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Goldman fraud case: 'Old and simple deception and conflicts'

April 16, 2010 |  2:11 pm

The heart of the Securities and Exchange Commission's surprise fraud case against Goldman Sachs & Co. on Friday: The investment banking titan duped investors in toxic mortgage securities by failing to give them the entire story about the deal -- and who really stood to benefit.

"The product was new and complex but the deception and conflicts are old and simple," Robert Khuzami, the SEC's enforcement chief, said in a statement. "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."

In its complaint filed in federal court in New York, the SEC alleged that Paulson & Co., one of the world's biggest hedge funds, paid Goldman $15 million in April 2007 to structure a so-called collateralized debt obligation, or CDO, that Paulson could then bet against via the use of credit default swaps.

Paulson, led by former Bear Stearns banker John Paulson (no relation to former Goldman CEO and ex- Treasury Secretary Henry M. Paulson), was one of the biggest beneficiaries of the housing meltdown because the firm saw early on that the market was headed for collapse, and figured out ways to profit from that catastrophe. His spectacular success was chronicled in the 2009 book "The Greatest Trade Ever."

"We believe we are in the early stage of a correction in this market and that the market will eventually implode,'' John Paulson said in a letter to investors in March 2007. He predicted that bad loans would  "skyrocket'' and that "most, if not all, of the independent [mortgage] originators will go bankrupt.''

In its complaint, the SEC said that the marketing materials Goldman gave investors for a CDO known as ABACUS 2007-AC1 represented that the mortgage securities underlying the CDO were picked by ACA Management, a third party with expertise in analyzing credit risk in such securities.

Instead, the SEC alleges, "unbeknownst to investors, the Paulson & Co. hedge fund, which was poised to benefit if the [securities] defaulted, played a significant role" in picking which securities went into the portfolio.

Paulson -- who isn't charged in the SEC's case -- earned $1 billion from the credit default swaps on the ABACUS deal, the SEC said. That also was what investors who bought the CDO securities lost as the  portfolio plunged in value.

Goldman on Friday decried the SEC's charges, saying they were "completely unfounded in law and fact." The company's shares plummeted $23.57, or 13%, to $160.70.

According to the SEC's complaint, Fabrice Tourre, the 31-year-old Goldman banker who assembled the ABACUS deal and who also is charged in the case, sent an e-mail to a friend in January 2007 that said, in part: "More and more leverage in the system, The whole building is about to collapse anytime now ... Only potential survivor, the fabulous Fab[rice Tourre] ... standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities!!!"

-- Tom Petruno