Goldman Sachs Deep Pockets May Still Make It Lawsuit Target

By and | July 20, 2010

Goldman Sachs put one headache behind it by settling with U.S. securities regulators, but it looks like a tempting deep pocket for banks and hedge funds that bought subprime-backed mortgage securities.

A day after the U.S. Securities and Exchange Commission said that nearly half of the $550 million penalty paid by Goldman will go to some of its European victims, at least one of those banks is saying the deal may not go far enough.

In settling with the SEC and admitting it made a “mistake” in marketing a mortgage-related security, it could open the door for other institutional investors to seek some revenge.

And while Goldman has more than enough money to defend the private litigation and even pay out damages, an endless stream of lawsuits has the potential to create more negative headlines for the storied investment firm.

Indeed, the ink was barely dry on the proposed regulatory settlement when Royal Bank of Scotland indicated that it may pursue Goldman Sachs for substantially more than the $100 million it is receiving under the agreement.

AUSTRALIAN HEDGE FUND

RBS said on Friday it would “carefully consider all of its options.”

RBS lost $841 million on the collateralized debt obligation at the heart of the SEC’s case, known as Abacus 2007, because it provided a form of back-up insurance on the underlying collateral in the CDO. When the Abacus deal collapsed, RBS was forced to make good on its insurance coverage.

Much of the money paid out by RBS ultimately went to Paulson & Co., the hedge fund client for whom Goldman had arranged the CDO.

In settling with the SEC, Goldman said it “regrets that the marketing materials” for the Abacus deal never disclosed that Paulson, which bet against the deal, had a hand in selecting the underlying portfolio of securities.

Goldman is already facing a lawsuit in New York federal court from an Australian hedge fund, Basis Yield Alpha Fund, which invested $100 million into another collateralized debt obligation called Timberwolf.

The investment firm also is dealing with a number of potential class action lawsuits in which shareholders claim they lost billions because Goldman never disclosed that the SEC had warned it last year that it could face an enforcement action over the Abacus deal.

Goldman’s stock plunged the day of the SEC lawsuit and at one point the the firm lost some $25 billion in market capitalization. The stock has risen about 7 percent since the settlement was announced late Thursday.

RBS may have a case in pursuing a lawsuit against Goldman because, unlike another European victim, German bank IKB, it was not made whole in the settlement. Of the $550 million Goldman is paying, the German bank will get $150 million, which covers the full extent of its lost investment on the Abacus 2007 deal.

Some investors have urged RBS, which is 83 percent owned by the British government, to sue Goldman. Former UK Prime Minister Gordon Brown said in April that Goldman would have to pay back “hundreds of millions of dollars” if the charges against it were proven.

By 1412 GMT RBS shares were down 3.4 percent at 43.67 pence, compared with a 3 percent fall in the European bank index as U.S. banks Citigroup and Bank of America reported weaker-than-expected revenue.

STATE BAILOUTS

RBS and IKB were two of the biggest losers in the financial crisis. Each needed billions of euros in state bailouts to survive.

IKB approached the brink of collapse in 2007, in part because of subprime-related products Goldman sold to IKB’s off-balance-sheet investment vehicle Rhineland Funding.

IKB, which required multiple bailouts and is now majority owned by Lone Star, declined to comment before it had a chance to review the SEC settlement.

The payment provided “little consolation, if any, given that overall losses were much higher for IKB,” said Merck Finck analyst Konrad Becker.

But Goldman may also get some relief from the courts from potential litigation.

On July 8, Goldman signaled that it may use a recent U.S. Supreme Court case to seek a dismissal of the Basis Yield case. The decision, in a case known as Morrison v. National Australia Bank, could potentially limit the ability of foreign investors to sue in the United States for a violation of federal securities laws based on a transnational securities fraud.

The Basis Yield hedge fund bought its Timberwolf securities from an Australian subsidiary of Goldman.

Also, the terms of the settlement with the SEC could make it a bit harder for private investors to sue the firm.

In the original April 16 complaint, regulators alleged that Goldman committed fraud in violation of two sections of the federal Securities Act. But the settlement only charged Goldman with violation one of those provisions — a section that normally does not give rise to a private right of litigation.

While the settlement does not preclude investors from suing Goldman, it could complicate their claims, said legal analysts.

No matter what, the ghost of Abacus and other busted CDOs brought to market by Goldman before the housing market crash of 2007 may well haunt the firm in court for years to come.

(Reporting by Matthew Goldstein and Steve Slater. Additional reporting by Edward Taylor and Alexander Huebner in Frankfurt; editing by David Cowell and Robert MacMillan)

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