Its the Law, Bitches!

“…it is impossible for us, with our limited means, to attempt to educate the body of the people. We must at present do our best to form a class who may be interpreters between us and the millions whom we govern.”

-Thomas Babington Macaulay, member of the Governor General`s Council, in Calcutta, in 1834. Quoted in The New Yorker, May 31, 2010.

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FT’s Alphaville says I am cranky. Jeff Matthews says I am wrong. Michelle Leder points out the settlement is a pittance relative to GS’ cash.

Here’s a news flash: All of that is irrelevant. We are a nation of laws, and that is what guides SEC prosecutions, negotiations, and settlements. Sure, I may be cranky (only fellow curmudgeon Alan Abelson agrees with me), but what I truly am is astonished at some of the uninformed commentary pinging about inter-tubes about this subject.

Spin isn’t fact, opinions aren’t laws, and having an opinion is not the same as being informed.

One might hope that various folks discussing these issues have a passing familiarity with Securities law, but apparently not. Let’s see if we can edumacate some folks who are unfamiliar with the 1933 and 1934 Security acts.

1) Its the Law, Bitches!: First and foremost, this is a legal issue: It is not a philosophical debate, a political question, or a case of ethical transgressions; It is not even an investing question.

I am not going to get all Kartik Athreya on everyone, or claim that only lawyers should discuss this. But too many people seem to be forgetting that this is a legal case. It turns on what the law is, how regulatory agencies enforce that law. Discussing this out of that context is fun and intellectually stimulating, but it also provides zero insight into the legal case, or its prosecution, or its resolution.

Here is the classic legal syllogism: Understand the relevant law, apply the facts to that law, draw your conclusion. And the relevant law?

2) Securities Exchange Act of 1934:

Since this is a legal case, what say we actually look at the law?

“It shall be unlawful for any person, directly or indirectly to make any untrue statement of a material fact or to omit to state a material fact . . . [or to] engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.”

-Rule 10b-5, Securities Exchange Act of 1934 *

Based upon the evidentiary information the SEC had — emails, phone calls, sworn statements, etc. — the “Fabulous Fab” told Abacus buyers that John Paulson was long the Abacus CDO when he was in fact short it; Further, Fab omitted to mention that a short seller helped to construct the synthetic CDO that he was betting against.

That factual description is a clear violation of Rule 10b-5.

There are some folks who have argued that yes, Fab made untrue statements and omitted others — but they were not material. That is a very good, very lawyerly argument — but it is one that would be a stone cold loser in front of any jury.

Bottom line: IMO, this was a no brainer case based on these facts and the law. Unless you can show Fab never said those things, it is case closed.

THAT is why Goldman settled.

3)  Its a pittance! This is only a) 14 days of profits; b) 7X the CEOs salary c) 5% of Cash on hand:

Pay attention, this is important: I have been laboring under the impression that fines and penalties are relative to the legal transgression — you know, the law that was violated, and the damages that violation caused.

Fines are not based upon your bank account or annual income.

But that seems to be precisely what some people are arguing for. Does anyone here really want to see  the law structured so that fines and penalties are dependent upon your assets and income — and not based on the actual infraction?

Imagine getting pulled over for a speeding ticket, and in addition to license and insurance and registration, you give the cop (or the judge) your IRS 1040, bank account and IRA/401k statements. Fines are then assessed based on your income and wealth — rather than the actual seriousness of the infraction?

Pretty ugly and absurd thought! Yet that is exactly what I keep hearing people claim — that apparently, we should use a company’s finances and income to assess a far greater penalty.  Therefor, the fine should have been much greater — regardless of the transgression, because GS is so profitable and has so much cash.

Is that the road any of you seriously want to go down?

4) Penalties should be proportionate to infractions: Consider the transgression at hand: Fab lied in the sale of structured products, and his firm Goldman Sachs failed to adequately supervise him in these transactions. In the grand scheme of things, this was actually a minor transgression. Sure, it was sleazy, but it was not a billion dollar violation; It sure as hell was not an Arthur Anderson type massive firm-wide fraud deserving of the death penalty — as some of the angrier posts have demanded.

As much as many people want to blame the entire economic meltdown on the vampire squid, they deserve only a modest amount of blame. Worse still, this was not their most egregious offense.

In a nation of laws, we punish people for the crimes/transgressions they caught doing — not the ones we suspect they are guilty of (although OJ might beg to differ).

5) Securities Act of 1933: Civil Recovery by Defrauded Investors

As to the issue of Civil recovery by Goldman’s client’s, again, the 1933 Act is clear:

“In general,any person who offers or sells a security by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact, shall be liable to the person purchasing such security from him, who may sue either at law or in equity in any court of competent jurisdiction, to recover the consideration paid for such security with interest thereon . . . ”

–Section 12 — Civil Liabilities Arising in Connection with Prospectuses and Communications, Section 12 A

As noted Friday, this now opens Goldman to all manner of civil litigation by clients. I have no idea what the final cost of this will be; but a multiple of the $550 million in SEC settlements is likely, and a 10-20X final dollar amount is certainly in the range of possibilities.

6) Goldman’s Stock Rallied, therefore, its a victory:  I’ve always hated that analysis, but since you brought it up: Pre-indictment, GS was north of $180. It closed Friday at $146. Its still some 20% below where it was.

On a related noted, since the indictment, Goldman Sachs has lost about $15 Billion if market capitalization. Isn’t that part a consequence of the SEC indictment? Isn’t that, in effect, part of the penalty?

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Life is not a black & white, bull/bear debate. There is nuance and subtlety to complex issues. But there are also law, facts, and actually a functioning legal system with specific rules and procedures.

Some people seem keen to ignore that . . .


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* The full 10b-5 rule is

“Rule 10b-5: Employment of Manipulative and Deceptive Practices”:
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) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,
in connection with the purchase or sale of any security.”

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