Goldman Sachs was last night facing one of the greatest crises in its history after it was charged with fraud over sales of the toxic mortgage investments at the centre of the financial crisis.
The company is accused of selling a subprime debt product created in cahoots with a hedge fund that had a financial interest in seeing the product collapse. Investors lost $1bn (£650m) when it did indeed subsequently tumble in value, while the hedge fund manager, Paulson & Co, made $1bn.
The charges – in a civil lawsuit brought by the Securities & Exchange Commission, the Wall Street regulator – sparked an immediate 10 per cent fall in Goldman's share price. They could lead to a heavy fine and require Goldman to pay back the money made from marketing the product, called Abacus.
Also named in the civil charges yesterday was a 31-year-old employee at Goldman who was central to the creation of Abacus in 2007. Fabrice Tourre, a maths graduate who is still working for the company, now in London, joined Goldman straight after university in 2001, having studied at the Ecole Centrale in Paris and at Stanford University.
In emails written before Abacus was sold to investors, Mr Tourre declared his belief that the subprime market was already on the brink of disaster. "The whole building is about to collapse anytime now ... Only potential survivor, the fabulous Fab[rice] ... standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities!!!" In another, he wrote: "We don't have a lot of time left."
Abacus was a collateralised debt obligation – a type of derivative linked to subprime mortgages. Paulson & Co played a key role in putting together the portfolio of loans that made up the product, including vetoing mortgages from lenders known for their better underwriting standards, before betting against it. The SEC says Goldman failed to mention this when it was marketing Abacus, saying instead that the debt had been put together with the help of ACA Management, a third party with expertise in analysing credit risk.
Goldman was paid $15m by Paulson & Co for structuring and marketing the product in April 2007 and 99 per cent of the credit within Abacus had been downgraded by rating agencies within nine months. Investors in Abacus included ABN Amro, now part of Royal Bank of Scotland.
Robert Khuzami, director of the SEC's enforcement division, said: "The product was new and complex but the deception and conflicts are old and simple. 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."
Goldman said the charges were unfounded and it would "vigorously contest them". In a long rebuttal last night it pointed out that it lost money on Abacus, and it said that it provided extensive disclosure to "sophisticated" investors. It said aca had selected the portfolio.
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