France could become the latest country to examine whether Goldman Sachs Group Inc defrauded investors in marketing a mortgage investment product while the hedge fund that played a key role in the deal moved to head off investor concerns.

Goldman is accused of defrauding investors by failing to say that prominent hedge fund manager John Paulson bet against a Goldman subprime debt product that he helped design.

Goldman is being investigated by the Securities and Exchange Commission (SEC) and Britain's market watchdog, which launched its own probe on Tuesday.

The accusations warrant a full probe by French regulators, Economy Minister Christine Lagarde said on Wednesday. Regulator AMF (Autorite des Marches Financiers) said earlier this week that it planned to co-operate with the SEC over the Goldman case if necessary, adding on Wednesday that it aimed to publish an update on the probe next week.

Goldman shares were up 0.7 percent on Wednesday, reducing their decline over the last week to 13 percent.

But archrival Morgan Stanley, which reported better than forecast earnings, outperformed Goldman, with its shares rising nearly 6 percent. The sectoral Amex Securities Broker Dealer index has lost 2.1 percent over the same period.

The cost to insure Goldman's debt widened to about 133 basis points from about 122 basis points late on Tuesday.

Goldman itself reported blowout earnings on Tuesday, but so far has gained little credit from investors who remain concerned about the fallout from the SEC accusations.

Uncertainty abounds, and headline risk should drive near-term volatility, Sandler O'Neill analyst Jeff Harte wrote in a research note, adding that he believed the reputational and financial risks seem manageable.

In the latest sign that the probe could hurt Goldman's standing with some customers, German public sector Landesbank Bayern LB said it had cut business ties with Goldman given the SEC investigation.

DERIVATIVES REFORM ADVANCES

Another German bank, IKB Deutsche Industriebank AG, was one of the main investors in the Abacus synthetic collateralized debt obligation deal that is the focus of the SEC complaint.

Goldman declined to comment.

Newly released official documents showed that Goldman aggressively increased political campaign donations and lobby spending in Congress in early 2010, as the financial reform debate gathered momentum.

In another sign that Goldman and its Wall Street allies are struggling to gain traction in Washington, a U.S. Senate committee approved on Wednesday a bill aimed at reforming the derivatives market, moving the Senate one step closer to passing sweeping regulation over the $450 trillion derivatives market.

Paulson, in a conference call on Monday and followed up with a letter to investors late on Tuesday, says neither he nor anyone else at the firm had received a so-called Wells notice indicating that charges might be filed against the fund, several investors who listened to the call said.

No one had yet notified the $32 billion fund of their intentions to pull money out, they said.

We are interested in buying out people who want to get out of Paulson, but so far no one has stepped forward, one of the investors, who asked not to be named because of the sensitivity of the matter, said late on Tuesday.

A spokesman at Paulson & Co, which earned $15 billion by correctly betting in 2007 that the U.S. housing market would collapse, declined to comment.

Paolo Pellegrini, a former top executive at Paulson & Co, told investigators at the Securities and Exchange Commission that he had informed ACA Management LLC that his firm was betting against the transaction, The Wall Street Journal reported on Wednesday.

ACA was the outside manager tapped to oversee the transaction at the heart of the SEC complaint.

To lead their defense against the charges, Goldman has brought in Richard Klapper, a lawyer with an impressive record of courtroom victories for some of the biggest financial firms and a reputation as a fearsome litigator.

Rival institutions in Asia were seizing the chance to try to elbow in front of Goldman on major upcoming deals, sources familiar with the matter told Reuters.

Investment bankers have been lobbying executives at state-owned Agricultural Bank of China and pushing officials in Beijing to drop Goldman as an underwriter for the bank's more than $20 billion IPO.

Rivals are also asking officials at state-controlled Bank of Communications to ditch Goldman from its joint global coordinator role in the Chinese bank's $6.1 billion rights issue, the sources said, though there was no evidence either bank was considering pushing Goldman aside.

(Additional reporting by Steve Eder and Paritosh Bansal in NEW YORK, Dan Margolies in WASHINGTON; Christian Kraemer in MUNICH and Alexander Huebner in FRANKFURT; George Chen and Fiona Lau in HONG KONG and Steve Slater in LONDON; Writing by Christian Plumb and Lincoln Feast; Editing by Ian Geoghegan and Matthew Lewis)

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