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Aug 13, 2010
by Don Azarias
In one of my previous columns dated May 22, 2010, I wrote about the Securities and Exchange Commission’s (SEC) filing of civil fraud charges against Goldman Sachs & Co., the largest Wall Street’s brokerage firm, for misleading investors who purchased mortgagerelated securities. The civil charges the SEC filed on April 16 were the most significant legal action related to the mortgage meltdown that caused the country’s economic crisis.
Consequently, it resulted in the federal government’s plan to file a criminal fraud charges against Goldman, through the Justice Department. The SEC says Goldman broke the law and committed fraud when they sold clients a complex investment linked to the value of home loans that was secretly designed to fail. Another firm, Paulson & Co., a hedge fund, helped Goldman create the investment and planned to bet against it. The SEC says the relationship was not disclosed to Goldman’s clients, ACA Financial Guaranty and the German bank IKB. The investments were devised with input from a Goldman client who was betting on them to fail. The securities cost investors close to $1 billion while helping Goldman client, Paulson & Co., capitalize on the housing bust.
The Justice Department opened a criminal investigation of Goldman’s illegal business transactions as recommended by the SEC. The Justice Department typically investigates high-profile cases of securities fraud, but the threshold for criminal prosecution is significantly higher than that of civil cases, and such investigations are highly complex. The prosecution has the burden of proof in presenting evidence that the defendant is guilty beyond reasonable doubt. Failure on the prosecution’s part to do so could result in the defendant’s acquittal. However, in a civil case, the so-called “preponderance of evidence” is enough to convict a defendant.
For the readers’ information, the threat of criminal prosecution can ruin a business. We can still recall that a criminal case spelled doom for the Wall Street firm, Drexel Burnham Lambert, in the 1980s, even though it settled the case with the government. Well, I think Goldman decided that it doesn’t want to be hit with a double whammy by the federal government in the form of both, civil and criminal charges, at the same time that it decided to settle the civil fraud charges with the SEC to get it out of the way. The settlement came on the same day that the Senate passed the stiffest restrictions on banks and Wall Street since the Great Depression. Executives of the firm were grilled and publicly rebuked by senators at a politically-charged hearing.
The SEC announced that Goldman will pay $300 million in fines and $250 million in restitution, totaling $550 million to settle civil fraud charges. Goldman did not admit or deny wrongdoing in the suit, which alleged the firm misled investors. A federal judge in the Southern District of New York still has to approve the settlement. Surprisingly, no charges were filed by the SEC against Paulson & Co. Under the proposed settlement, Goldman would pay back the $15 million in profit it made from the Abacus deal and also pay a civil penalty of $535 million. The money would be given to the two banks that had incurred losses on the deal $150 million to IKB Deutsche Industriebank and $100 million to the Royal Bank of Scotland Group with the rest, $300 million, going to the United States Treasury as a fine. The settlement also requires Goldman to review how it sells complex financial mortgage investments. Goldman acknowledged in a court filing that its marketing materials for the deal at the center of the charges omitted key information for buyers.
The government ordered that, from now on, Goldman’s marketing materials for some mortgage securities would need to be approved by outside authorities. Also, Goldman employees would need extra training in those investment areas. The firm’s officials said that they are conducting a “comprehensive, firm-wide review of its business standards.”
The penalty appeared to be the largest ever imposed on a Wall Street financial institution. But, in reality, the settlement amounts to less than 5% of Goldman’s 2009 net income of $12.2 billion or a little more than two weeks of net income. Goldman’s first-quarter earnings this year were $3.3 billion.
While the SEC hailed the $550 million settlement as the largest in Wall Street history, many outside analysts questioned why the government didn’t demand more. Investors responded favorably as Goldman Sachs shares jumped by five percent in late trading, adding far more to the firm’s market value than the amount it will have to pay in the settlement. It would seem to suggest that Goldman, ultimately, was the winner in this debacle.
“This settlement is a stark lesson to Wall Street firms that no product is too complex, and no investor too sophisticated, to avoid a heavy price if a firm violates the fundamental principles of honest treatment and fair dealing,” said Robert Khuzami, the SEC’s enforcement director. The settlement is subject to approval by a federal judge in New York’s Southern District. The Justice Department move against Goldman is a calculated one.
It has pitted the culture of Wall Street against the nation’s chief executive and lawmakers in an election year. In the wake of the financial crisis that plunged the country into the most severe recession since the Great Depression of the 1930s’ it only proves one thing: That those politicians from the White House and Capitol Hill are really shrewd when it comes to saving their own thick skin. In addition to the $2 billion so-called collateralized debt obligation (CDO), that is the focus of the SEC’s civil charges against Goldman, the subcommittee analyzed five other such transactions, totaling around $4.5 billion. The panel concluded that Goldman dumped toxic mortgage securities into the bloodstream of the financial system.
For the readers’ information, a CDO is a pool of securities, tied to mortgages or other types of debt, that Wall Street firms packaged and sold to investors at the height of the housing boom. Buyers of CDOs, mostly banks, pension funds and other big investors, made money off the investments if the underlying debt was paid off. But as U.S. homeowners started falling behind on their mortgages and defaulted in droves in 2007, CDO buyers lost billions.
Then the housing bubble burst. And then came the Great Recession that was triggered by the sinister moves made by those Wall Street “bright boys”, who ended up getting richer while ordinary taxpayers, like us, are stuck to bear the brunt of the economic downturn. Those Wall Street financial institutions are evil at times. They have shown that they only care about their bottom line at the expense of big and small investors. The government should prosecute and mete out punishment on them to the fullest extent of the law. Anything less would be a travesty of justice .