by Michael Connor
Investment banking firm Goldman, Sachs & Co. agreed to pay a record $550 million penalty and reform a number of its internal business practices to settle Securities and Exchange Commission charges that Goldman misled investors in a subprime mortgage product just as the U.S. housing market was starting to collapse.
The Goldman settlement came ironically on the same day that the U.S. Senate approved by a 60-39 vote a sweeping financial reform bill that promises profound changes in the way Goldman and other investment banks do business. The bill is expected to be signed into law soon by President Obama.
Of the $550 million to be paid by Goldman in the settlement, $250 million would be returned to harmed investors and $300 million would be paid to the U.S. Treasury.
In agreeing to the SEC’s largest-ever penalty paid by a Wall Street firm, Goldman “also acknowledged that its marketing materials for the subprime product contained incomplete information,” the agency said.
In its original complaint filed in April, the SEC alleged that Goldman misstated and omitted key facts regarding a synthetic collateralized debt obligation (CDO) it marketed that hinged on the performance of subprime residential mortgage-backed securities.
The SEC said Goldman failed to disclose to investors vital information about the CDO, 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 in, and was betting against, the CDO.
The SEC said in its complaint that investors in the ABACUS CDO had lost more than $1 billion.
In a consent order submitted to the U.S. District Court for the Southern District of New York, Goldman said:
“Goldman acknowledges that the marketing materials for the ABACUS 2007-ACI 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 CDO 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 SEC’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.”
The SEC said Goldman agreed to settle the 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.
The settlement with Goldman does not include Fabrice Tourre, a Goldman banker who played a key role in marketing the securities in question and who was charged along with the firm.
A copy of the final judgment regarding Goldman filed with the court can be found here.
“The landmark settlement also requires remedial action by Goldman in its review and approval of offerings of certain mortgage securities,” the SEC said. “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.”
In its consent document, Goldman said it is “presently conducting a comprehensive, firmwide review of its business standards.” The review includes an evaluation of Goldman’s “conflict management” and “disclosure and transparency of firmwide activities, structured products and suitability, education, training and business ethics, and client relationships and responsibilities.” The SEC said it “has taken this review into account in connection with the settlement of this matter.”
Goldman acknowledged that the SEC had not made any promises “with regard to any criminal liability that may have arisen or may arise from the facts underlying this action or immunity from any such criminal liability.”
The SEC’s Mr. Khuzami said in a press conference following announcement of the settlement that there was no relationship between the agency’s announcement and passage by the Senate of the finance reform bill. “Let me personally assure you that there is absolutely no consideration to those kinds of external events in deciding what cases we bring, how we bring them, or when we bring them,” he said. “The internal processes, the nature of settlement negotiations, and a whole host of other variables makes that virtually impossible to do. And even if it were possible, it is absolutely not the type of considerations that the S.E.C. engages in.”