More than a year after Wall Street banks triggered the world's biggest financial crisis, the US government has finally cracked the whip by suing Goldman Sachs, a 139-year old institution for mortgage securities fraud.

Goldman Sachs, in which the Oracle of Omaha, Warren Buffet had had invested $5 billion in September 2008 to restore its shattered confidence during the peak of the global financial crisis, (See: Warren Buffett invests $5 billion in Goldman Sachs)  has been sued by the US Securities and Exchange Commission (SEC) for defrauding investors to the tune of $1 billion in subprime-related financial products.

The SEC alleges that Goldman Sachs created and marketed a synthetic collateralised debt obligation (CDO) called 'Abacus' that hinged on the performance of subprime residential mortgage-backed securities (RMBS).

The 22-page civil suit filed by the SEC filed in a New York Court against Goldman Sachs and one of its employees Fabrice Tourre, the SEC accuses the firm of not disclosing to investors vital information about the CDO, in particular the role played by one of the world's largest hedge funds, Paulson & Co, in the portfolio selection process, where it had taken a short position against the CDO.

Although Paulson has not been named as a defendant in the suit, the SEC alleges that Paulson paid Goldman $15 million to create junk subprime residential mortgage-backed securities (RMBS) to enable it to take short positions against the RMBS.

Goldman, in turn then duped ACA Management (ACA), a third party with expertise in analysing credit risk, into saying that the RMBS were creditworthy so that Golman could offload them on to unsuspecting clients.

The SEC alleges that Goldman Sachs' vice president, Fabrice Tourre, was principally responsible for Abacus since he structured the transaction, prepared the marketing materials, and communicated directly with investors.

Tourre allegedly knew of Paulson's undisclosed short interest and role in the collateral selection process. In addition, he misled ACA into believing that Paulson invested approximately $200 million in the equity of Abacus, indicating that Paulson's interests in the collateral selection process were closely aligned with ACA's interests.

In reality, however, the SEC alleges that their interests were sharply conflicting.

"The product was new and complex but the deception and conflicts are old and simple," said Robert Khuzami, director of the 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."

By 24 October 2007, 83 per cent of the RMBS in the Abacus portfolio had been downgraded and 17 per cent were on negative watch and by 29 January 2008, 99 per cent of the portfolio had been downgraded.

In this highly deceptive financial game Paulson gained $1 billion, at the cost of investors.

These supbrime mortgage backed securities is what triggered the worst global financial crisis and Goldman Sachs is not the only Wall Street institution involved in this greedy and messy game.

Other banks like Merrill Lynch are already facing a similar fraud suit filed by Rabobank for structuring a $1.5 billion collateralised debt obligation, known as Norma CDO Ltd.

Goldman said yesterday that it did not tell ACA that Paulson was going to be a long investor in the Abacus.

In a statement put out by Goldman Sachs late yesterday, the investment bank said, "The SEC's complaint accuses the firm of fraud because it didn't disclose to one party of the transaction who was on the other side of that transaction. As normal business practice, market makers do not disclose the identities of a buyer to a seller and vice versa."

But Goldman Sachs was silent on the SEC's other main allegation, that it did not tell investors that Paulson was going to take short positions against the RMBS.

To clear its image, Goldman Sachs said that although it was paid $15 million by Paulson, it lost $90 million of its own money on the RMBS, but did not clarify as to exactly how and why it lost the money.

As far as the SEC is concerned, this is by far the most aggressive move made by it after it was heavily criticised for being a silent spectator prior to the financial crisis. Incidentally, the SEC had also failed to detect Bernard Madoff's $50-billion fraud (See: SEC to investigate in-house flaws to nail Madoff)

The change obviously has come after the US President removed the then chairman of SEC, Christopher Cox and replaced him with Mary Schapiro, a Wall Street veteran of 20 years with a reputation for tenacity, who had said at the time of her appointment that she would be more aggressive in policing the financial industry and advocating the agency's interests.