The civil fraud suit against Goldman is a "massive, a watershed event," said Sean Egan of Egan Jones. "It's directly addressing the fundamental problem in the market that has been at the root of the financial crisis. The SEC's actions have underscored the basic problem that has existed and continues to exist in the financial market whereby investors don't have sufficient information to make judgment independently. Something like this had to happen. There had to be some action that puts this fundamental market problem into focus, and this is the event."
"It took a lot of guts to take this action," Egan said of the SEC. "You are likely to see some significant changes in how business is done."
Shares of Goldman Sachs, which rebutted the SEC charges, fell 10 percent in trading Friday, touching off a triple-digit decline in the Dow Jones Industrial Average and a sell-off in financial stocks.
The SEC alleges that Goldman Sachs was peddling an investment that was secretly set up to fail.
Ultimately, investors in the deal lost more than $1 billion, the SEC said, while Paulson & Co. raked in a $1 billion profit from its short position. Goldman Sachs received $15 million for brokering the transaction. Within nine months of the transaction that created ABACUS 2007-AC1, 99 percent of the mortgages in the portfolio had been downgraded -- an almost perfect failure rate.
Some critics say that it's about time the SEC started looking at the fallout from the kinds of investments -- collateralized debt obligations, also known as CDOs -- that Goldman is facing heat over.
"I think they have been absent without leave," said Bill Bartmann, the president of investment advisory firm Bartmann Enterprises in Tulsa, Okla.
Bartmann and others fault the SEC for failing to regulate CDOs from the start.
"They should have put checks and balances in place to prevent the catastrophe that ultimately occurred," he said. "The SEC seemingly was asleep on the switch or looked the other way and sometimes you can't tell which one it is."
The SEC "charged that Goldman failed to make adequate disclosures on the role that Paulson & Co. played in selecting the portfolio," the SEC's enforcement director Robert Khuzami said on a conference call with reporters Friday. Paulson & Co. wasn't charged because the hedge fund did not make representations to investors, the SEC said.
Friday afternoon, Paulson & Co. issued a statement, saying that "we were not involved in the marketing of any ABACUS products to any third parties. ... Paulson did not sponsor or initiate Goldman's ABACUS program, which involved at least 20 transactions other than that described in the SEC's complaint.
For its part, Goldman Sachs adamantly rebutted the SEC charges.
"The SEC's charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation," the company said in a statement.
Goldman Sachs said that it too, lost money on the deal -- more than $90 million.
"The transaction was not created as a way for Goldman Sachs to short the subprime market. To the contrary, Goldman Sachs's substantial long position in the transaction lost money for the firm," the company said Friday in a statement.