The Securities and Exchange (SEC) has charged Goldman Sachs with securities fraud for misleading clients about a financial product it offered called Abacus 2007-AC1. According to the SEC, Abacus was designed by Goldman Sachs to lose money.
Abacus was a collateralized debt obligation linked to the performance of subprime mortgages. According to The New York Times, Goldman Sachs marketed Abacus in 2007 when the housing crisis was beginning to unfold. According to the SEC civil complaint, marketing documents for Abacus indicated that the mortgage bond portfolio would be selected by a firm called ACA Management.
In reality, those bonds were selected by hedge fund manager John A. Paulson. Paulson, who is not named in the SEC complaint, operates one of the world’s largest hedge funds, Paulson & Co. According to a report in The New York Times, Paulson earned an estimated $3.7 billion in 2007 by correctly betting that the housing market would collapse.
According to the SEC, Paulson selected mortgage bonds for Abacus 2007-AC1 that he believed were most likely to lose value. Goldman Sachs placed insurance on those bonds â€” called credit-default swaps â€” inside Abacus 2007 AC1. This allowed Paulson to bet against the bonds while Goldman Sachsâ€™ clients were betting that the same bonds would make money.
The SEC complaint charges that Goldman Sachs failed to disclose the role that Paulson played in selecting the Abacus portfolio, and did not reveal the fact that his hedge fund had taken a short position against it. ACA Management was led to believe that Paulson was positive on mortgages, not negative, and so it did not see a problem with his involvement, the SEC said.
According to the SEC, $10.9 billion of Abacus investments were sold. In the end, investors in Abacus lost more than $1 billion.
In addition to Goldman Sachs, the SEC lawsuit names Goldman Sachs Vice President Fabrice Tourre, who the agency says was principally responsible for Abacus.
Hedge fund manager Paulson was not been named in the complaint. According to the Associated Press, when he was asked why the SEC is not pursing charges against Paulson, Robert Khuzami, the director of the SECâ€™s enforcement division, said: “It was Goldman that made the representations to investors. Paulson did not.”
According to The New York Times, word of the SEC lawsuit caused shares in Goldman Sachs to close down 13 percent, wiping away more than $10 billion of the companyâ€™s market value. Other bank stocks also suffered amid widespread speculation that the SEC lawsuit signaled a more aggressive stance on the part of the agency. Khuzami added fuel to that fire yesterday when he said the SEC is investigating a wide range of practices related to the recent financial crisis.