The Securities and Exchange Commission (SEC) today charged Goldman Sachs (GS: 111.77 +2.96%) and one of its vice presidents for allegedly defrauding investors by misstating and omitting key facts about a financial product tied to subprime mortgages, demanding a jury trial for the allegations to be heard.

According to a compliant filed in US District Court for the Southern District of New York Friday (download here), the SEC alleges Goldman and Fabrice Tourre made materially misleading statements and omissions in connection with a synthetic collateralized debt obligation (CDO) that Goldman structured and marketed to investors. All told, the investors are said to have lost more than $1bn, the claim states.

That CDO, ABACUS 2007-AC1, was tied to the performance of subprime residential mortgage-backed securities (RMBS) and according to the SEC, Goldman failed to disclose to investors the role that a major hedge fund played in the portfolio selection process and the fact that the hedge fund had taken a short position against the CDO.

“The product was new and complex but the deception and conflicts are old and simple,” said Robert Khuzami, director of the SEC division of enforcement. “Goldman wrongly permitted a client that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio, while telling other investors that the securities were selected by an independent, objective third party.”

Goldman Sachs did not immediately return HousingWire’s request for comment, but earlier this month, in its 2009 annual report, Goldman CEO Lloyd Blankfein denied allegations that Goldman made billions betting against subprime RMBS and its clients.

According to the allegations Paulson & Co., a hedge fund with $32bn under management across merger, event and credit strategies, paid Goldman Sachs $15m to structure a transaction for Paulson to take short positions against MBS it chose, believing the securities would experience credit events.

The SEC alleges Goldman marketed the RMBS that comprised the CDO as being selected by ACA Management, a third party with expertise in analyzing credit risk in RMBS, but failed to disclose the Paulson arrangement in those marketing materials. Goldman did not disclose Paulson's short position or its role in the collateral selection process in the term sheet, flip book, offering memorandum, or other marketing materials provided to investors, the SEC said. As a result, unbeknownst to investors, the selection of the RMBS for the CDO was impacted by the fact that Paulson would stand to profit if the underlying RMBS defaulted, the SEC claims.

The Paulson deal closed on April 26, 2007 and by Oct. 24, 2007, 83% of the RMBS in the ABACUS portfolio had been downgraded and 17% were on negative watch. By Jan. 29, 2008, the SEC said, 99% of the portfolio had been downgraded.

The SEC's complaint alleges that after participating in the portfolio selection, Paulson & Co. effectively shorted the RMBS portfolio it helped select by entering into credit default swaps (CDS) with Goldman to buy protection on specific layers of the ABACUS capital structure.

According to the complaint, the SEC claims Tourre was principally responsible for the CDO in question, structuring the transaction, prepared the marketing materials, and communicated directly with investors. He also knew about Paulson’s undisclosed short interests and role in the collateral selection process, the SEC alleges.

In addition, Tourre allegedly misled ACA into believing that Paulson invested approximately $200m in the equity of ABACUS, indicating that Paulson interests in the collateral selection process were closely aligned with ACA's interests, the SEC said, but in reality, their interests were sharply conflicting.

Write to Austin Kilgore.

The author held no relevant investments.

The Office of Thrift Supervision (OTS), the primary regulator of failed Washington Mutual, “wrung its hands” as the bank took on riskier and riskier mortgage lending practices but failed to stop the toxic and sometimes fraudulent mortgages that ultimately collapsed the bank, according to Sen. Carl Levin (D-Mich.).

The Senate Permanent Subcommittee on Investigations is grilling current and former regulators today over the bank’s subprime lending and securitization practices.

Levin, who chairs the Subcommittee, noted "feeble oversight by regulators" that reported less than satisfactory underwriting and potentially fraudulent practices and did not take enforcement actions.

“Washington Mutual’s collapse is a tale of greed and mismanagement, but it is also a case history of ineffective bank regulators who saw years of unsafe and unsound banking practices, but failed to stop them,” Levin said in opening statements. “Instead of stopping the abuses they saw, OTS regulators stood idly by while WaMu executives loaded up on risk and churned out billions of dollars in toxic mortgages that poisoned not only the bank, but also our financial system.”

He said OTS regional officials obstructed efforts by the agency's own staff to rein in WaMu, while OTS impeded efforts by the Federal Deposit Insurance Corp. (FDIC) to bring enforcement actions and protect the Deposit Insurance Fund (DIF).

US Treasury Department inspector general Eric Thorson told the Subcommittee OTS enforcement actions against WaMu were limited and late.

"WaMu failed because its management pursued a high-risk business strategy without adequately underwriting its loans or controlling its risks," he said in prepared statements.

Despite the high risk and lax underwriting standards at the bank, OTS relied on WaMu management to track progress in resolving identified weaknesses, he said. Thorson noted that OTS did not take any type of enforcement action against WaMu until 2008 — after the thrift began sustaining significant losses.

FDIC inspector general Jon Rymer, also testifying today, said said the FDIC wanted to resolve the issues forming at the bank as quickly as possible, to minimize the risk to the DIF. He noted the FDIC's challenge of WaMu's strength ratings set by OTS was met with resistance.

Additionally, he said the FDIC elected not to invoke its own enforcement authority against WaMu in 2008 because of procedural road blocks — for instance, the FDIC would have to request the permission of a panel that included an OTS representative.

"We … believe that it may not be in the best interest of FDIC to place too much reliance on the ability of the primary regulator to assess risk to the DIF," he said in prepared remarks. "Ultimately, the DIF, which is backed by the full faith and credit of the United States, and thus the American taxpayer, is responsible for absorbing an institution’s failure, not the primary regulator."

Write to Diana Golobay.

Bank of America (BAC: 7.29 -0.14%) today reported Q110 net income of $3.2bn, compared with a net loss of $194m in the Q409 and net income of $4.2bn in the year-ago quarter.

The positive quarterly results from BofA — as well as JP Morgan Chase (JPM: 37.21 -0.75%) — arrive amid ongoing loan losses as mortgage default and modification leads to write-downs.

Provision for credit losses fell to $9.8bn in Q110, down by $3.6bn from the year-ago period, reflecting an improvement in credit quality. But net charge-offs rose to $10.8bn, from $8.4bn in the previous quarter, and $6.9bn in the year-ago quarter.

"With each day that passes, the 2010 story appears to be one of continuing credit recovery, and our results reflect a gradually improving economy," said CEO and president Brian Moynihan, in a press release.

BofA extended $150bn in credit during the quarter, including $69.5bn in first mortgages and $10bn in commercial real estate loans. Funding for mortgages included $17.4bn in funding for nearly 115,000 low- and moderate-income borrowers. Approximately 37% of first mortgages were for home purchases.

The volume of nonperforming loans, leases and foreclosed properties rose to $35.9bn, from $35.7bn in the previous quarter and from $25.6bn in the year-ago quarter.

BofA expanded its default management staff by nearly 7% to more than 16,000 during the quarter to help customers experiencing difficulty with their home loans.

During the quarter, BofA completed 77,000 loan modifications with total unpaid principal balances of $17.8bn, including 33,000 customers who converted from trial-period to permanent modifications under the government's Making Home Affordable Program (HAMP).

BofA’s results arrive after JP Morgan Chase reported Q110 net income of $3.3bn, despite a $1.2bn reserve increase for credit costs associated with Washington Mutual credit-impaired portfolios.

"The firm's net income of $3.3bn reflected another strong quarter for the Investment Bank, particularly in fixed income markets, and continued solid performance across asset management, commercial banking and retail banking,” said CEO Jamie Dimon in a press statement. “Unfortunately, these good results were partially offset by high losses in the consumer credit portfolios."

Home equity net charge-offs were $1.1bn in the quarter, unchanged from the previous-year quarter. Subprime mortgage net charge-offs were $457m, increased from $364m last year. Prime mortgage net charge-offs totaled $459m, compared with $312m in the previous-year period.

Write to Diana Golobay.

Disclosure: the author holds no relevant investment positions.