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Are we really surprised about Goldman's admission?


For years, Wall Street whispered that Goldman Sachs profited handsomely by trading ahead of -- or even against -- its own clients.

On Tuesday, a Goldman executive made an unusual admission that, in some cases, the rumors were true.

In an e-mail message to select clients, Thomas C. Mazarakis, the head of Goldman's fundamental strategies group, acknowledged that his unit often provided investment ideas that the firm had already traded on. Sometimes Goldman has even taken the opposite approach, betting against particular instruments that the group has recommended.


"We may trade, and may have existing positions, based on trading ideas before we have discussed those trading ideas with you," he wrote.

The statement comes as the firm faces growing criticism over its role in the financial crisis, and is a rare acknowledgment of Goldman's conflicts with certain of its clients.

"The way that the business is evolving is that it is laden with conflicts of interest," Anant K. Sundaram, a professor of finance at Dartmouth's Tuck School of Business, said.

Last month, the Securities and Exchange Commission and Congress began investigating how Goldman and other firms had created bundles of mortgages known as collateralized debt obligations, or C.D.O.'s, that were sold to investors at the same time that the banks had privately bet against the instruments. Some of these C.D.O.'s later fell in value, creating losses for those clients who bought them -- and profits for Goldman.

Goldman also prevailed upon ratings agencies to assign the C.D.O.'s high investment grades, even as it planned to short, or bet against, the securities.

The e-mail message is a blunt acknowledgment of what often appeared in the fine print of Goldman's marketing materials. Lucas van Praag, a Goldman spokesman, said in a statement: "We have been providing this disclosure, which we think is best practice, for a number of years and there is nothing new in the disclosure you were sent."

But Mr. Mazarakis's letter also highlights the enormous clout wielded by Goldman's army of traders, many of whom make enormous bets using the firm's own capital and who provide the bulk of the firm's immense profits. Goldman insists that its trading business is done on behalf of its clients.

Since the firm went public in 1999, traders have come to dominate Goldman's mix of businesses, overshadowing the firm's traditional investment banking practice. Both its chief executive, Lloyd C. Blankfein, and its president, Gary D. Cohn, rose from the traders' ranks.

Unlike Goldman's equity research department, which issues buy and sell recommendations about specific stocks, the fundamental strategies group's primary job is to supply investment ideas to the firm's own traders. (Still, Goldman attracted scrutiny last year for "huddles" that its research analysts held with the firm's traders, information that it only later shared with clients, if at all. That has prompted inquiries by regulators like the Financial Industry Regulatory Authority into how banks distribute their research.)

But the fundamental strategies group also disseminates some of those strategies to select Goldman clients, typically big institutional investors and hedge funds. Because of its role, the unit does not have to conform to the traditional rules governing equity research departments.

Under federal rules, research analysts cannot mislead clients by promoting stocks that the analysts privately do not believe in or that the firm has a vested interest in. Research analysts are also prevented from providing information to their firms' own traders before disseminating their reports more broadly.

But according to clients who receive notes from the fundamental strategies group, Goldman does not always disclose its own positions when it shares its trading ideas.

Mr. Mazarakis's e-mail statement was clearly meant to reinforce Goldman's conflict-of-interest policy and head off any legal liability. "As part of our commitment to managing conflicts of interest appropriately, this message is to explain how the Fundamental Strategies Group interacts with other parts of our organization and how that impacts on the Trading Ideas," Mr. Mazarakis wrote. Mr. van Praag said the language in the message had been vetted by the Financial Services Authority in Britain.

But Mr. Mazarakis makes clear that when it comes to his unit's advice, the firm comes first. "We may continue to act on trading ideas, and may trade out of any position, based on trading ideas, at any time after we have discussed them with you," he wrote.