Legal Mess for Goldman Continues

According to Reuters, the federal judge in New York rescinded the bid filed by The Goldman Sachs Group Inc. ( GS - Analyst Report ) regarding the dismissal of a lawsuit charged against the bank, accusing it of selling risky debts via misleading statements. The U.S. District Judge, Paul Crotty, has ordered the plaintiffs to pursue the proceedings over their claims against Goldman relating to the offering of collateralized debt obligations (CDOs) stating "Goldman's arguments in this respect are Orwellian”.

CDOs typically repackage bonds and other assets into new securities. These are not traded on a public exchange, allowing firms like Goldman to generate fees through brokering deals between buyers and sellers. However, CDOs have performed miserably since these were invested in securities comprising sub-prime mortgages, which are known to have larger-than-average risk of defaulting in the market. Eventually, the market downturn ruined the investment banker’s expectations, resulting in huge losses for the common investors.

The aforesaid lawsuit has been filed by the shareholders of the company in Manhattan federal court. They claimed that Goldman concealed the fact of betting against its clients by taking short positions in four CDO transactions, which were sold to the investors. Institutional investors, such as the Arkansas Teacher Retirement System, the Plumbers and Pipefitters National Pension Fund and the West Virginia Investment Management Board are also among the plaintiffs.

All these plaintiffs alleged that Goldman’s act of concealing facts at the time of entering such transactions led to inflated stock prices. Therefore, investors faced losses when the lawsuits were filed against Goldman relating to these transactions, which led to a fall in its share price.

The complaints claimed that Goldman deceptively sold the sub-prime mortgage-linked securities that gradually failed. In addition to that, it misrepresented the value of instruments by providing materially misleading statements.

Among the four transactions involved in the lawsuit, the first one was the Securities and Exchange Commission’s (SEC) charges against the company accusing it of misleading investors by misrepresenting facts in its mortgage-backed securities of over $1 billion. The SEC's complaint accused the investment bank of creating a CDO called Abacus 2007-AC1, which was made up of mortgage-backed securities.

Goldman was also charged by the SEC in the U.S. for misstating facts and selling bad quality sub-prime investments to its customers in 2006, without disclosing the risk factors and the vital role of Paulson & Co., a prime hedge fund, in the portfolio selection process. Therefore, Goldman reached a settlement of $550 million in July 2010 with SEC.

The other three transactions included the Hudson CDO in 2006, the Anderson CDO in 2007, and Timberwolf I hybrid CDO-squared transaction in 2007. In all these transactions, Goldman was blamed for making billions by selling poor quality assets to clients while short selling those securities.

Moreover, claims against individual defendants, such as the chief executive officer Lloyd Blankfein; the chief financial officer David Viniar and chief operating officer Gary Cohn, were also not dismissed by the federal judge.

The continuously increasing number of lawsuits is sure to dent Goldman’s reputation and its financials. However, investors, who have lost their hard-earned money in such investments, should feel relieved.

Among other banks, Citigroup Inc. ( C - Analyst Report ) , JPMorgan Chase & Co. ( JPM - Analyst Report ) , HSBC Holdings Plc ( HBC - Analyst Report ) and M&T Bank Corp. ( MTB - Analyst Report ) have also been legally accused for distorting documents related to mortgage-backed securities and other losses in 2011.

Goldman currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. Considering the fundamentals, we also maintain a long term ‘Neutral’ recommendation on the stock.