TOPICS > Economy

Goldman Sachs Could Face Sanctions, Fines After SEC Fraud Charge

April 16, 2010 at 12:00 AM EST
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The SEC charged powerful investment bank Goldman Sachs with defrauding investors in the runup to the subprime mortgage crisis. Jim Lehrer talks to a Washington Post reporter about the charges.
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JIM LEHRER: The federal government accused Goldman Sachs today of fraud. The Securities and Exchange Commission filed civil charges against the powerful Wall Street investment banking firm. The SEC alleged, Goldman didn’t disclose it was marketing subprime mortgage securities while, at the same time, betting against them through a large hedge fund.

Investors in those securities lost more than $1 billion when the housing market crashed. In response, Goldman called the charges “completely unfounded.”

It is the most prominent case brought by the government thus far in response to the financial crisis.

Zachary Goldfarb is covering that story for The Washington Post.

Zachary, welcome.

ZACHARY GOLDFARB, The Washington Post: Thank you.

JIM LEHRER: In the simplest of terms, what is it exactly that the government has said Goldman Sachs did?

ZACHARY GOLDFARB: The government has said that Goldman Sachs defrauded its investors by omitting key details about investment products that Goldman was selling them.

In essence, the government has said that Goldman allowed a fund that was betting against these products to create the products, and then sold the investment to investors without telling them that someone who was betting against them had come up with the idea and formulated a large part of it.

So, it’s an issue of defrauding investors.

JIM LEHRER: And the allegation is that Goldman Sachs created this kind of double-bet situation, right?

ZACHARY GOLDFARB: Right. That’s right. Goldman has been accused and criticized for taking a stand against the housing market for itself and on behalf of some clients, while letting other clients invest in Goldman Sachs and bet on the housing market. So, it tried to make a profit, allegedly, both ways.

JIM LEHRER: And there was one — they named one vice president of Goldman Sachs as the main perpetrator, alleged perpetrator, correct?

ZACHARY GOLDFARB: That’s right, Fabrice Tourre, a Goldman vice president who is now in London, allegedly came up with the idea, and knew weeks and months before creating the investment product that it was going to fail, or that the entire housing market was going to start a significant decline.

And the SEC has obtained e-mails showing that or suggesting that. He has not released a statement yet today defending himself, although Goldman has said that the charges are untrue.

JIM LEHRER: And they plan to fight them all the way, right? That’s their statement?

ZACHARY GOLDFARB: That’s right. And that’s quite unusual. Most banks and entities dealing with the SEC settle on the day that charges are filed. They don’t want to…

JIM LEHRER: That’s the first time you hear about it is when they settle, right?

ZACHARY GOLDFARB: Right. That’s right, because companies don’t want to deal with the public-relations struggle or the legal costs involved.

Goldman, however, has been willing to really go its own in many ways in the financial crisis. And it’s been immensely profitable for them to do so. But it’s really another example of Goldman pushing its own sort of approach to dealing with its public relations concerns.

JIM LEHRER: Now, there was a hedge fund that — that was involved in doing the betting on the downside, right? And it’s John Paulson — it’s run by John Paulson, a very prominent person in the hedge fund business and Wall Street, correct?

ZACHARY GOLDFARB: That’s right. John Paulson made billions and billions of dollars personally by creating exotic techniques to bet against the housing market when everybody else was betting that it would continue to rise.

And he — and Goldman Sachs helped him to do that. Now, the allegation is that, on behalf of him, they created the security and they then sold to investors who believed the housing market would continue to go up. And he benefited from this, although the SEC has clearly said today he didn’t play a role in any kind of fraudulent action.

So, he is not being charged. He’s not facing any allegations of wrongdoing. It’s Goldman Sachs that are facing — that is facing those allegations.

JIM LEHRER: And the word there, of course, is that Paulson saw the collapse coming and went with that bet on his own, and Goldman Sachs just simply bought into that bet, correct, without telling people they were doing it?

ZACHARY GOLDFARB: Right. Right. Goldman was paid $15 to create this sort of exotic financial instrument — it’s very complicated — that Paulson was able to use to bet against the market.

At the same time, they were promoting it as a positive thing to their investors, and, so, without telling them that Paulson played a role in creating the product. That’s the allegation.

JIM LEHRER: All right. Now, why civil charges, rather than criminal charges?

ZACHARY GOLDFARB: Well, a couple of reasons. The SEC, first of all, doesn’t have criminal authority. That’s the Department of Justice. And we don’t know if there’s a Justice Department investigation. There may be one.

But the second reason, and perhaps more important, is that a civil case has a lower threshold for action than a criminal case. And it’s very hard to, beyond a reasonable doubt, prove financial fraud. It happens, of course, but it’s very hard to do. And, so, if you want to bring a case as fast as possible and get financial remedies and other sanctions, you often go the civil route first, and there always can be a criminal case to follow.

JIM LEHRER: So, what specifically is the government asking as a penalty against Goldman Sachs?

ZACHARY GOLDFARB: Well, they’re asking for a few things.

They’re going to seek a financial penalty, a pure penalty, which is supposed to deter further conduct. They’re going to seek that Goldman Sachs repay any gains it had. So, that could include both the $15 million it was paid in fees, but also perhaps…

JIM LEHRER: Fifteen million dollars they…

ZACHARY GOLDFARB: Fifteen million in fees from Paulson, but also possibly up to $1 billion in investment — investor losses on the fraudulent security.

And then there could also be other kinds of gains we don’t about. In addition, there could be a variety of sanctions against Goldman Sachs, limiting its ability to do business in this area, if the court agrees with the SEC.

JIM LEHRER: Did this come as a big surprise on Wall Street, that the SEC was going to move against Goldman Sachs, or was this expected?

ZACHARY GOLDFARB: I think people were surprised today. There’s been a lot of discussion about Goldman Sachs and other big banks. There was a big case with Bank of America recently that was much more, I think, pretty well-known and public before it came.

And people were somewhat surprised by the Goldman Sachs case. I mean, I think people were surprised that there was no settlement in the works either. So, I think people are surprised. The SEC is under a new team now, and they’re trying to sort of show the world that, post-Madoff, they can reform themselves. And they’re continuing to do so.

But, really, the devil will be in the details, as the court case unfolds. And it could be, actually, years and years before there’s any kind of resolution, which shows how difficult this is. This is dealing with conduct from early 2007. We’re in 2010 now.

And if there’s a court case, it could be 2011, 2012 before that is resolved, so four or five years between conduct and resolution. And that shows how difficult it is to prosecute these kinds of cases.

JIM LEHRER: Sure.

OK, Zachary Goldfarb, thank you very much.

ZACHARY GOLDFARB: Thank you.