Goldman Sachs Under Fire In US Senate

by Glen Shapiro, LawAndTax-News.com, New York

29 April 2010

In the midst of attempts by the US Senate to place stricter controls on the finance industry and the complex products it sells, and after the Securities and Exchange Commission (SEC) had charged it with defrauding investors, the most influential US investment house, Goldman Sachs, was required to testify before a US Senate committee.

On April 16, the Securities and Exchange Commission charged Goldman Sachs and one of its vice presidents, Fabrice Tourre, with defrauding investors by misstating and omitting key facts about a financial product tied to subprime mortgages as the US housing market was beginning to run out of steam.

The SEC alleges that Goldman Sachs structured and marketed a synthetic collateralized debt obligation (CDO) that hinged on the performance of subprime residential mortgage-backed securities, known as ‘ABACUS’. According to the SEC, Goldman Sachs failed to disclose vital information to investors about ABACUS, in particular the role that a hedge fund, Paulson & Co, played in the portfolio selection process and the fact that the hedge fund had taken a short position against it. Investors in the ABACUS CDOs are alleged to have lost more than USD1bn.

"The product was new and complex but the deception and conflicts are old and simple," said Robert Khuzami, the SEC’s Director of the Division of Enforcement. "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."

At the time, Kenneth Lench, Chief of the SEC's Structured and New Products Unit, added that: "The SEC continues to investigate the practices of investment banks and others involved in the securitization of complex financial products tied to the US housing market as it was beginning to show signs of distress."

That comment has led to assumptions that the charge filed against Goldman Sachs was only the first of many to be proceeded with by the SEC, and that other banks involved in its investigations were being encouraged to cooperate with it or suffer the same fate.

For its part, Goldman Sachs has strongly denied, and has said that it will vigorously defend itself against, the charge. In their testimony before the US Senate Permanent Subcommittee on Investigations (PSI) on April 27, the seven Goldman Sachs executives called strongly denied the allegations made by the SEC and stood by Goldman Sachs’s role in the housing market at the time.

In particular, in his prepared statement, Lloyd C. Blankfein, Goldman Sachs’s Chairman and Chief Executive Officer, recognized that “many Americans are sceptical about the contribution of investment banking to our economy and understandably angry about how Wall Street contributed to the financial crisis,” and that, during the boom years, “one consequence of the growth of the housing market was that instruments that pooled mortgages and their risk became overly complex.”

While he strongly disagreed with the SEC’s complaint, he also recognized how such a complicated transaction might look to many people. In addition, he said that: “Much has been said about the supposedly massive short Goldman Sachs had on the US housing market. The fact is we were not consistently or significantly net ‘short the market’ in residential mortgage-related products in 2007 and 2008.”

“We didn’t have a massive short against the housing market and we certainly did not bet against our clients,” he added. “Rather, we believe that we managed our risk as our shareholders and our regulators would expect.”

“Our performance in our residential mortgage-related business confirms this,” he concluded. “During the two years of the financial crisis, while profitable overall, Goldman Sachs lost approximately USD1.2bn from our activities in the residential housing market.”

According to the SEC, Tourre was principally responsible for ABACUS. He structured the transaction, prepared the marketing materials, and communicated directly with investors. He suffered particularly strong questioning by the PSI.

It should be remembered, however, that the PSI was created with the broad mandate to determine whether any changes are required in US law to better protect the public. It does not make the law, nor is it able to recommend charges. The PSI has been conducting an investigation into the financial services industry and the financial crisis for more than a year, with Goldman Sachs as only one of several financial institutions requested to testify.

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