On Goldman

By now, everyone has heard that the SEC has brought charges against Goldman Sachs. In this post, I'm going to put my lawyer hat on and walk you through my thoughts on the complaint (here's a link to the complaint) to explain what's there and why it's important.

First, the document filed by the SEC is a complaint. The purpose of this document is to define the issues for trial. Usually, the person filing the complaint has done a lot of investigation before filing the document -- so much so that they can more or less anticipate what the defendant will do.

The government is arguing Goldman committed fraud under the securities laws. More specifically,

(a) Use of interstate commerce for purpose of fraud or deceit

It shall be unlawful for any person in the offer or sale of any securities or any security-based swap agreement (as defined in section 206B of the Gramm-Leach-Bliley Act) by the use of any means or instruments of transportation or communication in interstate commerce or by use of the mails, directly or indirectly—

(1) to employ any device, scheme, or artifice to defraud, or

(2) to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; or

(3) to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser.

The second law the government is alleging Goldman broke is similar to the first:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange—

(a)

(1) To effect a short sale, or to use or employ any stop-loss order in connection with the purchase or sale, of any security registered on a national securities exchange, in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

(2) Paragraph (1) of this subsection shall not apply to security futures products.

(b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities-based swap agreement (as defined in section 206B of the Gramm-Leach-Bliley Act), any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

In addition, the government has asked for a jury trial. This is a good idea, considering that Wall Street is yery unpopular right now.

There are several good points to mention here. First, by making this a fraud case, the government is avoiding a discussion about complex financial instruments. Instead, this is a case that is essentially about one party lying to another person. Remember -- the best cases are simple stories that everyone can understand. Lying is about as basic as it gets.

Second, it appears as though the government has done a great deal of investigation regarding this matter. The complaint presents a specific time line of events which the government has copiously documented. I don't know under what authority the investigation was constructed, but it was very thorough.

Third, in government based litigation, the government is going to argue more or less the same thing in a line of cases. Therefore, they usually bring their best case first to set a precedent for other jurisdictions to follow (this is what the IRS does in anti-avoidance litigation). I'm guessing this is the government's best case in this area. In correlation, the SEC is desperately trying to re-establish itself as a potent enforcement arm. I don't think they would bring a case right now unless they thought they had as close to a slam dunk case as possible.

Fourth, the government has brought allegations against Goldman and Fabrice Tourre, a Goldman employee who more or less was the primary mover behind the transaction in question. My guess is the SEC is going after Tourre directly to get him to flip on Goldman. I have no basis in fact for thinking that, it's just that he's the only person specifically mentioned in the complaint and he was intimately involved in the transaction.

Fifth, this is a civil rather than criminal case. This goes to the burden of proof. In a criminal case, the government must prove the facts beyond the shadow of a doubt. In a civil case, the government must prove the facts by a preponderance of the evidence -- a much lower burden.

Sixth -- why wasn't Paulson named? Largely because Paulson doesn't seem to have done anything illegal. Goldman was the company that lied about the contents of sales literature, not Paulson.

Finally -- the complaint lays out a very easy to understand time line of events. I have no personal knowledge of the team of lawyers trying this case for the SEC, but a good trial lawyer would have a pretty easy time telling this story. It comes down to greed, hubris and lying -- all committed to essentially screw people out of a lot of money. Assuming counsel stays of track, keeps the water clear from too much defendant laid chum, the SEC has a good case.