The Wall Street Journal
Goldman Sachs Group Inc. officials said they knew as far back as August 2008 that regulators were examining controversial mortgage securities created by the firm but were stunned by the bombshell civil fraud suit lodged against it Friday, with most having learned about it from news reports.
Firms typically get a chance to settle such suits, but not in this case, Goldman said. The Wall Street giant said it was alerted to the probe in the summer of 2008 and was warned that it might face a suit in July 2009.
It says it then responded in detail to the Securities Exchange Commission's inquiry in September, but heard nothing back from the government until Friday's unveiling of the civil suit. The SEC usually notifies firms ahead of a lawsuit as a courtesy to give them a chance for a last-ditch settlement or to prepare for the public fallout.
The move showed a combative streak from the SEC, which has been under mounting pressure after letting slip through its fingers early probes into the Ponzi scheme of Bernard Madoff and the alleged fraud of Texas financier R. Allen Stanford.
The case, SEC v. Goldman Sachs & Co. and Fabrice Tourre, sets the stage for what could become the signature lawsuit from the financial-crisis era.
It comes at a time when the Obama administration is trying to move through Congress a bill to overhaul financial regulations in the wake of the crisis, legislation that would likely affect the regulation of products used in the Goldman deal. The effort is being resisted by major banks and by Republican lawmakers.
Lawsuits by the SEC are subject to a vote by the agency's five commissioners, and the tally on the Goldman case will be closely watched in Washington, as the current commission is split along party lines—with two Republicans and two Democrats, plus one independent who was appointed by President Obama.
The way the SEC launched the suit "certainly doesn't follow the spirit" or practice of the agency, said Paul Atkins, who served as a Republican SEC commissioner last decade.
An SEC spokesman said the agency followed standard practices in pursuing the case. The SEC said the suit's timing wasn't influenced by external events.
White House spokeswoman Jen Psaki noted that the SEC is an independent agency, "and it does not coordinate with the White House the announcement of its enforcement actions. We were not given advance notice at the White House about the announcement."
The SEC suit centers on a deal Goldman structured by the name of Abacus. In early 2007, Goldman was helping one of its clients, hedge fund Paulson & Co., design a security known as a collateralized debt obligation, which was built out of a set of risky mortgage assets that the fund and founder John Paulson helped select. Paulson then placed a "short" bet that mortgages contained in the Abacus CDO would fall in value. The CDO had three investors: Paulson, securities firm ACA Capital Ltd. and German bank IKB Deutsche Industriebank AG.
The SEC alleges that Goldman should have disclosed Mr. Paulson's involvement in creating the portfolio and his bearish bet. The portfolio quickly lost value and delivered huge returns for the hedge fund. Both Goldman and Paulson say the nature of the deal and the sophisticated investors involved meant that no such disclosure was necessary.
Goldman said it first heard from the SEC about the investigation in August 2008, when it received a subpoena from attorneys requesting documents related to the transaction.
It sent about eight million pages, said a person familiar with the matter.
Five Goldman employees, including Fabrice Tourre, the trader involved in marketing Abacus who was named as a defendant by the SEC, were interviewed, say people familiar with the matter. Mr. Tourre has not responded to repeated requests for comment.
In July 2009, Goldman and Mr. Tourre received so-called Wells notices from the SEC. Such notices are a formal warning that regulators intend to file civil charges, and serve as a point of negotiation about a settlement. By September 2009, both Goldman and Mr. Tourre had responded to the charges in a 41-page document, according to people familiar with the matter.
The gist of Goldman's defense: The disclosure of Mr. Paulson's involvement would not have had any real effect on buyers of the CDO created by Goldman.
"If this matter is litigated, Goldman Sachs is confident that a fuller record...will underscore that no one in fact considered Paulson's role important and that no one was misled," Goldman told the SEC in September 2009, in a document reviewed by The Wall Street Journal.
That was the last contact Goldman had with the SEC about the matter until late March, when Goldman placed a phone call inquiring about the case.
The call wasn't returned, Goldman said. On Friday, the SEC moved ahead with charges, stunning Goldman officials. Perhaps more than any other Wall Street firm, Goldman has been steadfast in defending its actions during the credit boom.
As employees gathered around television sets Friday, they groused about getting scapegoated in Washington.
The SEC's enforcement division, meanwhile, has been under pressure to show it has teeth. Last fall, federal Judge Jed Rakoff rejected as too lenient the SEC's proposed $33 million settlement with Bank of America over disclosures made to shareholders about its takeover of Merrill Lynch.
Firms typically get a chance to settle such suits, but not in this case, Goldman said. The Wall Street giant said it was alerted to the probe in the summer of 2008 and was warned that it might face a suit in July 2009.
It says it then responded in detail to the Securities Exchange Commission's inquiry in September, but heard nothing back from the government until Friday's unveiling of the civil suit. The SEC usually notifies firms ahead of a lawsuit as a courtesy to give them a chance for a last-ditch settlement or to prepare for the public fallout.
The move showed a combative streak from the SEC, which has been under mounting pressure after letting slip through its fingers early probes into the Ponzi scheme of Bernard Madoff and the alleged fraud of Texas financier R. Allen Stanford.
The case, SEC v. Goldman Sachs & Co. and Fabrice Tourre, sets the stage for what could become the signature lawsuit from the financial-crisis era.
It comes at a time when the Obama administration is trying to move through Congress a bill to overhaul financial regulations in the wake of the crisis, legislation that would likely affect the regulation of products used in the Goldman deal. The effort is being resisted by major banks and by Republican lawmakers.
Lawsuits by the SEC are subject to a vote by the agency's five commissioners, and the tally on the Goldman case will be closely watched in Washington, as the current commission is split along party lines—with two Republicans and two Democrats, plus one independent who was appointed by President Obama.
The way the SEC launched the suit "certainly doesn't follow the spirit" or practice of the agency, said Paul Atkins, who served as a Republican SEC commissioner last decade.
An SEC spokesman said the agency followed standard practices in pursuing the case. The SEC said the suit's timing wasn't influenced by external events.
White House spokeswoman Jen Psaki noted that the SEC is an independent agency, "and it does not coordinate with the White House the announcement of its enforcement actions. We were not given advance notice at the White House about the announcement."
The SEC suit centers on a deal Goldman structured by the name of Abacus. In early 2007, Goldman was helping one of its clients, hedge fund Paulson & Co., design a security known as a collateralized debt obligation, which was built out of a set of risky mortgage assets that the fund and founder John Paulson helped select. Paulson then placed a "short" bet that mortgages contained in the Abacus CDO would fall in value. The CDO had three investors: Paulson, securities firm ACA Capital Ltd. and German bank IKB Deutsche Industriebank AG.
The SEC alleges that Goldman should have disclosed Mr. Paulson's involvement in creating the portfolio and his bearish bet. The portfolio quickly lost value and delivered huge returns for the hedge fund. Both Goldman and Paulson say the nature of the deal and the sophisticated investors involved meant that no such disclosure was necessary.
Goldman said it first heard from the SEC about the investigation in August 2008, when it received a subpoena from attorneys requesting documents related to the transaction.
It sent about eight million pages, said a person familiar with the matter.
Five Goldman employees, including Fabrice Tourre, the trader involved in marketing Abacus who was named as a defendant by the SEC, were interviewed, say people familiar with the matter. Mr. Tourre has not responded to repeated requests for comment.
In July 2009, Goldman and Mr. Tourre received so-called Wells notices from the SEC. Such notices are a formal warning that regulators intend to file civil charges, and serve as a point of negotiation about a settlement. By September 2009, both Goldman and Mr. Tourre had responded to the charges in a 41-page document, according to people familiar with the matter.
The gist of Goldman's defense: The disclosure of Mr. Paulson's involvement would not have had any real effect on buyers of the CDO created by Goldman.
"If this matter is litigated, Goldman Sachs is confident that a fuller record...will underscore that no one in fact considered Paulson's role important and that no one was misled," Goldman told the SEC in September 2009, in a document reviewed by The Wall Street Journal.
That was the last contact Goldman had with the SEC about the matter until late March, when Goldman placed a phone call inquiring about the case.
The call wasn't returned, Goldman said. On Friday, the SEC moved ahead with charges, stunning Goldman officials. Perhaps more than any other Wall Street firm, Goldman has been steadfast in defending its actions during the credit boom.
As employees gathered around television sets Friday, they groused about getting scapegoated in Washington.
The SEC's enforcement division, meanwhile, has been under pressure to show it has teeth. Last fall, federal Judge Jed Rakoff rejected as too lenient the SEC's proposed $33 million settlement with Bank of America over disclosures made to shareholders about its takeover of Merrill Lynch.
