Captain Renault: I’m shocked, shocked to find that gambling is going on in here! Casablanca
The SEC awoke from its long slumber to file a civil complaint against Goldman Sachs. Paragraph 3 outlines the case:
“In sum, GS&Co arranged a transaction at Paulson’s request [ed. note - Paulson &Co. is a hedge fund firm unrelated to the former Treasury Secretary Henry Paulson] in which Paulson heavily influenced the selection of the portfolio to suit its economic interests, but failed to disclose to investors, as part of the description of the portfolio selection process contained in the marketing materials used to promote the transaction, Paulson’s role in the portfolio selection process or its adverse economic interests.”
Paulson helped Goldman shape a portfolio of mortgage-backed securities which were virtually guaranteed to fail. The firm did not disclose Paulson’s influence or that he was shorting these securities. Losses totaled a billion dollars.
On February 18th, I described and criticized this and other Goldman transactions as not in their customers’ best interests. See A Reputation as Good as Goldman Part I.
From an SEC perspective Goldman’s only failure was in failing to disclose Paulson’s influence and his role in shorting the securities. That Goldman knowingly put together a collection of poor quality assets which immediately became worthless was not at issue. So designing junk, destined to fail, is not an issue?
The Over-Financialized Economy and Fraud
But, notably, Goldman got caught. The firm is the prime example in an over-financialized economy of an institution run amok wherein investors are nothing more than easy marks. A look at headline stories over the last several weeks clearly and sadly illustrates the point:
- Merrill Committed Same Fraud as Goldman – Rabobank, a Dutch firm, claimed that Merrill Lynch committed a similar fraud in structuring a $1.5b CDO.
- Senate Panel Finds Major Fraud at Washington Mutual – A Senate investigation found that the Office of Thrift Supervision failed miserably in their oversight of WAMU. In two top producing offices of the bank fraudulent loans exceed 58% and 8% of the loans written. Senior WAMU executives were aware of the fraud.
- Big Banks Mask Risk Levels – Reminiscent of the notorious Lehman 105 strategy, The Wall Street reports that 18 major banks used strategies at the end of five straight quarters to lower their risk level 42%. The SEC is looking into this practice.
- GE Capital, Jack Welch and Jeff Immelt: A Tissue of Lies and Subterfuge – It is alleged that GE CEO Welch managed earnings through creative accounting in recognizing gains and losses at Capital. It is further alleged that current CEO Immelt continued these practices. These practices were undertaken to enrich investors.
- Wall Street Real Estate Funds Lose Between 61% and 98% for Their Investors as They Continue to Rake in Fees! –(self explanatory)
- Ankle Bracelets for High-Frequency Traders – The SEC is struggling to control practices that give large Wall Street firms unfair advantage over the public. The SEC is seeking to put limits on high-frequency trading, off-exchange dark pools and broker-sponsored access to the markets.
Beginning of the End? Business as Usual?
Wall Street bemoans that volume in the current stock market rally is light and that the retail investor has not returned. Why would any investor trust banks and Wall Street firms? Synthesizing these headlines investors are exposed to the following risks:
- An SEC too slow to take effective action
- Complicit Office of Thrift Supervision
- Fraud
- Creation of near worthless securities
- Taking an adverse interest to your own customers
- Failure to Disclose
- Excessive fees
- Accounting Trickery
- Excessive executive compensation flowing from accounting trickery
- More protection is afforded to a used or new car buyer under state consumer protection laws.
The time has come for the casino operators masquerading as investment firms to stop viewing investors as “marks” ripe for fleecing. These firms need to return to their historic roles as trusted investment advisers. Maybe then investors can return to the markets with renewed confidence. Friday’s indictments were small ripples in a larger, very dirty pond.
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