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By DANIEL WAGNER, AP Business Writer
2 hrs 30 mins ago
WASHINGTON – The fraud charges against Goldman Sachs & Co. that rocked
financial markets Friday are no slam dunk, as hazy evidence and
strategic pitfalls could easily trip up government lawyers.
Yet that hardly matters, experts say, because the allegations will kick
off a new era of litigation that could entangle Goldman and other banks
for years to come.
The charges against Goldman relate to a complex investment tied to the
performance of pools of risky mortgages. In a complaint filed Friday,
the Securities and Exchange Commission alleged that Goldman marketed the
package to investors without disclosing a major conflict of interest:
The pools were picked by another client, a prominent hedge fund that was
betting the housing bubble would burst.
Goldman said the charges are "unfounded in law and fact." In a written
response to the charges, the bank said it had provided "extensive
disclosure" to investors and that the largest investor had selected the
portfolio — not the hedge fund client. Goldman said it lost $90 million
on the deal.
That doesn't contradict the SEC complaint, which says the largest
investor selected the mortgage investments from a list provided by the
hedge fund. And the fact that Goldman lost money has no impact on the
fraud charges.
The charges will unleash a torrent of lawsuits, and likely signal that
the government is prepared to file more lawsuits related to the
overheated market that preceded the financial crisis, experts said.
"This is just the tip of the iceberg," said James Hackney, a professor
at Northeastern University School of Law. "There are a lot of folks out
there in different deals who played similar roles, and once it starts
building steam, plaintiffs' lawyers will figure out this is where the
money is and there should be a lot of action."
Among the legal action expected in the coming months:
• Class-action suits by Goldman shareholders who believe Goldman
alleged
misconduct made their stakes less valuable could come as early as
Monday. Such suits are common when companies are accused of wrongdoing.
Goldman shares fell almost 13 percent Friday as the bank lost $12.5
billion in market capitalization.
• Suits by investors who believe Goldman sold them on deals that were
doomed to fail. The investors in the transaction at the heart of the SEC
case could sue first, followed by others who believe their losses were
similar.
• Possible criminal charges, if the SEC's civil case reveals evidence
that meets the higher standard of "proof beyond a reasonable doubt."
Experts said it's unlikely the company as a whole will face criminal
charges, but evidence could emerge that would expose the Goldman
executive named in the SEC complaint, 31-year-old Fabrice Tourre, to
criminal prosecution.
• Charges by regulators about other mortgage investments at Goldman
and
elsewhere. SEC enforcement chief Robert Khuzami told reporters Friday
the agency is racking up evidence on other deals in the overheated
market that preceded the financial crisis.
Already the case has provoked legal questions from foreign governments,
according to published reports. That's because the financial crisis
forced many countries to bail out banks that lost money on investments
arranged by Goldman.
German regulators are considering legal action against Goldman,
newspaper Welt am Sonntag reported, quoting a spokesman for Chancellor
Angela Merkel.
The charges would be on behalf of IKB Deutsche Industriebank AG — an
early victim of the financial crisis that was rescued by the state-owned
KfW development bank among others. IKB invested in the deal regulators
are targeting.
The flurry of legal activity is likely to proceed separately from the
SEC's case against Goldman, which experts said faces numerous pitfalls.
To prove its fraud case against Goldman, the government must show that
Goldman misled investors or failed to tell them facts that would have
affected their financial decisions.
The government's greatest challenge, experts said, will be boiling the
case down to a simple matter of fraud. The issues involved are so
complex that Goldman may be able to introduce enough complicating
factors to shed some doubt on the government's claims.
"If you wanted to go after Goldman with a complaint that wouldn't stick,
this would be perfect," said Janet Tavakoli, president of Tavakoli
Structured Finance, a Chicago consulting firm. "If you look at these
products, almost all of them look like hoaxes because of the junk
inside."
Legal experts pointed to the paucity of evidence in the government's
lawsuit, which contains short excerpts from e-mails but lacks key
information about what the various investors knew and what actions they
took.
The quality of the evidence was not clear from the complaint, said Jacob
Frenkel, a former SEC enforcement lawyer now with Shulman, Rogers,
Gandal, Pordy & Ecker PA.
Frenkel said there's been an uptick in "cases where the government
chooses select excerpts from e-mails as the basis for its allegations
only to find the balance of the text or other e-mails prove otherwise."
For example, prosecutors last fall tried unsuccessfully to use a series
of e-mails to convict two Bear Stearns hedge fund executives. They
wanted to convince jurors that there was behind-the-scenes alarm at the
hedge funds as investments in complex securities tied to mortgages began
to slide.
The jurors were not swayed. After the verdict, some jurors told
reporters they found the evidence against the two executives flimsy and
contradictory. Others suggested the pair were being blamed for market
forces beyond their control.
Goldman already has advanced a similar argument. "Any investor losses
result from the overall negative performance of the entire sector, not
because of which particular securities" were in the investment pool, the
bank said in a written response to the charges Friday.
That's part of a time-honored tradition of defusing accusations by
bringing in details that may or may not be relevant, said James Cohen, a
professor at Fordham University School of Law.
"Traditionally it's in the interest of the party that has Goldman's role
to muddy the waters — it's rarely in their interest to have the picture
as sharp as HDTV," Cohen said.
Several legal experts suggested Goldman and the SEC had reached an
impasse over a settlement before the charges were announced. They
speculated that Goldman was unwilling to admit that it allowed the hedge
fund to create a portfolio of securities that was designed to fail
because that admission could do irreparable harm to Goldman's
reputation.
"Goldman could've easily paid a fine already," said John Coffee, a
securities law professor at Columbia University. "So I don't think it's
money they're fighting over."
The case has been assigned to U.S. District Judge Barbara Jones of New
York. Jones is the federal judge who five years ago presided over the
$11 billion criminal fraud case that toppled WorldCom Corp. and sent its
former CEO Bernard Ebbers to prison for 25 years.
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