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Why Bad Publicity Never Hurts Goldman Sachs

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My last posting focused on the widely-publicized research conducted by Stéphane Côté, PhD, Associate Professor of Organizational Behavior at the University of Toronto’s Rotman School of Management, who worked with a team of four psychologists from the University of California at Berkeley to conduct seven studies on a rather timely subject.  Their article, “Higher social class predicts increased unethical behavior” was published in the February 27 issue of the Proceedings of the National Academy of Sciences (PNAS).  The following excerpt from the abstract of their paper provides the general theme of what their efforts revealed:

.   .   .  investigation revealed upper-class individuals were more likely to exhibit unethical decision-making tendencies (study 3), take valued goods from others (study 4), lie in a negotiation (study 5), cheat to increase their chances of winning a prize (study 6), and endorse unethical behavior at work (study 7) than were lower-class individuals.

I began my discussion of that paper by looking back at a Washington Post opinion piece entitled, “Angry about inequality?  Don’t blame the rich”.  The essay was written last January by James Q. Wilson (who passed away on March 2).  On March 4, William K. Black took a deeper look at the legacy of James Q. Wilson, which provided a better understanding of why Wilson would champion the “Don’t blame the rich” rationale.  As Bill Black pointed out, Wilson was a political scientist, known best for his theory called “broken windows” – a metaphor based on a vacant building with a few broken windows, which quickly has all of its windows broken because petty criminals feel emboldened to damage a building so neglected by its owners.  Bill Black emphasized that Wilson was exclusively preoccupied with minor, “blue collar” crimes.  Black noted that in a book entitled, Thinking About Crime, Wilson expressed tolerance for “some forms of civic corruption” while presenting an argument that criminology “should focus overwhelmingly on low-status blue collar criminals”.  Bill Black went on to explain how Wilson’s blindness to the relevance of the “broken windows” concept, as it related to “white collar” crime, resulted in a missed opportunity to attenuate the criminogenic milieu which led to the 2008 financial crisis:

Wilson emphasized that it was the willingness of society to tolerate relatively minor blue collar crimes that led to social disintegration and epidemics of severe blue collar crimes, but he engaged in the same willingness to tolerate and excuse less severe white collar crimes.  He predicted in his work on “broken windows” that tolerating widespread smaller crimes would lead to epidemic levels of larger crimes because it undermined community and social restraints.  The epidemics of elite white collar crime that have driven our recurrent, intensifying financial crises have proven this point.  Similarly, corruption that is excused and tolerated by elites is unlikely to remain at the level of “a few deals.”  Corruption is likely to spread in incidence and severity precisely because it undermines community and the rule of law and it is likely to grow more pervasive and harmful the more we “tolera[te]” it.

*   *   *

Taking Wilson’s “broken windows” reasoning seriously in the elite white collar crime context would require us to take a series of prophylactic measures to restore integrity and strengthen peer pressures against misconduct.  Indeed, we have implicitly tested the applicability of “broken windows” reasoning in that context by adopting policies that acted directly contrary to Wilson’s reasoning.  We have adopted executive and professional compensation systems that are exceptionally criminogenic.

*   *   *

Fiduciary duties are critical means of preventing broken windows from occurring and making it likely that any broken windows in corporate governance will soon be remedied, yet we have steadily weakened fiduciary duties.  For example, Delaware now allows the elimination of the fiduciary duty of care as long as the shareholders approve.  Court decisions have increasingly weakened the fiduciary duties of loyalty and care.  The Chamber of Commerce’s most recent priorities have been to weaken Sarbanes-Oxley and the Foreign Corrupt Practices Act.  We have made it exceptionally difficult for shareholders who are victims of securities fraud to bring civil suits against the officers and entities that led or aided and abetted the securities fraud.

*   *   *

In the elite white collar crime context we have been following the opposite strategy of that recommended under “broken windows” theory.  We have been breaking windows. We have excused those who break the windows.  Indeed, we have praised them and their misconduct.  The problem with allowing broken windows is far greater in the elite white collar crime context than the blue collar crime context.

To find a “poster child” example for the type of errant fiduciary behavior which owes its existence to Wilson’s misapplication of the “broken windows” doctrine, one need look no further than Matt Taibbi’s favorite “vampire squid”:  Goldman Sachs.  One would think that after Taibbi’s groundbreaking, 2009 tour de force about Goldman’s involvement in the events which led to the financial crisis . . .  and after the April 2010 Senate Permanent Subcommittee on Investigations hearing, wherein Goldman’s “Fab Four” testified about selling their customers the Abacus CDO and that “shitty” Timberwolf deal, the firm would at least try to keep a lower profile these days.  Naaaaw!

Goldman Sachs has now found itself in the crosshairs of a man, formerly accused of carrying water for the firm – Andrew Ross Sorkin.  Sorkin’s March 5 DealBook article for The New York Times upbraided Goldman for its flagrant conflict of interest in a deal where the firm served as an adviser to an oil (and natural gas) pipeline company, El Paso, which was being sold to Houston-based Kinder Morgan for $21.1 billion.  Goldman owned a 19.1 percent stake in Kinder Morgan at the time.  Andrew Ross Sorkin quoted from the script which Goldman CEO, Lloyd Blankfein read to El Paso’s CEO, Douglas Foshee, wherein Blankfein confirmed that Foshee was aware of Goldman’s investment in Kinder Morgan.  It was refreshing to see a bit of righteous indignation in Sorkin’s discussion of the dirty details behind this transaction:

When the deal was announced, buried at the end of the news release was a list of Wall Street banks that had advised on the deal, including Goldman Sachs.  Goldman received a $20 million fee for playing matchmaker for El Paso.  The fee, of course, was not disclosed, nor was the Kinder Morgan stake owned by Goldman Sachs’s private equity arm, worth some $4 billion.  Nor did the release disclose that the Goldman banker who advised El Paso to accept Kinder Morgan’s bid owned $340,000 worth of Kinder Morgan stock.

Now, however, a court ruling in a shareholder lawsuit has laid bare the truth:  Goldman was on every conceivable side of the deal.  As a result, El Paso may have unwittingly sold itself far too cheaply.  Mr. Blankfein may have said he was “very sensitive to the appearance of conflict,” but the judge’s order ruling “reluctantly” against a motion to block the merger made it clear that Goldman’s conflicts went far beyond mere appearances.

Here’s just one example:  In an effort to help mitigate its clear conflict, Goldman Sachs recommended that El Paso hire an additional adviser so that El Paso would be able to say that it had received completely impartial advice.  Goldman did not say it would step down, and lose its fee, it simply suggested that El Paso hire one more bank – in this case, Morgan Stanley.

After explaining that Goldman included a provision in the deal that Morgan Stanley would get paid only if El Paso agreed to the sale to Kinder Morgan, Sorkin expressed this reaction:

Goldman’s brazenness in this deal is nothing short of breathtaking.

Goldman’s conflict of interest in the El Paso deal was also the subject of an article by Matthew Philips of Bloomberg BusinessWeek.  Mr. Philips reminded us of whom we have to thank for “helping Greece dupe regulators by disguising billions of dollars’ worth of sovereign debt”:

New details have also emerged about Goldman’s role in helping Greece hide its debt so it could qualify for membership in the European Union.  In a Bloomberg News story out this week, Greek officials talk about how they didn’t truly understand the complex swaps contracts they were buying from Goldman bankers from 2001 to 2005, and that each time Goldman restructured the deal, things got worse for Greece.

The story reads like a cautionary tale of a homeowner who keeps returning to the same contractor to repair the damage done by the previous fix-it job.  At one point, Goldman prohibited Greece’s debt manager, Christoforos Sardelis, from seeking outside price quotes on the complicated derivatives Goldman was selling to Greece.

*   *   *

Yet Goldman’s sullied reputation doesn’t appear to be negatively impacting its business.  In fact, Goldman is outpacing its Wall Street competition recently in key areas of business.  In 2011, Goldman was the top adviser for both global M&A and equity IPOs.  A Bloomberg survey of traders, investors, and analysts last May showed that while 54 percent of respondents had an unfavorable opinion of Goldman, 78 percent believed that allegations it duped clients and misled Congress would have no material effect on its business.

In other words:  Goldman Sachs keeps breaking windows and nobody cares.  Thanks for nothing, James Q. Wilson!


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In Pursuit Of The TARP Thieves

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February 12, 2009

On Wednesday, February 11, the Senate Judiciary Committee held a hearing on a subject of concern to many taxpayers: “The Need for Increased Fraud Enforcement in the Wake of the Economic Downturn”.  With trillions of dollars being expended in bailouts while the corporate beneficiaries of this government largesse allow their executives to line their pockets with those very dollars, the outrage felt by the working (or unemployed) public has found its way to Capitol Hill.  What we learned from this hearing is that there is plenty of fraud taking place while the FBI and other branches of law enforcement are understaffed to cope with the immense rise in reported fraud cases.

The Committee heard testimony from John Pistole, Deputy Director of the FBI.  Pistole explained how the current economic crisis resulted in numerous areas of FBI scrutiny, only one of which is the overwhelming subject of mortgage fraud:

For example, current market conditions have helped reveal numerous mortgage fraud, Ponzi schemes and investment frauds, such as the Bernard Madoff alleged scam. These schemes highlight the need for law enforcement and regulatory agencies to be ever vigilant of White Collar Crime both in boom and bust years.

The FBI has experienced and continues to experience an exponential rise in mortgage fraud investigations. The number of open FBI mortgage fraud investigations has risen from 881 in fiscal year 2006 to more than 1,600 in fiscal year 2008. In addition, the FBI has more than 530 open corporate fraud investigations, including 38 corporate fraud and financial institution matters directly related to the current financial crisis. These corporate and financial institution failure investigations involve financial statement manipulation, accounting fraud and insider trading. The increasing mortgage, corporate fraud, and financial institution failure case inventory is straining the FBI’s limited White Collar Crime resources.

The most disgusting activity covered during this hearing concerned fraud related to the ongoing $700 billion TARP bailout.  Neil Barofsky, Special Inspector General for the Troubled Asset Relief Program (SIGTARP) provided testimony concerning his plans to establish a mechanism for bringing TARP thieves to justice:

The SIGTARP Hotline is operational and can be accessed through the SIGTARP website at www.SIGTARP.gov by telephone at (877) SIG-2009, as well as through email. Plans are being formulated to develop a “fraud awareness program” with the objective of informing potential whistleblowers of the many ways available to them to provide key information to SIGTARP on fraud, waste and abuse involving TARP operations and funds, and explaining how they will be protected.

Mr. Barofsky’s testimony was largely a plea for passage of the Fraud Enforcement and Recovery Act, sponsored by Senators Patrick Leahy (D., Vt.) and Senator Chuck Grassley (R., Iowa) as well as the SAFE Markets Act, sponsored by Senators Charles Schumer (D., N.Y.) and Richard Shelby (R., Ala.).  The latter bill would authorize hiring of the following personnel to investigate and prosecute “fraud relating to the financial markets”:  500 FBI agents, 50 Assistant United States Attorneys and 100 additional Securities and Exchange Commission enforcement staff members.  Mr. Barofsky’s explanation of the need for this legislation was an illustration of using “experience as our guide”:

Now, with $700 billion going out the door under TARP, additional hundreds of billions (if not trillions) of credit being provided through the Federal Reserve, and additional hundreds of billions through the proposed stimulus bill, we stand on the precipice of the largest infusion of Government funds over the shortest period of time in our Nation’s history.  Unfortunately, history teaches us that an outlay of so much money in such a short period of time will inevitably draw those seeking to profit criminally.  One need not look further than the recent outlay for Hurricane relief, Iraq reconstruction, or the not-so-distant efforts of the RTC as important lessons.

The Fraud Enforcement and Recovery Act (S 386) addresses TARP fraud, fraud related to economic stimulus funds, mortgage fraud and fraudulent activities in the commodities markets.  The measure will:

  • Amend the definition of “financial institution” to extend federal fraud laws to mortgage lending business not directly regulated or insured by the Federal government.
  • Amend the major fraud statute to protect funds expended under the Troubled Asset Relief Program (TARP) and the economic stimulus package.
  • Authorize funding to hire fraud prosecutors and investigators at the Department of Justice, the FBI, and other law enforcement agencies, and authorize funding for U.S. Attorneys’ Offices to help staff FBI mortgage fraud task forces.
  • Amend the federal securities statute to cover fraud schemes involving commodities futures and options.
  • Amend the criminal money laundering statute to make clear that the proceeds of specified unlawful activity include the gross receipts of the illegal activity, and not just the profits of the activity.
  • Improve the False Claims Act to clarify that the Act was intended to extend to any false or fraudulent claim for government money or property, whether or not the claim is presented to a government official or employee, whether or not the government has physical custody of the money, and whether or not the defendant specifically intended to defraud the government.

Once these new measures are implemented, I would love to see the Feds bust those miscreants whom I (and others) suspect were manipulating the equities markets with TARP money in the month after Thanksgiving.  During that time, we saw an almost-daily spate of “late day rallies” when stock prices would be run up during the last fifteen minutes of the trading day, before those numbers could have a chance to settle back down to the level where the market would normally have them. The inflated “closing prices” for the day were then perceived as the market value of the stocks.  This process was taking place despite the constant flow of dire news reports, which would normally have sent stock prices tumbling.  News services covering the action on Wall Street were using the same three words to start each day’s headline:  “Stocks rally despite …”  This pattern ceased as legislators and commentators demanded to know what was being done with the first $360 billion of TARP money.  Hmmm . . .

At this point, we can only speculate as to who has been pilfering TARP money and what could have been done with a few billion here and a few billion there.  Perhaps in the not-too-distant future, we will be watching movies about the sleazoids who stole money intended to save the world economic system from ruin.