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Goldman Sachs Must Face Fraud Claims in Timberwolf Lawsuit

JAN 30, 2014 4:43pm ET

Goldman Sachs Group Inc. must face fraud claims in a lawsuit filed by the Australian hedge fund Basis Capital Funds Management Ltd. over the sale of collateralized debt obligations, an appeals court ruled.

An appellate court in Manhattan upheld state Supreme Court Justice Shirley Werner Kornreich’s October 2012 denial of Goldman Sachs’s motion to dismiss the fraud claims, while modifying it to throw out claims of negligent misrepresentation, unjust enrichment and rescission.

Basis Capital’s Basis Yield Alpha Fund accused New York- based Goldman Sachs of making false and misleading statements on the sale of the securities, known as Timberwolf and Point Pleasant. It seeks to recover more than $67 million it said it lost in the deal and $1 billion in punitive damages.

Goldman Sachs in 2010 reached a $550 million settlement with the U.S. Securities and Exchange Commission to resolve claims over the marketing of collateralized debt obligations. The penalty is the largest ever levied by the SEC against a Wall Street firm, according to John Nester, an SEC spokesman.

The appeals court said disclaimers and disclosures made in offering circulars for the securities “fall well short” of tracking the misrepresentations and omissions that Basis Yield alleges were made.

The disclosures “simply provide boilerplate statements regarding the speculative and risky nature of investing in mortgage-backed CDOs and the possibility of market turns,” Judge Dianne T. Renwick wrote.

“If plaintiff’s allegations are accepted as true, there is a ‘vast gap’ between the speculative picture Goldman presented to investors and the events Goldman knew had already occurred,” the judge wrote.

Basis Yield Alpha Fund first sued Goldman Sachs over the securities in June 2010 in federal court in Manhattan. U.S. District Judge Barbara Jones threw out that suit, ruling the Australian fund couldn’t use U.S. securities laws to pursue the claims. Basis Capital filed another case in New York State Supreme Court in October 2011.

The suit relates to Point Pleasant, a collateralized debt obligation based on subprime residential home mortgages, and two credit default swaps that referenced securities from a similar CDO known as Timberwolf, Basis Capital said in the lawsuit.

Basis Capital accused Goldman Sachs of marketing new CDO investments in early 2007, after the company had determined that the value of securities in that market “would likely go into sharp decline in the near future,” and used the new CDOs as a vehicle to short the market, the lawsuit says.