SEC v. Goldman as a Simple Case
Despite a complex context and heated rhetoric on all sides, the core of the SEC’s complaint against Goldman Sachs is simple: Goldman sold to investors a bet based on a list of securities it said would be hand-picked by an independent expert when the list was allegedly picked in part by a Goldman client with interests diametrically opposed to the investors. The only successful defense to this allegation is that the independent expert did in fact hand-pick the list and neither Goldman nor its other clients played a role in it.
Picking the list is vital and related disclosures or non-disclosures material within the meaning of federal securities laws. If investors are told a list is chosen by an independent party, they are told that the bet will be a fair game—knowing, of course, that other investors will have different views and either refuse to buy the same device or even take short positions against it. But if investors are told that a list will be chosen by someone who will make money only if its value declines, rational investors will eschew such a game as rigged, not fair.
Since the incubation of the asset-backed securities markets decades ago, when I helped to design them, selection of the pool or reference securities has always been seen as vital. In original deals consisting of a bank’s mortgage loans, for example, the selection is to be made using a haphazard selection protocol from across the bank’s entire mortgage loan portfolio. Banks cannot cherry pick their overall portfolio and dump only the worst-performing loans into a pool. Investors would not buy it if they knew that were happening.
The same is true for the kind of deal at issue in SEC v. Goldman Sachs. Multiple bettors would wage gambles on whether a selected reference group of securities is heading up or down over a stated time period. If the group is selected either haphazardly or by an independent agent, no one has a rigged advantage and all face a fair game. If the group is selected by an undisclosed participant with an interest in one direction or the other, a strong case of fraud appears.
The importance of the independent selection is why the Goldman offering circular prominently displays ACA as the Portfolio Selection Agent on page one, prominently describes it and its role on pages 2-3 and 84-85, and makes hundreds of references to it throughout. That’s also why the SEC complaint highlights the importance Goldman attached to identifying and advertising that ACA would perform that role. If investors knew someone lacking ACA’s independence were making the selection, whether Goldman itself or another client, they would have shunned the bet as rigged.
The Goldman circular describes the securities in detail over 176-pages, replete with intensive emphasis on the numerous conflicts of interest Goldman and its various affiliates face in the deal. Never once does it say that the reference list may be chosen by anyone other than the independent expert. There would be no issue in the case if that circular had disclosed that the reference list may be chosen by Goldman or its affiliates or clients. There will also be no issue if, in fact, no one other than that independent expert chose the reference list.