How the SEC cracks down on unethical behavior

By Felix Salmon
April 20, 2010
Emanuel Derman has a fantastic two-line blog entry on the SEC/Goldman affair, which I can't really help but quote in full:

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Emanuel Derman has a fantastic two-line blog entry on the SEC/Goldman affair, which I can’t really help but quote in full:

The architects of the bailout have been trying to cure insolvency by treating it as illiquidity.

The SEC may be trying to cure unethical behavior by treating it as illegality.

This is also known as “how people behave when the only tool they have is a hammer”. Central banks can inject liquidity much more easily than finance ministries can spend money. And the lawyered-up SEC, if it finds a deal it considers odious, will go to great lengths to find a way in which that deal is illegal. Once they’ve done that, Goldman’s lawyers at Sullivan & Cromwell will go to equally great lengths and start quoting City of Monroe Employees Ret. System v. Bridgestone Corp, along with lots of other prior cases, in support of their argument.

I don’t doubt for a minute that Goldman’s behavior was more unethical than it was illegal. Goldmanites never stop talking about how they always put clients first, but because the U.S. has a rules-based rather than a principles-based regulatory system, that’s not an explicit regulatory requirement. One thing that the SEC has already done, in filing its complaint and making it public, is reveal that at least one banker — “Fab” Fabrice Tourre — does not fit that conception at all. Rather than treat every client with the utmost respect and transparency, he favored the sponsor of the Abacus deal, John Paulson, who was paying Goldman $15 million to put it together. And he blithely talked about a 0-9% equity tranche in emails to ACA, when no such tranche even existed.

Here’s the cunning thing about the SEC filing: they could settle with Goldman for $1 tomorrow, and Goldman’s reputation would still be tarnished for years to come. Here’s Allan Sloan:

I don’t much care about the legality of what Goldman allegedly did, because something doesn’t have to be illegal to be wrong. And almost everything about the Abacus 2007-AC1 “synthetic collateralized debt obligation” deal was wrong…

The SEC case seems more than a little weak legally, but tars Goldman as amoral at best, immoral at worst. It will take years for Goldman to erase the stain to its reputation, if it ever does.

If I were a betting man, I’d put money on Goldman prevailing in court, should the SEC charges go to trial. But in the court of public opinion, Goldman has already lost. And given the current state of things, that’s the court that matters.

This helps to explain why Goldman leads off its public self-defense by characterizing this deal as “a single transaction in the face of an extensive record”; general counsel Greg Palm said something very similar on the conference call today. Everybody at Goldman is hyper-aware of the degree to which a single mistake can ruin a bank’s reputation, and also of the degree to which that reputation is singlehandedly responsible for bringing enormous amounts of money into the bank. If you’re a journalist, no matter how good you are, you get better if you start working for the NYT or WSJ: your calls are returned that much more quickly, you’re that much more likely to be chosen as the outlet for leaks, and so on.

Similarly, if you’re a banker, you get better on your first day working for Goldman Sachs. Your calls get returned, you get better access to clients, and so on and so forth. The revelations in the SEC’s suit will hurt Goldman’s revenues, and Goldman wants to signal to the markets that they’re not at all typical of how it normally does business — while at the same time maintaining that they’re not even well-grounded in the first place.

It also helps explain why the SEC didn’t give Goldman the opportunity to settle the charges. The real damage to Goldman has already been done, and is much greater than any fine it might end up having to pay the SEC. (Which won’t be large, given that the firm lost money on the trade.) It’s an interesting case of the SEC using its rules-based structure to impose damages on firms who violate a hypothetical principles-based regime. It’s not what the SEC is necessarily meant to do, but that doesn’t mean it isn’t extremely effective.


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One thing that is interesting is that Goldman had the brand valued (in the billions). Yet there is no mention of the it or its quantum in public discourse.

saying “a single transaction in the face of an extensive record”

is like when Floyd Landis said “that’s my story and I’m sticking to it”

It is a denial of guilt that actually implies guilt.

Posted by randolfduke | Report as abusive goldman-gets-ex-white-house-counsel.html

We have reached the point where politics is impossible to parody. This makes “Springtime for Hilter” look like a searing documentory.

Posted by fresnodan | Report as abusive

So, being the clients are still sticking, is there a grifter mentality that prevails so that no one feels they can get any stinkier then they already are by sticking with the ‘good ole boys’?

Should there be unethical trades and kickbacks, Paulson should be investigated for complicity to commit fraud.

Posted by hsvkitty | Report as abusive

Goldman’s unethical behavior was not that it screwed clients, as they are all sophisticated enough (or should be if they are managing other people’s money) to know that there is a buyer on the other side of each trade. Rather, it was doing deals that they had to know would screw the financial system and the economy. Their speculating and brokering of loans that should never have been made enabled many of those guaranteed-to-default mortgages possible. While it probably wasn’t illegal, it was very bad for the social system that they are part of, and depend heavily on for their completely undeserved bonuses (Goldman’s operations, like those of most big corporations, is optimized for the benefit of its managers, not its customers or shareholders).

When they settle or win their case, they will still not be punished by a tarnished reputation, because their clients do not care about that. Their clients are typically just like them, in that they do not care how they make their money, or what effect it has on the economic system around them, as long as they profit. That might work in the short term, but it is not sustainable, for any parasite that kills its host eventually dies also.

And make no mistake, Goldman and their ilk are parasites. They add absolutely no value to society yet they extract an enormous amount of wealth and capital from it. I think the case against them is really designed to help get financial reform legislation passed, which is a good thing, but would still probably not prevent another devastating re-structuring of the nation’s and the world’s financial system. Forcing derivative trades to be traded on exchanges will not stop managers from getting their employers to take on excessive risk and leverage, which is really the cause of all this financial havoc, and can be stopped by regulators who actually believe in regulation.

Goldman is just like a polluter who dumps all kinds of toxic waste into rivers, lakes, and streams because “there’s no law against it”, and they can make more money if they pollute because it gives them an edge over their competition. Why anybody thinks that’s good for anybody not in line for a Goldman bonus is beyond me.

Posted by OnTheTimes | Report as abusive

Felix, I’m financially unsophisticated, but it seems to me that the tone of this post is very different from your tone of the previous days. You argued assiduously that the failure to disclose the fact that the individual on the other side of the bet got to choose the cards that were being dealt constituted fraud (or that the person who got to choose the cards was in fact on the other side of the bet, to reverse the logic). You now seem to argue that it probably wasn’t fraud, but it is unfair play, or at least poor sportsmanship.

So which is it? It seems pretty cut and dried to me, and the rest of the words being scattered about are simply misdirection.

Posted by Curmudgeon | Report as abusive

Great article. Well-written and lucid. We should sentence everyone who increased their holdings in Goldman to a year of community service, under the supervision of those who sold Goldman stocks.

Posted by JUANDEMTY | Report as abusive

Beg to differ here, Felix: the damage that needs doing to Humpty Dumpty Goldman et al. has not yet been done. The score is a long way from being settled. When there isn’t a leper colony left on earth that will take them in, then, maybe.

Posted by HBC | Report as abusive

Curmudgeon, I’m not for a minute saying it wasn’t fraud — although Sloan seems to be leaning that way. I’m just saying that even if it isn’t fraud, it’s still wrong.

Yes, it is still wrong.

But as for the hard charges of fraud, I do believe they will stick. Goldman lied when they said to the CDO investors that an independent party selected the securities. And they lied again in their earnings call when they said that ACA was solely responsible for the selection of the securities. Indeed they are guilty of making false statements every time they repeat that line.

The reason the charges against Goldman will stick most of all is that in America, a jury of one’s peers means a jury of fellow American citizens, not a jury of fellow Wall Street traders. Only a fellow trader could be persuaded by Goldman’s tortured logic. If the trial is with a judge, well judges too are human and take into account both the spirit and letter of the law, like it or not.

What is beyond me is why Goldman insists on repeating that they did nothing wrong (and making this a referendum on the entire firm) rather than coming down hard on themselves and taking the wind out of the sails of their critics. It appears that Goldman would rather not take charge of their own reform, meaning forces outside of Goldman (including the governments of many nations) will be in the driver’s seat.

Posted by DanHess | Report as abusive

Just a side point of disagreement: Read the magnificently broad and flexible Section 10(b) of the Securities Exchange Act of 1934 (the core anti-fraud provision on which the SEC sued Goldman and typically sues for fraud) and tell me that the SEC and US financial regulation is “rules based” rather than “principles based.” That is a canard that gained currency a few short years ago when Henry Paulson and Chris Cox were trying to (further) neuter US financial regulators by making them more like the supposedly more enlightened and “principles-based” FSA. Granted, there are many technical SEC rules concerning many aspects of the securities business, but the biggest weapons — the anti-fraud provisions — are about as principle-based as you can get: don’t lie about the securities you’re selling, and don’t conceal facts that make your statements about those securities misleading.

Posted by BDouglas | Report as abusive

Correct me if I am wrong, but I am pretty sure that the SEC has subpoena power. Financial and business reporters do not. So the SEC’s real value is to use their subpoena power to expose this kind of behavior, to shine a light on GS practices. I doubt that we will get to a point where a jury foreman stands up and says we find for the plaintiff, and Goldman is required to pay the plaintiff X dollars. But I am 99 percent sure that we will also never hear a jury foreman say that Goldman is innocent, exonerated, vindicated, etc.

The SEC has confirmed what everyone suspected, that Goldman is not to be trusted, and that lack of trustworthiness is actionable.

On a day when GS reported huge earnings, their stock went down $3.34, and went down a little more in after hours trading. They got no bounce off those earnings, although the market may have already factored in their earning based on information that had come out before the earnings reports. So… maybe without the earnings, Friday’s big fall would have been worse.

So Goldman’s future might be falling stock prices, investors shying away from dealing with them, lots of legal expenses…..which can lead to falling stock prices, etc.

I am not saying death spiral here, but did anybody predict Bear Stearns death spiral happening in just a few days?

Posted by randymiller | Report as abusive

BDouglas, fine point!

Here’s 10(b):
“It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,

in connection with the purchase or sale of any security”

Some people have taken to saying that while what they did was morally wrong, it wasn’t illegal. If you are a judge or jury and you think they hid facts in a way that was misleading, that is all you need.

Goldman needs to stop the bravado and combative stance and deal with their deep ethical problems, pronto. Even if there is a small chance they beat the SEC charges, they face action in many jurisdictions. The odds that they are exonerated everywhere is exactly nil.

Posted by DanHess | Report as abusive

This statement was included with GS annual report copied to the SEC. Does this suitably warn that they are under investigation by the SEC?

“GS&Co. and certain of its affiliates, together with other financial services firms, have received requests for information from various governmental agencies and self-regulatory organizations relating to subprime mortgages, and securitizations, collateralized debt obligations and synthetic products related to subprime mortgages. GS&Co. and its affiliates are cooperating with the requests.”

The wells report means documents (millions of pages) have already been sifted through and and it is notification there is grounds for charges and warns action will commence, so I don’t think it does.

Note: this same notice was in the previous year’s annual report during the time the information was being handed over to the SEC.

Posted by hsvkitty | Report as abusive

In the court of public opinion, Goldman is already toast:

“73% Say It’s Likely Goldman Sachs Committed Fraud” ontent/business/general_business/april_2 010/73_say_it_s_likely_goldman_sachs_com mitted_fraud

Posted by DanHess | Report as abusive

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