The Goldman case and the SEC’s irrelevance

As I've said, the fraud at the heart of the SEC's case against Goldman has a materiality problem. A story in today's Journal has more on this:

Some outside observers are not persuaded by the government's argument ACA was duped by Paulson's input in the process. "If ACA performed an independent analysis and concluded that the [Abacus] portfolio met ACA's criteria, I'm not sure what the issue is," says Leslie Rahl, president of Capital Markets Risk Advisors, a derivatives and structured finance consultancy in New York. In essence, "one sophisticated market participant thought that the portfolio was a good 'buy' and another a good 'sell' -- that happens all the time in financial markets and is what makes markets," she adds.

I also pointed out that the case is more about the SEC struggling to be relevant to the financial crisis than about securities fraud. A WSJ editorial has more on that:

After 18 months of investigation, the best the government can come up with is an allegation that Goldman misled some of the world's most sophisticated investors about a single 2007 "synthetic" collateralized debt obligation (CDO)? Far from being the smoking gun of the financial crisis, this case looks more like a water pistol.

The editorial wonders: "Is that all there is?" The SEC has been looking for a long time into what crashed the markets. It had every incentive to lead with its strongest case. And this is what it came up with?

But the SEC was under pressure to come up with something. The timing of this complaint continues to be suspicious. The editorial continues:

The SEC charges conveniently arrive on the brink of the Senate debate over financial reform, and its supporters are already using the case to grease the bill's passage. "I'm pleased that the Obama Administration is using all of the tools in its arsenal to bring accountability to Wall Street and standing up for homeowners and small businesses across America," said Senate Majority Leader Harry Reid on Friday about the SEC case. "This is also why we need to pass strong Wall Street reform this year."

A story in today's WSJ supports this political timing:

Goldman Sachs Group Inc. officials said they knew as far back as August 2008 that regulators were examining controversial mortgage securities created by the firm but were stunned by the bombshell civil fraud suit lodged against it Friday, with most having learned about it from news reports.

Firms typically get a chance to settle such suits, but not in this case, Goldman said. The Wall Street giant said it was alerted to the probe in the summer of 2008 and was warned that it might face a suit in July 2009. * * *

The way the SEC launched the suit "certainly doesn't follow the spirit" or practice of the agency, said Paul Atkins, who served as a Republican SEC commissioner last decade. * * *

In July 2009, Goldman and Mr. Tourre received so-called Wells notices from the SEC. Such notices are a formal warning that regulators intend to file civil charges, and serve as a point of negotiation about a settlement. By September 2009, both Goldman and Mr. Tourre had responded to the charges in a 41-page document, according to people familiar with the matter. * * *

"If this matter is litigated, Goldman Sachs is confident that a fuller record...will underscore that no one in fact considered Paulson's role important and that no one was misled," Goldman told the SEC in September 2009, in a document reviewed by The Wall Street Journal.

That was the last contact Goldman had with the SEC about the matter until late March, when Goldman placed a phone call inquiring about the case. The call wasn't returned, Goldman said. On Friday, the SEC moved ahead with charges, stunning Goldman officials.

In other words, the SEC, under pressure to come up with something on the eve of Congress's final push toward financial regulation comes with a case that the complaint makes clear is much more about the creation of systemic risk than about securities fraud.

This reflects, in part, the new Wall Street, more than three quarters of a century after the securities laws were enacted. Financial regulation is now much more about sophisticated market intermediaries than about individual investors who need somebody to ensure they have the truth about securities.

This is not to say that securities fraud is irrelevant. However, the SEC has struggled on that front – the Bank of America settlement, Madoff, Stanford.

And so now we are left with . . . Goldman.

Comments

[Eddy Elfenbein]

The SEC's case reminds me of the DA in the Bonfire of the Vanities who searched for the Great White Defendant.