Thinking through the Goldman Sachs charges
April 17, 2010 4:04 AM   Subscribe

If I am a stockbroker whose clients have invested in Coca-Cola (for whatever reason), am I now guilty of a conflict of interest if I recommend to one or more clients (for whatever reason) to short it? if I sell Coke short in my own account? Don't the personal views and personal goals of the clients enter into this equation?
posted by yclipse to Work & Money (12 answers total)
 
well two things - the relationship between a stockbroker and his clients is different than the one between Goldman and a 'qualified investor' which is a term of art used to say someone is a big boy and can watch out for themselves. So wrt to the title of this question the answer is no for a very simple direct reason - there is no fiduciary relationship.

WRT to your actual question it is a much grayer area but despite stockbrokers having a fiduciary responsibility in most cases what you have suggested is legal. For example I could recommend to client one who is only interested in LT Buy and Hold investing to own KO and have another client who wants to trade all the time whom I suggest short KO around a certain event or something like that. I probably have some sort of research that suggests both ideas make sense. I also have tons of disclaimers in my marketing materials suggesting I might do this. What would be illegal would be suggesting to a client a position because it would enrich me or another client unfairly (I.e. having client A buy something worthless from Client B because Client B is a better client).
posted by JPD at 4:41 AM on April 17, 2010


I think you've misunderstood the nature of the SEC's allegations. The SEC has alleged that Goldman Sachs materially misstated and omitted facts in disclosure documents for a synthetic credit default obligations (CDO) product it originated. The allegation is that Goldman misrepresented to investors that an objective third party (ACA Management) had assembled the mortgage package underlying the CDO's when, in fact, a large hedge fund (Paulson & Co) with economic interests directly adverse to investors had a major role in assembling the mortgage package. The SEC claims that the hedge fund specifically inserted mortgages that it knew were very likely to default so that it could make money by shorting those same CDO's.
posted by RichardP at 4:50 AM on April 17, 2010 [1 favorite]


"Conflict of interest" means a situation where two sets of interests are in conflict. In the stockbroker example, this might for example mean that you recommend that your client (say) sell something short because you will personally profit if they do (except of course from taking a normal and proper fee for giving advice, or setting up the sale or whatever). If you think that it will profit your clients to sell something short, and you don't have a personal interest in the outcome, it's probably your professional duty to advise them to do so. Disclaimers: I have not taken into account any law about shorting; IANASB (stockbroker).
posted by Logophiliac at 4:58 AM on April 17, 2010


I think you've misunderstood the nature of the SEC's allegations. The SEC has alleged that Goldman Sachs materially misstated and omitted facts in disclosure documents for a synthetic credit default obligations (CDO) product it originated. The allegation is that Goldman misrepresented to investors that an objective third party (ACA Management) had assembled the mortgage package underlying the CDO's when, in fact, a large hedge fund (Paulson & Co) with economic interests directly adverse to investors had a major role in assembling the mortgage package. The SEC claims that the hedge fund specifically inserted mortgages that it knew were very likely to default so that it could make money by shorting those same CDO's.

The also misrepresented to ACA the nature of Paulson & Co's economic interest in the CDO. As a result of this ACA was willing to listen to Paulson's input on security selection. To me this is more damning than telling investors ACA was the manager (which was correct from a legal standpoint)
posted by JPD at 5:43 AM on April 17, 2010


The alleged fraud isn't that Goldman believed the synthetic CDO tranches it was selling were bad investments. That happens all the time on Wall Street, and even on Main Street. A broker's duty is for a client's investments to be "suitable," which is a very different thing.

The alleged fraud isn't that Goldman got paid by Paulson to structure the CDO knowing Paulson planned to bet against it. (If it were, Paulson would have been sued, too.)

Where the complaint is unclear is whether the SEC believes that failing to disclose Paulson's role was, itself, fraudulent. I think the answer is no, because if the SEC believed that it could have added Paulson in as a conspirator on that count.

The fraud clearly alleged instead, is this: Goldman knew investors wouldn't buy without ACA's endorsement, and Goldman knew ACA wouldn't accept input from Paulson if it knew Paulson was buying protection against rated tranches of the CDO -- a position that would pay off if the reference RMBS of the CDO performed worse than expected. Goldman allegedly resolved this dilemma by lying to ACA and saying that Paulson was taking a 180-degree different position: buying the CDO's equity tranche -- the piece of the deal that pays off only if the RMBS perform better than expected.

For the moment, the SEC seems not to have evidence that Paulson knew of this lie, or, once again, Paulson would have been sued.
posted by MattD at 6:41 AM on April 17, 2010


Why would Paulson knowing about the lie matter? He's not selling anything to anyone. If he lied to ACA that's one thing but just knowing GS lied? Isn't that a bit of a tough arguement? Its moot anyway as the enforcement head of the SEC specifically said Paulson was not part of the investigation.
posted by JPD at 6:49 AM on April 17, 2010


If I am a stockbroker whose clients have invested in Coca-Cola (for whatever reason), am I now guilty of a conflict of interest if I recommend to one or more clients (for whatever reason) to short it? if I sell Coke short in my own account? Don't the personal views and personal goals of the clients enter into this equation?

The short answer to your question is this: the allegations against Goldman Sachs are not really comparable to the hypothetical you've posed, and, in any event, a good lawyer will say to any such question: "it depends."

The ultimate fate of this allegation will turn, in part, on the extent to which Goldman's very high-priced lawyers can make mincemeat out of the government's allegations.
posted by dfriedman at 7:17 AM on April 17, 2010


The alleged fraud isn't that Goldman believed the synthetic CDO tranches it was selling were bad investments. That happens all the time on Wall Street, and even on Main Street. A broker's duty is for a client's investments to be "suitable," which is a very different thing.

For whom would a bad investment be "suitable"? A client actively seeking a falling asset for tax reasons?* In which case, is it legal to market investments as "Can't Win!"?

*(Pretty hard to imagine, but never underestimate a financial planner and the tax code)
posted by IndigoJones at 11:36 AM on April 17, 2010


There are risky investments with high returns and safer investments with lower returns. (*) A good adviser will recommend the correct balance of risk and return for each client - a retiree will likely prefer a regular income stream; someone with a longer time scale will likely prefer riskier investments that will provide a higher average rate of return.

(*) In the hypothetical world of perfect knowledge and perfect liquidity there are no bad investments. Every investment adjusted for risk will give the same return. In the real world there are certainly bad investments, but those are the ones where the risk is not balanced by a higher return, or where the return is too low even for a safe investment.
posted by Joe in Australia at 5:27 PM on April 17, 2010


Fair enough, and fairly boiler plate. But we are talking about a broker who was selling a vehicle so risky that the guy who put it together was betting against it. Hard to make the case that this was suitable for anyone. Full disclosure was at least warranted.

As to Paulson, well, for his sake, one can hope that no Russian mobsters bought that particular bill of goods.
posted by IndigoJones at 1:09 PM on April 18, 2010


But we are talking about a broker who was selling a vehicle so risky that the guy who put it together was betting against it. Hard to make the case that this was suitable for anyone.

There is always someone betting the other side of a deal. The fraud is that the opposing "bettor's" position was totally and willfully misrepresented by GS. The fact that he was betting against it wasn't the problem.
posted by jckll at 12:53 PM on April 19, 2010


There is always someone betting the other side of a deal.

Not necessarily. There are offers that have to be repriced due to underwhelming market demand. And there's stuff you can't give away at any price. Not unless you doll it up and turn back the odometer and neglect to mention the week it spent at the bottom of the Mississippi and get a third party to certify that it's a pip that was owned by a little old lady who only drove it to church on Sundays.

Okay, maybe there still would be buyers. But I'm guessing that if buyers had known just how toxic the stuff was (information held back from them but well known to Paulson, since he packaged the damn things), they would have offered a fraction of what they actually paid.

At which point, Paulson could not have made the billion dollar one way bet against them.

Too many people in this one saying "It wasn't me, it was someone else".
posted by IndigoJones at 2:49 PM on April 22, 2010


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