A New York State Supreme Court judge has denied a motion to dismiss a lawsuit for fraud against Goldman Sachs. The judge ruled that the case may go forward.

The brokerage firm of Goldman Sachs is being accused of fraud by a bond insurer, ACA Financial Guaranty Corp. The plaintiff alleges that Goldman Sachs tricked them into insuring a security called a collateralized debt obligation that was deliberately designed for failure.

ACA Financial Guaranty Corp. is alleging that the Goldman Sachs worked with a hedge fund, Paulson & Co. Inc., to create the collateralized debt obligation and design it in such a way as to guarantee failure. Paulson would then profit from the failure by taking a short position on the security. The security was attached to a grouping of residential mortgage-backed securities.

Goldman Sachs moved to dismiss with the argument that ACA could not show that their losses were caused by any misrepresentations. The brokerage firm said ACA had the opportunity to find out that Paulson was taking a short position by simply asking, but ACA never did.

The judge ruled that it would be “premature” to dismiss ACA’s claims of fraud. She stated that ACA’s suit was different from similar suits that had been dismissed because Goldman Sachs concealed that Paulson had a short position, and the fact was not publicly discoverable.

A collateralized debt obligation (CDO) is created by pooling a group of similar loan types into a single investment, known as a synthetic investment. Investors can buy and sell their share of the CDO, and have a right to a portion of the interest income and principal.

Source: New York Law Journal, “Bond Insurer’s Fraud Suit Against Goldman Survives Dismissal Bid”, Brendan Pierson, April 26, 2012

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