June 10 (Bloomberg) -- Goldman Sachs Group Inc.’s $2 billion Hudson Mezzanine collateralized debt obligation, sold in
2006, is the target of a probe by the Securities and Exchange
Commission, according to a person with knowledge of the matter.
The inquiry into the CDO may not lead to any additional actions against the New York-based securities firm, said the
person, who declined to be identified because the investigation
isn’t public. Michael DuVally, a spokesman for Goldman Sachs,
declined to comment, as did SEC spokesman John Nester. The
Financial Times reported the probe yesterday.
Goldman Sachs shares have fallen 26 percent since the SEC filed a fraud lawsuit against the firm on April 16 that related
to its 2007 sale of a CDO called Abacus. Senator Carl Levin, a
Michigan Democrat, said in April that Goldman Sachs’s sales of
CDOs such as Hudson raised “a real ethical issue.”
“The ethical issue is valid, but Goldman isn’t the only investment bank” that sold CDOs, said Ambrose Chang, a Hong
Kong-based fund manager at Daiwa SB Investments HK Ltd. “After
the financial crisis, all Wall Street banks’ reputations have
been fundamentally damaged.”
In the Abacus suit, the SEC said Goldman Sachs and one of its employees, Fabrice Tourre, didn’t disclose to investors the
role played by hedge fund Paulson & Co. in devising and betting
against the securities. Goldman Sachs has denied wrongdoing on
the Abacus CDO and said it will fight the SEC’s case.
Hedge Fund Suit
CDOs parcel fixed-income assets such as bonds or loans and slice them into new securities of varying risks, providing higher returns than other investments of the same rating.
In a separate case, Goldman Sachs was sued by Australian hedge fund Basis Capital for $1 billion. In the suit, filed
yesterday in Manhattan federal court, Basis claims it was forced
into insolvency after buying mortgage-linked securities that the
firm created and one of its executives termed “one shi**y deal.”
“The lawsuit is a misguided attempt by Basis, a hedge fund that was one of the world’s most experienced CDO investors, to
shift its investment losses to Goldman Sachs,” Goldman Sachs
said in a statement.
The U.S. Senate’s Permanent Subcommittee on Investigations, led by Levin, released e-mails in April related to Goldman
Sachs’s mortgage-linked deals, including the Hudson Mezzanine
transaction. In one October 2006 e-mail, a Goldman Sachs
employee describes how the Hudson deal might be viewed by
investors as “junk.”
Hudson Mezzanine
The Hudson Mezzanine 2006-1 CDO contained credit default swaps that referenced $2 billion in subprime, BBB-rated
residential mortgage-backed securities, according to the
documents released by Levin’s committee. While Goldman Sachs
selected the assets in the deal, the firm was also the only
investor buying credit protection on the entire transaction, the
documents show.
Goldman Sachs created and sold the Hudson CDO in late 2006, near the time documents released by Levin show senior executives wanted to reduce the firm’s exposure to subprime mortgages.
“The CDO imploded within two years. Your clients lost; Goldman profited,” Levin said in an April 27 hearing during
which he questioned Goldman Sachs Chief Executive Officer Lloyd
Blankfein about the Hudson deal and other CDOs. “To go out and
sell these securities to people and then bet against those same
securities, it seems to me, is a fundamental conflict of
interest and is -- raises a real ethical issue.”
Blankfein responded that “we are one of the largest client franchises in market-making in these kinds of activities we’re
talking about” and that “they know our activities, and they
understand what market-making is.”
While Goldman Sachs was short on the Hudson Mezzanine CDO, meaning it stood to gain from a collapse because of the credit
protection it had purchased, a marketing document for the deal
released by Levin’s committee states that “Goldman Sachs has
aligned incentives with the Hudson program.”
In a short sale, an investor bets the value of a security will decline.
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