Erosion of Trust

That's why I was surprised to see in Goldman Sachs's (GS) reply to the SEC's charges of alleged fraud that "As normal business practice, market makers do not disclose the identities of a buyer to a seller and vice versa. Goldman Sachs never represented to ACA that Paulson was going to be a long investor." I understand that market makers don't have to give up the two sides of a trade. I may not be the brightest bulb as an observer I was surprised to read that securities origination was now a market-making function. Also surprised to learn that rather than the parties disclosing the facts it is now important for the investor to ascertain who is not disclosed as a party to selecting underlying securities for a portfolio and whether those who have a hand in selecting those underpinning securities backing an investment could actually select securities that are most likely to benefit them in an opposing trade that they are structuring with that in mind, whether by going long, short or both. (For the multitude of readers who are smarter than I am, please enlighten me as to how investors should be reading minds here, for I am at a loss.) That the additional conflicts no longer have to be disclosed--again, I totally missed that memo. I must also have missed the announcement that omitting facts was not a big deal under business as usual now on Wall Street.

To me the entity that picks the underlying securities and whether they have an axe to grind in that selection is a fundamental piece of information. As a party to the creation of the security in question, it would seem reasonable that Paulson & Co.'s hidden agenda, selecting securities that would back the investment while at the same time constructing with GS a way to short those securities...well, if that's not material, what is?

This, needless to say, does not help bring trust back to Wall Street firms. There is, anecdotally, the sense that there may be loads more securities like this one originated by different Wall Street firms or banks.

The reasoning that this was a single individual at GS who allegedly didn't disclose Paulson & Co.'s "role" in selecting the underlying securities and at the same time shorting those and that it's okay because the buyers were sophisticated, institutional investors is disingenuous. Even the best due diligence could fail to discover something about something or some party that is undisclosed.

As an "intermediary," in the creation and sale of the securities, as well as, allegedly for Paulson & Co., the creation of the short part of the deal, GS seems to have been in a position to know that there was enormous conflict in this endeavor. This would stretch the suitability standard's "fair dealing" and "not misleading" tenets, not to mention the obligation to disclose material facts.

Is this now business as usual on Wall Street? Certainly, this is not simply taking two sides in market-making function. If it has become de rigueur for Wall Street to not disclose material facts, I must have missed the memo. But if that is the sad case, then it does not bode well for the future of Wall Street, investors of all stripes or retirement for most Americans. Caveat emptor becomes empty when facts are obfuscated or perhaps deliberately not revealed.

Comments? Please send them to kmcbride@wealthmanagerweb.com. Kate McBride is editor in chief of Wealth Manager and a member of The Committee for the Fiduciary Standard.

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Once an advisor has that trusted relationship with a client, how can the advisor "go back" to a non-fiduciary relationship? The answer is they can't.

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