Wall Street giant Goldman Sachs was yesterday accused of defrauding investors in a civil lawsuit filed by America's Securities and Exchange Commission (SEC).
The US government's financial watchdog alleges that Goldman Sachs misled investors by failing to disclose conflicts of interest in mortgage investments it sold as the housing market was faltering.
The SEC announced it had lodged civil fraud charges against the company and one of its vice presidents - news that sent stock markets worldwide reeling. In fact London's FTSE 100 Index plunged 1.4 per cent in reaction, while the Dow Jones Industrial Average in America fell more than 160 points at one stage.
The SEC alleges Goldman, which employs 5,500 people in the UK, failed to disclose that one of its clients helped create - and then bet against - sub-prime mortgage securities that Goldman sold to investors. Investors in the mortgage securities are alleged to have lost more than a billion US dollars, the SEC said. The agency is seeking to recoup profits made on the deal.
The Goldman client implicated in the fraud is one of the world's largest hedge funds, Paulson, which paid Goldman roughly $15 million for structuring the deals in 2007.
Goldman Sachs shares fell more than 12 per cent after the SEC announcement, which also caused shares of other financial companies to plummet. In the UK, Barclays closed three per cent down and HSBC dropped two per cent.
The civil lawsuit filed by the SEC in federal court in Manhattan was the US government's most significant legal action related to the mortgage meltdown that ignited the financial crisis and helped plunge the country into recession.
The agency also charged a Goldman vice president, Fabrice Tourre, 31, who it said was principally responsible for devising the deal and marketing the securities.
The SEC is seeking unspecified fines and restitution from Goldman Sachs and Mr Tourre.
Goldman told investors that a third party, ACA Management, had selected the underlying mortgages in the investment.
But the SEC alleges Goldman misled investors by failing to disclose that Paulson also played a role in selecting the mortgages and stood to profit from their decline in value.
"Goldman wrongly permitted a client that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio, while telling other investors that the securities were selected by an independent, objective third party," SEC enforcement director Robert Khuzami said.
But Goldman Sachs issued a defiant response to the SEC charges today.
The group said: "The SEC's charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation."
One lawyer who specialises in fraud said the case raised questions over the prospect of similar action in the UK.
Raj Chada, a partner at Hodge Jones & Allen, said: "This is one of the largest potential actions that regulators have started and which arises from the banking meltdown.
"It will be interesting to see if British regulators follow suit and consider further action against other banks for UK activities.