Goldman Sachs Group Inc. lost its bid to dismiss a lawsuit accusing it of defrauding investors by selling risky debt linked to subprime mortgages that it planned to bet against.
The decision by U.S. District Judge Victor Marrero in New York keeps alive a hedge fund's claims over a $2 billion offering of collateralized debt obligations, amid intense scrutiny over Goldman's activities before and after the 2008 financial crisis.
Marrero said the hedge fund Dodona I LLC may pursue nearly all its claims against Goldman, including that the Wall Street bank recklessly or intentionally sold the Hudson Mezzanine Funding CDOs to offload subprime risk on unsuspecting investors.
"Goldman's sudden -- and prescient -- shift to reducing subprime risk supports the inference that it possessed some unique insight" about the "bittersweet potion" of CDOs it was selling, Marrero wrote in a 64-page decision.
A Goldman spokesman, Michael DuVally, declined to comment. Richard Klapper, a lawyer for the bank and co-defendants Peter Ostrem and Derryl Herrick, who were Goldman structured finance executives, did not immediately return a call seeking comment.
Lawrence Lederer, a lawyer representing Dodona, called Marrero's decision "extremely well-reasoned, measured, and very substantially supported. We are eager to ultimately try the case on behalf of our client and other investors in the Hudson CDOs."
SCRUTINY FROM WASHINGTON
The decision was issued one week after Goldman faced a public assault from former banker Greg Smith, who in a New York Times op-ed piece called the bank a "toxic" place that put its own interests ahead of those of its clients.
Goldman's CDO practices have drawn regulatory scrutiny. In April 2010, Goldman agreed to pay $550 million to settle U.S. Securities and Exchange Commission charges that it sold the risky Abacus 2007-AC1 CDO while letting hedge fund billionaire John Paulson bet against it. The bank did not admit wrongdoing.
Last April, the U.S. Senate Permanent Subcommittee on Investigations concluded that Goldman tried to profit at clients' expense ahead of the 2008 financial crisis by shedding exposure to subprime mortgages, including by selling the Hudson securities, and then shorting that market.
"RUBE GOLDBERG-LIKE" SECURITIES
Dodona was formed in 2007 by Alan Brody, who also created the firm Epirus Capital Management LLC.
It accused Goldman of creating the Hudson Mezzanine Funding 2006-1 and 2006-2 CDOs, which were backed by residential mortgage-backed securities, in late 2006 as part of a secret scheme to offload subprime risk.
The hedge fund said it lost nearly all of its $4 million investment, selling its holdings for 2.5 cents on the dollar in October 2007 after having paid 95 cents or 100 cents on the dollar the previous winter.
Marrero dismissed one claim by Dedona that accused Goldman of market manipulation.
But the judge said even "large sophisticated" investors such as Dodona might not have understood Goldman's CDOs, and that the bank's boilerplate disclosures on their "speculative" nature might be inadequate.
Goldman "created the synthetic CDOs here in dispute, a form of investment instrument that, Rube Goldberg-like, few but a select group of its own designers, engineers and lawyers could clearly explain, let alone understand, precisely how it functions or exactly what it does," the judge wrote.
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