Will The SEC's Case Against Goldman Be Difficult To Win?

The NYTimes writes a news analysis story arguing so:

In accusing Goldman Sachs of defrauding investors, regulators are not only taking aim at a company with deep pockets and a will to fight — they are also pursuing an unusual claim that could be difficult to prove in court, legal experts said.

I have not delved enough into the facts of the case to know if this is true, but some statements in the article seem clearly wrong on the law. This statement for instance:

To win its case, the S.E.C. must prove that Goldman was not merely silent about Mr. Paulson’s role but actually gave investors the wrong impression, experts in securities law said. Then it must prove that the missing information was material, a legal term meaning that investors armed with that knowledge might have decided not to buy the product from Goldman, or to do so at a lower price.

(Emphasis supplied.) That is not a good description of the standard in my view. We went through this issue before. The standard the reporter is trying to articulate is this:

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 [. . .]

The issue is less likely to be, in my view, whether Goldman was misleading about the role of Paulson (which was shorting the position of the investment), but whether Paulson's position on the investment position was material to the offering. Indeed, in the next paragraphs of the story, it becomes clear that this will be the key issue:

Allen Ferrell, a law professor at Harvard, said the suit rested on an unusual definition of material information.

From a common sense perspective, it seems to me that this law professor has the better of the argument:

Adam C. Pritchard, a law professor at the University of Michigan, said that the S.E.C.’s focus on the construction of Goldman’s security reflected the increased complexity of financial instruments. Construction has simply become a more important part of the process, he said. But he added, “The basic idea that an undisclosed conflict of interest could be misleading is pretty much as old as stockbrokers.”

(Emphasis supplied.) Indeed. One other flaw in the story it seems to me is this idea that convincing a jury will be difficult for the SEC:

Several experts on securities law said fraud cases like this one, which focuses on context rather than content, are generally more difficult to win, because it can be hard to persuade a jury that the missing information might have led buyers to walk away.

(Emphasis supplied.) I must strongly disagree with the legal experts the Times is relying on. The easiest part of this case for the SEC will be convincing a jury to find against Goldman. The hardest part for Goldman would be GETTING to a jury and avoiding a judgment as a matter of law by the judge who will preside over the case.

Indeed, the most important aspect of this case is not discussed in the story in my view - what judge has the case been assigned to? (kaleidescope helpfully informs me that the case has been assigned to Judge Barbara Jones.) It is possible that Goldman will fight the case all the way to the Supreme Court. I personally doubt it and figure the issue is how much will Goldman pay to settle the case and how much will the SEC accept. A key consideration to that calculus is how confident is Goldman that it can win a judgment as a matter of law. The judge in the case will decide that in the first instance.

If settlement is the route chosen, what will it take to make this case go away? Both for Goldman and the government, this could be the key consideration. Will Goldman judge the PR hit too extreme? Will the government think the same, for opposite reasons? The dollars are, frankly, meaningless to Goldman. Whatever they pay will be chump change for them. But how will the number be perceived? It seems more of a PR decision than a legal decision, both for the government and Goldman.

In any event, in the words of Roland Hedley, Jr., time will tell.

Speaking for me only

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    As to scienter (5.00 / 1) (#17)
    by Tom Maguire on Tue Apr 20, 2010 at 10:42:50 AM EST
    This is from the post:

    The issue is less likely to be, in my view, whether Goldman was misleading about the role of Paulson (which was shorting the position of the investment), but whether Paulson's position on the investment position was material to the offering.

    To square that circle, I think that proving that Goldman deliberately misled ACA will go as long way towards establishing materiality and intent.

    To belabor that, if the SEC can show that Goldman made a real effort to confuse ACA, then Goldman's assertions that Paulson's role was not material and Goldman honestly considered them not to be material collapse - if it was immaterial, why lie?

    OTOH, if the SEC cannot prove a deliberate attempt to mislead ACA, then Goldman can say that (a) they sincerely believed Paulson's role was immaterial, and (b) it was in fact immaterial.

    If they can convince a jury of (a) and (b) they are in great shape; if they can only convince a jury of (a), they still are OK on lack of intent, although I think they remain exposed on a negligence charge.

    ...but I think Maguire misunderstands the law in one crucial aspect.

    Only one?!?  I was having a good day.

    I'm currently looking at this case as Dreadful v. Awful, and I can't pick a side.  I don't like weak, politically motivated prosecutions, but I really don't like Goldman Sachs.  I really wish this case were stronger, and (to steal someone else's thought), I am surprised that of all the deals the SEC must have looked at, this is the one they wanted to open with.

    If you are having doubts (none / 0) (#36)
    by BTAL on Tue Apr 20, 2010 at 05:34:56 PM EST
    then Greg Craig will have a field day defending GS.

    If Rep Issa's digging into the SEC records pulls even the slightest whiff of political involvement, the entire house of cards comes tumbling down.  

    This is a very poorly chosen battle for the Obama administration for short term November populous results.


    As for the Judge (none / 0) (#1)
    by kaleidescope on Tue Apr 20, 2010 at 08:45:16 AM EST
    The case has been assigned to Barbara Jones who presided over the Worldcom fraud case.  Judge Jones sentenced Worldcom CEO Bernard Ebbers to 25 years.

    Thanks (none / 0) (#2)
    by Big Tent Democrat on Tue Apr 20, 2010 at 08:48:02 AM EST
    I should add that to the story.

    Judge Jones is terrific (none / 0) (#12)
    by Democratic Cat on Tue Apr 20, 2010 at 10:05:34 AM EST
    Smart and tough.  Ten years ago she found against Visa and MasterCard in an antitrust case brought by the DOJ.

    More on Goldman (none / 0) (#3)
    by MO Blue on Tue Apr 20, 2010 at 08:50:41 AM EST
    ...Britain's financial regulator is "launching a full-blown investigation into Goldman."

    Goldman Sachs has hired ex-White House counsel Gregory Craig to run its legal defense and public relations campaign against recent charges from the Securities and Exchange Commission (SEC). link

    Is this a matter of "old tired" law (none / 0) (#4)
    by Militarytracy on Tue Apr 20, 2010 at 08:56:20 AM EST
    bumping up against the newer self conceived Wall Street laws that never existed? Boy they chap me.  I don't pretend to understand any of the legal side yet, but I will do my best.

    The facts and observations (none / 0) (#5)
    by Abdul Abulbul Amir on Tue Apr 20, 2010 at 09:36:10 AM EST
    It is a good piece (none / 0) (#10)
    by Big Tent Democrat on Tue Apr 20, 2010 at 09:47:02 AM EST
    but I think Maguire misunderstands the law in one crucial aspect. While a sophisticated investor standard is certainly in order, it remains an objective standard, not a question of what ACA or any investors should have known specifically.

    It is whether the offering was one which complied in the context of an objective sophisticated investor.

    Maguire focuses too much on the players.

    Plus it requires Goldman to argue that its clients are a bunch of idiot dupes.

    Not good business marketing.


    It's a sound argument though! (5.00 / 1) (#14)
    by kdog on Tue Apr 20, 2010 at 10:24:05 AM EST
    You gotta be a dupe to give those Goldman cats a dime...I mean seriously farkin' stupid.

    a bunch of idiot dupes. (none / 0) (#23)
    by Abdul Abulbul Amir on Tue Apr 20, 2010 at 11:53:30 AM EST
    Plus it requires Goldman to argue that its clients are a bunch of idiot dupes.

    Hmmm.  I read it the opposite, in that the SEC is promoting the idea that the long side of the transaction (including Goldman itself for $95mill loss) were duped be Goldman.  

    Since ACA (on the long side) had the final say so as to what was in the package it is going to be tough to prove that Goldman duped both ACA and itself.  

    This kind of trade is a zero sum transaction.  The players know for certain going in that what is a gain or loss for one side will be the opposite on the other side.  

    The case looks really weak.  The timing of going after "Wall Street" when the financial takeover bill is being pushed is hard to ignore.  Add to that the partisan 3/2 split to bring the case in the first place and it looks more and more like a political exercise.  

    It is interesting how much ink this is getting when the SEC's role in the Stanford Ponzi scheme gets nary a peep.  The Stanford Ponzi wiped out many small investors,


    I totally agree (none / 0) (#38)
    by klassicheart on Wed Apr 21, 2010 at 01:34:55 AM EST
    I haven't done more than read the complaint (none / 0) (#6)
    by Maryb2004 on Tue Apr 20, 2010 at 09:40:29 AM EST
    but I also don't see the problem.  Of course, I don't practice securities law so I'm no expert.  But there was an omission and while I can't see how it isn't material I guess that's the question.  

    I did read somewhere (I should keep track of where I read these things) that the case is unusual because the security is a synthetic CDO and there was some speculation about whether the SEC had ever used 10b-5 on a synthetic CDO.  But as long as the SEC can show it is a security I don't know what difference that makes.

    iirc even the SEC has to prove scienter, but that shouldn't be an issue here.

    So I'm not seeing the big problem here.  

    I don't do it much now (none / 0) (#8)
    by Big Tent Democrat on Tue Apr 20, 2010 at 09:43:17 AM EST
    But I did some back in the day and to me it is obvious that the question is whether Paulson's role and actions are material is the question.

    It seems no one disputes it was not disclosed.

    But, the litigator in me tells me that the issue now is how do the respective parties feel about their chances before Judge Jones.

    The case will be settled some time next year I imagine.

    To wit, AFTER the midterms.


    As for Settlement (none / 0) (#18)
    by kaleidescope on Tue Apr 20, 2010 at 10:44:02 AM EST
    Dollars are one thing. What kind of injunctive relief do you think the government will be seeking?  In the world of environmental law that I inhabit, legislation by consent decree is very useful in filling gaps in actual legislation.  

    Excellent question (none / 0) (#22)
    by Big Tent Democrat on Tue Apr 20, 2010 at 11:39:36 AM EST
    The complaint prays for (none / 0) (#33)
    by scribe on Tue Apr 20, 2010 at 02:41:46 PM EST
    the standard, meaningless, injunction against Goldman violating the securities laws in the future.

    Not that anyone ever gets tagged with contempt over breaching that injunction.


    To wit, AFTER the midterms. (none / 0) (#19)
    by squeaky on Tue Apr 20, 2010 at 10:59:39 AM EST
    What? You think that bringing this case against Goldman Sachs has political motives for the Obama admin?

    What an imagination you have... lol


    Ask yourself this (none / 0) (#30)
    by BobTinKY on Tue Apr 20, 2010 at 02:24:37 PM EST
    if you were one of the purchasers and you had been told prior to purchasing, would you have gone through with the purchase?

    That is even a higher standard than I believe the law requires.  I would think a reasonable investor just figuring the disclosure into his/her decision would be enough to make it material.


    You see this with (none / 0) (#39)
    by klassicheart on Wed Apr 21, 2010 at 01:41:58 AM EST
    perfect clarity.  The interview of Paul Krugman by Rachel Maddow was pretty interesting.  Sort of supports your analysis re next year's quiet settlement.

    Jury (none / 0) (#7)
    by jbindc on Tue Apr 20, 2010 at 09:42:49 AM EST
    You're right that getting a jury to convict will be pretty easy - a first year law student could do it.  The average person on the street HATES Goldman et al - it wouldn't matter if the jurors understood the case or not.

    I imagined you had more respect (none / 0) (#24)
    by oculus on Tue Apr 20, 2010 at 12:42:27 PM EST
    for the jury system than your comment demonstrates.  Have to assume both sides will be looking for sophisticated, educated jurors.

    This is one where any simple analogy (none / 0) (#34)
    by scribe on Tue Apr 20, 2010 at 02:59:52 PM EST
    will work to communicate to even an unsophisticated jury.  Actually, if I were picking the jury (from the SEC side), the people I would not want on the jury would be the intelligent sophisticates.  They are the ones most susceptible to the delusions which Goldman will try to cast throughout the case.  

    Reduce the case to a metaphor* and it's very simple.  In this case, the one Ratigan used the other day works well for me:  

    Paulson comes to Goldman to have Goldman make a car for Paulson.  Paulson wants to bet on the car breaking and Goldman knows that.  Paulson and Goldman agree that Paulson will get to pick which parts get left out of the car. Goldman goes to ACA to have ACA put the car together following Paulson's/Goldman's instructions, but explicitly omits Paulson's involvement.  Paulson's a known bear - a whisper of his involvement would reveal what was really going on.  ACA puts the car together and Goldman markets the car to unsuspecting buyers (looking for a car that will work) as having been put together with the ACA seal of approval (so to speak), again omitting any mention of Paulson's involvement in its construction.  Paulson buys his insurance on the car and, as predicted, the car breaks down.

    The average NYC working stiff can understand that.

    Remember, too, that all the big I-banks save all the emails and tape their voice calls.  Avoids disputes over whether the client said buy or sell and that kind of stuff.  The complaint borrows liberally from those emails - you have to assume the SEC has all of them and, FWIW, the delay in bringing the case was likely the result of having to go through all of them, first.  


    * One of the first lessons I learned about preparing for a jury trial was to find the metaphor in the facts.  E.g. (from a case about a defective industrial furnace):  "I was sold a Cadillac but it turned out to be a Chevy and a junker at that."  Then use that metaphor as the skeleton (or story arc) around which to build your presentation of the facts, so that they all went into telling a story that hewed to that metaphor.  One of the other first lessons I learned about trying a jury case was:  before anything else (and especially before writing and filing your complaint), go to the pattern jury instructions and read the ones you think might pertain to your case, then build your discovery and trial preparation around them.

    One would think the SEC knows and applies both those lessons, too.


    I do respect juries (none / 0) (#35)
    by jbindc on Tue Apr 20, 2010 at 03:44:58 PM EST
    But I think with the economy in the shape it's in, people are very angry.  More sophisticated jurors may be more likely to have had money invested in the markets and gotten hosed.  Less sophisticated jurors will just see things like last quarter's profits and bonus payouts and wonder why they are sitting on a jury, missing work and pay, to look at those smug SOB's in their $2000 suits - they will want to make someone pay.

    But it wasn't intentional (none / 0) (#9)
    by Manuel on Tue Apr 20, 2010 at 09:46:53 AM EST
    So says Goldman

    They could do some good by paying their fine, saying they are sorry, and putting procedures in place to make sure it doesn't happen again. PR win for Goldman and the SEC.

    Meh (none / 0) (#11)
    by Big Tent Democrat on Tue Apr 20, 2010 at 09:48:24 AM EST
    scienter will be, as MAryB says, I think the least hard part of the case.

    It is not a question of proving that you were trying to deceive but rather that you intended to NOT disclose,even if you wrongly thought that nondisclosure was ok.


    Are they going to argue (none / 0) (#15)
    by jbindc on Tue Apr 20, 2010 at 10:38:51 AM EST
    Something like Nonfeasance (or misfeasance) vs. malfeasance?

    Not the end of the story (none / 0) (#13)
    by CST on Tue Apr 20, 2010 at 10:11:28 AM EST
    Is Goldman going to be made an example of, and then that's it?  Or will they be going after other companies too.  The most interesting line in that nytimes article to me is:

    "In pursuing a new twist on an old idea, however, the S.E.C. has deeply unsettled the financial markets, opening the way for investors to file claims against banks that sold similar products, and forcing firms to reconsider their own liability."

    It seems like Goldman is just the tip of the iceburg.  So is Goldman gonna fry and then we forget all the other fish?  Or do we go gunning for everyone?  It's easy to make Goldman into the face of this, and I'm pretty sure they deserve it, but I seriously doubt they were the only ones doing it.

    Definition: Scienter (none / 0) (#16)
    by vicndabx on Tue Apr 20, 2010 at 10:42:10 AM EST

    Scienter is a legal term that refers to intent or knowledge of wrongdoing. This means that an offending party has knowledge of the "wrongness" of an act or event prior to committing it. For example, if a man sells a car to his friend with brakes that do not work, and he does not know about the problem, then the man has no scienter. If he sells the car and knew of the problem before he sold the car, he has scienter. The word has the same root as science, the Latin scienter (knowingly), from scire (to know; to separate one thing from another).

    Well (none / 0) (#20)
    by Big Tent Democrat on Tue Apr 20, 2010 at 11:25:09 AM EST
    tell it to the courts.

    They simply have not interpreted scienter that way.


    Thank you (none / 0) (#21)
    by gyrfalcon on Tue Apr 20, 2010 at 11:27:57 AM EST
    I was just about to go look that up and you saved me the trouble!

    End of NYT article quotes a Univ. (none / 0) (#25)
    by oculus on Tue Apr 20, 2010 at 12:53:17 PM EST
    of Minnesota law professor who says government should quickly disclose what it will try to prove so as not to unsettle the financial market and confuse other purveyors as to whether they may also be at risk.  Too big too fail.

    P.S.  I keep reading Goldman, Sachs is a bank.  Is it?  

    It is (none / 0) (#26)
    by Maryb2004 on Tue Apr 20, 2010 at 02:09:39 PM EST
    an investment bank that also elected to become a bank holding company during the 2008 financial meltdown.

    Thanks. I gather I can't bank there. (none / 0) (#27)
    by oculus on Tue Apr 20, 2010 at 02:11:21 PM EST
    No, (none / 0) (#28)
    by Maryb2004 on Tue Apr 20, 2010 at 02:14:38 PM EST
    it does not own a depository bank.  

    Maybe we ought to give them billions more (none / 0) (#31)
    by BobTinKY on Tue Apr 20, 2010 at 02:28:12 PM EST
    so as not to unsettle "the markets"  too.  I beliee the complaint ought to spell out pretty compeltely what it is the goverment intends to prove.  It usually does.

    As for confusing other purveyors, if they are that unfamiliar with the rules they shouldn't be in the business.


    No Motion for SJ (none / 0) (#29)
    by BobTinKY on Tue Apr 20, 2010 at 02:20:36 PM EST
    the government should take it to trial and get what is needed for criminal charges.

    And weren't the products themselves (none / 0) (#32)
    by BobTinKY on Tue Apr 20, 2010 at 02:35:14 PM EST
    intentionally made by cobbling together those mortgages GS believed most likely to crater?  Putting aside the failure to disclose Paulson's shorting, who in their right mind would buy such a product if told about how it was designed?

    Agree with your analysis (none / 0) (#37)
    by klassicheart on Wed Apr 21, 2010 at 12:33:03 AM EST
    Especially insofar as to how this will actually play out. This is never going to a jury.  I also wonder if the real issues will be discussed....Again, I highly recommend The Big Short by Michael Lewis.  It does an excellent job of explaining the flaws in the system.