By Steve Eder and Steve Slater
NEW YORK/LONDON (Reuters) - Goldman Sachs Group Inc reported blow-out quarterly earnings on Tuesday, but investors appeared to focus on the U.S. fraud case against the bank as Britain's market watchdog launched its own probe.
Goldman's results, which failed to bolster its sagging shares, came four days after the U.S. Securities and Exchange Commission accused the dominant Wall Street bank of defrauding investors by concealing that a prominent hedge fund manager helped structure a debt product tied to subprime mortgages and was betting against it.
Anton Schutz, president of Mendon Capital, said the rash of negative headlines had muted Goldman's beat on earnings.
"You've probably got some long-term long-holders selling stock because they are afraid," Schutz said. "You have shorts pressing it because they think they can run with it. How much bad news keeps coming in terms of regulators and suits? It is hard to know where the end is."
Goldman said first-quarter net income nearly doubled to $3.29 billion, bolstered by strength in fixed income trading and principal investments. The earnings of $5.59 a share easily beat analysts' average forecast $4.01, according to Thomson Reuters I/B/E/S.
The bank reported its lowest-ever first-quarter compensation ratio, but it still set aside $5.5 billion for compensation and benefits in the period.
Goldman shares were down 1.3 percent at $161.13 in midday trading. The cost of insuring against potential default on the bank's bonds fell.
Goldman emerged as Wall Street's most influential bank after the financial crisis but has faced a backlash over its pay and business practices.
The bank's co-general counsel, Greg Palm, launched a rebuttal of the SEC charges during the bank's earnings conference call.
Palm said the firm was "very disappointed" that the SEC had brought charges and insisted that Goldman "would never mislead anyone."
He also said investors who lost money on the subprime mortgage product that is the focus of the SEC suit had a wealth of experience and background in such deals.
Palm faced questions about Goldman's failure to alert investors when it first received a so-called Wells Notice from the SEC regarding the agency's investigation. Palm insisted that Goldman would disclose any type of investigation or inquiry that it considered material.
"We do not disclose every Wells Notice we get because that would not make sense," he said.
He said the firm has had "no conversations whatsoever" with the U.S. Department of Justice about potential charges beyond the SEC's civil case.
'RECKLESSNESS AND GREED'
Goldman's forecast-beating earnings came as Britain's Financial Services Authority (FSA) said it had started a formal investigation into Goldman Sachs International in relation to the SEC allegations. FSA said it would work closely with its U.S. counterpart.
UK Business Secretary Peter Mandelson said on BBC Radio, "We have got to look at the whole system of constituting and regulating banks. We need a system of regulation, a system of levying banks, which is internationally applied."
Nick Clegg, leader of the Liberal Democrats, the UK's third-largest party, said the allegations against Goldman "are a reminder, if we needed one, of the recklessness and greed that disfigured the banking industry as a whole."
"We believe that Goldman Sachs should now be suspended in its role as one of the advisers to the government until these allegations are properly looked into."
The comment by Clegg, who is seen as a potential kingmaker in Britain's upcoming general election, highlighted an area of concern among some: that the fraud allegations could lead to client defections.
Goldman Chief Financial Officer David Viniar said Goldman was "distressed" by the wave of negative publicity and insisted that most customers remain loyal.
"We are out talking to our clients," he told analysts on the conference call. "You can see from our results last quarter that our clients still support us."
Some financial institutions are likely reviewing their dealings with Goldman during the financial crisis to see if they have any legal recourse. American International Group Inc took a loss of up to $2 billion last year as it ended credit default swaps it had written on some Goldman collateralized debt obligations.
On Friday, attorneys for Lehman Brothers Holdings Inc filed notices of subpoena for firms including Goldman, seeking access to documents and employees in an investigation of whether certain third parties interfered with and damaged Lehman's business.
Some firms may have issues hiring Goldman for advice, a financial institutions banker said. "You have to ask yourself what are they thinking: Are they thinking about whether they have got causes of action against Goldman and can they hire Goldman as an adviser on the one side while they may be seeking to recover on the other side?"
Palm, the co-general counsel, said German bank IKB, one of the main buyers of the synthetic CDO at issue in the SEC case, had reviewed the portfolio of mortgage bonds that comprised the product and suggested some changes, but fewer than did hedge fund manager John Paulson.
Goldman's alleged failure to disclose that Paulson helped design the CDO -- and bet against it -- is the main basis for the SEC case.
"If we had evidence that someone here was trying to mislead someone, we wouldn't condone that at all," Palm said.
IKB declined to comment on Palm's statements.
In what some observers viewed as an oblique dig at Goldman's troubles, Citigroup Inc Chief Executive Vikram Pandit said at the bank's annual shareholder meeting that "responsible finance" was the driving force behind the bank, which was bailed out more than any other major U.S. financial institution.
In the United States, political tensions were heightened by reports that the five SEC commissioners split along political lines last week in a vote on whether to file suit against Goldman. The three Democrats voted in favor of the legal action, while the two Republicans opposed it, according to press reports.
"I have my doubts about this attack on Goldman Sachs, for the simple reason that with two members of the SEC clearly against the indictment, it doesn't make (SEC Chairman) Mary Schapiro's job any easier," said David Buik, senior partner with BGC Partners in London.
(Reporting by Steve Eder in New York and Steve Slater in London; Writing by Christian Plumb; Additional reporting by Douwe Miedema and Jon Hopkins in London and Ed Taylor in Frankfurt; Editing by John Wallace)
