WASHINGTON — Goldman Sachs agreed Thursday to pay $550 million — the largest penalty ever imposed on an investment bank — to settle civil fraud charges over its "incomplete" disclosures to investors who lost $1 billion in an exotic offshore mortgage securities deal.
Goldman said it was told that the settlement resolves all Securities and Exchange Commission inquiries into its conduct. The investment bank was the only major Wall Street firm to safely exit the market for risky residential mortgage securities, and Goldman has been a magnet for scrutiny because it profited by secretly betting on a housing downturn before the subprime mortgage meltdown in late 2007.
Robert Khuzami, the SEC's enforcement chief, said that Goldman had acknowledged "misleading" investors to help a major client, the hedge fund Paulson & Co., reap a $1 billion profit. He said that Goldman pledged to tighten internal controls and "to assess the roles and responsibilities of various Goldman personnel" to ensure that future disclosures about mortgage-related products "are full, accurate and complete."
He said that the settlement "is a stark reminder — a very stark reminder — that there will be a heavy price to be paid if firms violate the fundamentals of the securities laws: full disclosure, honest treatment and fair dealing."
His deputy, Lorin Reisner, cited Goldman's "egregious conduct" in the deal.
Goldman, however, pointed to language in the proposed court settlement stating that it had neither admitted nor denied any of the allegations. Goldman said it had made a "mistake" in the marketing omissions and "regrets" the omission.
The Wall Street giant said in a statement that SEC enforcement officials indicated that they'd completed a review of the firm's marketing of mortgage securities in similar offshore deals and do "not anticipate recommending any claims against Goldman Sachs or any of its employees with respect to those transactions."
"We recognize that, as is always the case, the SEC has reserved the right to reopen those matters based on new information," the firm said.
With the action, the SEC also appeared to signal that a preliminary Justice Department criminal investigation into Goldman's offshore securities dealings wouldn't lead to prosecution.
By settling, Goldman limited damage that an ongoing federal suit might cause as it seeks to defend against numerous shareholder and investor suits over its sale of securities backed by subprime mortgages to marginally qualified homebuyers — securities that plummeted in value when the housing bubble burst.
"We believe that this settlement is the right outcome for our firm, our shareholders and our clients," the firm said.
James Cox, a Duke University law school professor specializing in securities, called the settlement "a great victory for the SEC" in a case that wasn't "anywhere near a slam dunk."
"The young David was successful against financial goliath Goldman Sachs," both in extracting an admission that the firm's disclosures were inadequate and in recovering more than half of the money lost, he said.
Cox said that many of the offshore mortgage securities deals were highly complicated, and records no longer exist to support enforcement actions. He said he suspects that "the SEC didn't have enough to go forward in the other cases."
"In this case," he said, "Goldman was either incredibly sloppy or incredibly brazen, or the SEC was incredibly lucky."
As part of the settlement, Goldman agreed to a permanent injunction barring violations of the antifraud sections of the Securities Act of 1933, which prohibits both intentional and unintentional fraud.
The deal, which is subject to approval by a U.S. District Court in Manhattan, was announced just hours after the Senate gave final passage to sweeping legislation to overhaul regulation of the nation's financial industry.
Critics had contended that the SEC brought the suit against the world's most prestigious investment bank to help win passage of the legislation, but Khuzami cited the settlement as proof of the merits of the case.
The SEC sued Goldman and one of its vice presidents, 31-year-old Frenchman Fabrice Tourre, on April 16, charging that they had duped investors in a sophisticated deal in 2007, known as Abacus AC1, in which the parties didn't buy or sell any mortgage securities, but instead wagered on how they'd perform. Goldman broke the law, the suit said, by allowing Paulson & Co. to stack the deal with highly risky mortgage securities without telling other investors that Paulson planned to bet on their failure.
Goldman's marketing materials stated that ACA Management LLC, the firm managing the deal, had selected all of the mortgage securities.
Paulson, which reportedly racked up $3.7 billion in profits by betting against the housing market before it collapsed, wound up making $1 billion on that deal alone, while investors on the other side — ACA Capital Management and German bank IKB, together lost that much. Through later acquisitions, IKB's losses eventually fell to the Royal Bank of Scotland.
Goldman has responded to allegations that it failed to fully inform investors in its mortgage securities of the risks by emphasizing that it limited sales to sophisticated investors, who have fewer protections under securities laws.
Khuzami stressed Thursday that the settlement serves as a warning to Wall Street that "no product is too complex and no investor too sophisticated" to shield them if they violate "fundamental principles of honest treatment and fair dealing."
Under the proposed settlement, Khuzami said, $300 million of the penalties would go to the U.S. Treasury, and $250 million would be returned to the harmed investors.
Khuzami said that the case against Tourre would proceed and that Goldman had pledged its cooperation. Tourre took a leave of absence from his London job with Goldman shortly after the suit was filed.
The SEC's suit against Goldman stunned Wall Street, and the enforcement agency's decision to make peace with the investment powerhouse comes at a fortuitous time for the Obama administration and Democrats in Congress as they try to avoid big losses in the fall election campaign. Employees of Goldman rank among the nation's biggest political donors.
In the 2008 election cycle, Goldman donated nearly $6 million, of which $4.7 million went to Barack Obama, other Democratic presidential candidates and Democratic congressional candidates, according to the Center for Responsive Politics.
So far in the 2010 cycle, however, Goldman employees' $1.4 million in donations are divided almost equally.
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