Goldman's Gold

The views expressed in this column are those of the author and not SVB Financial Group.

It is with some temerity that I put fingers to keyboard to write about Goldman Sachs' recently settled legal dispute with the SEC. If you recall, in May the SEC charged the firm with fraud in the brokering of a synthetic collateralized debt obligation with the catchy name, CDO Abacus 2007-AC1. The last time I touched this topic (see A Nation of Losers, May 2, 2010) a few readers took umbrage with my analysis telling me that I "should be ashamed of myself" and hoping that "Goldman would go bankrupt and all their partners to jail."

It was clear that with the political and major media spinmeisters in high gear, Goldman had become a popular demon at the heart of the financial contagion. My view at the time was that the fraud case against the firm was mostly a politically motivated attack to help promote the pending financial reform legislation. I predicted that Goldman would ultimately pay a "meaningful fine" and move on without "admitting or denying any wrongdoing" in the customary language of Wall Street misdeeds.

In the event, Goldman agreed to pay a fine of $550 million which, as an all-time record for these types on fines, certainly is meaningful. On another measure it pales a bit as the total equals a mere 3.7 percent of Goldman's net profit for the trailing 12 months ended March. In the June quarter its profits dropped a satisfying (at least to promoters of the demon Goldman narrative) 83 percent. We cannot help but wonder if its exceptional profitability had become too obvious a target and it told the team to take it down a notch and let Morgan Stanley take the heat for a few quarters.

As to not "admitting or denying any wrongdoing," my crystal ball clouded a bit. Goldman admitted to violating subsection 17(a) (2), which prohibits the sale of a security or a derivative if a material omission renders the sale "misleading." Without the whopping multi-million dollar fine Goldman essentially admitted to a clerical error in the presentation material for Abacus 2007-AC1. Whether correcting this error would have changed the unfortunate consequences for some investors is debatable.

In the settlement language all references to Section 10(b) of the Exchange Act and Section 17(a) of the Securities Act which cover fraud and intent to defraud have been dropped. As we saw last May, proving intent to defraud would be difficult because they would need to relate it to the actual results for Goldman itself, which was a loss of $100 million. The absence of fraud may also preclude any further civil action by aggrieved third parties.

Once again the timing of the settlement is interesting. If there really was a case for fraud, why did the political appointees at the SEC toss in the towel so quickly? And whatever happened to the rumors of a criminal indictment similar to the one that brought about the demise of Arthur Andersen? (Don't forget that Andersen was ultimately exonerated by the Supreme Court more than a year after the firm was destroyed by that regulatory excess.) As I see it, there are two possibilities. First, the case was built on something other than the essential facts needed to prove fraud under the Exchange Act or the Securities Act. Second, with the Financial Reform Bill passed and on the books and election day rapidly approaching, it was time to kiss and make up with a firm that has been a stalwart Democratic Party campaign contributor for decades.

There is unfortunately one difficult human loose end here. That is the situation of Fabrice Tourre, the relatively junior Goldman VP who is still in the legal hot seat. Readers of these pages will note that I have been frequently disappointed by regulatory fecklessness in cases like this where the guilty firm pays a fine as a small cost of doing business and the individuals that perpetrated the deed simply go back to work as if nothing had happened. Let's be clear on one thing. As fabulous as Fabrice may have been, he is not the miscreant we are referring to here. No one at Goldman or any other firm puts this magnitude of capital at risk without approvals from the very top. Let's hope we do not discover some months from now that the SEC required a body to prosecute to protect their political backside and that Goldman threw their man overboard to close the deal.

Finally, we also note that the fine will be split two ways. First, $250 million is slated for investor restitution and will go to the two foreign banks in the deal with the voracious appetites for more exposure to U.S. subprime mortgages. The remaining $300 million will drop into the SEC's coffers and will hopefully be used to hire attorneys that can put together serious prosecutions that will not unravel in a few months.

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