Goldman accused of fraud over subprime conflicts of interest

• Goldman Sachs headquarters in New York

Officials from the Securities and Exchange Commission announced civil fraud charges against the company and one of its vice-presidents. It alleges Goldman failed to disclose that one of its clients helped create – and then bet against – subprime mortgage securities that Goldman sold to investors.

Investors in the mortgage securities are alleged to have lost more than $1 billion (650 million), the SEC said.

The agency is seeking to recoup profits reaped on the deal.

The Goldman client implicated in the fraud is one of the world's largest hedge funds, Paulson, which paid Goldman roughly $15m for structuring the deals in 2007.

Shares in Goldman Sachs, which employs about 5,500 people in the UK, fell more than 12 per cent after the SEC announcement, which also caused shares of other financial companies to sink.

The civil lawsuit filed by the SEC in federal court in Manhattan is the government's most significant legal action related to the mortgage meltdown that ignited the financial crisis and helped plunge the country into recession.

Officials also charged a Goldman vice-president, Fabrice Tourre, 31, who they said was principally responsible for devising the deal and marketing the securities.

The SEC is seeking unspecified fines and restitution from Goldman Sachs and Tourre.

Goldman told investors that a third party, ACA Management, had selected the underlying mortgages in the investment. But the SEC alleges Goldman misled investors by failing to disclose that Paulson also played a role in selecting the mortgages and stood to profit from their decline in value.

SEC enforcement director Robert Khuzami said: "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."

News of the fraud charge sent London's FTSE 100 index plunging into the red yesterday. The index closed down 1.4 per cent, having been down 1.7 per cent at one stage.

The civil fraud charge caught markets by surprise on both sides of the Atlantic as investors feared further fallout from the investigation. Benchmark US index the Dow Jones Industrial Average fell more than 1 per cent.

Joshua Raymond, market strategist at City Index, said: "This news creates uncertainty in the market in terms of whether there are likely to be any other major banks involved or under investigation.

"Moreover, we don't know what the consequences of this charge will be for Goldman Sachs."

He added: "Whenever there is uncertainty, investors tend to run for the hills and with there likely to be more news on this over the weekend when the markets are shut, investors have sought to move out of their riskier holdings by selling the banks and the miners into the European close."

UK banks had been ahead for most of the session, but suffered sharp declines after the Goldman announcement. Barclays fell 3 per cent, HSBC dropped 2 per cent and part-nationalised Lloyds Banking Group slipped 1 per cent.

The only British bank to stay out of the red was taxpayer-backed Royal Bank of Scotland as it clung on to gains thanks to cheery comments earlier in the session from broker Morgan Stanley.

The wider market closed 81.1 points down at 5,744, mirroring falls across stock markets globally.

In Europe, France's Cac 40 suffered a 1.9 per cent decline and the Dax in Germany was 1.8 per cent in the red.

Goldman's fraud charges come as the US bank earnings season gets into full swing, with Goldman itself due to report first-quarter figures next week.

Founded in 1869, the company has its headquarters in New York and has offices in London, Frankfurt, Tokyo, Hong Kong and other major financial centres around the world.