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Burning questions about the SEC fraud charge against Goldman Sachs

Goldman Sachs Group, Inc.

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The big business news of the day -- heck, of the quarter, I'd say -- is today's bombshell SEC fraud charges against Goldman Sachs and one of its executives, a 31-year-old Frenchman named Fabrice Tourre.

You don't need to know what a "synthetic collateralized debt obligation" is (an exotic financial instrument) to understand what this charge is about: The SEC says that Goldman created an investment vehicle full of securitized sub-prime mortgages that included some really terrible ones selected by a big hedge fund manager who wanted to make money when they failed. In order for him to do that, he needed people to take the bet that they wouldn't fail. The SEC charges that Goldman did not tell the investors it sold this vehicle to that (a) it included crap mortgages that were (b) picked by the guy who wanted them to crash. The things failed, the hedge fund manager made money, the other investors lost money. Oh, and Goldman scored a $15 million management fee.

You can see the problem, if true. Goldman says the SEC charge is false in "law and fact" and will fight it.

My colleague Ezra Klein has asked three questions about about the case.

I have several more:

1. Timing. Why did the SEC take the highly unusual step of announcing a major action at the height of midmorning trading instead of before or after the markets closed? The SEC didn't know anything more at 11 a.m., when it released the news, than it did at 9:30 a.m., when the markets opened. As a result, the markets tanked and a major sell-off ensued, nearly wiping out the week's gains. Why did this happen? The markets react this way every time you toss a grenade into the middle of them and run. If bad news is announced before the markets open, traders price the bad news into stocks and, though they may go down, it will be a slower decline and a softer landing.

2. The second timing question is this: Traders are wondering about the politics of the SEC charge. Consider: Goldman Sachs is the lion of Wall Street, the gold standard of investment banks. It has weathered the financial crisis largely unscathed. There is massive financial regulatory reform on the Hill right now designed to clip the wings of big banks like Goldman. Traders wonder: Is there a better way to give tough regulatory reform the final push over the finish line than to level a fraud charge against the biggest, best-regarded bank on Wall Street?

3. WWCD? Or, "What Will Cuomo Do?" As New York attorney general, and as a man who's made a reputation of going after Wall Street, will Andrew Cuomo file criminal charges against Goldman and Tourre? The SEC can file only a civil complaint; Cuomo can put guys in jail. Cuomo has thus far remained silent on this case, but that can hardly be the case for long.

4) Does this charge represent a war on Wall Street? Many traders and bankers already have felt the chill from the Obama administration and lawmakers, who they believe want to take this opportunity -- the aftermath of a financial crisis -- to fundamentally change the way Wall Street does business. Obama used confrontational language in addressing the issue Friday, warning GOP lawmakers not to side with the embattled financial industry.

"Every member of Congress is going to have make a decision," Obama said. "Are they going to side with the special interests and the status quo, or are they going to side with the American people?"

This is going to be a long and fascinating case -- assuming the SEC does not settle -- with plenty of discovery. We may learn a lot.

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By Frank Ahrens  |  April 16, 2010; 5:06 PM ET
 | Tags: Andrew Cuomo, Business, Financial instrument, Goldman Sachs, Hedge fund, SEC, Subprime lending, Wall Street  
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Comments

Good questions, Frank.

I have a #5 question:

what is the difference between Obama wanting to regulate/control using the financial reform and the history of Communism vs Capitalism?

I believe this is the bigger issue and VERY revealing about Obama. HE is anti-Wall Street because fundamentally, he is NOT about the individual or the rights and freedom of individuals to prosper. BUT he believes in collectivism and socioeconomic equality. First health care and now financial market...

Posted by: american17 | April 16, 2010 6:57 PM | Report abuse

american17 wrote about Obama: "he is NOT about the individual or the rights and freedom of individuals to prosper".

So let me see if I understand Mr. american17. When those inviduals used their "rights" to game the system and collect billions of dollars for each of themselves (they are individuals. right?) you are OK with it? Despite the fact that collectively, we the rest of the American people, then had to use our dollars to bail them out.

Posted by: WPL22 | April 16, 2010 7:30 PM | Report abuse

Exactly which individuals' prosperity are you talking about, Mr. American17? I don't think I have the right to become prosperous by cheating any more than I have the right to drive a car while drunk. The whole point of regulating the markets is to prevent just the kind of dishonest and predatory behavior described in the SEC's charges. There was all sorts of prosperity happening when the markets were better regulated than they are now.

Posted by: willythekorn | April 16, 2010 7:36 PM | Report abuse

RE: "what is the difference between Obama wanting to regulate/control using the financial reform and the history of Communism vs Capitalism?"

Under capitalism, too-big-to-fail banks should *pay* for last resort insurance coverage provided by the US Treasury. Under communism, they wouldn't. In this case, all the pro-Wall St types basically want the US taxpayer to foot the bill for the banks' anti-failure insurance. It's you who are the communists, if terms must be misused.

Posted by: Matthew_DC | April 16, 2010 7:45 PM | Report abuse

The timing is pitch perfect.

It is the answer to Wall Street's arrogant and predatory behavior.

Wall Street and the "The Business Of America is Business" crowd refuse to accept any responsibility for the damage and misery they caused. Fair enough. They put the line in the sand and dared any body to cross it.

Now they squeal like stuck pigs (overfed ones at that) when arrogant position is challenged.

President Obama and his advisers got their attention with a hard kick not to their groin but in a much more sensitive spot-their wallets.

He continues to show he is on the side of the victims not the predators. Not the insurance companies that kill for higher earnings, not the mine owners who sacrifice the miners' lives for bigger and bigger profit margins and not for gamblers on Wall Street who are perpetually willing to sacrifice anybody and everything on the the alter of their god, the God of Profit.

Sock it to them Obama! The loudness of their squeal is a true measure of the effectiveness of your needed actions.

Posted by: apspa1 | April 16, 2010 8:10 PM | Report abuse

Assuming (and it's a big assumption) everything claimed by the SEC is true, this complaint by itself is not that big a deal.

The details are very specific to one CDO issuance and the most senior Goldman employee implicated was only a Vice President.

Everyone at Goldman is a VP - they have thousands. These are subordinate to the 300 partners and the many more managing directors.

If this is all the SEC has against Goldman or other big firms, it will create some news for a couple of weeks and create a buying opportunity for stocks of big finanancial institutions, but will have little further direct impact.

As the author suggests, the most significant impact may be on the pending finanancial regulation bills. But who could possibly believe that Saint Obama released this suit for political purposes.

Posted by: ronStrong | April 16, 2010 8:44 PM | Report abuse

Q1: Because that was when the paper work was finalized with the court and became publicly known. Why should the SEC and the DOJ time their filings to suit Wall St sensibilities.

Q2: If GS is the lion of Wall St then it makes sense to go after the biggest game first rather than the small-fry and possibly let the big one get away. It also sends the message that none are immune.

Q3: WWCD? Likelly, hopefully, file criminal charges if GS knew these mortgages were picked by Paulson specifically because they were more likely to fail and that Paulson was betting that they would. This would seem to signify a willfull, and knowledgable, intent to decieve potential investors which is somewhat of a threshhold for criminal charges.

Q4: It represent a crackdown on illegal, and otherwise unsavory, trading practices. Does that constitute a war, or does it merely represent actual enforcement of the law?

Posted by: jmdziuban1 | April 16, 2010 8:46 PM | Report abuse

If you really want answers, you should listen to Paul Volcker. The administration is surely going to be looking for fundamental changes in how our financial markets and institutions work. Clearly denial is rampant. But the events of the last three years should make it obvious that there are major problems with the financial services industry and financial markets that need to be fixed. One central one is the simple fact that an excessive part of our economy revolves around financial services. Another one is that the top tier of the financial services industry are among the worst offenders among those who have developed the expectation of an endless entitlement to very large rewards for efforts that at best do little to serve the public interest and at worst are very damaging to it. Then there is the simple fact that one might expect everyone to get. It is that our economy almost collapsed because of a major failure in private financial markets. Only those with their heads in the sand can deny the need for major reforms to at least make an attempt at fixing the problems that caused the recent acute crisis.

Posted by: dnjake | April 16, 2010 8:47 PM | Report abuse

Goldman Sachs is not the only investment bank guilty of this type of behavior. Our financial markets are corrupt and all of the major players are guilty. In this case, the accusation of fraud is more important that a conviction. Any fines imposed will be tiny compared to the damage done to the integrity of our “trusted” markets.

The recent proposal by Sen. Lincoln (D- Ark) has it about right, demanding, 100% open transactions, separation between trading and banking activities, and prohibition of fed window access to any company engaging in trading activities. Rather than punishing them; the time has come to rewrite the rules.

Regardless of the timing, it is about time.

Posted by: NewThoughts | April 16, 2010 8:59 PM | Report abuse

Get Medical Insurance for your entire family at the lowest price from http://bit.ly/dqJw9Z

Posted by: MaryJames1 | April 17, 2010 7:26 AM | Report abuse

We believe this may be the first in a series of actions targeting Goldman. An examination of Goldman's transactions with AIG will probably reveal similar questionable practices. As we noted on July 9, 2009, the US lost 53% supporting Goldman.

As we noted on March 5, 2009, Goldman was one of several firms accused of systematically cheating customers.

And, finally, as noted on July 19, 2007,

"From an ethical standpoint, (Goldman) has repeatedly engaged in behavior that would cause a prudent person to question its objectivity and fairness. We note that a smaller firm engaging in similar conduct would have been severely sanctioned by the market. Goldman has escaped meaningful sanction, however. We have found these behaviors often the prelude to the development of a set of fraudulent business practices."

See: http://twisri.blogspot.com/2009/07/us-lost-53-supporting-goldman-sachs.html

http://twisri.blogspot.com/2009/03/wall-street-firms-systematically.html

http://twisri.blogspot.com/2007/07/gs-sustain-focus-list.html

Posted by: billycdc | April 17, 2010 12:22 PM | Report abuse

The happy French peasant and the imperial impersonation of force and murder known as "Napoleon the Great." I would of rather lived in a hut with a vine growing over the door, and the grapes growing purple in the kisses of the autumn sun. At least the dreamless dust is clearing up now. All the stars are still like diamond dust in the heavens. What are you going to do? Living on the danger line. Grandmother set me up for life and this is living. Don't keep her waiting or face the wrath of a woman kept waiting guys.

Posted by: tossnokia | April 19, 2010 9:48 AM | Report abuse

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