TOPICS > Economy

Was Record Settlement Against Goldman Sachs a Good Deal for Company?

July 16, 2010 at 12:00 AM EDT
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Accused by the Securities Exchange Commission of civil fraud, Wall Street behemoth Goldman Sachs agreed this week to a record $550 million settlement, but did not admit to or deny the SEC's allegations. Jeffrey Brown speaks with experts about whether the settlement was a victory for the company or for regulators.
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JEFFREY BROWN: And we turn to the fallout from that record settlement between investment giant Goldman Sachs and the SEC.

Goldman Sachs had emerged relatively unscathed from the mortgage market collapse. But, in some quarters, its eye-popping profits during the financial crisis made the firm a symbol of excess, culminating in a scathing congressional hearing this spring…

SEN. JOHN MCCAIN, R-Ariz.: There’s no doubt their behavior was unethical.

JEFFREY BROWN: … and a major case of civil fraud filed in April.

Yesterday, Goldman agreed to settle that matter. The Securities and Exchange Commission announced the investment bank will pay a record $550 million in fines and compensation to investors.

Robert Khuzami, the SEC’s director of enforcement, called the settlement a stark message to Wall Street.

ROBERT KHUZAMI, director of enforcement, Securities and Exchange Commission: That there will be a heavy price to be paid if firms violate the principles fundamental to the securities laws: full disclosure, honest treatment, and fair dealing. And those principles do not change, regardless of how complex the product or how sophisticated the investor.

JEFFREY BROWN: Goldman was accused of selling securities tied to subprime mortgages, but not telling investors it had consulted with a client who was betting the investments would fail.

Yesterday, the company conceded to having made a mistake, but in a statement added, “The firm entered the settlement without admitting or denying the SEC’s allegations.”

Still, Khuzami hailed the outcome.

ROBERT KHUZAMI: Today’s settlement sends a powerful message of deterrence and accountability.

JEFFREY BROWN: The SEC is continuing its case against Fabrice Tourre, a Goldman executive accused of shepherding the disputed transaction. And a federal criminal investigation against the company remains to be resolved.

In the meantime, the settlement in the civil case must be approved by a federal judge.

And we assess the outcome of all this now with Lawrence McDonald, managing director of Pangea Capital Management, a private investment fund management company, and author of the book “A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers.” And John Coffee, professor of securities law at Columbia University, he has served on advisory boards in the past to the SEC and the New York Stock Exchange.

So, Lawrence McDonald, it’s a complex subject, but a simple question to start. Who won this?

LAWRENCE MCDONALD, managing director, Pangea Capital Management: Oh, Goldman Sachs won. And I could have sworn I saw the CEO of Goldman Sachs doing a cartwheel down Park Avenue last night.

I mean, quite frankly, a $550 million fine is less than their charitable contributions in 2009. And it’s also less than the bonus pool of their top executives. So, it’s a big win for Goldman Sachs.

JEFFREY BROWN: John Coffee, what do you see?

JOHN COFFEE, professor of securities law, Columbia University Law School: Well, I disagree.

Every settlement is a compromise, and both sides have to give in at an intermediate position. I think the SEC got what they most needed. The SEC chose here to vindicate a principle more than to maximize the penalty. And that was sound.

If you go back to April, when this case was brought, most of the industry was protesting that the SEC was pushing the envelope and there was no obligation to make the disclosures the SEC wanted. Yesterday, Goldman did admit quite clearly that it made a mistake and that it made inadequate disclosure to its investors, and it had not told them that Paulson & Co. was really designing the portfolio that they said was designed by someone else.

Secondly, that — that is the principle. They have vindicated that, and that will be the template for future settlements. Now, in terms of the money, I understand this doesn’t satisfy the populist anger that is out there. But this probably covered most of the investor losses. That $250 million in the restitution fund will go to the principal European banks.

And if they think they have more losses, they can easily sue because Goldman is now very vulnerable, given the admissions it has made. Finally, if this case had gone to trial, I don’t believe the federal judge hearing the case, even if the SEC had won, would have imposed a higher penalty. The SEC got as much as they might get at trial by using their leverage, because Goldman really needed a settlement.

JEFFREY BROWN: Well, Mr. McDonald, what about that, especially the part about the principle? They won the principles is what Professor Coffee says.

LAWRENCE MCDONALD: Well, Professor Coffee is right in the sense that the SEC really needed victory here. They did not want to go 15 rounds and take a chance at hearing from the judges. So, they needed a victory.

And, if you think back to that 2007 period, Goldman Sachs was heading toward an iceberg at 160 miles an hour. So was Lehman Brothers. So was Bear Stearns. They hit a right full rudder. And when they did, when they hit that right full rudder, they missed that iceberg, but they were laying off a lot of toxic products onto their clients.

And on the global lecture tour that I have been on all over the world, the biggest question I get is, what is wrong with Wall Street? There’s too much proprietary trading. In other words, years ago, Goldman Sachs didn’t trade for their own account as much as they are today. Today, upwards of almost 70 percent of their profits are traded for their own account, trading almost against customers. That has to stop.

JEFFREY BROWN: So what are you — saying with you, Mr. McDonald, what do you make — the company didn’t admit fault, but they did say they would change some of these practices. Now, what does that mean to you?

LAWRENCE MCDONALD: Well, the good news here is, these 21st century financial products that are such a — you know, so complicated that people don’t understand, and a lot of them — I was on the trading flooring of Lehman Brothers in 2007, and these products were coming out every week. It was amazing to be there. Every week, there was a new invention, a new product.

And I think, going forward, Wall Street firms will think very carefully and there will be a very closely scrutinized origination product, a process of these new products.

JEFFREY BROWN: Well, John Coffee, the word that the SEC enforcement officer used was a deterrence to the rest of Wall Street. Is he right? Is there a case for that?

JOHN COFFEE: I won’t say that this is a financial deterrent. But $1 billion wouldn’t have been a financial deterrent. Even $2 billion wouldn’t have been the kind of deterrent that would have caused Goldman to stop in its tracks.

I think, however, the reputational loss here is humbling. Goldman has been embarrassed. There are many European clients that may not want to use its services, because it’s particularly been the European investors who were disadvantaged. And I think any time you have this kind of reputational penalty, it’s going to change your internal practices.

But I agree with the other speaker. There are immense new conflicts of interest arising in these complex derivative transactions and in these kind of synthetic derivatives particularly. And, in that world, I don’t think we yet have a good handle on whether these firms are adequately monitoring their conflicts of interests.

JEFFREY BROWN: And do you expect now that CEO Lloyd Blankfein and other top officials will stay in place? What do you make of that?

LAWRENCE MCDONALD: Well, I think…

(CROSSTALK)

JOHN COFFEE: My own guess is…

(CROSSTALK)

JEFFREY BROWN: Hold on. Let me ask Professor Coffee first.

LAWRENCE MCDONALD: Oh, excuse me.

JOHN COFFEE: My guess — my guess is that he probably will. You have to give something up. The SEC got what they wanted, was Goldman’s concession they made a mistake and didn’t make full disclosure. They didn’t demand any executive departure.

And, quite frankly, I don’t think the SEC is entitled to ask the CEO to be the vicarious insurer for conduct engaged in by staff at 10 or 15 levels lower. If the shareholders at Goldman want to replace Mr. Blankfein, more power to them. They don’t seem to.

And I don’t think the SEC can go after people who don’t seem to have been, in any conscious way, involved in the transaction.

JEFFREY BROWN: All right, Lawrence McDonald, you wanted to weigh in on that one?

LAWRENCE MCDONALD: Well, yes.

One of the things I talked about in my book “The Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers” is, during that period of our CEO — our CEO’s tenure was about 15 years. So, it was almost like a monarchy.

At Goldman Sachs, during that same 15 years, where we had one CEO, they had almost — I think they had six. So, you had a real change at Goldman Sachs. Goldman Sachs tends to — you know, when they run into difficulties, they tend to change their top management team. I think Mr. Blankfein’s days could be numbered, only because they will try to put a good face forward, and the public backlash of Wall Street and Goldman Sachs still might linger, and they might use that card to move forward.

JEFFREY BROWN: Now, Lawrence McDonald, what — what do you expect next going forward? I mean, is — do we look for the SEC to bring some cases against other companies for similar practices, or was this sort of the top of the wave here?

LAWRENCE MCDONALD: Oh, there is no question. Goldman Sachs was actually a third-tier player in these kind of synthetic CDOs. Other firms were much more active. And I think you will see things there in terms going after the other firms on these toxic products.

But, more interestingly, I can give you some — I can break some news tonight. Behind the scenes, I think the big fish that the SEC wants is Lehman Brothers. Lehman Brothers’ bankruptcy is 10 times the size of Enron. It’s bigger than Enron, WorldCom, Adelphia combined. And I’m hearing behind the scenes, the SEC, the FBI, and the Justice Department are active in going after Lehman Brothers executives.

And I think that the Lehman Brothers executive team have been interviewed in the last several weeks. So, I think that could be the big fish, kind of what is behind curtain number three.

JEFFREY BROWN: What do you see, John Coffee? You see strong new enforcement measures from the government?

JOHN COFFEE: There’s no question that the SEC has a more activist and more zealous Enforcement Division than say three or four years ago.

The real problem, however, is that the SEC right now is the most overworked agency in Washington. And, in yesterday’s legislation, they got required to conduct maybe 30 or more studies, plus adopt rules in 25 to 30 different areas. And they didn’t get the budgetary reforms they were hoping for. So, they don’t have the full funding they want.

And they’re going to be working a 24-hour-a-day regime at the SEC over the next year. So, I think there will be further enforcement cases, but I have to say that their time is going to be divided among many, many different responsibilities.

JEFFREY BROWN: Yes, that’s something we have talked about, you have talked about on this show over the years, is just this resource question, right, for the SEC.

JOHN COFFEE: That is the critical question. It takes money to litigate. And that’s why you have to settle, because you can’t afford to take every case to trial.

JEFFREY BROWN: And, meantime — in the meantime, Lawrence McDonald, before we end, whither now, what happens to Goldman Sachs? They go on. You think possible shakeup at the top, but what happens?

LAWRENCE MCDONALD: Well, they move forward. And it’s a breath of fresh air that they can kind of put this behind them.

They’re — you know, they’re the best and the brightest. That’s the firm everybody strives to really challenge. I mean, they have the most market share in all the big product lines. So, I think, now that they can put this behind them, I think that the business will be back to normal in most of the product lines.

But, you know, getting back to the SEC, I have to say, in 2007, Mary Schapiro admitted recently — and she’s the head of the SEC — we only had 27 people overseeing these big investment banks. And I think it’s a breath of fresh air to see more talent at the SEC and a more robust team looking at these big, big, giant pieces of risk.

JEFFREY BROWN: All right, Lawrence McDonald, John Coffee, thank you both very much.

JOHN COFFEE: Thank you.

LAWRENCE MCDONALD: Thank you