It is unlikely that criminal charges will be brought, a person close to the matter said. Representatives for the Justice Department declined to comment.
Yet the lawsuit is widely expected to spur other lawsuits, and is “probably the first of several,” according to Doug Kass, president of hedge fund Seabreeze Partners Management.
“Regulators and plaintiffs’ lawyers are going to be looking at other deals, to what kind of conflicts Goldman has,” said Jacob Zamansky, a lawyer who represents investors in securities fraud lawsuits.
“I’ve been contacted by Goldman customers to bring lawsuits to recover their losses,” he added. “With the SEC bringing fraud charges it’s going to expose what’s behind the curtain.”
According to the SEC, Goldman marketing materials showed that a third party, ACA Management LLC, chose the securities underlying ABACUS, without revealing Paulson’s involvement.
The SEC complaint quotes extensively from internal e-mails and memos, noting that in early 2007 it had become difficult to market CDOs tied to mortgage-backed securities.
It quoted a Jan. 23, 2007, e-mail from Tourre to a friend as saying: “The whole building is about to collapse anytime now ... Only potential survivor, the fabulous Fab ... standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstrosities!!!”
Another e-mail, to Tourre from the head of Goldman’s structured product correlation trading desk, complained: “The CDO biz is dead we don’t have a lot of time left.”
Other communications detail the importance of hiring ACA.
The SEC said Goldman reached out to German bank IKB to buy securities that Paulson was selling, knowing it would buy only securities selected by an independent asset manager.
“We expect the strong brand-name of ACA as well as our market-leading position in synthetic CDOs of structured products to result in a successful offering,” a March 12, 2007, Goldman e-mail said.
IKB ultimately took on exposure to ABACUS, as did the Dutch bank ABN Amro Holding NV.
The German government ultimately bailed out IKB in the summer of 2007, in part because of the bank’s investments, while lenders that eventually bought much of ABN Amro were also subjected to their own government bailouts.
In a statement after U.S. markets closed, Goldman said it lost more than $90 million on the transaction, six times the $15 million fee it received, and provided “extensive disclosure” on the securities involved.
It also said it never represented to ACA Capital Management, which invested $951 million in the transaction, that Paulson was going to be a “long” investor, meaning that Paulson was betting the securities would gain in value.
Paulson & Co paid Goldman $15 million to structure and market the ABACUS CDO, which closed on April 26, 2007, the SEC said. Little more than nine months later, 99 percent of the portfolio had been downgraded, the SEC said.
Janet Tavakoli, president of Tavakoli Structured Finance Inc in Chicago and author of a book on synthetic CDOs, said it may have been common on Wall Street for hedge funds to play big roles in picking mortgage-backed securities for use in CDOs.
“Many investors were not aware of how disadvantaged they were by these CDO structures,” she said.
The charges are expected to fuel anti-Wall Street sentiment on Capitol Hill where sweeping financial industry reforms are expected to soon arrive on the Senate floor for a vote.
A Democratic bill, strongly supported by President Barack Obama, would slap new restraints on major banks, likely curtailing their opportunities for profit and revenue growth.
Similar legislation was approved in the House of Representatives in December. Analysts believe a bill could be signed into law by Obama by mid-year.
“Banks were getting their mojo back, successfully fighting the regulatory reform bill,” said James Ellman, president of Seacliff Capital in San Francisco. “Clearly, such malfeasance could help get the bill to go through.”
Last month, Buffett praised Goldman as a “very, very strong, well-run business,” and said of Blankfein, “You cannot find a better manager.”
Buffett had no immediate comment, his assistant Carrie Kizer said.
The SEC lawsuit was assigned to U.S. District Judge Barbara Jones, who was appointed to the bench in 1995 by President Bill Clinton. She presided over the 2005 criminal trial of former WorldCom Inc Chief Executive Bernard Ebbers over an $11 billion accounting fraud at the phone company.
The case is SEC v. Goldman Sachs & Co et al, U.S. District Court, Southern District of New York, No. 10-03229. (Reporting by Jennifer Ablan, Maria Aspan, Clare Baldwin, Karen Brettell, Jeffrey Cane, Elinor Comlay, Kevin Drawbaugh, Steve Eder, Ellen Freilich, Burton Frierson, David Gaffen, Joseph A. Giannone, Matthew Goldstein, Svea Herbst-Bayliss, Ed Krudy, Herb Lash, Grant McCool, Jeremy Pelofsky, Christian Plumb, Aaron Pressman, Leah Schnurr, Jonathan Spicer, Jonathan Stempel, Caroline Valetkevitch, Phil Wahba, Dan Wilchins, Rolfe Winkler, Karey Wutkowski and Rachelle Younglai; Editing by Robert MacMillan and John Wallace)