Despite all the sound bites and the high profile hearings we have seen in Washington DC, there is still a high degree of confusion over one issue. What level of responsibility does Goldman Sachs (GS) have towards its clients?
Is it a broker or an investment advisor?
At issue are two differing definitions of the duty a Wall Street firm like Goldman Sachs owes to it clients. One view is that Goldman is an investment advisor, and thus, is required to act as a fiduciary or steward. A fiduciary is required to look out for the best interests of its clients. Another view is that Goldman is just a brokerage firm and thus held to much looser standards. That is, it is just required to carry out transactions at the direction of clients, and is not really obligated to disclose its own interests or conflicts in a given transaction.
Why I left a Wall Street firm
As a fee-only investment advisor, this is an important issue to me. And, as a former broker at Merrill Lynch, I am somewhat familiar with the inner workings of a Wall Street firm. Brokerage firms love to talk about their devotion to clients, but that devotion is often forgotten in the rush to sell financial ‘products’ that make money for the firm and its brokers. In fact, that issue — pressure to push poor financial products — is what caused me to leave Merrill Lynch 27 years ago. Now, we are seeing another iteration of this conflict.
Here is a MarketWatch report that gave one Senator’s rather jaundiced view of Goldman’s actions [emphasis added]:
…Goldman sees clients not as valuable customers but as “objects” for making profit, Carl Levin, chairman of the Senate’s Permanent Subcommittee on Investigations, said at the start of the hearing.
The firm’s conduct of betting against mortgage-related securities that it sold to clients “brings into question the whole function of Wall Street,” Levin said. Wall Street used to be an “engine of growth,” betting on America’s successes, not its failures, he added.
Goldman’s cause wasn’t helped later in the hearing when former and current bankers at the firm disagreed on whether it has a duty to act in the best interests of clients…
Another MarketWatch piece highlighted the confusion among high level Goldman executives on this issue of the firm’s duty to its clients:
Former and current bankers at Goldman Sachs Group Inc. disagreed Tuesday about whether the firm has a duty to act in the best interests of its clients, during a hearing Tuesday of the Senate’s Permanent Subcommittee on Investigations.
Sen. Susan Collins asked the question to Dan Sparks, former head of the mortgages department at Goldman... He paused briefly, then said: “I believe we have a duty to do well for our clients.”
Collins asked the same question to Joshua Birnbaum, a former managing director in structured products group trading at Goldman. Birnbaum said Goldman has such a duty and has fulfilled that duty.
Collins asked the question to Fabrice Tourre, executive director in structured products group trading at Goldman. He said the firm has a duty to serve clients in its role as a market maker by providing liquidity. “I do not believe we act as an investment adviser to our clients,” Tourre added…
Obviously, these three executives have not exactly gotten their messaging straight, as they all have different opinions as to this critical issue.
This distinction is of fundamental importance to anyone who is a client of a Wall Street firm. These are often very large and diverse financial services firms that have — wittingly or unwittingly — blurred the distinction between the standard of responsibility a firm has as a broker versus the requirements of an investment advisor. These firms like to tout their brilliant and objective advisory capabilities in marketing brochures, but when pressed in a hearing, they tend to fall back on the much looser standards required of a brokerage firm, which could be expressed like this:
Well, the firm made money and the traders made money. Two out of three ain’t bad, right?
The third party referred to indirectly would be the clients who, all too frequently, are left out of the equation.
And, this distinction between a broker versus an investment advisor can be very confusing at Wall Street firms because these large firms have internal investment advisory groups that are required to act as fiduciaries. However, these firms also have many brokerage and trading operations that are not required to act as fiduciaries. Typically, the troubles come from the brokerage or trading side of Wall Street.
So, Just because you are dealing with Goldman or Morgan Stanley (MS) or Merrill Lynch (MER) that does not mean they are acting in your best interest. As the buyer of investment advice from Wall Street, you may want to remember the old adage ‘Let the buyer beware.’
Disclosure: No positions