April 17, 2010
Goldman Sachs Fraud Charges Just The Beginning For Wall Street
For Goldman, a Bet’s Stakes Keep Growing
By LOUISE STORY and GRETCHEN MORGENSON
For Goldman Sachs, it was a relatively small transaction. But for the bank — and the rest of Wall Street — the stakes couldn’t be higher.
Accusations that Goldman defrauded customers who bought investments tied to risky subprime mortgages have only just begun to reverberate through the financial world.
The civil lawsuit that the Securities and Exchange Commission filed against Goldman on Friday seemed to confirm many Americans’ worst suspicions about Wall Street: that the game is rigged, the odds stacked in the banks’ favor. It is the first big case — but probably not the last, legal experts said — to delve into a Wall Street firm’s role in the mortgage fiasco.
It is a particularly sensitive time for Wall Street. Washington policy makers are hotly debating a sweeping overhaul of the nation’s financial regulations, and the news could embolden those seeking to rein in the banks. President Obama on Saturday stepped up pressure for financial reform by accusing Republicans of “cynical and deceptive” attacks on the measure.
The S.E.C.’s action could also hit Wall Street where it really hurts: the wallet. It could prompt dozens of investor claims against Goldman and other Wall Street titans that devised and sold toxic mortgage investments.
On Saturday, several European banks that lost money in the deal said they were reviewing the matter. They could try to recoup the money from Goldman.
And it raises new questions about Goldman, the bank at the center of more concentric circles of economic and political power than any other on Wall Street. Goldman — whose controversial success has leapt from the financial pages to the cover of Rolling Stone — has fiercely defended its actions before, during and after the financial crisis. On Friday, it called the S.E.C.’s accusations “unfounded.”
Wall Street played a complex and, at times, seemingly conflicted role in the mortgage collapse. Goldman and others worked behind the scenes, bundling home loans into investments for sale to investors the world over. Even now, more than 18 months after Washington rescued the teetering financial system, no one knows for sure how much money was lost on those investments.
The public outcry against the bank bailouts was driven in part by suspicions that a heads-we-win, tails-you-lose ethos pervades the financial industry. To many, that Goldman and others are once again minting money — and paying big bonuses to their employees — is evidence that Wall Street got a sweet deal at taxpayers’ expense. The accusations against Goldman may only further those suspicions.
“The S.E.C. suit against Goldman, if proven true, will confirm to people their suspicions about the total selfishness of these financial institutions,” said Steve Fraser, a Wall Street historian and author of “Wall Street: America’s Dream Palace.” “There’s nothing more damaging than that. This is way beyond recklessness. This is way beyond incompetence. This is cynical, selfish exploiting.”
On Friday, Goldman’s stock took a beating, falling 13 percent and wiping out more than $10 billion of the company’s market value. It was a possible sign that investors fear that the S.E.C. complaint will damage Goldman’s reputation and its ability to keep its hands on so many sides of a trade — a practice that is immensely profitable for the firm.
It is unclear whether the S.E.C. can prevail against Goldman. The bank has long maintained that it puts its clients first and, in a letter in its latest annual report, it reiterated that position. Goldman said it never “bet against our clients” in its trades but rather was trying to hedge against other trading positions.
The transaction cited in the S.E.C. complaint cost investors just over $1 billion, relatively small by Wall Street standards.
Still, Wall Street analysts said Goldman and other banks, having navigated the financial crisis, might now face a new kind of risk: angry investors. Most major Wall Street banks also created collateralized debt obligations, which are at the heart of the Goldman case. C.D.O.’s, which are essentially bundles of securities backed by mortgages or other debt securities, turned out to be among the most toxic investments ever devised.
“Any investor who bought these C.D.O.’s and lost a significant amount of money is probably looking at their investment and wanting to know: what were the details behind the sale?” said William Tanona, an analyst at Collins Stewart. “Will they contact the S.E.C. and say, ‘Here’s the transaction we participated in, and we’d love to know who is on the other side of it?’ ”
The biggest victim among investors, the S.E.C. complaint said, was the Royal Bank of Scotland, which inherited a loss of $841 million after it took over the Dutch bank ABN Amro. According to a person briefed on the matter, the Royal Bank, now controlled by the British government, is studying the documents but is not ready to decide whether to try to recoup money from Goldman.
The German bank IKB Deutsche Industriebank, as well as the German government, which in 2007 put up billions to prevent IKB from collapsing, still seemed to be sorting out who might have legal standing to pursue a possible claim.
Goldman faces a dilemma in its response. Wall Street firms tend to settle cases like this one, but Goldman’s statement on Friday indicated it intended to dig in its heels and fight, perhaps in part to discourage suits by investors. That strategy could set it up for a long, messy and public battle.
The S.E.C. complaint named just one Goldman employee: Fabrice Tourre, a vice president in the bank’s mortgage operation who worked on the questionable transaction.
But securities lawyers say Mr. Tourre appears to be a small fish. Federal investigators may try to gain his cooperation and extend their investigation to other Goldman employees. On Friday, Mr. Tourre’s lawyer did not provide a comment on the complaint.
A big question is how far up this might go. The S.E.C. said the deal in its complaint had been approved by a panel at Goldman, the Mortgage Capital Committee.
“It’s typical that they’d start with someone lower down on the chain and try to exert pressure on that person,” said Bradley D. Simon of Simon & Partners, a white-collar defense lawyer in New York. “Is it really conceivable that no one else was involved in this?”
As the housing market began to fracture in 2007, senior Goldman executives began overseeing the mortgage department closely, said four former Goldman Sachs employees, who spoke on the condition they not be identified because of the sensitivity of the matter.
Senior executives routinely visited the unit. Among them were David A. Viniar, the chief financial officer; Gary D. Cohn, then the co-president; and Pablo Salame, a sales and trading executive, these former employees said. Even Goldman’s chief executive, Lloyd C. Blankfein, got involved.
Top executives met routinely with Dan Sparks, the head of the mortgage trading unit, who retired in spring 2008. Managers instructed several traders to sell housing-related investments. Indeed, they urged Mr. Tourre and a colleague, Jonathan Egol, to place more bets against mortgage investments, the former employees said.
A Goldman spokesman said Saturday that the top executives were not involved in the approval process for Abacus, the deal cited by the S.E.C., and that their involvement with the mortgage department in 2007 was related to their desire to counterbalance the positive bets on housing the banks had already made.
Mr. Blankfein has already been questioned by a Congressional commission about the toxic vehicles Goldman devised and sold, even as the bank realized the housing market was in trouble.
Recent public statements made by Mr. Blankfein seem to conflict with the S.E.C. account.
In testimony in January before the Financial Crisis Inquiry Commission, the panel appointed by Congress to examine the causes of the crisis, for example, he described Goldman’s approach to dealing with its clients: “Of course, we have an obligation to fully disclose what an instrument is and to be honest in our dealings, but we are not managing somebody else’s money.”
But the S.E.C. complaint says Goldman misled investors who bought one of the bank’s Abacus deals. The bank failed to tell them the mortgage bonds underpinning the investment had been selected by a hedge fund manager who wanted to bet against the investment, the S.E.C. says. Those bonds were especially vulnerable, the commission says.
Graham Bowley and Jack Ewing contributed reporting.
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Goldman Sachs finds $5bn for pay and bonuses amid fraud investigation
Goldman staff will benefit from almost half the investment bank's first-quarter revenues
Lloyd Blankfein, CEO Goldman Sachs
Lloyd Blankfein, chairman and CEO of Goldman Sachs, is expected to put $5bn in the compensation pool for the bank's staff. Photograph: Ramin Ralaie/EPA
Goldman Sachs is expected to earmark about $5bn (£3bn) for staff pay and bonuses this week, days after being accused of securities fraud by the US regulators, fuelling the controversy over bankers' rewards in the teeth of the financial crisis.
Chief executive Lloyd Blankfein is expected to unveil revenues of $11bn for the first quarter of this year on Tuesday, up from $9.4bn in the same period of 2009. About 47% of that will go into a "compensation pool" for bosses and employees.
The bank, along with Fabrice Tourre, one of its vice presidents, is the subject of a civil fraud complaint by the US Securities and Exchange Commission (SEC). It denies the accusations and is understood to believe they are the result of a politically motivated witch-hunt – timed to coincide with a drive by President Obama to get tough on banks, and to come just ahead of its results.
The bank has been aware of the SEC's investigation for two years but had not spoken to investigators since September 2009 and is thought to have been taken by surprise by last week's events. Tourre has been interviewed by Goldman's internal compliance department but is still employed by the bank and has not been suspended.
Speculation over Blankfein's future is seen by insiders as "silly". However, the episode is likely to have incurred the ire of US investor Warren Buffett, who lost more than $1bn on paper in 24 hours on warrants held by his Berkshire Hathaway investment fund as Goldman shares plunged. Buffett endorsed the bank by loaning it $5bn at the height of the crisis at 10% interest. He is an outspoken critic of Wall Street sharp practice and excessive pay. Senior Goldman executives have held talks with major investors, thought to include Buffett, over the SEC accusation.
Blankfein is also anticipating tough questioning later this month on Capitol Hill. Along with other financiers he is expected to testify before the Senate's permanent subcommittee on investigations. The panel's head, Democratic senator Carl Levin, said it had discovered levels of greed that were "frankly disgusting".
Goldman made record profits of $13.4bn last year, after net revenues more than doubled to $45.2bn, racking up at least $100m in net trading revenues every other working day. This came after the demise of several rivals and despite the bank coming close to disaster itself when the crisis was at its height. It took $10bn of US government money, which it has since repaid.
Amid widespread popular anger against the banks, Goldman last year shrank its bonus pool to 36% of revenues rather than the usual 50%. Despite reining in, however, it still paid out a total of $16.2bn. Blankfein was awarded a $9m bonus in shares in 2009, down from the $68m he received in cash, shares and options in 2007.
Due to accounting rules, Goldman sets aside a higher proportion of revenues for staff rewards at the start of the year. The rate at which they are accruing for 2010 overall is likely to drop in subsequent quarters, to end up at about the same as in 2009.
Analysis: Goldman Sachs Case Could Impact Every Investor
by KYW special contributor Larry Kane
In a case that could signal a turning point, the US government is filing fraud charges (see related story) against a financial giant.
Business stories can be complicated, but Friday’s should not be overlooked by anyone. The nation's most well-known investment bank, Goldman Sachs, was accused by federal regulators of fraud.
But the charges are much more than that and could -- if proven -- affect the way investments are made in America.
To put it in focus, the company was accused of allowing one of its biggest clients to recommend mortgage investments that the client was shorting -- in other words, betting against. That, if true, would mean that Goldman Sachs -- while helping a big client make money -- may have contributed to the mortgage meltdown and the recession.
Watch this case carefully. It could change the way investment firms do business -- and it is a hot issue, because the firms had close ties to both the Bush and Obama administrations.