a hedge fund to be collateral manager. That alone should not necessarily be red flag. That is how these deals are put together,” he said. “Ultimately, it will come down to actual facts—what was actually said, under what circumstances, when did the parties know certain types of info, who was relaying it, how was it being relayed. Obviously, willful deception is wrong and illegal and should be prosecuted.”
In any case, the market reaction to the news may have been unwarranted, says Jay. Goldman Sachs stock (GS) closed the day off 24 percent to $160, suggesting the market thinks this case is more than a one off thing, that the firm may have done the same thing on multiple deals, and that there are dozens of other lawsuits lined up, he said. “But that is a huge huge stretch. If it were something broad and systemic, when a company is in deep doo doo, some very senior guys get named.”
Rochdale Research analyst Dick Bove agreed. The SEC has said it will look at other firms and participants, but Bove said he does not believe that in this case there will be “wide spread sweeping indictments.” If there were, these would have been announced all at once, he wrote in a research report.
Bove wagers that the timing of the Goldman Sachs indictment is politically motivated, meant to aid the passage of the banking reform bill.
Bove also said he thought LLoyd Blankfein, CEO, and David Viniar, CFO, would get the ax as a result of the SEC lawsuit. “Someone must ‘fall on their swords’ for the devastating decline in this company’s persona and they may be forced to do so for public relations reasons,” Bove wrote in areport. “These men are brilliant and capable but this situation is now out of hand. I believe however that there is a deep bench at Goldman and these executives, despite their capabilities, can be replaced. I suspect the new CFO if there is one must come from the outside.”
Bove estimated the penalty Goldman Sachs might have to pay if found guilty of the SEC charges could total $2 billion, an amount he said the bank could absorb.