This morning, the SEC filed securities-fraud charges against Goldman Sachs and a vice-president at the company, London-based Fabrice Tourre. In the complaint, they allege that in 2007, Tourre allowed hedge-funder John Paulson to structure a collateralized debt obligation called Abacus, made up of crappy subprime-mortgages securities he handpicked himself, and that the firm then turned around and marketed Abacus to its clients, without mentioning that Paulson had created the CDO specifically in order to buy credit-default insurance against it.
To aid in the deception, the suit alleges, Goldman brought in a firm called ACA Management, an independent company of the sort that firms hire to select assets for CDOs, and told them that Paulson was helping pick the securities because he was investing in the CDO, rather than betting against it. From the complaint:
Tourre allegedly knew of Paulson & Co.’s undisclosed short interest and role in the collateral selection process. In addition, he misled ACA into believing that Paulson & Co. invested approximately $200 million in the equity of ABACUS, indicating that Paulson & Co.’s interests in the collateral selection process were closely aligned with ACA’s interests. In reality, however, their interests were sharply conflicting.
Paulson, who has not been charged with anything, made billions of dollars off credit-default swaps when the housing market collapsed. According to the SEC, investors in ABACUS lost more than $1 billion on their side of the trade. “The product was new and complex but the deception and conflicts are old and simple,” said Robert Khuzami, director of the division of enforcement. Like the abacus itself.
Update 1: With their stock tumbling (and pulling down the rest of the market with it) Goldman Sachs has responded to the charges in an uncharacteristically sober, non-withering way: "The SEC's charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation."
Update 2: SEC Complaint
The Marketing Materials for ABACUS [PDF, via commenter extraordinaire Comfortably Smug]
Update 3: Goldman has released a second statement, noting that they lost money on the trade, ACA did help select the portfolio, there was full disclosure about everything, and they're not mad they're just "disappointed."