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What Does the SEC Fraud Filing Against Goldman Mean for the Financial Sector?

|Includes: Bank of America Corporation (BAC), C, GS, JPM, WFC
Will the SEC’s fraud filing against Goldman Sachs be the first of many shots expected to be fired upon the big financial companies or a punch that won’t even be a glancing blow? You could not have asked for a better script. The two companies involved at the epicenter of the lawsuit and financial crisis are Goldman Sachs, a company that according to its CEO, Lloyd Blankstein, ‘Does God’s Work’ and John Paulson’s company, best known for profiting from the financial crisis. (Note: The SEC has stated Paulson & Company will not be charged because they did not make false representations to investors.)
From what I have read in regards to the SEC’s filing and an analysis of historical fraud filings, I view the chances of the charges sticking against Goldman and the other large financial institutions unlikely. However, even if the charges do not stick, there is plenty of potential collateral damage that can be done to the five financial behemoths (Goldman, Bank of America, Citigroup, J.P. Morgan and Wells Fargo).
First, my guess is there will be dozens of additional lawsuits brought by other foreign governments, individuals and companies. These lawsuits are inexpensive to file given the fact that the lawyers work on a contingency basis. However, they can be very expensive for the defendants in terms of money and time.
Second, even if the charges do not stick, the accusations and perception of the events that unfolded during the financial crisis adds more ammunition to the call for greater financial regulation. This is a cost that will lower profits and returns on equity for these companies.
Third, reputation risk increases as more lawsuits are filed and the image of these firms are tarnished. A lot of customers were irate at the companies before news of the SEC fraud charges became public. In talking to customers of these financial behemoths over the past 18 months and what I have read in the media, there has been a movement by customers from the big banks to smaller financial institutions and independent financial advisors. Why would anyone do business with a company where you may be the ‘sucker’ at the poker table? My guess is this will further increase the rate of customer attrition for these large financial companies.
The fourth risk is bailout risk. I seriously doubt these companies will be given the same support 18 months ago when they were bailed out by the U.S. government. I think the Goldman lawsuit increases the chances these companies could fail but the government would step in to make sure the customers of these institutions are made whole. I think the ‘Too Big to Fail’ safety net is gone.
As of Friday, the financial sector was up 165% from its March 6, 2009 bottom. The Goldman lawsuit starts another chapter of the financial crisis. I think this uncertainty are not reflected in the current prices of these financial institutions and exposes them to further downside risk.

Disclosure: The author and its clients do not have any positions in the stocks mentioned in this article.