WASHINGTON, April 16 The US government on Friday charged a Wall Street giant with defrauding investors, causing financial shares across the world to tumble.

The fraud caused investors to lose more than $1 billion.

In a statement issued in Washington, the US Securities and Exchange Commission charged that Goldman Sachs & Co. and one of its vice presidents “defrauded investors by misstating and omitting key facts about a financial product tied to subprime mortgages as the US housing market was beginning to falter.”

Goldman Sachs is the most profitable firm in Wall Street history, but on Friday its shares tumbled 10 per cent to $165.02 in New York Stock Exchange composite trading for the biggest intraday decline in a year.

A gauge of banks and brokerages in the Standard & Poor's 500 Index sank 4.3 per cent for its biggest decline since February 4 and the top loss among 24 groups.

Bank of America Corp., Morgan Stanley and JPMorgan Chase & Co. lost at least 4.3 per cent as all 27 companies in the S&P 500 Diversified Financial Index declined at least 1.7 per cent after the SEC announced its action. Berkshire Hathaway Inc. Class A shares tumbled 5.1 per cent.

The SEC alleged that Goldman Sachs structured and marketed a synthetic collateralised debt obligation (CDO) that hinged on the performance of subprime residential mortgage-backed securities (RMBS).

Goldman Sachs failed to share with investors vital information about the CDO, in particular the role that a major hedge fund played in the portfolio selection process and the fact that the hedge fund had taken a short position against the CDO.

“The product was new and complex but the deception and conflicts are old and simple,” said Robert Khuzami, SEC Director of the Division of Enforcement. “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.”

Kenneth Lench, Chief of the SEC's Structured and New Products Unit, added, “The SEC continues to investigate the practices of investment banks and others involved in the securitisation of complex financial products tied to the US housing market as it was beginning to show signs of distress.”

The SEC alleged that one of the world's largest hedge funds, Paulson & Co, paid Goldman Sachs to structure a transaction in which Paulson & Co could take short positions against mortgage securities chosen by Paulson & Co based on a belief that the securities would experience credit events.

According to the SEC's complaint, filed in US District Court for the Southern District of New York, the marketing materials for the CDO known as ABACUS 2007-AC1 (ABACUS) all represented that the RMBS portfolio underlying the CDO was selected by ACA Management LLC (ACA), a third party with expertise in analysing credit risk in RMBS.

The SEC alleged that undisclosed in the marketing materials and unbeknownst to investors, the Paulson & Co hedge fund, which was poised to benefit if the RMBS defaulted, played a significant role in selecting which RMBS should make up the portfolio.

The SEC alleged that after participating in the portfolio selection, Paulson & Co effectively shorted the RMBS portfolio it helped select by entering into credit default swaps (CDS) with Goldman Sachs to buy protection on specific layers of the ABACUS capital structure.

The SEC alleged that Goldman Sachs Vice President Fabrice Tourre was principally responsible for ABACUS 2007-AC1. Tourre structured the transaction, prepared the marketing materials, and communicated directly with investors. Tourre allegedly knew of Paulson & Co's undisclosed short interest and role in the collateral selection process.

In addition, he misled ACA into believing that Paulson & Co invested approximately $200 million in the equity of ABACUS, indicating that Paulson & Co's interests in the collateral selection process were closely aligned with ACA's interests. In reality, however, their interests were sharply conflicting.