the facts behind the Goldman Sachs fraud case, accusations made by the Securities and Exchange Commission

Introduction

Every country desires to be economically sable and powerful. For this to happen, the financial sector must be keenly focused on to ensure the economy is changing for the better. This is clear in the case of the United States of America, where they face an economic recession which led to loss of employments by the citizens, thus prioritizing the financial reforms. Besides loss of jobs, the failure of the financial sector led to ye collapse of many institutions, which necessitated the introduction of strict reforms to regulate the finances of the country. This would also ensure the situation did not get any worse, thus the introduction of the ‘Wall Street Reforms Bill’ ( HYPERLINK “http://topics.nytimes.com/top/reference/timestopics/people/h/david_m_herszenhorn/index.html?inline=nyt-per” o “More Articles by David M. Herszenhorn” Herszenhorn, 2010). This bill advocated for the more governmental overseeing of the financial market and the system of banking which were becoming complex with time, yet were responsible for the stability of a country’s economy. This paper is intended at exploring the facts behind the Goldman Sachs fraud case, accusations made by the Securities and Exchange Commission, reaction of Goldman Sachs, final agreement and effects the case had on the financial reforms made.

Background

Many organizations and persons are still in the process of recovery from the recent financial crisis which hit the United States of America. The reestablishment of institutions that closed is among the processes meant to stabilize the country again. Wrong decisions and irresponsibility on the part of some organizations, which included non adherence to the Wall Street Reforms Bill contributed largely to the depression. Since banks were the financers of the country’s economy, it was important to have them rescued first followed by financial other institutions. Research showed that the over extension of finances which have been overvalued by investment banks such as the Goldman Sachs also contributed to the economic lapse. Some of the important concepts related to the facts of the Goldman Sachs case and important for the discussion in the paper include:

Goldman Sachs

The Goldman Sachs Group, Inc. (Goldman Sachs) is an organization popularly known for its management of securities and banking and management of securities. Their dedication to service, variety background, popular principles applied in business and value attached to clients along with their status were the most valued assets of the company (goldman.com). Its service provision ranges from investment banking to and other financially related services such as acquisition and merger advice to clients. It has had a record of consistent increase in net worth and net profits realized per every quarter year, which has challenged similar institutions. The number of employees has also been on the records as constantly on the increase, a move which financial analysts interpret as increasing productivity. However, as discussed above, the paper reviews the facts of its fraud case against its clients. The good image maintained was tainted upon the law suit that was brought against them regarding the misleading of clients and inappropriate activities (goldman.com).

US Securities and Exchange Commission (SEC)

This is a federal body recognized in the American constitution as one that regulates the functioning and ethics of the security industry. It ensures that all the laws relating to the industry are observed by those in it, thus sufficient protection of the general public from any chances of exploitation and fraud. Popularly abbreviated as SEC, it stabilizes the market activities of their stock exchange to avoid cases of gambling with the economy. According to Ketchum, (1986), “what we see now is the challenge of adjusting the regulatory and legal structures to deal with changes in the market structure on an international basis” (Pg 33). Clearly, their mandate has been challenging following the ever changing market structure, however, it is their duty to adjust the laws and ensure their enforcement to an extent where the abuse of the citizens/general public will be eliminated. This explains its charges against Goldman Sachs as a way of protecting the public from exploitation.

Mortgage-Backed Security (MBS)

Mortgage Backed Securities (MBS) are a form of bonds that the government in any of its capacity makes available to the public. This service can also be extended by the financial institutions, especially those dealing in investments. According to Black Enterprise, (1990), “Ginnie Mac and its two sibling organizations act as conduits and collect or pull individual mortgages that have been sold to them by commercial banks, savings and loans or other mortgage companies” (Pg 33). This shows that the extended mortgages should be controlled by a transparent body where the rates will be fair and government regulation is available incase of private sectors. The regulation as mentioned earlier is carried out by the Securities and Exchange Commission.

Collateralized Debt Obligation (CDO)

As opposed to MBS which pools from an original source, CDO pools from bonds already in existence. This combines efforts from different banks which come together to increase the finances and enlarge their sources. It could also e referred to as bond or loan obligation depending on the specific subject matter being dealt with. Banks normally refer to the debts/loans/bonds, whichever is relevant in a specific scenario as securities or collaterals, which are further grouped depending on their similarity in risks. This could be either credit or maturity risk. With the knowledge of which type of risk one is exposed to, investors can be more cautious over the decision to invest in the bonds or not to (Hulse, 2010). Full information is also necessary to ensure there are no errors.

Credit Default Swap (CDS)

This is the financial concept whereby risk is transferable with advanced payment to the bearer. Losses through the risk occurrence will therefore not be the burden of the investor. The debt/loan/bond holder can get insurance so that incase of failure of the security in the market, they will receive full compensation, thus record no financial loss. However, just like any other form of insurance, premiums must be paid to the risk taker on a regular basis as per the agreement.

Subprime Mortgage Crisis

This is a crisis that was anticipated and later on occurred due to indulgence in criminal behavior which encouraged default in paying of mortgages. The circumstances surrounding its establishment are quite different. Criminal behaviors and tendencies to evade payment to the banks and other financial institutions led to his strict measures that would ensure guaranteed pay, thus less risk of failure of financial institutions as a result of default. This threatened to reduce the value of mortgages following the shaky background of the lenders who were the banks. Need for security and strictness helped correct the subprime mortgage crisis.

The Case

Parties Involved

In the case of the lawsuit brought against Goldman Sachs regarding their alleged fraud to the clients and going contrary to the regulations that govern the stock market, securities the parties involved were the Security and Exchange Commission and the Goldman Sachs Group, Inc. this case brought to light the events which led to the deception of general public and the larger picture where the financial sector took advantage of ignorance. This has been significantly encouraged by the existence of modern technology which few people understand. Information can also be easily concealed from the public where they have the right to know the actual facts. This was the case between the two parties where one, the Goldman committed fraud to the public and the other, SEC attempted to protect the public from exploitation which is its described duty by the government. The plaintiff in this case was the Securities and Exchange Commission which made the complaint. The defendant on the other hand was Fabrice Tourre who worked at the bank and was named in regards to the accusations against the investment management organization Goldman Sachs

Allegations

According to Gandel, (2010), “The civil fraud case the Securities and Exchange Commission filed in mid-April against Goldman is based on a single deal, called Abacus 2007-act.” the organization was accused of formulating the Act to favor its management in order to benefit when the recession became significant. Basically, the accusations were based on acts of fraud against investors by the Goldman Sachs. The firm was also strongly accused of gambling with the investor’s money in terms of trial and error where they would benefit regardless of the outcome. The investors were on the other hand at the risk of losing on their money which the firm did not let them know of (Newman, 2010). This amounts to fraud because despite the awareness of the available risks, the firm went ahead to assure the investors of the safety of their investments, thus holding important information, which they are, required to release upon doing business with the public or private partners.

Abacus Mortgage-Backed CDOs (Abacus 2007-AC1)

The Abacus 2007 is the copied CDO in this specific case, and was established in 2007. It is considered the poorest mortgage in performance which was also brought up from the accusations against Goldman Sachs Group, Inc. (Lucchetti, and Serena, 2010). In this specific case, it is considered a deliberate move by the organization to extort money from its clients. It is presumed to have been formulated by the Goldman Sachs to favor its intentions as the accusations were brought forth against them. According to Lucchetti, and Serena, (2010), “… the mortgage deal at the centre of Friday’s civil fraud lawsuit against Goldman Sachs Group Inc., also boasts another dubious distinction: It was one of the worst performing mortgage deals of the housing crisis” the Security and Exchange Commission accused it for fraud based on this issue as well. As clearly illustrated, the Goldman Sachs was meant to market its importance and advantages it had when used by the clients. The illustration below shows the trend of the abacus before and after the purchase by potential investors. It shows the worth people had entrusted on the bonds which led to the large numbers who purchased the bonds.

Source: (< HYPERLINK “http://online.wsj.com/article/SB10001424052748703757504575194521257607284.html” http://online.wsj.com/article/SB10001424052748703757504575194521257607284.html>)

Paulson’s Investment Strategy

In the lawsuit filed by Securities and Exchange Commission against Goldman Sachs firm, the specific people targeted and mentioned Paulson and Fabrice Gandel, (2010), argues/states that, “Paulson’s investment strategy was founded on the belief that, for diverse reasons, a number of mid-and subprime RMBS, particularly those rated “Triple B,” would go through credit events.” As an investor with the company, he based is assumption on the fact that a company could be distinguished by one slight difference in name since it was also a separate and legal entity, since it was an investment through the company. It is worth noting that the considerations given before the risk were critical and a detailed analysis was present on Paulson’s part in determination of which loss would be greater, either the CDS or the CDO. The decided that the CDOs would experience more losses in uncertain circumstances, following the mid and subprime RMBS which contains the reference assets.

Securities and Exchange Commission’s Point of View

As would be expected, in a court session, both the plaintiff and defendant are given a fair hearing before the decision by the judge to decide the defendant’s judgment. It is the duty of the accused to defend the accusations and the plaintiff to prove to the court beyond reasonable doubt that the allegations are true, with sufficient evidence. In this case, the Securities and Exchange Commission had the obligation to prove against the defense of the Goldman Sachs Group, Inc. involvement in fraud against the public and their investors. To efficiently do this, the SEC came up with the following arguments:

Goldman Mislead and Lied to Clients

Gandel, (2010) argued/stated that, “In the Goldman case, the investment banks and hedge funds that concocted the CDOs allegedly loaded them with the equivalent of toxic bonds and then bought CDSs for themselves, figuring the CDOs would lose value.” As previously discussed, the CDOs represent bonds which may be held for the purposes of control of money flow to these particular investments in mortgage. Therefore, purchase of the bonds as an investment when the prices are lower with the hope of getting them back at a higher price should be the target of any investor. This should be far from requirement for a firm with investments and people investing in it. However, according to the allegations by the SEC, the firm was obliged to tell the clients and the general public of the possibility of reduction in prices before allowing them to invest with them. Interested groups were encouraged to proceed with their massive investments without any further knowledge since the organization was trusted and enjoyed a good reputation (Gandel, 2010). The SEC reported this with the argument that they did not guide the clients to make appropriate decisions by advising them on all possibilities, thus misleading them. Similarly, they lied by assuring them of secure prices where they planned to buy them back at cheaper prices right after they went down. As its mandate, the SEC gave its opinion to the court of law with the necessary facts against the accuser. This was in line with the body’s duty description which entails the protection of public from unscrupulous moves and exploitation.

Goldman mislead ACA about Paulson’s strategy

Besides the clients, SEC was of the opinion that the move by Goldman Sachs was also deceptive to the ACA. Firstly, its parent company was ACA was misleading on the role of Paulson in the marketing of the Abacus 2007. Paulson had hidden motives which would lead to economic gains by the company (Gandel, 2010). The fact that this information was concealed from the public and the holding company was enough for the firm to be sued in a court of law. Besides the losses likely to occur and which occurred later on, to harm the public, the situation involved breach of contracts which specified that utmost good faith be exercised. According to Gandel, (2010), the accusations brought forward by SEC demanded that,” … the marketing resources used for ABACUS 2007-AC1 by GS & Co were misleading because they stated that ACA selected the reference portfolio and failed to mention that Paulson, who had economic interests unpleasant to CDO investors, had a significant role to play in selecting the reference portfolio.” Undoubtedly, the use of the parent company’s name in the carrying out of transactions amounts to misleading of the organization.

Conflict of interest

This was no a very relevant complaint that the SEC was interested in bringing u against the defendant and the company. It however came about in relation to Paulson who was the secret investor and the largest beneficiary at the end. The Abacus was an investment project that was extended to the public to increase the firm’s funding. However, the very person who came up with the idea was fully aware of the anticipated failure of the same. This shows conflict in interest by the organization for going ahead to market Abacus with the full knowledge of its poor performance and unsuccessfulness in meeting the clients’ requirements.

Goldman Sachs’s Response

As previously discussed, the defendant must be given a fair trial where they will argue against the case brought in front of the court. It is worth noting that the plaintiff here, the SEC, has no vested interest in either of the parties directly involved in the case. It is only a way of fulfilling its mandate by ensuring the public is not exploited and that any attempts to disregard the regulatory rules is punished in the court of law. This explains the responses that the defendant had to the claims:

Unfound allegations

Gandel, (2010) stated that, “In response to the SEC suit, Goldman says it didn’t set up investments to fail and it didn’t mislead its clients. It plans to fight the charges aggressively

It did not mislead clients” this is a clear indication of the defendant’s statement of acceptance or denial of the allegations. In this particular situation, the Goldman Sachs Group, Inc denied the accusations. They maintained that the all they needed to do was done according to the laws that governed them and that the marketing of the Abacus was a genuine motive to expand its operations. They also maintained that the allegations were baseless and did not deserve a court hearing, thus request for its withdrawal. There was also defense on the basis of not enough evidence where the defendant wanted the case out of court. This showed a response that insisted to having clear motives and following the correct procedure. They argued that the suit was unfounded as well on the accusations that Fabrice failed to alert the investors of the involvement of Paulson in the firm (Luchetti & Serena, 2010).

Goldman lost money on the transaction

With the marketing and sale of Abacus as bonds taking place followed by the drop in prices, the SEC claimed that no amount was lost by the organization, Goldman Sachs, which could probably mean awareness of the expectations. Similarly, since they were aware, there were assumptions of intentions to buy them back after the prices went low in order to benefit from the difference. However, in response to this, and in their defense, they claimed they were incapable of engaging in investment activities where they would lose that much money (Gandel, 2010). The firm also responded to the court by claiming that though unwilling, a lot of money had been lost on their part as well especially the amount which was used to finance the marketing and sale project (Luchetti & Serena, 2010).

Provision of Extensive Disclosure

It was earlier discussed that the Securities and Exchange Commission forwarded the Goldman Sachs’ case to court to sue for many things among them incomplete disclosure of the financial position. This is relevant in the case of the marketer, Paulson. The firm responded in defense of the accusations and claimed full knowledge of the Abacus was available to the investors. They also pledged full alert of the risks that faced this much anticipated investment so as to give both perspectives to the potentials. This also was in contradiction of the accusations by the plaintiff, the SEC.

ACA selected the portfolio

Being the holding company with the majority of shares, ACA was bound to be the greatest loser of the investment along with other investments. This was however not the case. Besides this, the accusations of disclosure of limited information faced a more interesting response from the defendant. Claims of exercising confidentiality on buyers and seller and disclosure only with their approval were presented in court. In this case therefore, the response was corresponding to the accusation with the application of legal ethics in defense of the motives. Paulson being a long-term investor was concealed for privacy measures (Korkery, 2010).

The settlement

Basically, cases like this require the accused to pay a large amount as compensation to the accuser where the court deems it fit. The opposite is also true where the circumstances are different. Reviewing the evidence and the strength of the case brought should enable the judge make legal and fair decisions that will be appreciated by the two parties. The Securities and Exchange Commissions and Goldman Sachs would be expected to accept the court’s decision which would be final. Any repercussions were also to be strictly observed. After the evaluation of all the tabled facts, the court found that the evidence was sufficient enough to demand compensation from the Goldman for what was termed as junk securities. According to Damon, (2010), “Goldman Sachs agreed Friday to pay $550 million to settle a civil indictment by the securities and Exchange Commission (SEC) charging that the investment bank misled investors…” we realize that despite the many accusations, not all were found worthy for in court trial and settlement. In this case, the judgment specifically related to the misguidance to the public who were the potential investors, thus destabilizing them economically.

Besides the wrong lead and inefficient information disclosure, the judge also decided that the securities advanced to the investors were not real and a strategy to make more funds for the organization and the secret investors such as Paulson and Fabrice. More analysis and critical evaluation would have been helpful with the bonds sale. The court there fore decided that SEC would be awarded an amount totaling $550 million for the disregard of its rules and regulations and exploitation of the public (Damon, 2010).

The most significant settlement was the reforms that would ensure no reoccurrence of these trends especially where the public is involved. Damon, (2010) stated/agued that, “the Goldman case is particularly sensitive because the bank and its hedge fund partner engaged, in SEC words, in ‘fraudulent misconduct’ in the run up to the 2007 collapse of the subprime mortgage market.” These reforms would ensure maximum supervision of all the activities that would also ensure transparency of the firms. Here, the cases of fraud would be minimal. This case was a little bit different because the defendant at some point admitted to the charges of limited disclosure of information. For instance, in an event that the defendant was found innocent of all the charges, the SEC would be required to pay to them an amount as would be decided by the court. This would be due to defamation and wastage of resources and time. It was earlier discussed that the reputation of Goldman is the most valuable asset they possess. Therefore, a good name is worth very much.

Impact on Financial Reforms

Timing had to do with Madoff?

These had to do with the release that was advanced to the clients or the conditions that surrounded their release. For instance timing had to do with the madoff and reforms. For instance, it is very time consuming for the acquisition of the same land issues where they need to settle the land and questioning of the people involved. The settlement was questionable in relation to the stocks of the bank.

Payment of the relevant amount to the SEC by the Goldman Sachs did not mean the end of the situation which was to be a lesson to others regarding the misuse of abilities to mislead the public. It is assumed that the coincidence of two events is not merely as it looks like and caution needed to be taken to cover up any inside job that was taking place. The financial reforms however assisted in the acquisition of justice and a warning to other firms who would be planning to exploit their clients and potential investors due to absence of rules to govern their operations. The SEC is responsible for this assurance and guarantee that the law, for the sake of its citizens, is followed.

Was it only Goldman who did this

Besides the confirmation that the accusations would be punished and sufficient compensation made by the accused, it was evident that the occurrence of the events was not an individual move and involved a couple of other people working with various companies. This was only a way to bring to light the existence of such kind of exploitation and the precautions that were to be taken to curb such acts. According to the Securities and Exchange Commissions, the duty to protect the public interests from unscrupulous businesses laid in its hands even though there were no direct benefits. They did this to stabilize the economy and ensure the satisfaction of the citizens in all sectors. It was a branch of the government that assisted to oversee the financial reforms implemented and their effectiveness. As stated above, the Goldman was only an indication of one of the firms engaging in secret and non-transparent operations which would lead to selfish gains at the expense of the public. The reforms however had made it easier and more strategically to discover the culprits. For instance, having Paulson involve in proposing of such a serious act and willingness to advertise it with full knowledge of its drop shows how much people make from the losses of the genuine investors.

Democrats and the reform bill

Calmes, (2010) stated that, “… the fraud suit against the Wall Street titan Goldman Sachs has emboldened Democrats to ratchet up pressure on Republicans who oppose the Obama administration’s proposal.” In their campaigns, the republicans and democrats clashed over the validity of the financial reforms acquired and the effectiveness of their implementation. The proposition of the Wall Street reforms was to closely monitor the functioning of the institutions. This was to the advantage of the Democrats who had faced criticism from the republicans over the efficiency of these policies and objected to the signing in of such agreements and reforms (Calmes, 2010). It was also evident that focus on the Wall Street scandal would result in increased acceptance of the comprehensive renovation of financial instruction and regulation which had earlier on received much mixed reaction over its viability.

Conclusion

The basis of this discussion has been the case of Goldman Sachs and the Securities and Exchange Commissions. Basically, the relationship between the financial regulations and the ethical governing of institutions was wanting. Institutions banked on the absence of comprehensive laws to protect the public against cases of fraud to exploit the clients. Lack of transparency in the financial sector was also a major contribution to the poor performance and recession. Therefore, reforms that will be beneficial to all, especially the public and potential investors are very favorable to the government. This is because it will encourage competence in the workers and healthy competition where inside trading does not occur. Clients will also be guaranteed to receive sufficient and complete information regarding the risk they are about to venture in to avoid surprises.

Works Cited:

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