The Securities and Exchange Commission has charged investment banking titan Goldman Sachs with civil fraud over a pre-packaged mortgage instrument they say was designed to fail.


Goldman Sachs created the derivative -- called Abacus 2007-AC1 -- in response to a request from a hedge fund manager who predicted that the housing market would collapse and wanted to bet against it. The trader, John Paulson, later earned $3.7 billion for his wager. Goldman's practices cost investors $1 billion, according to the filing.

According to the New York Times, which first revealed details of the Abacus case, the instrument was among 25 Goldman created so that clients could bet against the housing market:

As the Abacus deals plunged in value, Goldman and certain hedge funds made money on their negative bets, while the Goldman clients who bought the $10.9 billion in investments lost billions of dollars.

Goldman let Mr. Paulson select mortgage bonds that he wanted to bet against — the ones he believed were most likely to lose value — and packaged those bonds into Abacus 2007-AC1, according to the S.E.C. complaint. Goldman then sold the Abacus deal to investors like foreign banks, pension funds, insurance companies and other hedge funds.

But the deck was stacked against the Abacus investors, the complaint contends, because the investment was filled with bonds chosen by Mr. Paulson as likely to default. Goldman told investors in Abacus marketing materials reviewed by The Times that the bonds would be chosen by an independent manager.

Apparently, they weren't.

Fabrice Tourre, a vice president at Goldman who helped design and market Abacus, was also named in the SEC suit.

84 percent of Abacus' mortgage bonds would be downgraded within five months of their sale. By the end of 2007, Paulson's credit hedge fund soared 590 percent, and Goldman's clients lost billions.

Goldman reportedly targeted specific mortgage bonds at Paulson's request that Paulson felt were most likely to lose their golden credit ratings, which would trigger a payout for his firm.

Goldman did not immediately comment on the suit. The company's shares fell more than 10 percent on the news.

Shareholder recently sued firm for huge bonus payouts

In January, a lawsuit filed against the investment bank by a shareholder alleged that the company spent more money on corporate bonuses than it earned in 2008.

Shareholder Ken Brown's lawsuit is one of two suits filed against the company over its controversial decision to hand out billions of dollars in bonuses even after it was accused of playing a central role in the financial collapse of 2008 and receiving $10 billion in direct aid from the US government.

In his lawsuit (PDF), Brown asserted that Goldman Sachs gave out $4.82 billion in bonuses in 2008, despite earnings of only $2.32 billion that year. The lawsuit alleges that the company spent 259 percent of its income in the first quarter of 2009 on compensation.

Goldman Sachs handed out $16.7 billion in compensation in the first nine months of 2009, according to Bloomberg News, and that figure may reach $22 billion for the entire year. Brown's suit says the company typically sets aside 44 percent of its net revenue for employees.

“Payment of this exorbitant amount of compensation, which has little to do with Goldman Sachs’s performance, and was financed in large part with government bailout and taxpayer money, is a waste of the company’s assets and a breach of duty and loyalty," Brown asserts in the suit.

Goldman CEO Lloyd Blankfein earned $9 million in a non-cash bonus for 2009. In prior years, he'd earned more than $20 million.