Wall Street’s smartest will meet the Senate’s toughest at a hearing next week that could provide a seminal moment in the reckoning after the financial crisis.
Lloyd Blankfein, Goldman Sachs Group Inc.’s chairman and chief executive officer, and six current and former employees of his firm will face a grilling from the Permanent Subcommittee on Investigations. Led by Carl Levin, a Michigan Democrat who has served in the U.S. Senate for more than 30 years, the panel has a reputation for thorough research.
The interrogation of Goldman Sachs, the most profitable securities firm in Wall Street history, may echo Ferdinand Pecora’s Depression-era investigation of powerful financiers like J.P. Morgan Jr., said some historians. It comes after regulators sued Goldman Sachs and employee Fabrice Tourre, alleging fraud in the sale of a mortgage-linked investment as the market for such investments turned, accusations the firm denies.
“This is Pecora II,” said Charles Geisst, a finance professor at Manhattan College in Riverdale, New York, who has written about Wall Street’s history. “They have to squirm and they have to answer the questions.”
The Senate investigation into the causes of the Wall Street crash of 1929 became known as the Pecora Commission, after the former New York City assistant district attorney who was appointed its chief counsel. Congress went on to pass the Securities Act of 1933 and the Securities Exchange Act of 1934, portions of which Goldman Sachs and Tourre are accused of violating in the Securities and Exchange Commission’s suit filed on April 16.
The SEC said Goldman Sachs and Tourre, 31, failed to inform investors in a 2007 collateralized debt obligation that hedge fund Paulson & Co., led by billionaire John Paulson, played a role in choosing the mortgage securities that underpinned the CDO and planned to bet on its failure.
Goldman Sachs said it would never mislead investors and that ACA Management LLC and IKB Deutsche Industriebank AG, investors in the deal, had all the material information they needed. Tourre will tell the panel he did nothing wrong, according to a person briefed on his planned testimony.
Levin today released Goldman Sachs e-mails obtained by his committee that he said demonstrate the firm “made a lot of money by betting against the mortgage market.” Among them was an e-mail in which Blankfein said, “We lost money, then made more than we lost because of shorts.”
Lucas van Praag, a spokesman for Goldman Sachs in New York, today released information on the firm’s residential mortgage profits and losses in 2007 and 2008. The information shows Goldman Sachs had net losses of $1.2 billion in residential mortgage-related products in the period. While the firm generated more money than it lost on mortgage positions in 2007, losses overwhelmed gains in the first quarter of 2008, the documents show.
“The U.S. Senate subcommittee has cherry-picked just four e-mails from the almost 20 million pages of documents and e-mails provided to it by Goldman Sachs,” van Praag said. “It is concerning that the subcommittee seems to have reached its conclusion even before holding a hearing.”
Implications for Regulation
Like Pecora’s, Levin’s hearings could have implications for financial regulation. They take place as the Senate starts considering a package of financial rules that would require better disclosure of derivatives trading and could force banks to split off divisions that trade for their own accounts.
Blankfein, 55, may get tougher questioning than he received in front of the Financial Crisis Inquiry Commission led by former California state Treasurer Phil Angelides in January, Geisst said. Levin’s committee first subpoenaed information from Goldman Sachs on June 30 and sent a second subpoena on March 12, before conducting interviews with Goldman employees this month.
“Levin is smarter,” said Martin Mayer, a guest scholar of the Brookings Institution who has written books including “The Fed” and “The Bankers” about the financial system. “It’s a stronger committee.”
Levin, 75, has been chairman or the top Democrat on the Permanent Subcommittee for more than a decade. He delves deeply into the issues, said Jack Blum, who spent 14 years as an investigator for other Senate panels and has testified before Levin’s committee as a private citizen.
“What you’re going to expect is a guy who first of all really will have done his homework,” Blum said. “He’s a very influential senator.”
Blum said the Permanent Subcommittee also is one of the rare panels with bipartisan cooperation between the senators and their staffs.
Criticizing Goldman “is going to be everybody’s great moment,” Blum said. “It’s the parade you want to be in.”
Testimony is scheduled to begin at 10 a.m. Washington time on April 27. The first panel will question Tourre, Michael Swenson, a managing director in Goldman Sachs’s structured products group, and two former employees: Daniel Sparks, who was head of the mortgage department, and Joshua Birnbaum, who was a managing director in the structured products group.
A second panel will feature Chief Financial Officer David Viniar and Chief Risk Officer Craig Broderick, followed by a final panel at which Blankfein is slated to appear alone.
The hearing presents a “lose-lose situation” for Goldman Sachs, Geisst said, because the firm is fighting a battle over its reputation as well as the law.
“If they answer with generalities and maintain that they haven’t done anything wrong, then it just gets worse for them,” he said. “If they do admit that they’ve actually done something wrong, specifically, it won’t go well for them.”
As other banks struggled throughout the financial crisis, Goldman Sachs posted record earnings in 2007 and then set a new record in 2009. In late 2008, following the collapse of Lehman Brothers Holdings Inc., the firm was allowed to convert to a bank under the oversight of the Federal Reserve and received $10 billion of taxpayer money, which it repaid with interest about eight months later. Blankfein, whose $67.9 million bonus in 2007 was a record for a Wall Street CEO, received no bonus in 2008 and a $9 million all-stock bonus for last year.
Goldman Sachs disputes the criticism that the firm’s short position on mortgage securities during 2007 constituted a bet against its own clients. In a letter to shareholders earlier this month, Blankfein and President Gary Cohn said the positions “served to offset our long positions. Our goal was, and is, to be in a position to make markets for our clients while managing our risk within prescribed limits.”
“Some of these things Goldman did had no useful function,” said Richard Sylla, a financial historian and economics professor at New York University’s Stern School of Business. “They have that problem even if they didn’t do anything illegal.”
Five Goldman Sachs senior executives sold $65.4 million of stock after the firm received notice of possible fraud allegations last year from the SEC, the Wall Street Journal reported yesterday. Michael DuVally, a Goldman Sachs spokesman, declined to comment on the sales when contacted by Bloomberg News. The firm has said it didn’t disclose receiving a Wells notice from the SEC because it didn’t think it was material.
Robert Khuzami, the SEC’s enforcement chief, oversaw a group that helped create CDOs when he worked at Deutsche Bank AG, the Journal reported yesterday, citing unidentified people familiar with the matter. It isn’t clear whether Khuzami reviewed any documents at Deutsche Bank related to CDOs, the newspaper said. Khuzami declined to comment because the terms of his SEC recusal prevent him from discussing Deutsche Bank, John Nester, an agency spokesman, told Bloomberg News.
Levin’s chief investigator, Robert Roach, has been at Permanent Subcommittee since September 1997 and has almost 20 years of experience working for congressional oversight committees. Staff director Elise Bean has focused on the pay gap between executives and average workers for almost as long.
Roach balances his investigative work with speeches at conferences that interact with his areas of expertise, such as a meeting on offshore bank jurisdictions held annually in Miami Beach. After an interview over drinks last year, Roach insisted on paying for his own $3 beer, saying he never let anyone, reporters included, pay for his meals.
Keith Ashdown, chief investigator for the Republican staff led by Oklahoma Senator Tom Coburn, is a former executive at Taxpayers for Common Sense, the Washington-based budget watchdog group that first dubbed a proposal to build a bridge in Alaska the “Bridge to Nowhere.”
Created in 1948, the panel was led by then-Senator Joseph McCarthy of Wisconsin in the 1950s, who alleged that communists had infiltrated the federal government. McCarthy later was censured for hearings that Levin wrote in 2003 “destroyed careers of people who were not involved in the infiltration of our government.”
In the last two years, the committee focused on the role played by UBS AG and Liechtenstein’s LGT Group in facilitating offshore tax evasion worldwide. At a July 2008 hearing, UBS made worldwide headlines by announcing it would stop offering offshore banking services for U.S. customers.
Under Levin’s leadership, the panel has exposed how banks such as Citigroup Inc. and JPMorgan Chase & Co. helped Enron Corp. structure fraudulent financial transactions, and investigated the dangers of buying prescription drugs over the Internet and how former Iraq dictator Saddam Hussein abused the United Nations Oil-for-Food program.
Focus on Taxes
The committee has focused on tax issues other than the UBS case in recent years. In 2003, it revealed how firms such as KPMG LLP, Ernst & Young LLP and PricewaterhouseCoopers LLP spent much of the 1990s devising and marketing tax shelters judged illegal by the Internal Revenue Service.
In 2007, Levin introduced legislation to limit tax benefits for companies that pay executives millions of dollars in stock options after his panel concluded the tax subsidies helped widen the divide between compensation of top officials and ordinary workers.
The panel’s shortcoming, Blum said, is that it rarely enjoys legislative jurisdiction in the areas it investigates, meaning any bill the probes produce must go through other committees. In the Goldman case, any ensuing legislation would probably go through the Senate Banking Committee or the Committee on Homeland Security and Governmental Affairs.
Still, Blum said, when Levin holds hearings, “the companies involved have a hell of an image problem.”