By Karen Freifeld
NEW YORK (Reuters) - A New York state appeals court on Thursday refused to dismiss a $1.07 billion lawsuit accusing Goldman Sachs Group Inc of selling securities as the financial crisis began that it expected to lose value.
The lawsuit, brought by Australian hedge fund Basis Yield Alpha Fund, says Goldman made misleading statements and omissions about collateralized debt obligations known as Timberlake and Point Pleasant. It claims Goldman sold the securities as a way to offload subprime mortgages it knew were toxic and also sought to profit by shorting the securities.
In its ruling, a five-judge appeals panel said a lower court rightly declined to dismiss the fraud claims, rejecting Goldman's view that they should be thrown out because of disclosures and risk disclaimers in its offering circulars.
If the fund's allegations are true, "there is a 'vast gap' between the speculative picture Goldman presented to investors and the events Goldman knew had already occurred," Justice Dianne Renwick wrote in the decision on behalf of four judges on the court. A fifth judge concurred with different reasoning.
The court dismissed negligent misrepresentation, unjust enrichment and rescission claims against Goldman. But it also refused to order the case into arbitration, as the bank had sought.
"This is an excellent decision affirming that sellers of securities have to speak honestly and cannot use the fine print to avoid responsibility," said Eric Lewis, a lawyer who represents Basis Yield. "Goldman knew they had fixed the race. The securities were designed to fail."
Goldman has said the losses were caused by the collapse of the housing market, not misrepresentations.
"We are confident that we will ultimately prevail on the remaining claim by Basis, which was one of the world's most sophisticated investors in mortgage products," said Goldman spokesman Michael DuVally.
Basis Yield Alpha Fund brought the lawsuit in 2011 seeking to recoup $67 million in losses that contributed to the fund's insolvency. The lawsuit also seeks $1 billion in punitive damages.
Timberwolf was cited in a scathing 2011 U.S. Senate panel report that faulted Goldman and other banks for pushing debt they expected to perform poorly.
The report said Goldman kept marketing Timberwolf even after Thomas Montag, an executive who is now Bank of America Corp's co-chief operating officer, called Timberwolf "one shitty deal" in an email to a colleague.
Goldman's CDO practices also have drawn regulatory scrutiny. In April 2010, it agreed to pay $550 million to settle U.S. Securities and Exchange Commission charges it sold the risky Abacus CDO while letting hedge fund billionaire John Paulson bet against it. The bank did not admit wrongdoing.
The bank also was sued in London's High Court last week for allegedly exploiting a lack of financial knowledge at Libya's sovereign wealth fund, which became a Goldman client in 2007.
In court documents seen by Reuters on Thursday, the Libyan Investment Authority claims Goldman took advantage of the fund's "financially illiterate staff" when it encouraged investment in more than $1 billion in trades that ended up worthless. Goldman has said the claims are without merit.
In its complaint, the Basis Yield fund said it entered $80.8 million of credit default swaps related to "triple-A" and "double-A" rated Timberwolf debt. It said it bought $12.3 million of "triple-B" rated debt tied to subprime residential mortgages in a CDO known as Point Pleasant 2007-1.
Within weeks, the transactions began to lose value, and Basis Yield began to liquidate within two months. It said it lost $56.3 million on Timberwolf in under six weeks, and $10.8 million on Point Pleasant in less than three months.
Basis Yield was managed by Sydney-based Basis Capital Funds Management Ltd.
The case is Basis Yield Alpha Fund v. Goldman Sachs Group, Inc et al, New York State Supreme Court, New York County, No. 652996/2011.
(Reporting by Karen Freifeld; Editing by Cynthia Osterman)