NEW YORK (Reuters)—Goldman Sachs Group Inc. was charged with fraud on Friday by U.S. securities regulators in the structuring and marketing of a debt product tied to subprime mortgages.

The U.S. Securities and Exchange Commission lawsuit alleges that Paulson & Co., a major hedge fund run by the billionaire John Paulson, worked with Goldman in creating the collateralized debt obligation, and stood to benefit as its value fell, costing investors more than $1 billion.

Fabrice Tourre, a Goldman vp who the SEC said was principally responsible for creating the product, was also charged with fraud.

Paulson has not been charged. "Goldman made the representations here to the investors, Paulson did not," SEC enforcement chief Robert Khuzami said on a conference call.

Spokesmen for Goldman and Paulson had no immediate comment. Mr. Tourre could not immediately be reached.

The lawsuit, filed in Manhattan federal court, marks a dramatic expansion of regulatory efforts to hold people and companies responsible for activity that contributed to the nation's financial crises. It also comes as lawmakers in Washington debate sweeping reform of financial industry regulation.

"This is big," said Walter Todd, a portfolio manager at Greenwood Capital Associates L.L.C. "Reputationally, obviously, it is damaging. I'm still kind of in shock."

In morning trading, Goldman shares sank $22.30, or 12.1%, to $161.97 on the New York Stock Exchange. Other bank stock also fell.

Goldman hid information, SEC says

In its lawsuit, the SEC alleged that Goldman structured and marketed a synthetic collateralized debt obligation, ABACUS, that hinged on the performance of subprime residential mortgage-backed securities.

It alleged that Goldman did not tell investors "vital information" about ABACUS, including that Paulson & Co. was involved in choosing which securities would be part of the portfolio. It also alleged that Paulson took a short position against the CDO in a bet that its value would fall.

According to the SEC, the marketing materials for the CDO showed that a third party, ACA Management L.L.C., chose the securities underlying the CDO.

Paulson & Co. paid Goldman $15 million to structure and market the CDO, which closed on April 26, 2007, the SEC said. Little more than nine months later, 99% of the portfolio had been downgraded, the agency said.

"In sum," the complaint said, "Goldman Sachs arranged a transaction at Paulson's request in which Paulson heavily influenced the selection of the portfolio to suit its economic interests, but failed to disclose to investors...Paulson's role in the portfolio selection process or its adverse economic interests."

The cost to insure Goldman debt in the credit default swap market jumped on the news.

Goldman's credit default swaps jumped 20 basis points to 110 basis points, or $110,000 per year to insure $10 million in debt for five years, according to data by CMA DataVision.

The yield spread over Treasuries of Goldman Sachs' 4.750% notes due in 2013 also widened by about 5 basis points to 101 basis points, versus 96 basis points Thursday afternoon, according to MarketAxess.