Goldman Sachs is defending itself against charges that it defrauded clients in one of its mortgage deals by asserting that those clients were sophisticated investors, and understood the complex financial securities the bank was selling. According to The Washington Post, the U.S. Securities and Exchange Commission (SEC) says that doesn’t matter.
Last 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 complaint, Goldman Sachs failed to disclose the role that hedge fund manager John A. Paulson played in selecting the Abacus portfolio, and did not reveal the fact that his hedge fund had taken a short position against it. Instead, marketing documents for Abacus indicated that the mortgage bond portfolio would be selected by a firm called ACA Management. According to the SEC, Paulson selected mortgage bonds for Abacus that he believed were most likely to lose value. When Abacus tanked, the Goldman Sachs clients who invested in it lost more than $1 billion.
According to The Washington Post, Goldman Sachs contends that even the facts as presented by the SEC don’t amount to a violation of securities law because the clients who bet on Abacus would have done so even if Paulson’s role had been disclosed. Thus, Goldman’s lack of disclosure doesn’t qualify as a “material omission”.
But the SEC disagrees, and says the clients, no matter how sophisticated, likely would have made different decisions had they known about Paulson’s involvement.
“At the end of the day, it’s very hard to argue that investors wouldn’t want to know that the portfolio was put together by somebody selling short,” J. Robert Brown, a law professor at the University of Denver, told the Post.
To win its lawsuit in court, the SEC will have to prove that Goldman Sachs hid information from its clients because disclosure would have kept them from buying a stake in Abacus. Of course, both parties could settle out of court. According to the Post, a lawyer for Goldman Sachs did say on Tuesday that the bank would be open to an “agreeable” settlement with the SEC.