Goldman Sachs Knew of SEC Probe in July 2009

Goldman Sachs executives knew for months that it was being investigated by the Securities and Exchange Commission (SEC), but failed to disclose the probe. According to a Bloomberg report, Goldman Sachs received a “Wells notice” nine months ago. Such notices are a formal warning that regulators intend to file civil charges

On Friday, the SEC filed a civil suit against Goldman Sachs, as well as its Vice President Fabrice Tourre, over a financial product called Abacus 2007-AC1. As we reported previously, Abacus was a collateralized debt obligation linked to the performance of subprime mortgages that the SEC says was designed to lose money.

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. In addition to selecting the portfolio for Abacus, Paulson held a short position in it, and would make money when and if Abacus failed.

According to the SEC, Paulson selected mortgage bonds for Abacus that he believed were most likely to lose value. Eventually, Abacus did tank and Goldman Sachs clients who invested in it lost more than $1 billion.

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.

On Friday, word of the SEC lawsuit caused shares in Goldman Sachs to close down 13 percent, wiping away more than $10 billion of the company’s market value.

According to Bloomberg, Goldman Sachs received the SEC Wells notice in July 2009 and responded in September. However, in its 2009 annual report issued in March, the firm only stated in very generic language that it was cooperating with regulators’ requests for information.

While SEC rules apparently do not require a public company to disclose the receipt of a Wells notice, a former SEC attorney told Bloomberg that there is a question as to whether the March notification could be considered misleading because it left out important information. Omissions can be grounds for shareholder lawsuits.

For its part, Goldman Sachs is maintaining that Friday’s SEC filing took it by surprise, according to The Wall Street Journal. After responding to the Wells notice, Goldman Sachs said it heard nothing from the government until the civil suit was filed on Friday. Goldman Sachs officials told the Journal that the first many executives heard of the suit was via news reports that aired that day.

According to The Wall Street Journal, the SEC usually gives firms a chance to settle such charges before lawsuits are filed, but Goldman Sachs says that didn’t happen in this case. For its part, the SEC says it followed standard practices in pursuing the case.

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