By Zachary A. Goldfarb
Washington Post Staff Writer
Friday, April 23, 2010; A13
Behind closed doors, the two Republican members of the Securities and Exchange Commission sharply questioned senior investigators last week about whether the evidence they had assembled was strong enough to file a fraud case against Goldman Sachs, according to current and former SEC officials familiar with the matter.
Commissioners Kathleen L. Casey, a former top Capitol Hill aide, and Troy A. Paredes, a wunderkind law professor, were skeptical that the evidence showed that Goldman had misled its clients because the investors were big, sophisticated firms who should have known what they were doing. The two commissioners warned that if the SEC erred by filing a flawed case, it could seriously harm the agency's reputation, and voted against approving it.
But SEC Chairman Mary Schapiro, an independent appointed by President Obama, joined two Democrats on the commission, Elisse B. Walter and Luis Aguilar, to authorize the suit, arguing that it was important to hold Goldman responsible for improper conduct, even if the case had difficulties.
None of the commissioners would comment for this story, and the details of their deliberations are not public. The internal debate, however, underscores the challenges that face the SEC as it prosecutes its case against Goldman.
Lawyers said that a divided vote over a lawsuit has no bearing in court. But former SEC chairman Harvey Pitt said the disclosure of the divide could harm the agency's reputation. "The split might be seen as having political overtones," Pitt said. "It allows people to speculate on why things were done the way they were done. I think that ultimately hurts the agency's credibility."
Rep. Darrell Issa (R-Calif.) has questioned whether the SEC timed the lawsuit to help make the case for the Obama administration's proposal to overhaul the regulation of financial firms, but he has offered no evidence. The SEC as well as the White House have rejected the charge.
The disagreement over whether the agency could prove that big, savvy firms were victims of securities fraud echoes the debate over what rules to write for Wall Street. While Schapiro and her allies see a more expansive role for the agency, Casey and Paredes -- just as they objected to the Goldman suit -- have opposed measures, for instance, to regulate short selling and to require that companies tell investors more about how climate change affects their business.
The SEC suit against Goldman, filed Friday, asserts that the investment bank defrauded investors when it sold them a subprime-mortgage investment in 2007 that was secretly designed to lose value.
The agency alleges that Goldman created and marketed the investment without telling its clients that Paulson & Co., a prominent hedge fund, had helped the bank assemble it at the same time that it was placing bets on it losing value. Goldman has denied the allegations.
The Republican commissioners expressed skepticism that Goldman committed fraud because the investors were large companies, ACA Financial Guaranty Corp. and German bank IKB, saying both should have known about the risks involved in betting on the housing market. In a way, Casey and Paredes were endorsing what's known as the "big boys" legal concept: that sophisticated firms should be allowed much more rein to engage in complex financial transactions and receive less protection from securities law.
Schapiro and the Democratic commissioners, however, argued that Goldman should not escape accountability simply because its clients were big firms. They said the evidence showed that Goldman did not give clients crucial information about the investment that likely would have made them think again about placing a bet.
SEC enforcement lawyers do not need the commission's approval for most of the steps involved in building a case against a company or person accused of wrongdoing, but the commissioners must approve settlements and -- if there is none -- the agency's filing of a suit against a company.
Hundreds of cases come before the commission each year, and most are approved rapidly with little debate. Occasionally, some high-profile cases draw "no" votes from commissioners, especially if they involve a novel or expansive interpretation of securities law. Cases rarely fail.
Christopher Cox, Schapiro's predecessor, postponed many cases for many months to ensure that he could get four or five commissioners to sign on. Schapiro has been far more willing to push forward with a case when one or two commissioners oppose it.
Casey and Paredes have been the ones who most often criticize cases before the commission, usually citing concerns that the SEC was launching too ambitious a case against a company.
Schapiro sometimes faces opposition from her Democratic commissioners, too. While Walter has worked alongside her for years, agreeing often on cases, Aguilar, a former SEC lawyer, often pushes the commission to seek stiffer penalties than Schapiro does. He opposed a $33 million settlement with Bank of America last summer that the commission approved. A judge later rejected it. The SEC ultimately had to quintuple the fine and take other measures to win the court's approval.