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Regulatory Wire: Goldman Sachs opens door for the fiduciary standard; Senators pile on to the cause

Jail time for those who violate the standard? There's a new tone in Washington, D.C.

Friday, April 30, 2010 – 4:30 AM by Sara Hansard
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Goldman Sachs CEO Lloyd Blankfein denied that his firm had an obligation to sell securities they thought would be good investments, or to disclose the company’s short position on such securities.

Brooke’s note: When I think of Goldman Sachs, I recall an article I once read about how a car service took the firm’s investment bankers home to their children for dinner but then shuttled them right back to the office to work late into the evening. It was like something out of Barbarians at the Gate and I was both horrified and jealous of the practice. My general impression of Goldman Sachs people is that they’re hard to like sometimes because they are both smarter and harder working than most of us — not to mention much richer. Another impression is that they do things to make money that my non-quantitative mind could never grasp. Still, I always believed that in some Wall Street Machiavellian sense that Goldman Sachs people were basically ethical. Maybe I just wanted to believe that because their deals seemed to be too complex to police and so I would have to rely, as a small investor, on them policing themselves. I believed the Lloyd Blankfein’s of Goldman Sachs felt, as de facto patriarchs of Wall Street, some sense of fiduciary responsibility to the greater financial community. I admit I’m naive at times. Now that it looks like they’re little different — or worse — than some of their banking brethren, I can see why tolerance is thin. Even some Republicans are taking a new look at making sure that in the future Goldman Sachs executives will feel some sense of fiduciary duty to the investment community. It’s ironic. Bernie Madoff got the fiduciary movement rolling and now it may take ethically challenged Goldman Sachs deal makers to close the regulatory reform deal. Sara puts her finger on the pulse of the action in Washington in this article.

For the fiduciary standard, the Goldman Sachs case may be the other shoe dropping.

As the Senate takes up financial regulatory reform legislation, the Securities and Exchange Commission’s securities fraud case against the Wall Street bank is prompting Congress to examine the question of whether brokers should be fiduciaries when they provide investment advice.

The fiduciary issue was in the spotlight at the Goldman hearings this week and under discussion in the hallways of the Capitol building – and there’s more to come.

An amendment to the financial reform bill known as the Akaka-Menendez amendment, which would
set fiduciary standards for brokers who give personalized advice to retail investors, is expected to be introduced next week.

Whether the furor translates to action remains to be seen, however.

Fuel to the fire

“The Goldman case is adding fuel to the fire,” commented David Tittsworth, executive director of the Investment Adviser Association. “But it’s a very fluid situation.”

In one of the latest developments, Arlen Specter, D-Penn., the Senate Judiciary Subcommittee on Crime and Drugs chairman, scheduled a May 4 hearing on “Wall Street fraud and fiduciary duties: can jail time serve as an adequate deterrent for willful violations?”

The hearing will examine “under what circumstances, if any, do the investment bankers have a fiduciary duty to the investors?” Specter said in an April 22 Senate floor statement.

On April 16, the Securities and Exchange Commission filed a civil securities fraud complaint against Goldman Sachs, alleging the firm allowed hedge fund Paulson & Co., which was making short sales against the mortgage market, to influence the mortgage securities included in securities Goldman sold to investors.

Issue of jail time

Specter appeared to up the ante by bringing up the issue of jail time. He said said his hearing will look at:

• whether there are conflicts of interest in such transactions;
• whether investment bankers’ recommendations carry implicit representations that the investments are good;
• and whether there is a legitimate distinction between the investment counselor’s duty to provide only a suitable investment without a fiduciary duty involved.

“Congress should make a public policy determination as to whether such conduct crosses the criminal line,” Specter said. “Congress should then define what is a fiduciary relationship, what is a conflict of interest, and what conduct is sufficiently anti-social to warrant criminal liability and a jail sentence.”

Piling on

Senators piled on to the theme of the fiduciary duty, as well, during the grueling, day-long hearing April 27 of the Senate Homeland Security and Governmental Affairs Committee’s Permanent Subcommittee on Investigations. Seven Goldman officials, including Chairman and Chief Executive Officer Lloyd Blankfein were questioned.

Goldman Sachs reaped billions of dollars in the mortgage-backed securities market, Homeland Security Committee Ranking Member Susan Collins, R-Me., said at the hearing. “While the market was on the verge of collapse Goldman decided to go short, and earned billions from that strategy,” she said, adding that the company allegedly did so while continuing to sell clients long investments in the mortgage markets.

“While such conflicts of interest may not be illegal, they certainly seemed ethically questionable,” said Collins, a former state regulator in Maine whose responsibilities included securities regulation. “These conflicts of interest appear to be rooted in the fact that broker-dealers do not have a fiduciary obligation to their clients. That is an issue we will be considering. Clearly this system must be reformed so that Wall Street banks are not seen, and do not act, as unscrupulous operators who seek to profit from the public’s misfortune, even as they are pitching toxic investments, and even as hard-working, struggling taxpayers have to pick up the tab,” she said.

Permanent Subcommittee Chairman Carl Levin, D-Mich. said he wants to ensure that the financial service reform legislation contains provisions to deal with such conflicts of interest. During a press conference the day before, RIABiz had asked his opinion of an amendment to be offered by Sens. Daniel Akaka, D-Hawaii, and Robert Menendez, D-N.J., that would replace a study of broker-adviser harmonization with the House provision requiring the SEC to adopt fiduciary requirements for broker advisers. “Makes sense to me,” Levin replied.

Sen. Jon Tester, D-Mont., who reportedly has favored the study provision now in the Restoring American Financial Stability Act that the Senate is debating over the next couple of weeks, also asked pointed questions concerning fiduciary issues to Goldman executives. “Who do you work for?” Tester asked Daniel Sparks, the former head of Goldman’s Mortgages Department. “It’s a very complicated question,” Sparks said. “If you don’t prudently manage your risks, you won’t be around to serve clients.”

Sen. Mark Pryor, D.-Ark, also asked about the issue: “Whether it’s truly a conflict of interest or not, whether you truly have a fiduciary responsibility or not, I just think that we need to spend some time as the Senate and the subcommittee and various committees of the Senate, thinking through that.”

But it’s apt to be complicated

The hearing also shined a light on the complicated role companies play in the market – and the likelihood Congress will have trouble unraveling them. Under repeated questioning by Subcommittee Chairman Levin about selling securities that Goldman officials disparaged in emails, Goldman CEO Blankfein denied that his firm had an obligation to sell securities they thought would be good investments, or to disclose the company’s short position on such securities.

“In a deal where you are selling securities and you are intending to keep the short side of that deal, which is what happened here in a lot of these deals, do you think you have an obligation to tell the person that you’re selling that security to in that deal that you are keeping the short position?” Levin asked Blankfein.

“I don’t think we would disclose that,” Blankfein responded. Goldman’s position as a market maker puts it on the opposite side of clients, the executive said. As a market maker, “We are buying from sellers and selling to buyers,” he said. Buyers should mainly be concerned with whether the security they are being sold provides the exposure that they want, he said. “They wouldn’t care what our views are” on the security they are buying, he said.

“You are betting against the very security that you are selling,” Levin said.

Aguilar speaks out

SEC member Luis Aguilar, a long-time ally of people who favor having brokers operate under a fiduciary standard, reiterated his stance in a speech he gave to the Investment Adviser Association annual conference in Chicago April 29. “Broker-dealers are being permitted to end-run the [Investment Advisers Act of 1940],” Aguilar said. “As a consequence, investors are susceptible to receiving tainted advice from broker-dealers, and they will have no way of knowing that the advice was tainted by an undisclosed conflict.”

Disputing the need for another study, Aguilar said the fiduciary question “has long ago been asked and answered.”

Will the furor translate to action?

Proponents of fiduciary standards are holding out hope that the Senate may go further than the Akaka-Menendez amendment, which would replace the broker-adviser study now in the Senate bill with a provision in the Wall Street Reform and Consumer Protection Act approved last December by the House. That provision would require the SEC to set fiduciary standards for brokers who give personalized advice to retail investors.

A question raised by the House language is whether fiduciary standards would apply to institutional investors, which adviser groups and state regulators advocate. At the April 27 hearing, several Goldman officials, including Executive Director Fabrice Tourre, who has been charged in the SEC case, argued that their institutional clients are sophisticated enough to make informed decisions on the investments they bought from Goldman.

“The House language that’s in Akaka-Menendez would only apply to personalized investment advice to retail advisers,” said Neil Simon, vice president of government relations for the Investment Adviser Association. Still, he said, “It does give the SEC authority to apply that fiduciary duty to others.”

“The Goldman Sachs case just provides an example of what this actually looks like,” said Barbara Roper, director of investor protection for the Consumer Federation of America, which supports requiring brokers to come under fiduciary obligations when they give advice. “It’s the smoking gun of the damage that occurs when people aren’t required to act in their customer’s best interest.”

Before the April 27 hearing, the Akaka-Menendez amendment was the only game in town, she said. Now, however, “I think there will be a lot of members looking for something they can do,” she said. Roper said she’s had inquiries from some members looking for ideas, the she declined to identify them. “Who knows what could come of that?”

Brian J. Donovan

Brian J. Donovan

May 1, 2010 — 12:08 PM

Opacity reduces scrutiny and confers power on the few with the ability to pierce the veil. Although derivatives have indeed become extremely complex, in actuality, they are as old as the idea of finance itself. The credit derivatives market should borrow a thought from Leonardo: “Simplicity is the highest form of sophistication.”

For a clearer understanding of subprime mortgage-backed credit derivatives, visit:


Stephen Winks

Stephen Winks

April 30, 2010 — 5:18 PM


Finally the compelling case for the consumer, supporting the fiduciary standing of brokers and the reliability of advice in the best interests of the consumer. The misinformation of the brokerage industry, FINRA and SIFMA have clearily established their interest is not in the protection of the consumer and public trust but to protect the best interests of the brokerage industry.

The question is whether Congress will continue to put the best interest of the brokerage industry ahead of that of the consumer, who they are charged to protect? It looks like Consumer Protection, fiduciary standing for brokers and the best interests of the consumer actually has a real shot at a fair hearing.

With mid term elections comming up, woe be it Congressmen who thwart consumer protection by withholding leglislative authority from the SEC to establish, regulate and enforce the fiduciary standing of brokers.


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