March 16, 2012 in Business

Goldman charges ring familiar

Investment bank has faced series of allegations lately
Daniel Wagner Associated Press

The young banker whose dramatic public resignation stung Goldman Sachs this week joins officials from every corner of the government in questioning whether the august investment house deals honestly with all its clients.

In separate cases, judges, lawmakers and regulators have suggested the bank ignores conflicts of interest and sells to its clients investments it knows are weak, all in the pursuit of profit.

The resignation Wednesday by Greg Smith, a 33-year-old banker for Goldman in London, was a shot from within Goldman’s ranks. In an op-ed article for the New York Times, Smith said the bank sells financial products “that we are trying to get rid of.”

The essay was widely circulated online, and Smith became a trending topic on Twitter. But his charges were only the latest embarrassment for Goldman, which has built a sterling reputation over 143 years on Wall Street.

The bank paid $550 million in 2010 to settle civil charges that it misled investors while selling them investments in the U.S. housing market as the bubble burst – even as Goldman reaped hundreds of millions from its own bets against housing.

A congressional committee recommended that law enforcement authorities look into a series of deals that Goldman sold while executives derided them in emails as “junk,” “crap” and another profane adjective.

And last month, a Delaware court nearly blocked a merger between Kinder Morgan and El Paso, two energy companies, because Goldman had ties to both companies, raising questions about a conflict of interest.

“This is the latest entry into a long-running narrative that they don’t put their clients first,” said Michael Robinson, a former official with the Securities and Exchange Commission. “If your business is built on trust, that’s not going to fly.”

Robinson, who now works for Levick Strategic Communications, a public relations company, said regulators, Congress and prosecutors are almost certain to look into Smith’s claim that Goldman sold investments to clients that it wanted to get rid of.

The SEC, the FBI and federal prosecutors in Manhattan declined comment. A spokesman for Goldman also declined comment.

Legal experts said the bar for proving wrongdoing by executives at the bank would be high. The real danger for Goldman, Robinson said, is that clients will lose faith and abandon it.

“Whether what they’re doing is legal or not, it sure is going to keep them in the headlines – and remind people that they can’t always trust what they’re hearing from their banker,” he said.

Senators questioned CEO Lloyd Blankfein and other Goldman executives an April 2010 subcommittee hearing. A subcommittee report said Goldman marketed four sets of complex mortgage securities to investors but failed to tell them the securities were very risky.

The committee report also said Goldman secretly bet against the clients and deceived them about the bets so that they would pay for Goldman’s earlier, doomed housing investments.

Subcommittee chairman Sen. Carl Levin, D-Mich., questioned the accuracy of the executives’ testimony.

“Did anyone ever really think that Goldman was doing what was best for their clients?” said Rep. Brad Miller, D-N.C., a regular critic of the banking industry who serves on the House Financial Services Committee. “Goldman may have denied it, but I never really believed their denials.”

The Delaware case illustrates Goldman’s reach. The state judge declined to block the Kinder Morgan-El Paso deal but expressed misgivings. Goldman advised El Paso, owned a 19 percent stake in Kinder Morgan and controlled two of Kinder Morgan’s board seats.

The judge, Leo Strine, said Goldman took steps to separate its advisers to each company, but said the efforts were not effective.

“This kind of furtive behavior engenders legitimate concern and distrust,” he wrote.

Smith did not present specifics about the bank’s marketing to customers, and the young banker still had not spoken publicly Thursday beyond the Times op-ed.

Any regulatory or criminal probe of Goldman that grows from Smith’s charges would be an uphill battle, legal experts said. The recent SEC charges against Goldman relied on misleading statements in the marketing materials Goldman produced to sell the risky deal.

To defend itself against charges that it sold bad investments, Goldman would only need to prove that the investments it sold were “suitable” for clients. That’s a looser standard than the rules for investment advisers, who are required to act in their clients’ best interests.

“While these may be revelations to the marketplace, they likely are not revelations to anyone inside Goldman or to the securities regulators,” said Jacob Frenkel, a former SEC enforcement attorney now practicing with the firm Shulman Rogers.

“Goldman’s clients tend to be so loyal because they’re among the top tier of investors,” with enough assets that the law considers them capable of making investment decisions with less disclosure by their brokers, he said.

William Atwood, executive director of the Illinois State Board of Investment, which handles public employees’ retirement funds, said he was not convinced that Wall Street had changed its ways, despite an outcry since the 2008 financial crisis, when Goldman took $10 billion in government bailout money.

He said the board dropped Goldman as an investment manager four years ago.

“To say there’s still arrogance on Wall Street is like saying the sky is still blue,” Atwood said. “There’s this sense of entitlement, this outrageous compensation that people still get and think somehow they earned it.”

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