It’s not easy to parse a one-sentence statement, but Goldman’s declaration that “the SEC’s charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation” seems ill-advised to me, mainly because it’s so obviously untrue. It might be hard to successfully prosecute Goldman — they have a lot of very expensive lawyers, and securities law is murky at the best of times. But there’s enough in the way of smoking guns in the SEC’s complaint that it’s ridiculous to say that it’s “completely unfounded in fact”.
It makes a lot of sense here to do the old-fashioned thing and follow the money. Why was ACA so quiet about the fact that it wasn’t really picking the securities in the CDO it was nominally managing? Because it was being paid millions of dollars for its silence. And why was Goldman so happy to do Paulson’s bidding? Just look at the complaint.
The deal closed on April 26, 2007. Paulson paid GS&Co approximately $15 million for structuring and marketing ABACUS 2007-AC1.
Even by Goldman standards, that’s real money. But the fact is that the investors in the deal had every right to know who was paying the piper — and Goldman went to great lengths to keep that fact secret.
Goldman can and almost certainly will mount a legalistic defense here; Henry Blodget does a good job of glossing what it might look like. Essentially, he says, it’s reasonable to say that ACA picked the securities in the CDO, because it picked them from a list compiled by Paulson. Paulson, of course, having come up with the list in the first place, didn’t really mind which of the securities ACA picked: the game was already rigged by that point, and ACA had no more control over the final outcome than the guy up on stage being asked by the magician to “pick a card”. So long as ACA was playing on Paulson’s field, they were certain to end up losing the game.
But the problem for Goldman here is that even if this kind of defense stands up in a court of law, it’s not going to hold much water with the firm’s precious client relationships. Stephen Gandel has a good take on the whole affair:
Does this end Blankfein’s reign as head of Goldman? I think so. It’s a big deal for an investment bank to be charged with securities fraud. And it is not just a coincidence that Goldman would get hit with a fraud case when Blankfein was CEO. Even though he is not named in the complaint, Blankfein is to blame. He pushed the firm to become less of an investment bank and more of a trading behemoth. And this is the result: A brilliant trade that was so brilliant the Goldman people forgot that it also might be fraud.
Goldman talks ad nauseam about how everything it does it does for its clients, and how any profits it ultimately ends up making are just a result of being “long-term greedy”. But if it attempts legalistic hair-splitting about how its behavior in the Abacus case was technically not illegal, it’s just going to end up looking even more culpable in the eyes of its clients. Goldman, if it was behaving honorably here, would have been open about the whole truth of what was going on. It would have revealed Paulson’s role in structuring the deal to IKB and other investors, and it would have revealed Paulson’s short position to ACA. Instead, it played IKB and ACA for suckers. And that’s just not the kind of behavior that Goldman likes to think that it engages in.
It’s possible, pace Gandel, that if Blankfein goes, that might help placate Goldman’s clients. But I doubt it. The firm is run by traders now, and replacing one trader with another will not make any difference. And Blankfein’s culture is exactly the same as that of just about anybody who might replace him.
In any case, it seems to me that Goldman owes its clients and the public a massive apology. Blankfein has already said that Goldman “participated in things that were clearly wrong and have reason to regret”; he should make it clear that Abacus falls into that category. Instead, he’s trying to brazen it out, and is saying that the SEC’s charges are “unfounded in fact”. That might make sense from the point of view of a legal strategy, but it doesn’t make sense if he’s trying to rescue what remains of his and his firm’s reputation.