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Goldman Fraud Case: SEC Flashes Partisan Colors

Mary Schapiro, SEC ChairmanThe SEC's credibility has really taken a beating the past few years. The financial crisis, Bernie Madoff, Allen Stanford, and the market meltdown have us all wondering why we even bother having an independent agency for regulating and policing the securities industry.

I'm sure SEC Chairman Mary Schapiro (pictured) and enforcement head Rob Khuzami were feeling the heat when they decided to bet the farm on what, from a timing standpoint, among other things, appears to be a politically-motivated action against Goldman Sachs.

Why do I think that? Well, government bureaucrats are big on CYA, and CYA doctrine says if you can't please the customer, at least please the boss. And the boss, the guy who appoints the commissioners, is the President. And Barack Obama just happens to be pushing increased regulation of the banking industry.

So taking down Goldman and using the banking giant as a poster child for financial reform wouldn't be a bad strategy -- if it wasn't so risky.
You see, former SEC chairman Harvey Pitt did a pretty good job of laying out the facts when, in The Daily Beast, he pointed out that, aside from alleging "a garden variety securities fraud," Schapiro and company have wandered into unexplored territory by:

  • challenging the premier firm of Goldman Sachs,
  • about a synthetic derivative transaction,
  • on which Goldman lost millions of dollars,
  • where the parties were sophisticated and not in obvious need of SEC protection,
  • after a year-and-a-half investigation,
  • filed immediately after the President threatened vetoing financial reform legislation that doesn't strongly regulate derivatives,
  • and a few hours before release of the Inspector General's Report on SEC inadequacies in attacking Alan Stanford's Ponzi scheme,
  • but apparently without giving Goldman advance notice of the filing,
  • or exploring possible settlement, and
  • splitting 3-2 along political lines in a major enforcement action.
You know what I always say: if it looks like a duck and walks like a duck, it's probably a duck. And Occam's Razor says, all things being equal, the simplest solution is the right one. Well my friends, what we have here is, simply put, a duck.

Now, the SEC's civil action claims that Goldman sold a synthetic derivative product called Abacus, without disclosing to ACA Management, the company responsible for picking the mortgage securities that went into Abacus, or customers that Abacus was essentially developed by John Paulson, a hedge fund manager who intended to short or bet against it.

Never mind that, according to government testimony uncovered by CNBC, a Paulson official did in fact inform ACA that Paulson intended to short the product. That would seem to contradict the SEC's case, which hinges on Goldman's failure to disclose Paulson's intentions to ACA. Hmm.

Don't get me wrong; I'm not against regulation of derivatives. Au contraire, as I said in The Financial Crisis For Dummies:

Another key catalyst [of the financial meltdown] was then-Chairman of the Senate Banking Committee Phil Gramm pioneering the exemption of over-the-counter derivatives, such as credit-default swaps, from regulation. Greenspan and Rubin also supported deregulation of derivatives.
Nor am I saying the Obama administration was directly involved in the SEC's action. But the SEC's commissioners are appointed by the president, and three of the five are democrats who voted for the action along party lines. So, if the SEC loses the Goldman suit, it won't just weaken the SEC's credibility, it will also weaken the Obama Administration's position on banking reform.

And that looks like a very big risk, to me. Too big.


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