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Paulson & Co applied for dismissal of a lawsuit made by ACA Financial Guaranty related to Abacus – a collateralized debt obligation (CDO). The plaintiffs accused the company of joining banking major The Goldman Sachs Group, Inc. (GS - Analyst Report) to obtain guaranteed payments from bond insurers on risky investments.
In 2011, ACA Financial filed a $120 million lawsuit against Goldman and later in January, added Paulson & Co along with its hedge fund unit – Paulson Credit Opportunities Master II Ltd as the accused. The modified lawsuit claimed that Goldman and Paulson tricked ACA Financial into believing that Paulson was investing in the CDO. However, Paulson had taken a short position on it.
However, in a filing with a N.Y.–based court, Paulson declared that it did not mislead ACA Financial regarding Abacus. The company assured that it had nothing to do with how Goldman compensated its risk or how Abacus was sold to investors. Further, Paulson maintained that Abacus, being a synthetic CDO, ought to have a long and a short position and it made a credit default swap agreement with Goldman to take a short position on the latter.
Moreover, Paulson maintained that ACA Financial’s lawsuit was mainly dependent on mischaracterizations, mails unassociated with Abacus and scraps of communication, which were out of perspective.
The Abacus CDO has haunted Goldman and had entangled the banking major in a legal mess right from the onset. 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 subprime 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. Consequently, Goldman reached a settlement of $550 million in Jul 2010 with the 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 not dismissed by the federal judge.
Later in Jul 2012, the federal judge in New York revoked the bid filed by Goldman 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).
The continuously increasing number of run-ins with financial authorities could shatter Goldman’s reputation and its financials. Further, such issues are likely to add to the legal expenses of the company. 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) 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 carries a Zacks Rank #3 (Hold).