WASHINGTON (Reuters) - The U.S. Securities and Exchange Commission’s fraud suit against Goldman Sachs (GS.N) sent a shiver down the spine of Wall Street, a sign the agency is determined to be an aggressive enforcer.
Wall Street’s largest bank stands accused of marketing a debt product tied to subprime mortgages that the SEC says was destined to fail.
There were fears the suit could cast a regulatory cloud over the entire investment banking industry.
“The SEC should be regarded as no longer a tame kitten and (instead) a fairly angry tiger,” said John Coffee, a securities professor at Columbia Law School.
“This shows the style of a new tougher, harsher SEC. The SEC used to settle more easily, used to process cases more quickly and it was a very friendly, sometimes cozy relationship with the major investment banks,” he said.
Publicly humiliated for bungling probes that could have uncovered Bernard Madoff’s $65 billion fraud, the SEC has overhauled its enforcement division.
Under SEC Chairman Mary Shapiro and new enforcement director Robert Khuzami, the agency has cut middle managers, created mini squads to root out fraud and adopted tools traditionally used by federal prosecutors.
But reminders of the SEC’s mishandling of some previous major cases continue to surface.
The lawsuit was filed the same day the agency’s inspector general released a damning report on the SEC’s failure to stop Allen Stanford’s alleged $7 billion fraud.
The agency watchdog said SEC staff suspected as early as 1997 that Stanford was running a fraud, but took no action until late 2005, and even then missed their chance.
The SEC was also loosely responsible for supervising the five largest investment banks in the lead up to the financial crisis, including Lehman Brothers and Bear Stearns, firms that either had to be rescued or collapsed.
In its lawsuit, the SEC alleged that Paulson & Co, a major hedge fund run by billionaire John Paulson, worked with Goldman to create a collateralized debt obligation from which the hedge fund stood to benefit as its value fell.
Investors lost more than $1 billion while the fund, which shorted the CDO, made $1 billion, according to the SEC.
The agency charged that Goldman did not tell investors “vital information” about the CDO, including that Paulson & Co was involved in choosing which securities would be part of the portfolio.
A Goldman vice president, Fabrice Tourre, whom the SEC said was principally responsible for creating the product, was also charged with fraud. Paulson & Co. was not charged.
Goldman vowed to fight the SEC’s suit and called the SEC’s charges completely unfounded in law and fact.
“It’s a big moment for the SEC to see if they can stand up to Goldman Sachs and the best lawyers and experts on Wall Street. A battle of the titans,” said Jake Zamansky, a veteran plaintiffs lawyer with Zamansky & Associates.
The SEC was recently slapped down by a U.S. federal judge for going easy on Bank of America (BAC.N) when the agency charged the bank with misleading shareholders about its takeover of Merrill Lynch & Co.
U.S. District Judge Jed Rakoff eventually accepted the SEC’s settlement with the bank after it ramped up fines and accused the bank of hiding Merrill’s soaring losses.
For its part, Goldman vowed to fight the SEC’s suit and called the SEC’s charges “completely unfounded in law and fact.”
“We’ll see if the SEC is up to the challenge. They won’t be able to walk away with a slap on the wrist and a minor settlement after what Judge Rakoff did. This one has has to go the distance,” Zamansky said.
John Allan James, who teaches corporate governance at Pace University’s business school, said the SEC’s suit was the latest sign of a revived agency.
“If you look at the cases brought in 2007 and 2008, they must have been at Starbucks having coffee because they weren’t doing much of anything,” he said. “... But now they’ve become meaner than hell.”
Reporting by Dan Margolies and Rachelle Younglai; Additional reporting by Joseph Giannone in New York; Editing by Tim Dobbyn