Goldman fraud-claim case will test Supreme Court shaped by Trump

The U.S. Securities and Exchange Commission sent Goldman Sachs Group Inc. shares tumbling by 13% in a single day in 2010, when it accused the firm of defrauding customers by selling them a mortgage-backed investment that was secretly designed to fail.

Eleven years later, shareholders who lost money that April day are before the U.S. Supreme Court in a case that could deal an even more sweeping blow to investors. In an argument set for Monday, Goldman Sachs will urge the court to put new limits on class-action shareholder suits, and toss out a case that seeks to recoup potentially billions of dollars.

Investor advocates say they're nervous ahead of the first Supreme Court clash over shareholder lawsuits since former President Donald Trump appointed three justices and created a 6-3 conservative majority. The court is scheduled to rule by late June.

"I am very concerned, and very concerned where this particular court might come out," said Lynn Turner, a former SEC chief accountant.

The investors, led by the $19.5 billion Arkansas Teacher Retirement System, say they were deceived by Goldman Sachs' repeated public assurances that it was being vigilant about avoiding conflicts of interests. They say the assurances proved to be false, as details emerged about a group of so-called collateralized debt obligations, known as CDOs, including the Abacus portfolio that was at the center of the SEC suit.

The SEC said in its lawsuit that Goldman Sachs created and sold Abacus without disclosing that the hedge fund Paulson & Co. helped pick the underlying securities and bet against the vehicle.

Later that year, Goldman paid $550 million to settle with the SEC, a record amount for a Wall Street firm. Though Goldman didn't admit wrongdoing, the firm said it made a "mistake" in not disclosing the Paulson & Co. role, an unusual acknowledgment in an SEC case.

Wall Street's peddling of CDOs remains a touchstone of the global financial crisis, evidence to many that clients' interests came second to the massive profits bankers were making for themselves. Much of the 2008 economic collapse was fueled by losses suffered by banks and hedge funds that owned the complex securities. Ultimately, the U.S. government was forced to provide a $700 billion taxpayer-financed bailout for the financial industry.

Investigations by the SEC, Congress and the Department of Justice quickly followed, causing a drop in the share prices of Goldman Sachs and other banks at the time.

Goldman was featured in a scathing report on CDOs by a Senate panel, and former CEO Lloyd Blankfein was among several employees hauled up to Capitol Hill to testify. At a 2010 hearing, the panel's now-retired chairman, Michigan Democrat Carl Levin, blasted the executives over an internal email that labeled one of the securities Goldman was selling as "one sh**ty deal."

"Your people think it's a piece of crap and go out and sell it," Mr. Levin said at the hearing. "We're talking about betting against the very thing that you're selling, without disclosing that to your client."

The Supreme Court case centers on the rules the court has crafted to determine whether shareholders have enough in common with one another to press a securities-fraud suit as a class action.

In 1988, the top court said judges can presume that investors all relied on any public misrepresentations when they bought shares. But that ruling also said defendants can rebut that presumption — and block certification of the class action — by showing that the statements had no impact on the share prices.

Goldman Sachs says its assurances about conflicts were so "generic" they couldn't possibly have been responsible for propping up the stock price. The statements included promises in regulatory filings that the firm had "extensive procedures and controls that are designed to identify and address conflicts of interest" and that "our clients' interests always come first."

The "extreme generality of the alleged misstatements makes it exceedingly unlikely that the statements had any impact on the stock price," Goldman told the Supreme Court in court papers.

But a divided federal appeals court said the bank had to wait to make that argument and couldn't use it as a reason to block class-action status. A two-judge majority said Goldman was improperly "smuggling" an argument about the materiality of its statements into the class-action analysis.

The suing investors have partial support from President Joe Biden's administration and the SEC. The government says the appeals court should have considered Goldman's contention that its assurances were too generic to prop up the share price. But the U.S. also says Goldman and its allies are going too far in seeking a categorical rule that some types of statements are legally incapable of affecting stocks.

"Courts considering particular facts may appropriately credit evidence that seemingly generic statements would have been significant to the trading decisions of reasonable investors," acting U.S. Solicitor General Elizabeth Prelogar said in court papers.

Investor advocates say a ruling in Goldman Sachs' favor could leave companies free to mislead investors with impunity.

"It runs to whether or not when you're investing your money into the markets, you can trust them, you can have confidence that they're giving you accurate, complete information, and they're not omitting any facts," said Ms. Turner, the former SEC accountant. "All too often, we've seen where management has put out false facts to hype their stock."

University of Michigan law professor Adam Pritchard, a former SEC official who joined a brief supporting Goldman, called the shareholder activists' concerns "nonsense," and said the court is likely at most to take a middle ground in its decision. Part of the problem, he said, is that the case focuses on "trivial, procedural questions" that the justices, with little expertise in securities law, won't fully comprehend.

"They will not do anything useful," said Mr. Pritchard, who's recently written a book on the Supreme Court and securities law. "They are in over their heads."

The case is Goldman Sachs v. Arkansas Teacher Retirement System, 20-222.