WASHINGTON – The government has accused Goldman Sachs & Co. of defrauding investors by failing to disclose conflicts of interest in mortgage investments it sold as the housing market was faltering.
The Securities and Exchange Commission announced Friday civil fraud charges against the Wall Street powerhouse and one of its vice presidents. The agency alleges Goldman failed to disclose that one of its clients helped create — and then bet against — subprime mortgage securities that Goldman sold to investors.
Investors in the mortgage securities are alleged to have lost more than $1 billion, the SEC noted. The agency is seeking to recoup profits reaped on the deal.
The Goldman client implicated in the fraud is one of the world's largest hedge funds, Paulson & Co., which paid Goldman roughly $15 million for structuring the deals in 2007.
Goldman Sachs shares fell more than 12 percent after the SEC announcement, which also caused shares of other financial companies to sink. The Dow Jones industrial average fell more than 120 points in midday trading.
The civil lawsuit filed by the SEC in federal court in Manhattan was the government's most significant legal action related to the mortgage meltdown that ignited the financial crisis and helped plunge the country into recession. The SEC's enforcement chief said the agency is investigating a wide range of practices related to the crisis.
A Goldman Sachs spokesman didn't immediately return a call seeking comment.
The agency also charged a Goldman vice president, Fabrice Tourre, 31, who it said was principally responsible for devising the deal and marketing the securities.
The SEC is seeking unspecified fines and restitution from Goldman Sachs and Tourre.
Goldman told investors that a third party, ACA Management LLC, had selected the underlying mortgages in the investment. But, the SEC alleges, Goldman misled investors by failing to disclose that Paulson & Co. also played a role in selecting the mortgages and stood to profit from their decline in value.
"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," SEC Enforcement Director Robert Khuzami said in a statement.
The SEC charges come less than 10 days after Goldman Sachs denied it bet against clients by selling them mortgage-backed securities while reducing its own exposure to such investments before the housing market crashed.
In an annual letter to shareholders, Goldman said it began reducing its exposure to the U.S. mortgage market in late 2006. It said it did so by selling mortgage-related investments or buying credit default swaps. The swaps are a form of insurance that pays out if the value of the underlying asset declines.
Those hedges, also known as short positions, served Goldman well. As the housing market began cratering and losses piled up for the biggest banks, Goldman suffered less damage. That led to criticism that the bank benefited at the expense of clients who bought mortgage-backed securities that later became toxic. Goldman steadfastly denied that.
"Our short positions were not a 'bet against our clients,'" Goldman said in the letter. "Rather, they served to offset our long positions. Our goal was, and is, to be in a position to make markets for our clients while managing our risk within prescribed limits."
In the letter, Goldman also rejected claims that it profited from the mortgage market meltdown.
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