Goldman Sachs’ Worst Nightmare: Adoption of a Fiduciary Standard

Though Goldman Sachs claims it merely acted as a market-maker for the ABACUS deal, they really acted much more like “issuer” with an obligation to disclose all pertinent facts and risks, including the fact that the architect who helped choose the underlying securities was betting they would fail.  Goldman claims that there was no absolute certainty the ABACUS deals would implode and has repeatedly said that they lost more than $90 million by owning some of the securities themselves (the result of the firm failing to find enough suckers to sample it’s toxic cooking).

For a firm with no moral qualms about betting against its own clients, it comes as no surprise that Goldman Sachs is lobbying hard against Congress passing a so-called fiduciary standard that would require the firm to always act in the best interests of its clients.   Kicking off what is sure to be a full-court press on Capital Hill, Goldman’s President and COO Gary Cohn has warned that if market makers were forced to adhere to a fiduciary standard, the markets would stop functioning.

I wholeheartedly agree.  Imposing a fiduciary standard on market makers would not be wise legislation.  However, better defining the roles of “issuer” and “market-maker” and imposing a fiduciary standard on “issuers” would serve the best interest of all investors. Had this been done years ago, it’s highly unlikely Goldman would have dared to unload the ABACUS transactions.

On regulatory reform, Wall Street is pitching a shut out against investors.  Congress needs to step up to the plate.

Ethical Showdown: Goldman vs. Bear

Goldman Sachs has long reigned supreme on Wall Street because of the widespread perception and belief that they employed the smartest guys in the business.  But the SEC’s fraud charges against the firm have exposed another possible reason for the firm’s stratospheric success: The firm is more ethically challenged than some of its rivals.

We will let the courts decide the legal merits of the fraud charges the SEC filed against Goldman last week, but let’s consider the moral propriety of the firm selling its clients mortgage securities that hedge fund powerhouse John Paulson had determined were most likely to fail.  Goldman steadfastly maintains that it had no legal obligation to disclose that Paulson was the designer of the CDOs, but at least one competitor reportedly couldn’t stomach concocting such an arrangement.

In his book, “The Greatest Trade Ever,” Wall Street Journal reporter Greg Zuckerman discloses that Paulson first approached Bear Stearns trader Scott Eichel to structure  a package of highly toxic securities with a high likelihood of failure, but Eichel and his colleagues apparently wouldn’t do the deal.  According to Zuckerman:

Mr. Eichel said he felt it would look improper for his firm. “On the one hand, we’d be selling the deals to investors, without telling them that a bearish hedge fund was the impetus for the transaction, Mr. Eichel told a colleague; on the other hand, Bear Stearns would be helping Mr. Paulson wager against the deals.”

Zuckerman says that Deutsche Bank and other unnamed banks also worked with Paulson to structure CDOs that he could short, which, if true, raises the question as to why the SEC has singled out only Goldman for fraud.  Bears Stearns was hardly the paragon of ethical propriety (it marketed hedge funds filled with dubious subprime mortgage securities to unsuspecting retail investors), but its impressive that they chose to turn down a lucrative fee arrangement rather than engage in a transaction they perceived as morally wrong. Goldman and Deutsche Bank apparently had no such ethical compunctions.

Ironically, Eichel now reportedly works for Royal Bank of Scotland, which acquired a business unit of ABN AMRO that was on the losing side of the Paulson designed instruments.  Goldman maintains that it also lost $90 million on the deal, but I’m skeptical about the validity of the claim; the firm has long bragged about its risk management and its ability to hedge its trades. So while perhaps Goldman did indeed lose $90 million on one side of the transaction, it’s more than likely that they made it up on another.

Goldman Sachs and the “Fabulous Fab”

Goldman Sachs’ first day of reckoning may be dawning.  Today the SEC filed charges that a hedge fund seeking to short the mortgage market helped Goldman Sachs build a product so toxic, it would collapse in the matter of months…a plan executed with precision.  The arrangement was not disclosed to investors, who are otherwise known as Goldman Sachs’ customers.

Though the victims in this case are institutional investors, the SEC’s allegation that Goldman Sachs withheld material information from its clients is as much about fraud as it is restitution for the millions of families whose nest eggs were destroyed because of Wall Street’s greed.

I’m heartened the SEC is finally taking a critical look at Goldman Sachs’ activities, but it’s noteworthy the only person named in the complaint is a pretty small fry, albeit one with an outsized ego.  His name is Fabrice Tourre, or the “fabulous Fab” as the 31 year-old banker likes to call himself.  ‘Fabulous Fab’ was a lowly vice president, and he was likely following the ethical direction and guidance of his superiors.

Nevertheless, the allegations against Goldman Sachs are devastating in that it confirms what everyone suspected: the firm has little regard for disclosure rules and thinks nothing of ripping off customers if the price is right.  So let’s hope the SEC is up to the challenge. Indeed, it’s one thing for the SEC to bring charges, but the real test will be if the agency has the talent, resources and resolve to take on the mighty and politically connected Goldman Sachs.

Regardless, a bigger worry for Goldman Sachs are the inevitable private lawsuits from investors.  Institutions that purchased Goldman Sachs’ allegedly fraudulent securities will be seeking recourse for billions in damages of investment losses.

On cue, Goldman Sachs’ much ridiculed PR apparatus responded to the SEC’s charges by saying 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.”

We’ll see about the charges, but as far as Goldman’s reputation, there’s not much to defend there.

Some Questions for President Obama’s Financial Crisis Probe Panel to Consider

Tomorrow, A Who’s Who of Wall Street executives, including the top honchos from Goldman Sachs, Morgan Stanley, and Bank of America will parade before a bi-partisan panel of 10 wise men and women appointed by members of Congress to determine the root causes of our country’s brush with economic collapse last year.  Speculation is rife that the commission could create initiatives as meaningful as the Glass-Seagall Act and the creation of the SEC which were headed by Ferdinand Pecora in the midst of the Depression. Regretfully, I’m skeptical that will be the case.

Although the U.S. was on the brink of economic disaster again in 2008, the stock market’s subsequent surge has given Americans a false sense of confidence.  Wall Street understands that investors have short memories and that their anger has subsided, hence the decision to pay themselves big, fat bonuses again. The fact that Timothy Geithner remains Treasury Secretary speaks volumes about how Washington still serves at the behest of Wall Street.

Nevertheless, the members of President Obama’s Financial Crisis Inquiry Commission (FCIC) are an impressive bunch, and I have no doubt they will ask some pointed questions and elicit some headline grabbing answers.  A good start would be for them to read today’s column in The New York Times by Andrew Ross Sorkin.  He identifies several important questions we’ve yet to get a clear answer on.

Nevertheless, I remain skeptical that this commission will have lasting impact.

A Beantown Slugger Worthy of Yankee Pinstripes

The New York Yankees these days have overtaken the Boston Red Sox as decidedly the best team in baseball.  There is, however, one bright spot in Beantown - a homerun regulatory slugger who is having a “career year.” His name is William Galvin.

Galvin, Massachusetts’ chief financial regulator, has established an impressive track record serving the best interests of investors.  His list of accomplishments is too numerous to mention here, but suffice it to say that he has been at the forefront of investigating and aggressively pursuing Wall Street wrongdoing, sometimes recovering as much as 100 percent of the losses sustained by Massachusetts investors. As I’ve repeatedly noted, Galvin’s complaint against Merrill Lynch regarding the firm’s marketing of auction rate securities ranks among the best primers on how Wall Street firms routinely put their interests ahead of their clients.

Galvin now has set his sights on Goldman Sachs’ weekly trading huddles, which I wrote about earlier this week. As reported by the Wall Street Journal, Goldman analysts routinely hold a weekly “trading huddle” to give “tips” to the firm’s traders and 50 most-favored clients, including SAC Capital Advisors and Citadel Investment Group.  Some of these tips are reportedly at odds with the published recommendations of Goldman’s widely disseminated research reports.

Galvin is the real deal and he already has some insight as to how Goldman treats its less-than-favored customers.  His agency has reached a settlement with Goldman regarding its peddling of auction rate securities, though the details are still being finalized.

It is my hope that in addition to examining the trading huddles, Galvin’s investigation will include the entire range of services Goldman provides its biggest clients and the criteria these firms use to evaluate these services.  Hedge funds have a fiduciary obligation to get the best execution on their trades and it might behoove Galvin and his people to investigate whether that is in fact happening.

As the saying goes, where there is smoke there is often fire, but that’s not always true.  If, after investigating Goldman’s huddles, Galvin concludes that no wrongdoing occurred, investors can take comfort in knowing that the practice was properly vetted.  Sadly, the same probably can’t be said about the investigations of the SEC and FINRA.