SEC's Demand That Goldman Admit `Mistake' Could Spur Lawsuits
The demand that Goldman Sachs admit an error is a “major departure” for the SEC, said Harvey Pitt, a former chairman of the agency. Photographer: Jonathan Fickies/Bloomberg
By forcing Goldman Sachs Group Inc. to admit a “mistake,” U.S. regulators may be signaling a more confrontational approach to future settlements that could expose Wall Street to more investor lawsuits.
In its $550 million accord with Goldman Sachs, the Securities and Exchange Commission deviated from its usual practice of imposing a fine while letting a firm remain silent on whether it engaged in misconduct. Firms that are required to admit oversights may find it difficult to argue in private litigation that they conceded no wrongdoing and settled purely to end regulatory scrutiny, said Salvatore Graziano, a lawyer who specializes in class-action suits on securities fraud.
“This makes it even harder to assert that they settled out of convenience,” said Graziano, of Bernstein Litowitz Berger & Grossmann LLP in New York. “Once it’s out there, it’s out there.”
Last week’s accord between New York-based Goldman Sachs and the SEC removed a cloud over Wall Street’s most profitable firm. The SEC accused Goldman Sachs three months ago of selling a mortgage security without disclosing that hedge fund Paulson & Co. helped design the asset and was betting it would fail.
While Goldman Sachs still used the boilerplate language of not acknowledging or refuting improper conduct, the company also said it was a “mistake” that its marketing materials for the security called Abacus 2007-AC1 included “incomplete information.” The documents didn’t include Paulson’s role, according to the SEC settlement. The mistake admission was limited to the Abacus deal.
‘Major Departure’
The demand that Goldman Sachs admit an error is a “major departure” for the SEC, said Harvey Pitt, a former chairman of the agency.
“I don’t believe this will reflect a broadside decision to require concessions, because if that occurred, the SEC might not be able to settle a large percentage of the cases it brings,” he said. “Given the limits of the SEC’s budget, it is clearly not able to litigate every case it might otherwise bring.”
The SEC has about 1,400 employees in its enforcement division, which investigates and prosecutes wrongdoing. The entire agency operates on a budget of about $1 billion a year. Goldman Sachs has more than 34,000 employees and earned $4 billion in the first six months of 2010.
Companies and individuals that forge settlements with the SEC benefit from not having to admit wrongdoing, because it can limit their legal exposure, said Michael Piazza, a former SEC lawyer. The lack of any concession gives criminal prosecutors and private litigants nothing to build cases on, Piazza said. It also reduces the likelihood that insurance companies will deny paying lawyer fees on the basis that an SEC target is admitting guilt, he said.
‘World Will Change’
“An acknowledgment of some wrongdoing or specific acts of facts alleged could have a very different effect,” said Piazza, who now represents targets of SEC investigations at Greenberg Traurig LLP in Irvine, California. If the Goldman Sachs case “portends a trend for more fulsome acknowledgements, the world of SEC settlements will change.”
Goldman Sachs on April 16 said the SEC’s lawsuit was “completely unfounded in law and fact” and that the agency didn’t warn the company before announcing the case. The Financial Times reported in April that Chief Executive Officer Lloyd Blankfein told investors the suit may have been politically motivated to help President Barack Obama’s administration convince Congress to approve legislation overhauling financial regulation.
Those actions may have prompted the SEC to demand in the settlement that Goldman Sachs admit the mistake, Pitt said.
‘Vindicated’
“If you want to dispute the government’s allegations, that’s fine,” he said. “But if you want to malign or impugn the government’s motivations, that’s not fine. By extracting that agreement, the SEC has vindicated the fact that its lawsuit was filed for appropriate reasons.”
Goldman Sachs spokesman Michael DuVally declined to comment on why the firm admitted to a mistake. On a call with Wall Street analysts yesterday, David Viniar, the chief financial officer, was asked what impact the SEC settlement will have on any lawsuits against the company.
“We don’t think it’s going to have any material impact,” Viniar said. “We think there’s nothing new in the settlement.”
The SEC is examining other firms and a range of structured products that fueled losses during the financial crisis, Enforcement Director Robert Khuzami said when announcing the settlement. SEC spokesman John Heine declined to comment on whether any future settlements would include demands that companies admit mistakes.
Two Investors
Goldman Sachs’s risk of being sued in private litigation may be limited, because the SEC complaint only listed two investors who lost money on the Abacus transaction.
Royal Bank of Scotland Group Plc, which purchased a company that lost about $841 million on the mortgage security, hasn’t ruled out filing a lawsuit, a person with knowledge of the matter said July 16. The bank will receive $100 million as part of the SEC settlement.
IKB Deutsche Industriebank AG, which lost about $150 million on the Abacus deal, will recoup that amount from Goldman Sachs. KfW Group, Germany’s development bank that bailed out IKB, has said it is reviewing the SEC accord.
The regulatory settlement also requires Goldman Sachs to reform its business practices. Those changes, along with new regulations being considered by the SEC, may make it harder for all Wall Street firms to sell opaque financial products to banks, pension funds and governments.
Bolstered Compliance
When Goldman Sachs puts together a security tied to mortgages, the product must be reviewed and approved by a bigger group of corporate managers. The executives will be responsible for ensuring that marketing materials don’t include omissions or misstatements. Goldman Sachs also has to bolster compliance training for employees who sell the securities.
Khuzami said he hopes other firms adopt the “best practices.” If they do, it will create obstacles to getting some securitizations done quickly, said Cliff Rossi, a managing director at the University of Maryland’s Center for Financial Policy in College Park.
“The more pairs of eyes you have that have to review and sign off ahead of a deal, the more it slows things down,” said Rossi, a former senior risk officer at Countrywide Financial Corp., Washington Mutual Inc. and Citigroup Inc.
It’s a moot point for now, because there hasn’t been much demand for mortgage securities since the U.S. housing market collapsed in 2007.
Repackaging
Firms sold about $24 billion of these assets in the first half of 2010, and almost all were repackagings of existing bonds, according to newsletter Asset-Backed Alert. That’s down from a record of about $1.2 trillion in both 2005 and 2006.
The instrument involved in the Abacus deal was a collateralized debt obligation. CDOs are pools of assets such as mortgage bonds packed into new securities. Wall Street firms sell most CDOs through so-called private placements, offerings that aren’t subject to SEC disclosure requirements because only clients with more than $100 million of invested assets can buy the securities.
The SEC in April said it’s considering requiring issuers of private offerings to provide disclosures equal to those available in public sales, if investors request the information.
SEC Chairman Mary Schapiro said the proposal reflects a reconsideration of the regulator’s long-standing assumption that sophisticated investors like pension funds and endowments don’t need the same protections as individuals.
The private market would be “virtually shut down” if the SEC approves the proposal, because of increased compliance costs said Edward Gainor, a law partner at Bingham McCutchen LLP in Washington.
To contact the reporters on this story: Jesse Westbrook in Washington at jwestbrook1@bloomberg.net; Joshua Gallu in Washington at jgallu@bloomberg.net.
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