Goldman Sachs Group Inc was charged with fraud by the US Securities and Exchange Commission over its marketing of a subprime mortgage product designed to fail.
The civil lawsuit is the biggest crisis in years for Goldman, which emerged from the global financial meltdown as Wall Street's most influential bank.
It is also a huge test for chief executive Lloyd Blankfein, who has faced a firestorm of criticism over the bank's pay and business practices, and it comes as lawmakers in Washington debate sweeping reform of financial industry regulation.
The case has also ensnared John Paulson, a hedge fund investor whose firm Paulson & Co made billions of dollars by betting the nation's housing market would crash. This included an estimated $1 billion from the transaction detailed in the SEC lawsuit, which the agency said cost other investors more than $1 billion.
Fabrice Tourre, a Goldman vice president who the SEC said was mainly responsible for creating the questionable mortgage product, known as ABACUS, was also charged with fraud. Goldman vowed to defend itself.
"The SEC's charges are completely unfounded in law and fact," it said. "We will vigorously contest them and defend the firm and its reputation." In its lawsuit, the SEC alleged that Goldman structured and marketed ABACUS, a synthetic collateralized debt obligation that hinged on the performance of subprime residential mortgage-backed securities.
It alleged that Goldman did not tell investors "vital information" about ABACUS, including that Paulson & Co was involved in choosing which securities would be part of the portfolio.
It also alleged that Paulson took a short position against the CDO in a bet that its value would fall.
Shares of Goldman fell as much as 15.6 per cent, and dragged broad U.S. stock indexes lower.
"These charges are far more severe than anyone had imagined," and suggest Goldman teamed with "the leading short-seller in the industry to design a portfolio of securities that would crash," said John Coffee, a securities law professor at Columbia Law School in New York.
Reuters