On Friday April 16, 2010, the United States Securities and Exchange Commission (“SEC”) filed fraud charges against Goldman Sachs & Co. for misstating, and omitting key facts related to a synthetic collateralized debt obligation, named ABACUS, that it structured, marketed, and sold to investors. The CDO was based on subprime mortgage-backed securities.
The SEC alleges that Goldman Sachs failed to disclose to investors that a hedge fund, Paulson & Co., was betting against the securities. Moreover, the SEC accuses Goldman Sachs of failing to disclose to investors that it permitted that very hedge fund to be involved in choosing which securities would be part of the CDO. This is especially troubling because the hedge fund had made investments that were a direct bet against the performance of the CDO. In other words, the hedge fund would profit if the CDO declined in value. Not surprisingly, the hedge fund earmarked very risky, low-quality subprime mortgage securities for the CDO, creating the likelihood that the hedge fund’s bet against the CDO would be wildly profitable. As a result of apparently being allowed to rig the game, so to speak, the hedge fund reportedly realized a $1 billion profit from its bet against the CDO it had helped devise.
Notwithstanding the fact that Goldman Sachs allowed the hedge fund to influence the securities that were part of the CDO portfolio, according to SEC Enforcement Director Robert Khuzami, “Goldman wrongly permitted [Paulson & Co.] to heavily influence which mortgage securities to include in [the CDO], while telling other investors that the securities were selected by an independent, objective third party.” Even further, the hedge fund had paid Goldman Sachs $15 million to structure the CDO. So, it appears that Goldman Sachs acted in a way to benefit this hedge fund client at the expense of investors who purchased the CDO. Little more than nine months after the CDO was structured and marketed, 99 percent of the CDO’s portfolio had been downgraded. Investors who lost money in the CDO may have valid causes of action against, among others, Goldman Sachs.