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Goldman Settles Mortgage Suit with Australian Hedge Fund

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The Goldman Sachs Group, Inc. GS recently settled a $1 billion lawsuit concerning the sale of mortgage-linked securities with an Australian hedge fund. The case, related to the sale of the company’s collateralized debt obligations (CDOs) also known as Timberwolf and Point Pleasant, was filed by the Australian hedge fund Basis Capital Funds Management Ltd. in New York State Supreme Court.

CDOs typically repackage bonds and other assets into new securities. These are not traded on 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 dimmed hopes for the investment bankers, resulting in huge losses for the common investors.

However, terms of the agreement were undisclosed in the Jun 10 court filing in a state court in Manhattan.

Goldman’s spokesman Michael Duvally refrained from commenting on the matter while Bruce Grace, a lawyer for Basis Yield Alpha Fund, was not available for comments.

Background

Basis Yield Alpha Fund (Master) (BYAFM), the Australian hedge-fund, filed a securities fraud lawsuit against Goldman accusing the latter of deceptively selling the financial instrument -- Timberwolf collateralized debt obligation (CDO). It accused Goldman of selling the sub-prime mortgage-linked security that gradually failed and also misrepresented the value of the instrument by providing materially misleading statements.

Basis Capital Funds Management has claimed $67 million to compensate for the losses incurred. Moreover, it seeks an additional $1 billion for punitive damages. Goldman, in a vain attempt to defend itself, tried to relate the collapse of the housing market as the cause of the incurred loss.

The case was dismissed by a federal judge in 2010 but the fund sued Goldman in a state court. Moreover, the bank faced denial by the judge for dismissing the case in Oct 2012, a ruling which was defended by an appeals court in Jan 2014.

Conclusion

The overall crisis as well as housing market turmoil no doubt resulted in huge losses for the investors. However, the actual cause stemmed from the unfair practices of the Wall Street biggies in the pre-crisis period to maximize their profits. Therefore, Goldman’s securities, like many others’, did not fail because of an unstable market. Instead, it contributed to the economic turbulence.

After the financial crisis, Wall Street banks’ reputations have been badly bruised. Further, current litigations on civil frauds have augmented the risk on the financials as well. Nevertheless, fundamentally, Goldman is poised to grow significantly with its well-diversified business model and a more favorable operating environment. In all, we think Goldman’s strong capital and liquidity will lead to increased profitability from newer opportunities, once the economy starts recovering.

Currently, Goldman carries a Zacks Rank #3 (Hold). Apart from Goldman, other major U.S. banks that continue to face legal disputes related to the sale of risky mortgage-linked securities include Morgan Stanley MS, JPMorgan Chase & Co. JPM and Bank of America Corp. (BAC - Free Report) .

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