In the wake of the Securities and Exchange Commission's announcement that it has settled its case against Goldman Sachs, experts are divided about who exactly comes out ahead in the proposed deal. For its part, the SEC, which is trying to revive its reputation as a watchdog after it largely fell asleep at the switch in the years leading up to the recession, is touting the settlement as a landmark victory. Notably, Goldman has agreed to pay $550 million, which would represent the largest fine the SEC has ever levied against a Wall Street financial firm. "This is a very significant, healthy victory for the SEC," says Michael Greenberger, a professor at the University of Maryland School of Law.
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Still, other observers have been lining up to say that Goldman got off easy. "The $550 million is just a drop in the bucket for Goldman Sachs," says Jacob Zamansky, the founder of the New York-based financials and securities law firm Zamansky & Associates. Consider the following: Last year alone, Goldman's profits amounted to $13.39 billion. That translates into $36.7 million per day. Meanwhile, Goldman's stock price has soared since the settlement was announced on Thursday. At the close of trading on Wednesday, Goldman's market capitalization was roughly $71.6 billion. By noon on Friday, it had grown by $5 billion to $76.6 billion. Finally, many had expected that Goldman would have to pay somewhere in the neighborhood of $1 billion to settle. "This was a business decision and a check that they could easily write," Zamansky says of the settlement.
The stickier question involves what, if any, legal and regulatory ramifications the settlement, which is still tentative until a federal judge signs off on it, would have. One the one hand, Goldman has conceded that it made a "mistake" and provided investors with "incomplete information" in the course of packaging synthetic collateralized debt obligations. Namely, Goldman had represented to its clients that an independent third party had picked securities for the deal when in fact, according to the SEC, hedge fund manager John Paulson had been the driving force behind the selection process.
But Goldman has stopped short of admitting to fraud. In other words, Goldman, which in all likelihood still faces a bevy of civil lawsuits even now that the SEC's is largely out of the picture, got to play its cards close to its chest, admitting to very little that will be useful to plaintiffs in future cases. "It doesn't increase their exposure at all," says Adam Pritchard, a securities law professor at the University of Michigan Law School. Pritchard says the outcome could have been worse had the case actually been tried in court. "If it had gone to judgment and there had been a finding that there had been [fraud], Goldman would have had a problem," he says.
While this type of "guilt free" resolution is par for the course when the SEC settles with businesses, some say it leaves much to be desired. "The SEC, to their credit, brought a challenging case, raised a significant issue for Wall Street, and diminished Goldman's luster. But they never finished the job," says Zamansky. "That's the problem in my view with the SEC. They let people off with fines that are just the cost of doing business, and they never require an admission of liability."
In terms of regulation and deterrence, though, experts say there's a good chance that the precedent will be meaningful. "While Goldman, as is usual, didn't admit any wrongdoing except for having made a mistake, a civil penalty of this size is definitely a substantial marker and a warning as to how the SEC will hold Wall Street accountable for conduct of this nature," says Greenberger. Adam Sussman, the director of research for the TABB Group, a financial-sector research and advisory firm, says the case also helped establish a benchmark for how much firms will have to pay if charged with similar offenses. "Now there is a price tag for having conducted that type of behavior," he says. "This will set the tone for any other future cases with similar activities."
The settlement stems from the government's allegations that Goldman misled investors. The Goldman product that the SEC has targeted is quite complex. Known as ABACUS 2007-AC1, it is the result of years of evolution in the synthetic investment market. But the underlying theory is quite simple.
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Gary Kopff, a mortgage expert and the president of Everest Management, uses the example of wheat. "Two parties get together. One says, 'I think the price of wheat is going up.' The other says, 'I think the price of wheat is going down,'" he explains. "Neither party owns any wheat."
With the Goldman case, of course, the big difference was that investors were instead betting on mortgages. And since the investment products were synthetic, investors were able to place bets on the direction of the housing market without actually owning any physical mortgage bonds.
In arranging these deals, one of Goldman's roles was that of matchmaker. In other words, it was Goldman's job to find some investors who thought that the housing market would stay healthy and others who thought it would tank. Goldman would then pair the two sides up in a transaction.
"Acting as a swaps dealer, Goldman has a commodity. And in order for it to earn a fee for that commodity going out into the marketplace, it has to put together the short side and the long side. So it has to be simultaneously in possession of the names of bona fide longs and shorts," says Kopff. Using a gambling metaphor, he says, "In that sense, [Goldman] has a duel incentive. It wants some people to go short and some people to go long, because it's basically like the house. It's making money as long as it pairs up the longs and shorts."
The question then becomes: When should we blame the house? The most obvious answer is that the house could be at fault when the deck is stacked against some of the bettors.
In the Goldman case, this issue is particularly relevant. Notably, the SEC charged that Goldman let Paulson essentially hand pick mortgage bonds he thought were doomed to fail. Goldman then created a vehicle where investors could get synthetic exposure to those bonds.
Paulson, of course, effectively shorted the housing market by betting against the bonds, but there were also investors on the long side of the deal in question. The SEC alleged that Goldman, in its role as matchmaker, never told these investors that the bonds they were getting exposure to were chosen because a prominent manager thought they were poised to implode. Instead, according to the SEC, Goldman represented that an independent third party had handled the selection.
Goldman was hardly the only firm to package deals like this. As a result, Greenberger sees the SEC's case against Goldman as the first of several that will involve large Wall Street institutions. "The SEC has a lot of other fish to fry," he says. "This is not going to be the only case that they're going to bring."
Still, Zamansky says the settlement sends the wrong message. "If you write a check to the SEC, they go away, and that's not a good message for Wall Street," he says. Sussman takes the middle ground. "I think it was kind of a win-win for both the regulators and for Goldman," he says. "Goldman can move ahead with a lot less regulatory uncertainty, and [the SEC has] landmark dollar figure."
Also curious is the timing of the settlement. The SEC announced the agreement on Thursday, the same day that the Senate gave the key nod to the overhaul of the financial system. "Interesting timing would be my main thought," says Pritchard.
"The goal of the enforcement action was to create publicity that would give a push to financial reform," he continues. "It worked."
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