After Goldman Sachs settlement, SEC looking at exotic financial products
Saturday, July 17, 2010
The new Securities and Exchange Commission unit that obtained a $550 million settlement from Goldman Sachs in a fraud suit is pressing ahead with investigations into wrongdoing during the financial crisis by big banks, but is also turning its attention to exotic financial products that might be used to harm average investors, officials said.
The Structured and New Products Unit, one of several specialty groups in the agency's enforcement division, filed the landmark suit against Goldman and later negotiated with the powerful Wall Street bank's lawyers on a settlement. A source familiar with the unit's work, who was not authorized to discuss the matter publicly and spoke on the condition of anonymity, said that while it is looking at wrongdoing by other big firms, it's unclear whether the Goldman case will be replicated with other Wall Street firms.
Agency veteran Kenneth Lench, chief of the 40-person unit, said the agency is looking to examine exotic financial products that might be used to deceive or defraud ordinary investors. The investors allegedly defrauded by Goldman were Scottish and German banks.
"While the Goldman case -- which is the first case out of the unit -- involved larger institutional victims, we also are looking at products that are marketed and sold to retail or less sophisticated investors," Lench said in an interview Friday. "We are looking forward, looking around the corner for what's next. We assign small teams of people to do a deep dive into a new product that hasn't been around all that long."
Historically, the SEC has launched probes based on a specific tip about wrongdoing at a company or when a whistleblower comes forward. The Structured and New Products Unit will sometimes be more aggressive, scanning the marketplace for securities that seem unduly risky for investors, then examining those products and the companies that might be trading them.
For example, the group could target securities that have been touted by financial firms as ultra-safe for investors who have been burned by the ups and downs of financial markets.
A few months ago, when the SEC filed its suit against Goldman, it would have been hard to anticipate that the unit would obtain a settlement so soon and be free to focus on other cases. The Wall Street bank at first slammed the SEC and said it had done nothing wrong.
Sources close to the case said that about a month after the SEC filed its fraud suit, however, Goldman changed its attitude and began to seem much more serious about considering a settlement.
At the time, Goldman was facing a new Justice Department criminal probe and harsh questions from Congress about its conduct. Televised hearings put senior Goldman executives, including chief executive Lloyd Blankfein, through the gantlet. The SEC case wiped billions of dollars off the firm's market value.
A source familiar with Goldman's deliberations who spoke on the condition of anonymity to describe an internal matter said the bank determined it was important to put the SEC case behind it and preserve its reputation, despite the costs involved.
On Friday, Goldman's stock closed up 95 cents, or 0.7 percent, after rising several dollars in morning trading on the news of the settlement. The gains came despite a broad market sell-off that weighed on financial shares.
To win the settlement, the Structured Products unit not only had to reach an agreement with Goldman but also had to convince the agency's five commissioners. Just as they had when the SEC filed the lawsuit against Goldman, the two Republican commissioners voted against the settlement, according to a source familiar with the vote who spoke on the condition of anonymity because the proceeding was not public. But SEC Chairman Mary Schapiro and the two Democratic commissioners voted for it.
The SEC team moved on two fronts in recent months, building a court case against Goldman while negotiating with the firm over a settlement. The agency wanted Goldman to pay more than a fine. It wanted the bank to admit some sort of guilt and to undertake remedial actions. Such prescriptive settlements are being embraced by the SEC more commonly than in the past. The agency required a series of changes to how Bank of America runs its business in a settlement earlier this year.
SEC officials said they expect both Goldman's statement of regret and the remedial actions to serve as a template for future settlements. The SEC has long faced criticism that its settlements allow firms to pay a fine but avoid any sort of culpability.
Under the settlement, Goldman must review the role and responsibilities of company lawyers and compliance executives in the preparation of marketing materials for mortgage securities. Goldman employees in the mortgage business must receive additional education and training. Those changes put more pressure on Goldman to increase the vetting of disclosures that accompany products the bank sells to clients.
The deal let both the SEC and Goldman claim a share of victory.
The SEC was able to secure its largest penalty ever against a financial firm, make Goldman acknowledge it had made mistakes and strike at an issue at the heart of the financial crisis.
For Goldman, the company was able to put the matter behind it, pay a fine that won't make a big dent in its bottom line and avoid officially admitting wrongdoing.