By Kevin Chiu
The Securities and Exchange Commission is investigating at least three Wall Street investment banks for fraud related to the collapse of the real estate market and individuals associated with the banks, according to SEC officials. The investigations are part of a new SEC unit started to investigate banking fraud blamed for the financial crisis and collapse of the housing market.
The investigations led to charges being filed last week against Goldman Sachs and Company and one of its key vice presidents for defrauding investors by misstating and omitting facts about a financial product tied to subprime mortgages as the housing market began to tank.
The action was the first time that SEC investigators have filed charges against an investment bank tied to the seedy world of unregulated mortgage financing.
The SEC alleges that Goldman Sachs, long regarded as the premium brand of investment banking on Wall Street structured and marketed a synthetic collateralized debt obligation (CDO) that hinged on the performance of subprime residential mortgage backed securities. The securities provided the cash to finance risky subprime mortgages and adjustable rate mortgages sold to millions of homeowners, many of whom have had their homes foreclosed.
The SEC says Goldman Sachs failed to disclose to investors purchasing the investments vital information about the CDO, and that a major hedge fund player in the portfolio selection process worked with the company to set up the investments.
The SEC charged Goldman Sachs Vice President Fabrice Tourre, 31, a frenchmen for principally being the leader of the scheme. Tourre or “FAB” as he is nick-named was responsible for the ABACUS 2007-AC1 investment vehicle. Tourre structured the transaction, prepared the marketing materials, and communicated directly with investors. Tourre allegedly knew of Paulson & Co.’s role in the process to develop the investments.
“The product was new and complex but the deception and conflicts are old and simple,” said Robert Khuzami, 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.”
“The SEC continues to investigate the practices of investment banks and others involved in the securitization of complex financial products tied to the U.S. housing market as it was beginning to show signs of distress,” said Kenneth Lench, chief of the SEC’s structured and new products unit responsible for investigating fraud on Wall Street.
SEC officials say that one of the world’s largest hedge funds, Paulson & Co., paid Goldman Sachs to structure a transaction in which it took short positions against mortgage securities chosen by Paulson based on calculations that the securities would fail as a result of weak mortgage market underwriting by companies like defunct Countrywide Mortgage, CITI Bank and failed Washington Mutual.
The marketing materials for the CDO known as ABACUS 2007-AC1 (ABACUS) represented that the RMBS portfolio underlying the CDO was selected by ACA Management, a Limited Liability Company with expertise in analyzing credit risk, according to the SEC’s complaint.
The complaint alleges that after participating in the portfolio selection, Paulson & Co. effectively shorted the portfolio it helped to create with Goldman Sachs to buy protection on investments, putting down as little as 1% on each dollar invested. The funds chief investor John A. Paulson, who managed the hedge fund earned an estimated $3.7 billion betting against subprime mortgages in 2007.
Goldman Sachs isn’t the only major financial institution brought up on charges by the SEC related to the real estate market crash. Former Countrywide CEO Angelo Mozilo was charged with civil fraud and illegal insider trading. Mozillo is awaiting trial on charges that he “deliberately” misled investors about the risks associated with investing in investments that provided mortgages to millions of mortgage purchasers from the fallen lender, which before its demise was the largest U.S. provider of home mortgages.