Actual fraud is commonly defined as a misrepresentation of a material fact, knowingly and intentionally made, with the intent to mislead another person, which that other person relied upon with the result that he or she was damaged by the misrepresentation. In the first big case to delve into a Wall Street firm’s role in the mortgage fiasco, Goldman Sachs is about to spend the next few years litigating whether it committed fraud in connection with Goldman’s sale to investors of a so-called collateralized debt obligation vehicle tied to mortgages, which vehicle was intentionally designed to fail by the hedge fund, Paulson & Co., that designed it.
The investment vehicle called Abacus 2007-AC1, was one of 25 such vehicles that Goldman created so the bank and some of its clients could bet against the housing market. According to a complaint filed by the SEC accusing Goldman of securities fraud, Goldman created Abacus 2007-AC1 in February 2007 at the request of John A. Paulson, a hedge fund manager who earned about $3.7 billion (that’s billion with a "B") in 2007 by correctly wagering that the housing bubble would burst. The SEC accuses Goldman of wrongly permitting a client (the Paulson hedge fund) that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio. Goldman is accused of failing to tell other of its investors when selling them the collateralized debt obligation tied to mortgages that the vehicle had been designed to fail by the Paulson hedge fund which profited from the losses.
The SEC’s action against Goldman is going to prompt many other securities fraud lawsuits. Goldman chairman Lloyd C. Blankfein, is reported to have taken an unusually active role in overseeing the Goldman mortgage unit, even as the housing market began to crash. British Prime Minister Gordon Brown asked his nation’s securities regulator to investigate Goldman Sachs, and the German government said it was considering taking legal action because of a German bank’s losses. Brown accused Goldman of "moral challenges." It’s one thing to bet against the US housing market. The crux of the pending litigation is going to be whether Goldman intentionally mislead investors by steering them toward toxic mortgage investments that were designed to lose money.