By: Elaine E. Bedel, CFP®
Goldman Sachs agrees to pay a $550 million fine to the SEC. They said they made a mistake in not disclosing all the facts before investing their own clients’ money in a deal that was intentionally stacked against the investors. That’s appalling!
Over the last week, the news media has been reporting on the Security and Exchange Commission’s “victory” in their fraud case against Goldman Sachs. The case did not go to court, but rather was settled with the fine of $550 million in exchange for allowing Goldman to avoid admitting to engaging in fraud. Over $1 billion was lost by investors and they are expected to recoup only about $250 million from the settlement. The remaining $300 million goes to the U.S. Treasury. As a side note, the $550 million has been reported to be less than 5% of Goldman’s 2009 net income of $12.2 billion and approximately equivalent to 15 days of profits. Not much of a penalty to sweep a lot of bad actions under the carpet!
What Was the Bad Deal?
This case involved a deal sold in 2007 that was referred to as Abacus 2007-AC1. It was a collateralized debt obligation (CDO), an investment vehicle that has often been mentioned as a key ingredient in our near financial collapse. This deal involved subprime mortgages and a bet on whether the value of these securities would rise or fall. One of the best explanations of Goldman’s wrong doing was included in an article appearing in USA Today on Friday, July 16, 2010. It said: “…Goldman now says that it should have disclosed that some of the securities behind Abacus had been picked by a hedge fund manager, John Paulson, who planned to bet that it would fail. He (Paulson) made $1 billion, the SEC said, when Abacus tanked….”
This means that Goldman allowed a hedge fund manager to choose the specific subprime mortgages that went into this particular investment package (Abacus), knowing that the hedge fund manager was going to make an off-setting bet that those mortgages would default and the investment pool would lose value. Goldman then turned around and sold this investment to their own clients, again, knowing that it had a higher than normal chance of losing money rather than making money.
Are you Mad Yet?
How can a so-called financial advisor for Goldman Sachs do this to his/her own clients? Simply put, they are paid by the firm to do so. A financial advisor with a brokerage firm is paid a commission when a client invests in these types of deals. So, why do clients invest in bad deals? Clients tend to be trusting and loyal to their broker and generally uninformed about complex investment vehicles.
Isn’t it illegal for a financial advisor to put the firm’s interest above the client’s? It depends on who the advisor works for. An investment advisor who works for a brokerage firm or insurance company is required to adhere to a “suitability standard” when working with clients. This means that as long as the investment is defined as a suitable alternative for the client, it is deemed appropriate. This is true even if the investment is not necessarily the best alternative.
However, financial advisors that are registered with the SEC as Registered Investment Advisors (RIAs) must adhere to a much higher “fiduciary standard” when working with clients. They are legally required to put the client’s interest first. The investment not only needs to be appropriate, it must also be in the best interest of the client. This is something that clearly is not the case with the brokers at Goldman Sachs.
What Can Be Done?
A big opportunity was just missed. The new financial reform bill included a requirement that the fiduciary standard be expanded to include advisors at brokerage firms and insurance companies. However, before the final version was passed by the Senate, the lobbyists were successful in having this fiduciary requirement substantially struck from the language.
Investor Beware
As an investor, it is up to you to understand the standard of care that is required of your advisor. If it is anything less than the fiduciary standard, then beware. Ask questions regarding how the advisor gets paid. If it is by commission, then ask what the amount of commission is for each investment that is offered or purchased on your behalf. You have a right to a trusting relationship with someone providing you advice on how to invest your money. If the advisor is not on your side, then as an investor you must beware.
Summary
From the point of view of investors and Registered Investment Advisors, the actions of Goldman Sachs are truly appalling. However, Goldman Sachs just looks at it as a way to make money for its executives, employees, and shareholders...but that still doesn’t make it right. Luckily, as an investor, you can decide who to work with. You just need to figure out the rules of the game.
