The Securities and Exchange Commission April 16 filed a civil suit against Goldman, Sachs & Co. and one of its vice presidents for defrauding investors by misstating and omitting key facts about a financial product tied to subprime mortgages.
NCUA Director of Congressional and Public Affairs John McKechnie said the actions have "no bearing" on the agency's plans to address corporate legacy assets. However, he could not say whether Western Corporate FCU has any exposure to the offending instrument, ABACUS 2007-AC1.
Goldman Sachs failed to disclose to investors vital information about the collateralized debt obligation tied to subprime mortgages, 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, the SEC charges.
"The product was new and complex but the deception and conflicts are old and simple," said Robert Khuzami, SEC director of the division of enforcement. "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 alleges that one of the world's largest hedge funds, Paulson & Co., paid Goldman Sachs to structure a transaction in which Paulson & Co. could take short positions against mortgage securities chosen by Paulson based on a belief that the securities would experience credit events.
According to the SEC's complaint, filed in U.S. District Court for the Southern District of New York, the marketing materials for the CDO all represented that the residential mortgage-backed securities portfolio underlying the CDO was selected by ACA Management LLC, a third party with expertise in analyzing credit risk in RMBS. The SEC alleges that undisclosed in the marketing materials and unbeknownst to investors, the Paulson & Co. hedge fund, which was poised to benefit if the RMBS defaulted, played a significant role in selecting which RMBS should make up the portfolio.
The SEC's complaint alleges that after participating in the portfolio selection, Paulson effectively shorted the RMBS portfolio it helped select by entering into credit default swaps
with Goldman Sachs to buy protection on specific layers of the ABACUS capital structure. Given that financial short interest, Paulson had an economic incentive to select RMBS that it expected to experience credit events in the near future.
According to the SEC's 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% were on negative watch. By Jan. 29, 2008, 99% of the portfolio had been downgraded.
Investors in the liabilities of ABACUS are alleged to have lost more than $1 billion.
The SEC's complaint charges Goldman Sachs and a vice president, Fabrice P. 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. The commission seeks injunctive relief, disgorgement of profits, prejudgment interest and financial penalties.