In my last post I used a casino analogy to describe the background of the SEC case against Goldman Sachs. Hopefully the analogy made the fundamental issue at hand a little clearer without the Wall Street jargon that confuses most of us common folk. But now that you understand the circumstances, you may notice the holes in the case and the somewhat flawed logic that the SEC is using to build what I think is a house of cards case.
It Can’t Be That Easy
First, let me tell you where I think the SEC’s case has merit. Basically, what the SEC is saying is that GS did not live up to its fiduciary duties by notifying investors that John Paulsen was shorting the mortgages in the CDO that it sold its investors. In a general sense, I think they’re right. GS, as the broker, should disclose as much relevant information as possible to its investors to ensure they’re interests are being served. And if it is apparent that GS violated this responsibility, they should certainly be punished for it.
That’s it. That’s the only area where I think this case has merit. Now, with that out of the way, let’s discuss where it doesn’t have merit. I think the biggest flaw in the SEC’s logic is that they’re saying that GS should have disclosed the person on the other side of the trade (i.e. Paulsen).
Stop right there and think about that. Say you were the casino in my example. When you see those gamblers come and bet money, isn’t there an assumption that those gamblers know that there’s someone on the other side betting against them. In any gamble, whether in a casino or Wall Street, there are two sides to every gamble. In the casino, we call that the ‘house’. On wall street, it could be anyone that feels the opposite of what your bet is.
In other words, every time you bet on an asset, whether it’s a CDO or a stock or you double down on a hand of Texas Hold ‘Em, there is an implicit counter-bet. If everybody felt that the mortgages in the CDO would go up like the investors that bought them did, why would anyone sell them? Furthermore, does it provide any additional value to the buyer if they were explicitly told who the counter-party on the CDO is? I don’t think so. When I buy a stock, I know someone is selling it to me. Will it change my decision if I knew who is selling the stock I’m buying? If I’ve done my proper due diligence, it shouldn’t
The bottom line here is that I feel that Goldman did not have a fiduciary responsibility in not disclosing that John Paulsen is betting against those mortgages because it wasn’t relevant information that the buyers needed to know – it’s just not common practice on Wall St. to do that. Furthermore, the fact that the actual buyers of the CDO were banks who are sophisticated enough investors to perform the necessary due diligence only reinforces this notion.
Where Do We Go From Here?
Honestly, I think the SEC’s case against GS is a witch-hunt to a large extent. The SEC has come under a great deal of scrutiny lately for allowing the financial collapse to occur under their watch, and, unfortunately, I think this case is them trying to pander to the public and Washington that they are still relevant. Hopefully, in time this case will be dropped. However, I think the more likely scenario is they’ll settle with GS out of court and we can move on.
What are your thoughts?
Questions/Comments/Feedback?
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The Standard Disclaimer:
The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I've said above. This includes consulting with a financial advisor.
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