By Carolyn Cohn

LONDON (Reuters) - A Goldman Sachs executive's alleged arranging of prostitutes for himself and the brother of a decision-maker at Libya's sovereign wealth fund was completely unacceptable behavior for an employee of the bank, the first witness called by Goldman told a court on Thursday.

In a trial at London's High Court, the Libyan Investment Authority (LIA) is attempting to claw back $1.2 billion from the Wall Street investment bank from nine disputed trades carried out in 2008.

The LIA argues that the bank took advantage of its financial naivety by first gaining its trust, then encouraging it to make risky and ultimately worthless investments.

Goldman Sachs denies the allegations and says the trades in question "were not difficult to understand".

The LIA's claim hinges in part on its allegations that the trades were procured under "undue influence". It cites an internship the bank provided for the brother of Mustafa Zarti, the LIA's former deputy chief and a key decision-maker at the fund. It also says senior Goldman Sachs executive Youssef Kabbaj gave iPods to its staff.

The court has previously been told by a lawyer for the LIA that in February 2008 Kabbaj flew the brother, Haitem Zarti, from Morocco to Dubai at Goldman Sachs' expense, paid for accommodation at the five-star Ritz Carlton and arranged for two prostitutes to spend the evening with them at a cost of $600.

Goldman Sachs called as its first witness Andrea Vella, a former partner who now works as co-head of investment banking for Asia ex-Japan for the bank.

Under cross-examination by Philip Edey, a lawyer acting for the LIA, Vella was asked if he was shocked to hear Kabbaj, a salesman on the LIA account, gave the iPods.

"I am upset, or disappointed, maybe," Vella said.

Vella said in court on Thursday he was not shocked about the prostitutes as he had already heard about them. When asked if arranging prostitutes would be "completely unacceptable conduct for a Goldman Sachs employee", he replied: "Yes, I would agree with that statement."

The bank does not deny that it paid for some flights and hotels, but Kabbaj did not seek to expense the cost of the prostitutes to Goldman, and the bank did not know about it at the time, a source familiar with the bank's position said earlier this month. 

Kabbaj told Reuters by email earlier this month that neither he nor Goldman Sachs had ever paid for any "improper entertainment" for clients, including the LIA.

In a letter shown to the court, Kabbaj wrote that Vella was so angry with him in one meeting in July 2008 that he took off his shoe and banged it on the table. Asked about this, Vella said: "I really don’t remember that happening."

But Vella said he did remember being angry when he discovered Kabbaj had made contact with the LIA, after having been told not to, "as we were trying to solve and understand what was happening".

"I may have told him 'if you do something you are told not to do, you could get fired.'"

Vella said in a witness statement seen by Reuters that "the LIA, through its personnel, was financially sophisticated enough to understand the disputed trades".

Elaborating on this to the court, he said not all LIA staff were sophisticated, and that trades needed to match the level of sophistication of the client.

Asked whether his Goldman Sachs partners had conveyed to him that they perceived the LIA to be unsophisticated, Vella said: "What was conveyed to me was that we had to be cautious because... there were people in the LIA that were not sophisticated."

However, he said this did not mean all of the employees were unsophisticated, or that the organization as a whole was unsophisticated. "Sophistication is not a black and white description."

(Editing by Mark Trevelyan)