Goldman sued by hedge fund over notorious CDO deal

NEW YORK (Reuters) - An Australian hedge fund is suing Goldman Sachs Group Inc over an investment in a subprime mortgage-linked security that hastened the fund's demise in 2007, a lawyer for the fund said.

The lawyer, Eric Lewis, said Basis Yield Alpha Fund is suing Goldman to recoup the $56 million it lost on the now notorious Timberwolf collateralized debt obligation, which garnered a lot of attention during a recent congressional hearing.

The lawsuit, being filed on Wednesday in U.S. District Court for the Southern District of New York, also seeks $1 billion in punitive damages.

The hedge fund decided to file the suit after months of settlement talks with Goldman broke down. Reuters first reported on the likelihood of a lawsuit being filed on Tuesday.

The 36-page complaint, a copy of which was provided to Reuters, opens with a rhetorical flourish that repeats a Goldman executive's description of the Timberwolf CDO as "one s**tty deal."

The suit alleges that Goldman pitched the Timberwolf deal to Basis even as the bank's sales force and mortgage traders knew the market for CDOs could soon crumble. In June 2007, Basis paid $78 million for two pieces of the CDO with a face value of $100 million.

Basis, which financed the transaction with a loan from Goldman, said it lost more than $50 million when the bank began making margin calls on the product just weeks after selling the deal. Basis said the margin calls quickly forced it into insolvency.

"You can't say you are basically selling a strong performing high-yielding security that you know is going to tank," said Lewis, a partner with the law firm Baach Robinson & Lewis.

"MISGUIDED ATTEMPT"

Goldman called the suit "a misguided attempt by Basis ... to shift its investment losses to Goldman Sachs."

Michael DuVally, a Goldman spokesman, said, "Basis is now trying to recoup its losses based on false allegations that it was misled about aspects of the transaction and market conditions."

The $1 billion Timberwolf CDO and the aggressive tactics Goldman employed to sell the deal were a focal point of an April hearing by the Senate Permanent Subcommittee on Investigations. One of the documents unearthed by the panel was an email in which former Goldman mortgage executive Thomas Montag called Timberwolf "one shitty deal," just days after the firm completed the sale to Basis.

The hedge fund's lawsuit draws on other documents introduced by the Senate panel and is the latest in a string of legal and public relations headaches for Goldman. The U.S. Securities and Exchange Commission in April charged the bank with civil fraud in connection with the structuring and sale of another CDO called Abacus 2007.

The Basis lawsuit alleges that Goldman misrepresent the value of the Timberwolf securities and did not disclose that the Goldman trading desk had a role in working with Greywolf Capital Management in picking Timberwolf's underlying securities.

GOLDMAN COORDINATION

During the Senate subcommittee hearing in April, Goldman Chief Executive Lloyd Blankfein said the bank's employees are often unaware of what strategies are being employed elsewhere at the firm.

"We have 35,000 people and thousands of traders making markets throughout our firm," Blankfein said in response to a question from Senator Carl Levin. "They might have an idea. But they might not have an idea."

But the Basis lawsuit raises new questions about the coordination between Goldman's trading desks and its sales staff.

David Lehman, who joined Goldman in 2004 and worked as a managing director in Goldman's mortgage trading operation, met with representatives of Basis to convince them that the prices Goldman was selling the Timberwolf deal at were fair and legitimate.

The lawsuit alleges that Goldman's sales and trading desks worked together to sell the deal, which Goldman was taking a shorting position on.

"This is not a bad case for dealing with the whole issue of how Goldman was conducting its business," said Lewis. "They were selling bonds like they were used cars, in that you say what you need to get it done."

(Reporting by Steve Eder and Matthew Goldstein; editing by John Wallace)