Goldman Sachs faces questions in Europe

European leaders react to a Goldman Sachs backlash

Published April 18, 2010 8:07PM (EDT)

Goldman Sachs is facing a potential backlash in Europe over the fraud case brought against it in the United States, with Britain's Prime Minister Gordon Brown calling for authorities there to investigate and accusing the investment bank of "moral bankruptcy."

Germany also said it would ask for detailed information about the case.

Both governments had to bail out banks that lost hundreds of millions of dollars on investments marketed by Goldman, according to the fraud suit brought by the U.S. Securities and Exchange Commission, in Britain's case Royal Bank of Scotland through its acquisition of parts of ABN Amro.

The SEC said the Royal Bank of Scotland paid Goldman $841 million to unwind ABN Amro transactions. Royal Bank of Scotland is now 84 percent owned by British taxpayers after being partly nationalized by the government.

Germany's IKB Deutsche Industriebank AG, an early victim of the credit crunch, lost nearly all its $150 million investment, the SEC said.

Brown on Sunday called for a full inquiry by Britain's Financial Services Authority in conjunction with the SEC. Britain would join Germany, where government officials said they would seek information about the bank's activities.

Brown, currently facing a tough re-election battle, seemed additionally angry at Goldman Sachs' plan to pay 3.5 billion pounds ($5.4 billion) in bonuses as reported in British newspapers.

"I am shocked at this moral bankruptcy," he said on BBC TV. "This is probably one of the worst cases that we have seen."

Brown called for a "new global constitution for the banking system" that would, among other things, ban bonus packages like the ones planned by Goldman Sachs.

The U.S. charges against Goldman Sachs relate to a complex investment tied to the performance of pools of risky mortgages. In a complaint filed Friday, the Securities and Exchange Commission alleged that Goldman marketed the package to investors without disclosing that the pools were picked by another client, a prominent hedge fund that wanted to bet the U.S. housing bubble would burst. Within months, most of the mortgages had been downgraded as the U.S. housing boom went into reverse and the securities fell sharply in value.

The company denies it did anything wrong, saying investor losses came from the deterioration of the whole sector, not regarding which securities were in the pool.

Goldman Sachs already is facing an EU investigation into a 2002 swap deal it carried out with Greece that may have helped hide the extent of the country's financial troubles.

Brown said strict reform of the banking sector is needed. He was responding to British Sunday press reports about the billions in bonus payments planned for Goldman employees worldwide.

"Everything I find out convinces me that we have got to go in deeper, and I believe that I am the man to deal with these problems of the banks and to challenge them about the way they behave in the future," said Brown, who faces a difficult challenge from both the Conservative Party and the Liberal Democrats in the May 6 election.

The Goldman Sachs case also may spur legal action in Germany. The Welt am Sonntag newspaper quoted Chancellor Angela Merkel's spokesman, UIrich Wilhelm, as saying that German regulator BaFin will ask the U.S. Securities and Exchange Commission for detailed information.

"After a careful evaluation of the documents, we will examine legal steps," he said, according to the report. The government later confirmed Wilhelm made the statement.

IKB issued a profit warning on July 30, 2007, saying that it had "felt the impact of the crisis in the U.S. subprime mortgage market" and that then-chief executive Stefan Ortseifen had resigned.

IKB's problems sprang from its Rhineland Funding investment vehicle's apparent inability to cover its funding needs because of exposure to U.S. subprime loans.

The lender's biggest shareholder at the time, Germany's state-owned KfW development bank, and the banking industry put together multibillion-euro (dollar) rescue packages for IKB. IKB was sold in 2008 to Dallas-based Lone Star Funds.

Ortseifen went on trial in Duesseldorf in March, charged with share price manipulation and four counts of breach of trust. He said that he carries "no guilt."

German prosecutors accuse Ortseifen of misleading markets over the extent of its exposure to the financial crisis. They said that, 10 days before the profit warning, he issued a statement in which the economic impact on IKB from the looming financial crisis was deliberately portrayed too positively.

Ortseifen maintains that the market for mortgage backed securities was still functioning at the time of his statement and denies manipulating share prices.

He said when his trial opened that, from today's point of view, the assessment of subprime market risk was a "collective misjudgment," but that on the basis of the financial world's knowledge at the time he gave correct information.

The trial is scheduled through the end of May.

By Gregory Katz

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By Geir Moulson

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