SEC accuses Goldman Sachs of fraud over conflict in mortgage securities

WASHINGTON - The U.S. government has accused Goldman Sachs & Co. of defrauding investors by failing to disclose conflicts of interest in subprime investments it sold as the housing market was collapsing.

The Securities and Exchange Commission said in a civil complaint Friday that Goldman (NYSE:GS) failed to disclose that one of its clients helped create - and then bet against - subprime mortgage securities that Goldman sold to other investors.

Two European banks that bought the mortgage securities lost nearly $1 billion, the SEC said. The agency is seeking to recoup profits reaped on the deal.

Goldman Sachs denied the allegations. In a statement, it called the SEC's allegations "completely unfounded in law and fact" and said it will contest them.

The civil complaint comes as legislators seek to crack down on Wall Street practices that helped cause the financial crisis. Among proposals Congress is weighing are tougher rules for complex investments like those involved in the alleged Goldman fraud.

The Goldman client implicated in the fraud is one of the world's largest hedge funds, Paulson & Co. The SEC said it paid Goldman roughly $15 million in 2007 to put together an investment offering that was tied to mortgage-related securities the hedge fund viewed as likely to decline in value.

Separately, Paulson took out a form of insurance that allowed it to make a huge profit when those securities became nearly worthless.

Goldman Sachs shares plummeted after the SEC announcement and closed down $23.57 or just under 13 per cent at US$160.70 in a fall-off that also caused shares of other financial companies to sink. The Dow Jones industrial average finished 125.91 points lower at 11,018.66.

The Toronto Stock Market was also down sharply - off 140.86 points at 12,070.66-partly on what one analyst called a "knee-jerk reaction" to the allegations against Goldman.

The civil lawsuit filed by the SEC in federal court in Manhattan was the U.S. government's most significant legal action related to the mortgage meltdown that ignited the financial crisis and helped plunge the United States and much of the rest of the world into recession. The SEC's enforcement chief said the agency is investigating a broad range of practices related to the crisis.

The agency also charged a Goldman vice-president, Fabrice Tourre, 31, who it said was mainly responsible for devising the deal and marketing the securities. The SEC said he now is executive director of Goldman Sachs International in London.

Tourre, the SEC said, boasted to a friend that he was able to put such deals together as the mortgage market was unravelling in early 2007.