US Justice Department Probe Goes Far Beyond SEC Civil Suit

Justice probe of Goldman goes beyond deals cited by SEC

By Zachary A. Goldfarb and Jerry Markon
Washington Post Staff Writer
Saturday, May 1, 2010
The Justice Department's criminal investigation into Goldman Sachs goes beyond the financial transactions targeted by the Securities and Exchange Commission in the civil fraud suit brought against the firm last month, law enforcement sources said Friday.

The Justice Department probe began weeks ago and is essentially on a parallel track with the SEC investigation, the sources said. While prosecutors and investigators are focusing on some of the same mortgage-related transactions as the SEC, the sources said, the Justice Department has cast a wider net.

Investors pounded Goldman Sachs shares on Friday as it became increasingly clear that the Wall Street bank's problems are growing. After initial news media reports about the criminal investigation, investors sent Goldman shares down 9.4 percent, or $15.04, to $145.20.

It was another brutal day for a firm that survived the worst of the financial wreckage of the past two years. Since the SEC filed its suit April 16, Goldman's shares have lost 20 percent of their value, costing investors $20.6 billion in market value.

Goldman's stock price remains far higher than it was during the depths of the financial crisis in fall 2008. The firm's shares have essentially doubled in price since then as the company quickly returned to the black, seeing fewer losses on subprime mortgages than competitors and making significant trading profits with the help of government support.

Other actions pending

But analysts said the criminal probe and the civil case are just two of several developments that could threaten Goldman's reputation and bottom line in coming months. The firm also was the subject of a searing Senate investigative report this week examining Goldman's role in the financial crisis. Goldman's bottom line could also suffer if the Senate, now debating reforms to financial regulation, adopts proposed changes to limit trading in derivatives and certain investment activities at banks, for instance owning hedge funds.



Working alongside advocates for other big banks and industry trade groups that share similar concerns, Goldman's well-heeled roster of lobbyists have been meeting with the staff of key committee members, such as the financial services and agriculture committees in both the House and Senate.

Banking analysts at Standard & Poor's and Bank of America-Merrill Lynch downgraded Goldman's stock on Friday.

"Though traditionally difficult to prove, we think the risk of a formal securities fraud charge, on top of the SEC fraud charge and pending legislation to reshape the financial industry, further muddies Goldman's outlook," Matthew Albrecht, an analyst at Standard & Poor's, wrote Friday.

The U.S. attorney's office in Manhattan and the FBI are conducting the criminal probe, which sources said has been underway for weeks. Sources said a decision on whether to file any charges has not been made.

The U.S. attorney's office in Manhattan declined to comment. Goldman said it would cooperate with requests for information.

The SEC filed a civil securities fraud case against the firm two weeks ago, and a source familiar with the matter said the SEC had referred that investigation to the Justice Department for possible criminal prosecution.

But law enforcement sources said the probe by the Manhattan U.S. attorney's office -- which is known for aggressively investigating financial fraud cases -- was not based on an SEC referral and was underway before the SEC announced the civil case April 16.

High legal threshold

The Justice Department typically investigates high-profile cases of securities fraud, but the threshold for criminal prosecution is significantly higher than that of civil cases, and such investigations are highly complex.

The threat of criminal prosecution can doom a business. A criminal case ruined the Wall Street firm Drexel Burnham Lambert in the 1980s even though it settled.

The SEC says Goldman and employee Fabrice Tourre broke the law and committed fraud when they sold clients a complex investment linked to the value of home loans that was secretly designed to fail. Another firm, Paulson & Co., a hedge fund, helped Goldman create the investment and planned to bet against it. The SEC says the relationship was not disclosed to Goldman's clients, ACA Financial Guaranty and the German bank IKB.

Goldman and Tourre have denied any wrongdoing. Goldman says that ACA and IKB were sophisticated investors and that disclosure of Paulson's role was not required.

The Justice Department suffered a setback last year with the failure of the first major criminal case to arise from the financial crisis: the prosecution of two Bear Stearns hedge fund managers. A jury rejected securities fraud charges against the hedge fund managers, who ran funds linked to subprime mortgages, after presenting evidence that the men knew about risks but did not disclose these to investors.

The cases against Bear Stearns and Goldman Sachs have some overlap. One of the subprime-linked securities that contributed to the collapse of the Bear Stearns hedge funds was assembled by Goldman and sold under its Abacus program, which was the subject of the SEC suit and the Senate report this week.



Securities lawyers have said that the Bear Stearns case sent a chilling message to the Justice Department after jurors said the prosecution's evidence, drawn in large part from internal company e-mails, was not persuasive. Lawyers said the Justice Department would need a very strong case to defeat Goldman.

They also said the criminal probe could complicate the SEC case as it moves to trial. Facing criminal prosecution, Goldman employees might decline to testify and then invoke the Fifth Amendment if the SEC seeks new depositions for the trial, as is common.

However, in a civil case, unlike in a criminal case, invoking the Fifth Amendment can be held against you by a judge or jury.

Staff writer Tomoeh Murakami Tse in New York contributed to this report.