Goldman Case Is Likely Tip of the Legal Iceberg

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The Associated Press

Goldman Case Is Likely Tip of the Legal Iceberg

Shareholder suits, criminal indictments likely after fraud allegations

by
Daniel Wagner

Goldman Sachs' new headquarters are seen reflected in glass in Lower Manhattan April 16, 2010 in New York City. The SEC has filed civil fraud charges related to subprime mortgages against the investment bank.

WASHINGTON - The fraud charges against Goldman
Sachs & Co. that rocked financial markets Friday are no slam dunk,
as hazy evidence and strategic pitfalls could easily trip up government
lawyers.

Yet that hardly matters, experts
say, because the allegations will kick off a new era of litigation that
could entangle Goldman and other banks for years to come.

The
charges against Goldman relate to a complex investment tied to the
performance of pools of risky mortgages. In a complaint filed Friday,
the Securities and Exchange Commission alleged that Goldman marketed
the package to investors without disclosing a major conflict of
interest: The pools were picked by another client, a prominent hedge
fund that was betting the housing bubble would burst.

Goldman
said the charges are "unfounded in law and fact." In a written response
to the charges, the bank said it had provided "extensive disclosure" to
investors and that the largest investor had selected the portfolio -
not the hedge fund client. Goldman said it lost $90 million on the deal.

That
doesn't contradict the SEC complaint, which says the largest investor
selected the mortgage investments from a list provided by the hedge
fund. And the fact that Goldman lost money has no impact on the fraud
charges.

The charges will unleash a torrent
of lawsuits, and likely signal that the government is prepared to file
more lawsuits related to the overheated market that preceded the
financial crisis, experts said.

"This is
just the tip of the iceberg," said James Hackney, a professor at
Northeastern University School of Law. "There are a lot of folks out
there in different deals who played similar roles, and once it starts
building steam, plaintiffs' lawyers will figure out this is where the
money is and there should be a lot of action."

Among the legal action expected in the coming months:

  • Class-action
    suits by Goldman shareholders who believe Goldman alleged misconduct
    made their stakes less valuable could come as early as Monday. Such
    suits are common when companies are accused of wrongdoing. Goldman
    shares fell almost 13 percent Friday as the bank lost $12.5 billion in
    market capitalization.
  • Suits by investors
    who believe Goldman sold them on deals that were doomed to fail. The
    investors in the transaction at the heart of the SEC case could sue
    first, followed by others who believe their losses were similar.
  • Possible
    criminal charges, if the SEC's civil case reveals evidence that meets
    the higher standard of "proof beyond a reasonable doubt." Experts said
    it's unlikely the company as a whole will face criminal charges, but
    evidence could emerge that would expose the Goldman executive named in
    the SEC complaint, 31-year-old Fabrice Tourre, to criminal prosecution.
  • Charges
    by regulators about other mortgage investments at Goldman and
    elsewhere. SEC enforcement chief Robert Khuzami told reporters Friday
    the agency is racking up evidence on other deals in the overheated
    market that preceded the financial crisis.
  • Already
    the case has provoked legal questions from foreign governments,
    according to published reports. That's because the financial crisis
    forced many countries to bail out banks that lost money on investments
    arranged by Goldman.

    German regulators are
    considering legal action against Goldman, newspaper Welt am Sonntag
    reported, quoting a spokesman for Chancellor Angela Merkel.

    The
    charges would be on behalf of IKB Deutsche Industriebank AG - an early
    victim of the financial crisis that was rescued by the state-owned KfW
    development bank among others. IKB invested in the deal regulators are
    targeting.

    The
    flurry of legal activity is likely to proceed separately from the SEC's
    case against Goldman, which experts said faces numerous pitfalls.

    To
    prove its fraud case against Goldman, the government must show that
    Goldman misled investors or failed to tell them facts that would have
    affected their financial decisions.

    The
    government's greatest challenge, experts said, will be boiling the case
    down to a simple matter of fraud. The issues involved are so complex
    that Goldman may be able to introduce enough complicating factors to
    shed some doubt on the government's claims.

    "If
    you wanted to go after Goldman with a complaint that wouldn't stick,
    this would be perfect," said Janet Tavakoli, president of Tavakoli
    Structured Finance, a Chicago consulting firm. "If you look at these
    products, almost all of them look like hoaxes because of the junk
    inside."

    Legal experts pointed to the
    paucity of evidence in the government's lawsuit, which contains short
    excerpts from e-mails but lacks key information about what the various
    investors knew and what actions they took.

    The
    quality of the evidence was not clear from the complaint, said Jacob
    Frenkel, a former SEC enforcement lawyer now with Shulman, Rogers,
    Gandal, Pordy & Ecker PA.

    Frenkel said
    there's been an uptick in "cases where the government chooses select
    excerpts from e-mails as the basis for its allegations only to find the
    balance of the text or other e-mails prove otherwise."

    For
    example, prosecutors last fall tried unsuccessfully to use a series of
    e-mails to convict two Bear Stearns hedge fund executives. They wanted
    to convince jurors that there was behind-the-scenes alarm at the hedge
    funds as investments in complex securities tied to mortgages began to
    slide.

    The jurors were not swayed. After
    the verdict, some jurors told reporters they found the evidence against
    the two executives flimsy and contradictory. Others suggested the pair
    were being blamed for market forces beyond their control.

    Goldman
    already has advanced a similar argument. "Any investor losses result
    from the overall negative performance of the entire sector, not because
    of which particular securities" were in the investment pool, the bank
    said in a written response to the charges Friday.

    That's
    part of a time-honored tradition of defusing accusations by bringing in
    details that may or may not be relevant, said James Cohen, a professor
    at Fordham University School of Law.

    "Traditionally
    it's in the interest of the party that has Goldman's role to muddy the
    waters - it's rarely in their interest to have the picture as sharp as
    HDTV," Cohen said.

    Several
    legal experts suggested Goldman and the SEC had reached an impasse over
    a settlement before the charges were announced. They speculated that
    Goldman was unwilling to admit that it allowed the hedge fund to create
    a portfolio of securities that was designed to fail because that
    admission could do irreparable harm to Goldman's reputation.

    "Goldman
    could've easily paid a fine already," said John Coffee, a securities
    law professor at Columbia University. "So I don't think it's money
    they're fighting over."

    The case has been
    assigned to U.S. District Judge Barbara Jones of New York. Jones is the
    federal judge who five years ago presided over the $11 billion criminal
    fraud case that toppled WorldCom Corp. and sent its former CEO Bernard
    Ebbers to prison for 25 years.

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