Wall Street giant Goldman Sachs faced charges of financial fraud on Saturday as US financial firms eyed the prospect of a wider crackdown on those that bet on the collapse of the housing market.
A civil suit filed by the Securities and Exchange Commission Friday accused Goldman of "defrauding investors by misstating and omitting key facts" about a financial product based on subprime mortgage-backed securities.
The securities were a key contributor to the financial crisis that peaked in 2008 because many contained risky mortgages.
The charges are believed to be the first brought against a Wall Street firm for speculating on the collapse of the housing market, which is still struggling to emerge from the worst financial crisis in decades.
Underlining persistent concerns about the unfettered trade, US President Barack Obama said Friday he would veto a Wall Street reform bill that lacked tough rules for complex financial instruments.
"I will veto legislation that does not bring the derivatives market under control and some sort of regulatory framework assures that we don't have the same sort of crisis we have seen in the past," Obama said.
The SEC said Goldman failed to tell investors that a major hedge fund had helped put together the controversial financial product known as collateralized debt obligation (CDO) and was at the same time betting against it.
Paulson & Co, one of the world's largest hedge funds, paid Goldman Sachs to structure a transaction in which it could take speculative positions against mortgage securities chosen by the fund, the commission said in a statement.
The deal, which took place during a massive mortgage meltdown in 2007 and as the country was about to fall into a brutal recession, was said to have cost investors around one billion dollars.
Goldman claimed that it lost 90 million dollars from its own investment in the security.
"We are disappointed that the SEC would bring this action related to a single transaction in the face of an extensive record which establishes that the accusations are unfounded in law and fact," the company said.
Goldman said it would "vigorously contest them and defend the firm and its reputation."
Paulson & Co founder John Paulson said he had no role in choosing the mortgages. The 54-year-old fund manager was not named as a defendant in the suit, and Robert Khuzami, director of enforcement at the SEC explained that, unlike Goldman, Paulson & Co had not made misrepresentations to investors buying the security.
The lawsuit also named Fabrice Tourre, then a vice-president at Goldman. He was said to be the creator and salesman of the product, which caused investors to lose about one billion dollars.
"The product was new and complex but the deception and conflicts are old and simple," said Khuzami in a statement.
Analysts said a long courtroom battle could now be expected.
The authorities have not ruled out the possibility of others involved in the alleged fraud or other similar types of fraud.
"The SEC continues to investigate the practices of investment banks and others involved in the securitization of complex financial products tied to the US housing market as it was beginning to show signs of distress," said Kenneth Lench, head of the SEC's structured and new products unit.
It is not known whether the SEC might refer the case to the Department of Justice for criminal prosecution.
"The fact that the only individual charged here, after what was presumably a very thorough investigation, was a vice president rather than a managing director or higher, is relatively reassuring news for Goldman," said Bank of America-Merrill Lynch research analyst Guy Moszkowski.
He said it seemed most likely that the potential for more serious charges rose dramatically the higher up the management chain the charges went.
Among investors of Goldman's controversial product were German commercial bank IKB.
Goldman shares dived 12.79 percent Friday to 160.70 dollars, after falling as much as 15 percent when news of the fraud charges first hit the market.
The Dow Jones Industrial Average tumbled 125.91 points or 1.13 percent to end the week at 11,018.66 points, snapping a six-session winning streak that had driven the blue-chip index to a fresh 18-month high.
Oil prices also fell sharply, with New York's main contract, light sweet crude for delivery in May, slipping 2.27 dollars to 83.24 dollars a barrel.
On Saturday, The New York Times suggested in an editorial the charges may be just the beginning of a broader government campaign against Wall Street.
"Goldman is not the only bank to have sold mortgage-backed securities and then bet against them," the newspaper said. "We suspect that after Friday, others on Wall Street may have a harder time sleeping."