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HUDDLEGATE, DAY 7: Why Goldman's Trading Huddle Is a Major Fumble

|Includes: Goldman Sachs Group Inc. (GS)
It takes the average American worker four full years to earn $100,000. Meanwhile, after the first six months of 2009, Goldman Sachs has set aside a locked-in bonus pool of $386,489 per employee (based on average revenues of $609,000 per head, including secretaries). At this rate, for every ten-hour day a Goldman Sachs employee puts in, the average American worker would have to put in 31 working days (roughly 6 weeks, given weekends). 
Wow, the rest of the world marvels at the Goldman Mystique. How do they do it?
In part, it seems, because they may be cheaters.
The Wall Street Journal's Susanne Craig broke the page one story last week about Goldman's now infamous "trading huddles." According to the report, Goldman's top fifty institutional clients are given "verbal short term stock tips to the firm's traders and then its clients." Goldman denies wrongdoing, of course, stating that the market huddles are "always consistent with the fundamental analysis in published research reports."
Among those possibly in disagreement: SEC, FINRA and the stalwart Massachusetts state financial regulator, William Galvin. All have subpoenaed internal documents related to the "huddles."
"Huddles?" Who came up with the brilliant idea to call it a huddle? Sounds like a secretive circle of the firm's super-elite customers getting tips not available to the hoi polloi, that is, Goldman's second-tier clients. (That, and it rhymes with "cuddles.")
Goldman's emphatic public posture that it engaged in no wrongdoing is a vapid public relations ploy. The firm insists that it had on-site compliance officers involved in all the trading huddles. Perhaps. But any first year compliance officer three months into the job would have the gut-instinct to know this is not kosher. In market parlance, it's called "front-running."
From the WSJ's accounts, it appears that Goldman systematically maintained a two-tiered system for disseminating its views of the equities markets. The first method would be the traditional published research on the companies' fundamentals. The other method is a verbal, for-top-blue-chip-clients'-ears only, a regularly scheduled conference call where hedge funds and hot-money institutional accounts could have the opportunity to trade ahead of Goldman's own legendary prop traders. The prop traders would get the second bite of the apple. And then, maybe, just maybe, all of the other second-tier Goldman customers might get a research update -- after the Nifty Fifty and the prop guys have filled their bellies.
Certainly, the SEC and FINRA are looking into whether this cherry-picking of speed-trade stock tips led to a form of market manipulation (i.e., the hedge funds piled in, and when the rest of the news became available to the general public, did this insure a short-term profit for the prop traders and the selected clients at the expense of other Goldman clients and the rest of the investing public?). But even if there is no evidence of such manipulation, Goldman's audacity is breath-taking. 
After all, in October 2003, Goldman was one of the ten investment banks that participated in the Global Settlement with the SEC in which it and the other firms had "issued research reports that were not based on principles of fair dealing and good faith and did not provide a sound basis for evaluating facts, contained exaggerated or unwarranted claims about the covered companies, and/or contained opinions for which there were no reasonable bases in violation of NYSE Rules 401, 472 and 476(a)(6), and NASD Rules 2110 and 2210 as well as state ethics statutes . . . "
As a result of the global settlement, Goldman and the nine other firms agreed to "ensure that stock recommendations are not tainted by efforts to obtain investment banking fees, research analysts will be insulated from investment banking pressure. The firms will be required to sever the links between research and investment banking, including prohibiting analysts from receiving compensation for investment banking activities, and prohibiting analysts' involvement in investment banking 'pitches' and 'roadshows.'"
Okay, the SEC was talking about "pitches" and "roadshows," not "huddles." And we're talking about hedge funds here, not potential technology investment banking clients. Technically, this is a different animal entirely, isn't it? 
No, not really. The spirit and intent of the 2003 global settlement was to decouple the research function from driving quid-pro-quo revenues. It was meant to prevent an unholy alliance between the research group and a revenue-generating portion of the bank. In 2003, the research groups curried favored with hot, profitless technology companies by putting out unjustifiable STRONG BUY recommendations (in return for investment banking business). In 2009, it's a members-only "trading huddle" that drives commissioned-trading revenues from grateful hedge funds managers. It's at least a variation on a theme; if the Global Settlement's requirement is that "the firms will create and enforce firewalls restricting interaction between investment banking and research," by analogy, shouldn't that mean that hedge fund customers shouldn't be able to get special stock tips and "market color." (While we're at it, what market color are the research analysts giving Goldman's prop traders? How is that not per-se front-running?)
Infuriatingly to some, Goldman always seems to skate away gracefully from its controversies -- even something as breathtakingly appalling as Treasury Secretary Henry Paulsen's lack of arms-length dealings on his former employer's behalf during last year's AIG credit default swap crisis.  This time feels different.
Think about it -- how did Suzanne Craig get the goods on Goldman? Clearly, a disgruntled former employee approached the reporter and showed her the smoking gun. Accordingly, it shouldn't take long for the SEC or FINRA to untangle the huddle scandal, and penalize the firm if it finds wrongdoing.
Taking the football analogy one step further, the trading huddles prevent a level playing field for the firm's other clients and the investing public. Huddlegate is not going away, at least not soon.
 
I do not currently own any shares of Goldman Sachs or any other company mentioned in this submission.