Goldman Settles With S.E.C. for $550 Million
4:34 p.m. | Updated Updated with confirmation of the New York Times’s report about Goldman’s $550 million settlement.
Goldman Sachs has agreed to pay $550 million to the Securities and Exchange Commission, one of the largest penalties ever paid by a Wall Street firm, to settle charges of securities fraud linked to mortgage investments.
The S.E.C. filed a lawsuit against Goldman in April, accusing the bank of securities fraud. The settlement came just days before Goldman is scheduled to report its second-quarter earnings.
Under the terms of the deal, Goldman will pay $300 million in fines to the Treasury Department, with the rest serving as restitution to investors in the mortgage-linked security. Goldman will not admit wrongdoing, though it will admit that its marketing materials for the investment “contained incomplete information.”
Goldman will also change several business practices, including the way it draws up marketing materials for complex mortgage securities and the way it educates employees in that part of its business.
The settlement does not cover Fabrice P. Tourre, a Goldman employee who played a key role in marketing the security to potential investors, the S.E.C. said at a news conference. (Read DealBook’s live coverage of the S.E.C. briefing.)
The settlement must still be approved by Judge Barbara S. Jones of Federal District Court in Manhattan.
Goldman’s stock price climbed more than $5 in the last half-hour of trading after the S.E.C. said its director of enforcement, Robert Khuzami, would hold a news conference late Thursday afternoon.
“Half a billion dollars is the largest penalty ever assessed against a financial services firm in the history of the S.E.C.,” Mr. Khuzami said in a statement. “This settlement is a stark lesson to Wall Street firms that no product is too complex, and no investor too sophisticated, to avoid a heavy price if a firm violates the fundamental principles of honest treatment and fair dealing.”
The focus of the S.E.C. case, an investment vehicle called Abacus 2007-AC1, was one of 25 such vehicles that Goldman created so the bank and some of its clients could bet against the housing market. Those deals initially protected Goldman from losses when the mortgage market disintegrated and later yielded profits for the bank.
As the Abacus portfolios in the S.E.C. case plunged in value, a prominent hedge fund manager made money from his bets against certain mortgage bonds, while investors lost more than $1 billion.
According to the complaint, Goldman created Abacus 2007-AC1 in February 2007 at the request of John A. Paulson, a prominent hedge fund manager who earned an estimated $3.7 billion in 2007 by correctly wagering that the housing bubble would burst. Mr. Paulson is not named in the suit.
Goldman told investors that the bonds would be chosen by an independent manager. In the case of Abacus 2007-AC1, however, Goldman let Mr. Paulson select mortgage bonds that he believed were most likely to lose value, according to the complaint.
Goldman then sold the package to investors like foreign banks, pension funds and insurance companies, which would profit only if the bonds gained value. The European banks IKB and ABN Amro and other investors lost more than $1 billion in the deal, the commission said.
The full S.E.C. news release is below:
GOLDMAN SACHS TO PAY RECORD $550 MILLION TO SETTLE SEC CHARGES RELATED TO SUBPRIME MORTGAGE C.D.O.
Firm Acknowledges C.D.O. Marketing Materials Were Incomplete and Should Have Revealed Paulson’s Role
Washington, D.C., July 15, 2010 – The Securities and Exchange Commission today announced that Goldman Sachs & Co. will pay $550 million and reform its business practices to settle S.E.C. charges that Goldman misled investors in a subprime mortgage product just as the U.S. housing market was starting to collapse.
In agreeing to the S.E.C.’s largest ever penalty paid by a Wall Street firm, Goldman also acknowledged that its marketing materials for the subprime product contained incomplete information.
In its April 16 complaint, the S.E.C. alleged that Goldman misstated and omitted key facts regarding a synthetic collateralized debt obligation (C.D.O.) it marketed that hinged on the performance of subprime residential mortgage-backed securities. Goldman failed to disclose to investors vital information about the C.D.O., known as ABACUS 2007-AC1, particularly the role that hedge fund Paulson & Co. Inc. played in the portfolio selection process and the fact that Paulson had taken a short position against the C.D.O.
In settlement papers submitted to the U.S. District Court for the Southern District of New York, Goldman made the following acknowledgement:
Goldman acknowledges that the marketing materials for the ABACUS 2007-AC1 transaction contained incomplete information. In particular, it was a mistake for the Goldman marketing materials to state that the reference portfolio was “selected by” ACA Management LLC without disclosing the role of Paulson & Co. Inc. in the portfolio selection process and that Paulson’s economic interests were adverse to C.D.O. investors. Goldman regrets that the marketing materials did not contain that disclosure.
“Half a billion dollars is the largest penalty ever assessed against a financial services firm in the history of the SEC,” said Robert Khuzami, director of the S.E.C.’s Division of Enforcement. “This settlement is a stark lesson to Wall Street firms that no product is too complex, and no investor too sophisticated, to avoid a heavy price if a firm violates the fundamental principles of honest treatment and fair dealing.”
Lorin L. Reisner, deputy director of the S.E.C.’s Division of Enforcement, added, “The unmistakable message of this lawsuit and today’s settlement is that half-truths and deception cannot be tolerated and that the integrity of the securities markets depends on all market participants acting with uncompromising adherence to the requirements of truthfulness and honesty.”
Goldman agreed to settle the S.E.C.’s charges without admitting or denying the allegations by consenting to the entry of a final judgment that provides for a permanent injunction from violations of the antifraud provisions of the Securities Act of 1933. Of the $550 million to be paid by Goldman in the settlement, $250 million would be returned to harmed investors through a Fair Fund distribution and $300 million would be paid to the U.S. Treasury.
The landmark settlement also requires remedial action by Goldman in its review and approval of offerings of certain mortgage securities. This includes the role and responsibilities of internal legal counsel, compliance personnel, and outside counsel in the review of written marketing materials for such offerings. The settlement also requires additional education and training of Goldman employees in this area of the firm’s business. In the settlement, Goldman acknowledged that it is presently conducting a comprehensive, firmwide review of its business standards, which the S.E.C. has taken into account in connection with the settlement of this matter.
The settlement is subject to approval by the Honorable Barbara S. Jones, United Sates district judge for the Southern District of New York.
Today’s settlement, if approved by Judge Jones, resolves the S.E.C.’s enforcement action against Goldman related to the ABACUS 2007-AC1 C.D.O. It does not settle any other past, current or future S.E.C. investigations against the firm. Meanwhile, the S.E.C.’s litigation continues against Fabrice Tourre, a vice president at Goldman.
The S.E.C. investigation that led to the filing and settlement of this enforcement action was conducted by the Enforcement Division’s Structured and New Products Unit, led by Kenneth Lench and Reid Muoio, and including Jason Anthony, N. Creola Kelly, Melissa Lamb, and Jeffrey Leasure. Additionally, together with Deputy Director Reisner, Richard Simpson, David Gottesman and Jeffrey Tao have been handling the litigation.