Goldman Sachs to pay record settlement in fraud suit, change business practices
Friday, July 16, 2010
Goldman Sachs agreed Thursday to pay $550 million to settle a fraud suit brought by the Securities and Exchange Commission that accused the storied Wall Street bank of selling a subprime-mortgage investment that was secretly designed to fail.
The fine is the largest the SEC has ever assessed against a financial company. But the settlement also is striking because Goldman agreed to a host of changes to how it does business and because the bank, while not admitting wrongdoing, agreed to express "regret" for including "incomplete information" in marketing materials touting the investment to clients.
By doing so, Goldman acknowledged "the fundamental basis of our complaint," SEC enforcement director Robert Khuzami said at a news conference, standing with 10 colleagues who worked on the case. "Today's settlement is a stark reminder -- a very stark reminder -- that there will be a heavy price to be paid if firms violate the principles fundamental to securities law."
While Goldman will pay only a tiny fraction of its $13 billion in annual profits to resolve the claims, the settlement represents a black mark for the bank, which had insisted since the suit was filed three months ago that it had done nothing wrong. It comes on the same day that Congress sent legislation to the president to curb many Wall Street practices -- including ones that have made Goldman a lot of money.
Goldman was one of the few financial institutions to emerge from the economic crisis unscathed -- even richer -- until it became the subject of criticism from regulators and Capitol Hill that it exploited government bailouts and took part in deceptive business practices that exacerbated the financial crisis.
Still, by settling, Goldman is able to escape a protracted court case while it is trying to rebuild its public reputation. The company has lost billions of dollars in market value since the filing of the fraud suit and continues to face a Justice Department probe and private lawsuits. Securities lawyers said the settlement was carefully worded to not affect those suits. Goldman also said the SEC plans no other charges in connection with its mortgage securities.
"We believe that this settlement is the right outcome for our firm, our shareholders and our clients," the bank said in a statement.
For the SEC, a regulator trying to rebuild its own reputation after numerous setbacks, "it's a great victory," said Jacob Frenkel, a former SEC lawyer now in private practice. "When the agency resolves such a high-profile case quickly and with a strong deterrent message and result, it's a win."
The crux of the case alleges that Paulson & Co., a hedge fund, was looking for a way to bet on a drop in the housing market and that it asked Goldman to help create a financial product that would allow such a wager. Paulson, led by hedge fund manager John Paulson, essentially bought insurance against the investment -- much like taking out an insurance policy on a person who secretly has a potentially deadly disease.
Then, Paulson helped assemble that product by selecting individual securities to include in it. These were mortgage-related securities that Paulson thought were likely to lose value. The SEC claims that the fund's motivations and role were concealed when Goldman marketed and sold the investment, known as Abacus 2007-AC1, to clients who hoped it would gain value.
The investment ultimately lost virtually all its value, costing investors $1 billion.
As part of the settlement, Goldman said it "acknowledges that the marketing materials" for the transaction "contained incomplete information."
"In particular, it was a mistake for the Goldman marketing materials to state that the reference portfolio was 'selected by' " an objective third-party company "without disclosing the role of Paulson & Co. Inc. in the portfolio selection process and that Paulson's economic interests were adverse" to investors, Goldman said.
To settle the charges, Goldman will pay $300 million to taxpayers and $250 million to two foreign banks that invested in the subprime security that the SEC alleged was designed to fail.
The changes to how the company does business are just as significant, lasting three years, securities lawyers said. Goldman must review the role and responsibilities of company lawyers and compliance executives in the preparation of marketing materials for mortgage securities. Goldman employees in the mortgage business must receive additional education and training.
Those changes put more pressure on Goldman to dramatically increase the vetting that is done of disclosures that accompany products the bank sells to clients. Goldman has faced a range of accusations that it has bet against its clients and concealed important information from them -- accusations the bank has denied. But under the settlement, Goldman is likely to be far more cautious in ensuring that it is telling clients everything they might deem important.
Judge Barbara S. Jones of the U.S. District Court for the Southern District of New York must approve the settlement. Late last year, a judge sitting on the same bench rejected an SEC settlement with Bank of America, saying it was far too modest. Later that bank and the SEC settled for a much larger sum.
An SEC complaint against Fabrice Tourre, a Goldman vice president who arranged the deal, continues. Based in London, he is on leave from Goldman while that case unfolds.