How important is IKB’s sophistication?
John Carney has a defense of Goldman Sachs up at the Daily Beast, based on the not-novel-at-all idea that the investors in the Abacus deal were sophisticated.
A document exclusively obtained by the Daily Beast demonstrates (view them here) that just a few months before it invested in the derivatives at the center of the SEC’s case, the German bank was touting its prowess as a sophisticated investor in those derivatives.
But no one is asserting that IKB, or any other party to this transaction, wasn’t sophisticated. The word never appears in the SEC’s complaint against Goldman, for instance, and I have yet to see a Goldman critic latch onto the idea that IKB was some kind of naive widow or orphan, who was bamboozled by all these CDOs and CDSs and whatnot.
On the other hand, Goldman itself loves hammering home the idea that the investors in the deal were sophisticated. Its first big public statement on the deal uses the word twice, its second uses the word three times, and its two letters to the SEC use the word no fewer than twenty-three times between them.
Here, for example, is a chunk of the first letter:
The problem with all of this banging away about IKB’s sophistication is that it looks very much like protesting far too much. The SEC doesn’t need to show that IKB was unsophisticated, it just needs to show that Goldman didn’t make the disclosures required by the law.
Carney, a lawyer by training, tries to explain why he thinks this is such a big issue, but he’s far from convincing:
The sophistication of IKB will be an important issue in the Goldman case. In general, the securities laws of the United States assume that sophisticated investors can fend for themselves. That’s exactly why hedge funds—which only accept money from so-called “accredited investors”—are largely free from regulation. The focus of our securities laws is the protection of ordinary investors and market integrity.
I’m sure that a class on the history of US securities laws would be fascinated by their treatment “in general” of sophisticated investors, and by their overall focus in terms of investor protection. But the point at question here is whether Goldman failed to make necessary disclosures, simple as that. To be sure, the level of disclosure necessary changes according to the sophistication of the investor in question, and qualified institutional investors in the 144a market are much more sophisticated than ordinary individual investors. But the level of disclosure never goes away entirely, and in fact the statute in question is drawn very broadly:
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.
There’s nothing there about “any unsophisticated person”: if Goldman’s omission of Paulson’s role in its statements made what it was saying misleading, or if it was deceitful, then that’s it, case closed. IKB may or may not have been a sophisticated investor, but I don’t think that status matters nearly as much as Goldman and Carney think and/or hope that it does.