Goldman Sachs Smokescreen

Annemarie McAvoy in Forbes, April 22, 2010

Media Source

The case that the SEC has brought against Goldman Sachs is questionable at best. It appears likely that the charges may have been brought simply to create a smokescreen hiding other issues that should be discussed. It diverts attention from troubles facing the SEC, and it give the president fodder to call for the quick passage of his financial reform bill.

The timing of the case against Goldman is truly uncanny. The same day the Goldman case was announced the SEC Inspector General (IG) released a report showing severe shortcomings in the SEC's handling of the Stanford case. Stanford ran a multibillion-dollar Ponzi scheme similar to Madoff's. The IG found that the SEC had the information it needed on Stanford but, like in the Madoff case, they botched the investigation, thereby in effect allowing the fraud to continue and causing innocent investors to thereby suffer further losses. However, that report has gotten scant attention since all the talk is about Goldman.

There are also upcoming hearings in the U.S. Senate to discuss the culpability of regulators in the financial crisis. Now when they testify the regulators will undoubtedly point the finger at Goldman, the scapegoat.

Finally, the case against Goldman was made public just as the financial reform legislation is coming up for a vote. How convenient that the president can now use Goldman as the big reason why there needs to be more regulation on Wall Street.

This investigation was going on for 18 months, but the SEC chose Friday to make it public. The question is whether this was just a coincidence, or whether there was an ulterior motive involved here. This case has fully diverted all attention from the missteps of the SEC that otherwise would have been under scrutiny right now. After all, it couldn't even catch multibillion-dollar fraudsters when it had the facts in its grasp. Instead, the SEC's ineptitude allowed innocent investors to be scammed out of even more money. Moreover, the administration is now able to use the allegedly actions of Goldman Sachs as the rallying call for imposing incredibly onerous unnecessary regulations on the financial industry passed.

Look at the facts. Goldman is accused of misleading investors because it allegedly didn't let investors know that a hedge fund which was betting that sub-prime mortgages would fall in value was helping to pick the securities that made up the portfolio. However, it appears that the largest investor by far, an extremely sophisticated investor who was betting these securities would go up in value, was the one making the picks. That investor had discussions with the hedge fund about the picks, but was not at all bound to take the hedge funds suggestions and even turned down some of the securities the hedge fund wanted.

The SEC claims that Goldman Sachs was in cohoots with the hedge fund manager, helping to design this financial instrument in such a way that it would be destined to fail. The SEC alleges that this was done because the hedge fund would make money if the portfolio went down in value. However, the SEC fails to include in its complaint the fact that Goldman Sachs itself lost money on this financial instrument. Goldman, like the other investors who thought the sub-prime mortgage products would go up in value, took the opposite side of the transaction from the hedge fund. In the process Goldman itself lost $90 million. Even considering its $15 million fee, Goldman still lost $75 million. If Goldman had purposely set this up in the way the SEC claims, one would assume Goldman would have made money. In fact, Goldman made the same prediction in 2007 as most of the industry did, that sub-prime mortgages would increase in value.

This case is far from a slam dunk, and it may be motivated by self-protection and political goals. Let's not tar and feather one of America's foremost financial firms, as well as our financial industry, until all the facts are in and evaluated.

Annemarie McAvoy is a former federal prosecutor and in-house counsel at financial institutions. She currently is a consultant and teaches Anti-Money Laundering and Terrorist Financing at Fordham Law School in New York City.