I’ve been reading and listening to everything I can about the Goldman indictment by the SEC over the past few days. The talking heads on financial TV are, as usual, verbose but clueless. What’s more interesting is I find that legal experts being interviewed are unusually vague about what statute or principle of law Goldman is supposed to have violated.
And the more I think about the SEC complaint, the more I find myself agreeing, not with the SEC, but with Goldman.
1. Goldman doesn’t think it did anything wrong. The tone of all its public statements conveys this. Also, as a practical matter, the vast majority of the “toxic” derivative transactions were done in the UK, not the US, in order to take advantage (I think) of the more permissive regulatory environment there. If Goldman had any qualms about this deal, it would have happened in London.
2. No one seems to be disputing the general outline of the deal in question: Paulson asked Goldman to find institutions (perhaps “patsies” or “schlemazels” would be better words) to take the long side of a sub-prime mortgage derivative transaction that it wanted to be the short side of. Goldman located two, a bank and a financial services firm, both supposedly well-versed in sub-prime mortgages, who seemingly jumped at the chance.
3. No one, other than Paulson and its clients, is arguing that designing this transaction was a nice thing to do to the long side. But, then, it’s not nice when the opposing pitcher humiliates the home team in front of a stadium full of fans by striking out 15 and not allowing a run in a visiting-team victory. It wasn’t nice when the UCLA men’s basketball team defeated 88 other teams in a row, either. The Flyers aren’t being nice to the Devils.
That’s not the point. The real issue is whether any parties acted illegally.
4. The case may hinge (in this non-lawyer’s opinion) on a court deciding whether Goldman’s role in the transaction was to be an agent/middleman or to be a fiduciary for the bank, IBK, and the financial service company, ACA. In other words, did Goldman have an obligation to disclose Paulson’s plans and intentions to IBK and ACA?
Goldman is clearly saying that it was only an agent.
–both buyers, IKB and ACA, were institutional investors who had prior experience with sub-prime mortgages and who asserted to their own clients that they were experts in this area. No one so far is claiming that this representation was fraudulent. And generally an investor is regarded as “sophisticated” in the US if he has $100 million under management. So although they may not have been the most skilled players in the game, both IKB and ACA probably have to be regarded as professionals.
–even the SEC complaint says Goldman farmed out the function of advising on the reasonableness of the deal to ACA, the bond insurance company that had the final say on what bonds were backing the Paulson transaction. The biggest buyer of the actual transaction was an affiliated company of ACA, which presumably relied primarily on the ACA research and judgment. This seems to me to reduce Goldman’s role to that of a facilitator or agent in the deal.
–Goldman arguably had an obligation not to disclose Paulson information to ACA or IKB and vice versa. But Goldman also got Paulson and ACA into at least one fact-to-face meeting and kept them in communication with each other. So ACA knew who Paulson was.
ACA could have asked Paulson about what it was doing and where it stood in the transaction. What kind of analysts wouldn’t have? (Answer: bad ones.) A blush or a stammer would have been enough information. Maybe ACA understood Paulson’s intentions and thought the firm was wrong, or simply didn’t care.
–According to the Washington Post, the Paulson role in selecting “bad” securities may not have mattered anyway. Any 2006-vintage sub-prime mortgage securities would have imploded. I wonder if any has checked to see if the ACA-selected portfolio was better or worse than the original Paulson one.
6. The more I look at it, the weaker and more Spitzer-like (go for the headlines; don’t worry about the trial) the SEC case seems to me. The ramifications of losing the one action the agency finally brings after all the adverse publicity of Madoff, BofA-Merrill and similar cases can’t be good.
7. The Goldman professional who oversaw the deal has just been put on paid leave. This is the most sensible thing to do. Keeping him in his job likely angers the SEC further. His mind probably isn’t on his work anyway. Even if he has done something wrong, firing him only turns him into a cooperative source for the SEC.
The action may be Goldman opening the door to negotiating a settlement, rather than enduring a steady stream of negative publicity.