The SEC's case against Goldman, which it unveiled Friday, hinges mostly on one thing: what did the Wall Street giant tell investors about the toxic-waste-based CDO it sold them?The SEC has accused Goldman Sachs of securities fraud for the way it sold a collateralized debt obligation - a slice of a pool of subprime mortgages - that had been handpicked by hedge fund luminary John Paulson so that he could bet against it (as he believed the housing bubble would burst) to investors said to include German bank IKB and ACA Capital Management. One issue is where or not Goldman disclosed Paulson's role and motivations in structuring the deal.
Goldman says it was honest and told investors everything. "The two investors were provided extensive information about the underlying mortgage securities," said the firm in a statement Friday. "The risk associated with the securities was known to these investors, who were among the most sophisticated mortgage investors in the world. These investors also understood that a synthetic CDO transaction necessarily included both a long and short side."
You can read Goldman's Abacus pitch book for yourself here. It doesn't appear to give many specifics about the underlying securities of Abacus, other than listing a "reference portfolio."
Goldman also maintains that it lost money $90 million on the transaction. However, Goldman has not shared how much it made in overall fees from investors such as Paulson who were shorting the housing market including its own subprime CDOs.
One could argue that selling subprime mortgage-backed securities, with a known high risk of default, is securities fraud in and of itself, regardless of who designed the investment. Under that definition, many Wall Street firms would be culpable. On the other hand, deals such as Abacus offered investors a much higher rate of return in 2007, when this transaction took place, than they could find anywhere else. One could also argue that they had to have had some idea of the risks they were taking on.