Wall Street Journal:
WASHINGTON—The Securities & Exchange Commission on Friday charged Goldman Sachs Group Inc. with defrauding investors by allegedly marketing a financial product tied to subprime mortgages without telling them a big hedge fund was on the other side of the trade.
New York Times:
Goldman Sachs, which emerged relatively unscathed from the financial crisis, was accused of securities fraud in a civil suit filed Friday by the Securities and Exchange Commission, which claims the bank created and sold a mortgage investment that was secretly devised to fail.
It is unclear to me how this particular derivative was "devised to fail." Goldman had no control over whether the housing market really would collapse. Credit default swaps and other derivatives always involve one side "betting against" the other. More precisely, companies and investors try either to reduce risk or increase potential rewards by entering into these kinds of contracts. Anyone who invested in this kind of highly speculative financial instrument would have had access to information about the ratings of the underlying mortgage bonds.
The WSJ story puts the emphasis on the heart of the suit:
"Undisclosed in the marketing materials and unbeknownst to investors, a large hedge fund, Paulson & Co. Inc., with economic interests directly adverse to investors in the [CDO], played a significant role in the portfolio selection process," the complaint said.
The complaint said Paulson had an incentive to stuff the CDO with mortgage-backed securities that were likely to get into trouble. SEC enforcement chief Robert Khuzami alleged that Goldman misled investors by telling them that the securities "were selected by an independent, objective third party."
The S.E.C. alleges, in other words, that Goldman misrepresented Paulson & Co.'s role. The Times buries this fact in a later paragraph:
Goldman told investors in Abacus marketing materials reviewed by The Times that the bonds would be chosen by an independent manager.Instead, it focuses on the money that Goldman made - "unfairly," - from the housing market collapse:
The instrument in the S.E.C. case, called Abacus 2007-AC1, was one of 25 deals that Goldman created so the bank and select clients could bet against the housing market. Those deals, which were the subject of an article in The New York Times in December, initially protected Goldman from losses when the mortgage market disintegrated and later yielded profits for the bank.
As the Abacus deals plunged in value, Goldman and certain hedge funds made money on their negative bets, while the Goldman clients who bought the $10.9 billion in investments lost billions of dollars.
The official charges by the SEC can be found here.