Goldman Agrees to Huge Fine for SEC Fraud Case

Chris Lee

Goldman Sachs — the famous New York investment bank charged with fraud back in April — received approval to settle its investment fraud lawsuit filed by the U.S. Securities and Exchange Commission or SEC for $550 million on Tuesday, July 20th, 2010.

The lawsuit was filed by the SEC on April 16th, over alleged civil fraud in the marketing of a 2007 Collateralized Debt Obligation or CDO to Goldman’s clients. The suit claimed that the investment firm had withheld important information about the debt product, called Abacus, which apparently violated SEC rule 10b-5.

Only one Goldman Sachs employee, Executive Director Fabrice Tourre, was named in the lawsuit. Mr. Tourre filed a motion to dismiss the lawsuit against him the day before the settlement was announced, denying he had made any misleading statements or omissions in relation to the sale of the Abacus 2007 AC-1 CDOs.

That portion of the lawsuit is still pending, with Tourre still an employee of Goldman, although currently on a leave of absence. Goldman has agreed to cooperate with the SEC in their lawsuit against Tourre, as well as in other “ongoing litigation”.

SEC Lawsuit Fraud Allegations

The important information that Goldman Sachs withheld from clients was that hedge fund Paulson and Co. had apparently not only assisted in the selection of the toxic assets contained in the CDO, but had also bet against the securities they themselves selected through credit default swaps obtained via now troubled insurer AIG.

The play netted Paulson and Co. an estimated billion dollar profit, which was coincidentally what investors seem to have lost on the doomed Abacus CDO.

While the dollar amount of the settlement — at a whopping $550 million — may well be one of the largest fines ever levied against a Wall Street firm, the net effect on the company’s earnings was a drop of 82% for the quarter, while its stock price remains close to $150 per share.

The investment firm still made $613 million for the quarter or 78 cents per share versus the $3.43 billion it racked up in last year’s second quarter. The decline was due to the settlement with the SEC, as well as a U.K. payroll tax charge.

A sore point with shareholders is that they were kept in the dark about the SEC’s investigation which began in 2008, and of which Goldman Sachs was fully aware. Nevertheless, shareholders were not notified of the investigation through financial statements and many found out about the lawsuit after the fact.

Goldman Settles Without Admitting Wrongdoing

The settlement was agreed upon between the SEC and Goldman Sachs with the investment bank neither admitting nor denying wrongdoing. The bank admits it made a “mistake” however, in marketing investment products with “incomplete” information.

Getting off by paying only a fine — even a large one — and agreeing to reform some of its sales practices, apparently helped Goldman shareholders considerably. The stock gained 4.43% the day the settlement was announced, to close at $145.22 per share.

Nevertheless, the long term implications of the settlement have yet to sink in. While paying a fine may affect the company’s bottom line in the near term, the company will still be able to continue doing business in the markets in much the same way.

Despite promises of extensive reforms, had the bank been convicted of a fraud charge, then a more serious effort would have been made to ensure that the company does not repeat its transgressions.

The $550 million consists of a fine of $300 million and $250 million as restitution to principal investors IKB Deutsche Industriebank AG which will receive $150 million, and the Royal Bank of Scotland Plc which will receive $100 million.

Goldman Settlement Decreases Public’s Confidence

The fact that one of the most reputable investment banks on Wall Street could take part in the insidious way that the Abacus CDO was apparently marketed, has only added to the public’s lack of confidence in Wall Street and its sometimes sleazy practices.

Goldman still faces the potential loss of billions of dollars if the SEC decides to pursue the matter further, in addition to the risk of private litigation from individuals who lost money on the deal. No restitution for individuals was outlined in the settlement.

Other Wall Street firms which may have had similar practices will probably also be investigated, which will only add to the public’s wariness.

The popular view of Wall Street and its denizens continuing to deteriorate, and this could well constitute one of the worst consequences of the Goldman settlement.

Furthermore, as the lack in confidence in the U.S. financial system grows, the entire system of stock valuation is put into question because financial firms like Goldman play an important role in placing values on stocks and distributing them initially.

The culture that declared that “greed is good” is not just a relic from the 80’s movie Wall Street. Instead, the likes of Gordon Gecko still appear to be alive and well — in spirit at least — as they make questionable role models for Wall Street traders and executives to follow in their quest for ever greater profits.

Chris Lee

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