Goldman’s reputation in tatters

By Felix Salmon
April 16, 2010
Goldman's declaration that "the SEC’s charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation" seems ill-advised to me, mainly because it's so obviously untrue. It might be hard to successfully prosecute Goldman -- they have a lot of very expensive lawyers, and securities law is murky at the best of times. But there's enough in the way of smoking guns in the SEC's complaint that it's ridiculous to say that it's "completely unfounded in fact".

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It’s not easy to parse a one-sentence statement, but Goldman’s declaration that “the SEC’s charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation” seems ill-advised to me, mainly because it’s so obviously untrue. It might be hard to successfully prosecute Goldman — they have a lot of very expensive lawyers, and securities law is murky at the best of times. But there’s enough in the way of smoking guns in the SEC’s complaint that it’s ridiculous to say that it’s “completely unfounded in fact”.

It makes a lot of sense here to do the old-fashioned thing and follow the money. Why was ACA so quiet about the fact that it wasn’t really picking the securities in the CDO it was nominally managing? Because it was being paid millions of dollars for its silence. And why was Goldman so happy to do Paulson’s bidding? Just look at the complaint.

The deal closed on April 26, 2007. Paulson paid GS&Co approximately $15 million for structuring and marketing ABACUS 2007-AC1.

Even by Goldman standards, that’s real money. But the fact is that the investors in the deal had every right to know who was paying the piper — and Goldman went to great lengths to keep that fact secret.

Goldman can and almost certainly will mount a legalistic defense here; Henry Blodget does a good job of glossing what it might look like. Essentially, he says, it’s reasonable to say that ACA picked the securities in the CDO, because it picked them from a list compiled by Paulson. Paulson, of course, having come up with the list in the first place, didn’t really mind which of the securities ACA picked: the game was already rigged by that point, and ACA had no more control over the final outcome than the guy up on stage being asked by the magician to “pick a card”. So long as ACA was playing on Paulson’s field, they were certain to end up losing the game.

But the problem for Goldman here is that even if this kind of defense stands up in a court of law, it’s not going to hold much water with the firm’s precious client relationships. Stephen Gandel has a good take on the whole affair:

Does this end Blankfein’s reign as head of Goldman? I think so. It’s a big deal for an investment bank to be charged with securities fraud. And it is not just a coincidence that Goldman would get hit with a fraud case when Blankfein was CEO. Even though he is not named in the complaint, Blankfein is to blame. He pushed the firm to become less of an investment bank and more of a trading behemoth. And this is the result: A brilliant trade that was so brilliant the Goldman people forgot that it also might be fraud.

Goldman talks ad nauseam about how everything it does it does for its clients, and how any profits it ultimately ends up making are just a result of being “long-term greedy”. But if it attempts legalistic hair-splitting about how its behavior in the Abacus case was technically not illegal, it’s just going to end up looking even more culpable in the eyes of its clients. Goldman, if it was behaving honorably here, would have been open about the whole truth of what was going on. It would have revealed Paulson’s role in structuring the deal to IKB and other investors, and it would have revealed Paulson’s short position to ACA. Instead, it played IKB and ACA for suckers. And that’s just not the kind of behavior that Goldman likes to think that it engages in.

It’s possible, pace Gandel, that if Blankfein goes, that might help placate Goldman’s clients. But I doubt it. The firm is run by traders now, and replacing one trader with another will not make any difference. And Blankfein’s culture is exactly the same as that of just about anybody who might replace him.

In any case, it seems to me that Goldman owes its clients and the public a massive apology. Blankfein has already said that Goldman “participated in things that were clearly wrong and have reason to regret”; he should make it clear that Abacus falls into that category. Instead, he’s trying to brazen it out, and is saying that the SEC’s charges are “unfounded in fact”. That might make sense from the point of view of a legal strategy, but it doesn’t make sense if he’s trying to rescue what remains of his and his firm’s reputation.


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Heidi Moore thinks that this finally proves Matt Taibbi wrong, which I must say is a rather charitable spin on things, because Paulson was the inspiration for the deals rather than Goldman

Posted by gringcorp | Report as abusive

The correct response to their brazen-ette crackhead who-me? defense is to prosecute this fiasco as criminal as well as “civil” fraud. And keep going until Goldman gets a civil tongue in its head, or goes down. Whichever comes first.

If it’s at all unclear whether the FBI has saddled its pony yet, it shouldn’t be much longer.

Posted by HBC | Report as abusive

Such a shame for a company with such history and culture. I think:

> The CEO should apologise to his clients, his people and the public about the deals GS has been involved in under his leadership
> Next, he should step down and reshuffle the executive committee and the broad of directors
> There should be investigation and internal changes to the way Goldman runs. Go back to serving clients and long term profit.

Good luck.

Posted by savo | Report as abusive

“. Instead, it played IKB and ACA for suckers. ”

That seems more than a little overgenerous to IKB and ACA. IKB clearly needed adult supervision – they should have known (a) somebody was taking the other side of the bet for a reason and (b) GS and ACA were making money from putting the deal together. They acted like a befuddled 90 year old signing away his SS check. What were all the high salaried managers and analysts at IKB doing for their depositors? Flying to NYC and going out to dinner with GS?

And ACA put their name on the line. They represented to the customer that they had put together the package in good faith where they had really just taken a fee and passed on Paulson’s design. They had an ethical and seems to me legal obligation to walk away from the deal, but they too the fee and played along.

Posted by rootless | Report as abusive

I’m not impressed with Blodget’s ‘legalistic’ defense. The identity of the selection agent was clearly “material” to everyone involved: that’s the whole reason GS hired ACA, to attach the name of a selection agent to the CDOs, as their investors had started demanding. Thus, failing to disclose who the selection agents really were and their own investments is an “untrue” statement about a “material” fact.

Posted by MaxKennerly | Report as abusive

Couple points to add to the conversation:

- I could be wrong here, but there is a very good chance Paulson was actually long the equity tranche of ABACUS while still expecting the collateral to fail miserably. Because it takes a while for the bonds to start taking writedowns, they initially generate excess interest that is paid out to the equity holder. If they held the equity, they get paid a few million dollars on the long side before the bonds start to fail, and then they get their billion on the short side when the thing blows up. This serves as further cover that they were actually “long” the deal.

- This may further tarnish Goldman’s reputation on Main Street, but this whole thing comes as no surprise to anyone in the financial sector. Their reputation is not that they have their clients’ best interests in mind. Their reputation is that they are incredibly smart and good at making money and they will rip your face off without hesitation.

Posted by CBL | Report as abusive

Rootless – My initial reaction was that SEC would have a very difficult time making their case for the reasons you cite, i.e. that if IKB is a qualified institutional investor, then caveat emptor largely applies.

Even caveat emptor has limits, though, and they kick in at the word fraud. I still think SEC has something of an uphill battle, but if even one of the pieces of evidence presented in the complaint can constructively be interpreted as a lie, then the line is crossed.

Posted by fixedincome | Report as abusive