Goldman Agrees to Pay Fine – Analyst Blog

On Thursday, The Goldman Sachs Group Inc. (GS) announced that it would pay $550 million to the Securities and Exchange Commission (SEC) to settle a civil fraud suit linked to mortgage investments, which was filed in April. The SEC had alleged that Goldman sold mortgage-related investments without advising buyers that the securities had been gambled by a client who was betting on them to fail.

 

SEC claimed that Goldman created an investment vehicle named Abacus 2007-AC1 in February 2007, comprising subprime mortgage-backed securities. It was created just at the time when the housing markets started to crumble.

 

Further, the investors were told by Goldman that the mortgage bonds would be selected by an independent manager. However, according to the charges, Goldman asked its client Paulson & Co. to select those mortgage bonds that they believed were most likely to decline in value. Later, Goldman sold those bonds to investors such as foreign banks, pension funds and insurance companies.

 

Consequently, the value of Abacus portfolios declined. The European banks and other investors lost more than $1 billion, while Paulson made money from bets against the mortgage bonds.

 

Though Goldman denied the accusations of the SEC, the company confessed that the Abacus product omitted the information on marketing practices and that it failed itself to disclose the inbuilt risk factors including the vital role of Paulson in the portfolio selection process.

 

The settlement involved a civil penalty of $535 million and required Goldman to pay $15 million of profits from the Abacus deal. The amount of $250 million would be returned to the two banks that had invested in Abacus, including $150 million to IKB Deutsche Industriebank AG, a German bank, and $100 million to the Royal Bank of Scotland Group plc (RBS). Goldman paid the rest of the $300 million to the United States Treasury as a fine.

 

However, the settlement is yet to be approved by Judge Barbara S. Jones of Federal District Court in Manhattan. If approved, it would be one of the largest penalties in Wall Street history, although Goldman’s sentiments would not be hurt much as it has earned profits of $13.39 billion in the first quarter.

 

The SEC will, however, not free Goldman from legal hassles, as it would continue to scrutinize other products like collateralized debt obligations, issued by Goldman and other banks and would also review the Abacus deal for further findings.

 

 

Goldman has been subject to a number of litigations of late. Recently on July 12, Liberty Mutual Insurance Co. had sued Goldman for misleading it to buy the preferred stock of Fannie Mae (FNMA), which became practically valueless. Liberty Mutual had invested $62.5 million to buy the stock.

 

Last month, the securities regulator Financial Industry Regulatory Authority (FINRA) ordered Goldman to pay $20.6 million to settle claims with the creditors of a failed hedge fund. The creditors claimed that Goldman should have known about its clearing brokerage client Bayou Hedge Funds’ fraudulent activities in connection with a Ponzi scheme.

 

In addition, Goldman and some of its top officers and directors were charged recently with securities fraud, and a class action lawsuit has already been filed by Pomerantz Haudek Grossman & Gross LLP in the United States District Court, Southern District of New York.

 

 

While we believe that Goldman is well positioned to reap the benefits of its strategic cost-balancing initiatives and attractive business mix, we think that such allegations dampen investors’ confidence in the stock and damage the reputation of the company. Further, it will harm the relationship with major clients associated with Goldman, who have already become more cautious working with the firm.

 

Additionally, such fines also dent the company’s financials. As such, Goldman currently has a Zacks #5 Rank (Strong Sell), implying that there is a significant likelihood of downward pressure on the stock over the next one to three months.