Goldman Gambles as Lawyers Say Bank Should Settle With SEC

Photographer: Peter Foley/Bloomberg

Traders at the Goldman Sachs Group Inc. booth on the floor of the New York Stock Exchange watch a live broadcast of President Barack Obama speaking about financial regulatory reform in New York, on April 22, 2010. Close

Traders at the Goldman Sachs Group Inc. booth on the floor of the New York Stock... Read More

Close
Open
Photographer: Peter Foley/Bloomberg

Traders at the Goldman Sachs Group Inc. booth on the floor of the New York Stock Exchange watch a live broadcast of President Barack Obama speaking about financial regulatory reform in New York, on April 22, 2010.

Goldman Sachs Group Inc. may be better off cutting its losses instead of fighting what it terms “unfounded” fraud claims, say professors of securities law who have examined the U.S. Securities and Exchange Commission’s lawsuit against the bank.

The most profitable firm in Wall Street history will probably lose what is typically the first hurdle in court, a motion to throw out the April 16 suit because it lacks legal merit, the professors said in interviews this week. After that, Goldman Sachs’s risks will mount and its negotiating position will weaken, they said.

“There’s a very low probability that Goldman could get the case dismissed,” said Thomas Hazen of the University of North Carolina at Chapel Hill, whose books include a two-volume treatise on broker-dealer law. “Every pretrial motion the SEC wins, Goldman gets one step closer to losing.”

Goldman Sachs is the first major Wall Street firm accused by regulators of fraud connected to the collapse of the subprime mortgage market. The SEC’s allegation that Goldman Sachs defrauded investors sparked a 13 percent, one-day decline in its shares. The New York-based firm, led by Chief Executive Officer Lloyd Blankfein, 55, said it will vigorously contest the claims. It must weigh the risks of a drawn-out legal battle against the benefits of a more immediate resolution.

Photographer: Daniel Acker/Bloomberg

Lloyd C. Blankfein, chairman and chief executive officer of Goldman Sachs Group Inc., chats with other attendees prior to a speech by U.S. President Barack Obama about financial reform at Cooper Union in New York, on April 22, 2010. Close

Lloyd C. Blankfein, chairman and chief executive officer of Goldman Sachs Group Inc.,... Read More

Close
Open
Photographer: Daniel Acker/Bloomberg

Lloyd C. Blankfein, chairman and chief executive officer of Goldman Sachs Group Inc., chats with other attendees prior to a speech by U.S. President Barack Obama about financial reform at Cooper Union in New York, on April 22, 2010.

“We are disappointed that the SEC would bring this action related to a single transaction in the face of an extensive record which establishes that the accusations are unfounded in law and fact,” the bank said after the complaint was filed. Lucas van Praag, a Goldman Sachs spokesman, declined to comment yesterday on the likelihood of getting the case dismissed.

Senate Hearing

Blankfein and other executives at the bank are scheduled to testify at a Senate hearing next week along with Fabrice Tourre, the Goldman Sachs banker who was also sued by the SEC. The Permanent Subcommittee on Investigations will explore investment banks’ role in the financial crisis at the April 27 hearing.

Blankfein yesterday attended a speech by President Barack Obama in New York City pushing for financial regulatory reform, as Congress weighs legislation that could crimp profits for Goldman Sachs and the biggest U.S. banks. The legislation may come to the Senate floor as early as next week.

Even if top managers are certain they’re right on the merits of the case, Goldman Sachs should probably settle, said senior executives at three of the firm’s rivals. The executives, speaking anonymously because they wouldn’t comment publicly on a competitor, said Goldman Sachs would be better off by deciding to settle the suit, cut its losses, and focus on repairing the damage to the firm’s reputation.

Paulson’s Pick

Two of the executives said they also believe Goldman Sachs may have to change senior management to give the appearance that the firm is changing the way it does business.

The SEC’s case revolves around whether the firm should have told investors that hedge fund Paulson & Co. helped pick the underlying securities in a collateralized debt obligation -- and then bet against it. Paulson wasn’t accused of wrongdoing.

That’s too nuanced a judgment to make on the limited evidence available so far, making it unlikely the case will be dismissed, said Peter Henning, a former SEC attorney who teaches at Wayne State University Law School in Detroit. U.S. District Judge Barbara Jones, who was assigned the case and also presided over the case of former WorldCom Inc. CEO Bernard Ebbers, won’t dismiss it because materiality is what’s at issue, said Columbia University’s John Coffee.

Lawsuit Fodder?

If the SEC’s case survives a dismissal motion, the case would probably proceed to discovery, when the agency may seek additional testimony or information from the firm. That process could provide fodder for private lawsuits, additional allegations from regulators, or media attention that would further tarnish the firm’s image, according to George Cohen, a corporate law professor at the University of Virginia School of Law, and Lisa Casey, who teaches securities law at the University of Notre Dame in Indiana.

“The evidence and rumors would be difficult to contain,” Casey said. “The market could react any time more information leaks out to the press.”

Goldman Sachs’s shares have slipped 1 percent this week after the April 16 tumble. The stock rose $1.31 to $160.35 as of 9:35 a.m. in New York Stock Exchange composite trading.

Few professors were willing to predict which side would win in a trial, saying the case will depend on evidence and testimony that isn’t yet public. If weaknesses emerge in the SEC’s case, Goldman Sachs may decide to press on.

Reputational Risks

The reputational stakes are so high that Goldman Sachs may feel pressure to keep fighting, said Onnig Dombalagian, a former attorney fellow at the SEC who teaches at Tulane University Law School in New Orleans. “For Goldman not to stand behind its deals would be problematic for the firm,” he said.

If Goldman Sachs settles or loses at trial, “people are going to ask, ‘Am I one of the clients who Goldman does deals for, or am I one of the clients Goldman does deals against?’” Dombalagian said. “There’s the saying that if you don’t know who the mark at the table is, you’re probably the mark.”

Tamar Frankel, a corporate governance professor at Boston University, said a jury may be hostile to Goldman Sachs. “If many of the jurors have lost chunks of their savings in the crisis, the weight will be for the SEC,” Frankel said.

The case is Securities and Exchange Commission v. Goldman Sachs, 10-cv-03229, U.S. District Court, Southern District of New York (Manhattan).

To contact the reporters on this story: Joshua Gallu in Washington at jgallu@bloomberg.net; David Scheer in New York at dscheer@bloomberg.net.

Bloomberg reserves the right to edit or remove comments but is under no obligation to do so, or to explain individual moderation decisions.

Please enable JavaScript to view the comments powered by Disqus.