Goldman Lawsuit Expresses Populist Rage
By Jake Lynch 04/16/10 - 04:30 PM EDT 10
BOSTON (TheStreet) -- Populism has long posed a threat to the stock-market rally.
But such threats have remained, until today, theoretical. To date, all methods of Wall Street interference, including Kenneth Feinberg, Washington's pay czar, and the so-called Volcker Rule, which is set to be incorporated into the pending Dodd reform, have been viewed as idle threats or marketing schemes. Wall Street compensation has accelerated at many banks despite outrage on Main Street and in Washington. But today, the world has changed.
The Securities and Exchange Commission filed a lawsuit against Wall Street archetype Goldman Sachs(GS), and investors are panicking. Stocks and commodities dropped, and bonds rose. The suit is precarious in its action and its precedent.
It alleges that Goldman fraudulently marketed a synthetic collateralized debt obligation to investors. Paulson & Co., the most successful hedge fund of 2007, reaped a windfall by betting against subprime securities. In the supposed transaction, Paulson & Co. hand-picked subprime residential mortgage-backed securities from areas that it believed presented the highest default risk. Goldman then packaged the mortgages into a CDO. While Paulson & Co. shorted the CDO, Goldman sold long positions to other institutional investors.
Such action isn't illegal. But the SEC alleges that Goldman failed to disclose Paulson & Co.'s short position to long investors. Furthermore, in marketing materials, Goldman referred to ACA Management as the independent third party, with expertise in credit analysis, that picked the securities. The SEC claims that security selection was actually executed by Paulson & Co., which wanted the opportunity to short-sell the shoddiest mortgages available. Numerous questions need to be answered before an opinion can be rendered about this suit:
What was the actual role of ACA Management in the selection process?
What was ACA Management's relationship with Paulson & Co. and Goldman Sachs, respectively?
Is Goldman legally required to disclose which investors are taking the opposite side of trades in marketing materials?
Did Goldman retain a long or short position in its proprietary accounts?
In certain scenarios, this suit amounts to nothing. But the fact that the SEC has publicized allegations is a troubling precedent. The repercussions of Goldman's actions, which we are all well aware of, are far less important right now than its obscene pay practices are. CDOs are sophisticated financial products for investors who are supposed to be well-informed. Goldman may have skimmed a profit off of professionals who failed to perform adequate due diligence. But there are greater tragedies in the world.
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