April 28, 2010

Listening to Goldman

The fair dealing (suitability) standard withstood a full day of scrutiny under Congressional headlights. The incredulity of some subcommittee members seems to reflect a "Rand Report effect;" that is, there is an assumption, it seems, that the Fiduciary Standard does exist for brokers. An assumption that Goldman Sachs would not aggressively pursue its own best interests consistent with fair dealing practices and legal requirements.

Several Senators honed in on the fundamental contradiction between Goldman's stated commitment to client's interests' and the firm's 'shorts,' or "betting against" its own clients (as Senator Levin put it.) Senator Collins was most pointed in exploring whether execs accepted a fiduciary duty. The Goldman execs' testimony on April 27 affirmed Lloyd Blankfein's clear and unequivocal statement last January where he stated there was no fiduciary duty in the marketmaking role. Further, the "client best interest" standard, according to Goldman Sachs execs, seems to mean only what Goldman says it means. It means to, for example, "serve" clients, or to "create products that clients want to buy," among other things. "Client best interests" explicitly does not mean disclosing "adverse interests" except as it regards holdings or investments, or it does not mean offering the firm's "opinions." As Blankfein further explained, "They don't, or shouldn't, care about our views."

Execs staunchly defend not disclosing firm's positions to counterparties; one exec notes non-disclosure is "consistent" with industry standards.

Senator Levin. Senator Levin seems determined to bring back memories of an earlier age and recreate the gusto of Ferdinand J. Pecora. Pecora dramatically led the 1930s Senate investigation into the causes of the Great Depression, whose media coverage of the hearings is credited by many historians as creating the public support for the Wall Street reforms, then. Quoting the 1934 Senate conclusion, "The results of the unregulated activities of the investment bankers...were disastrous," Levin noted, "The parallels today are unmistakable." Later, after hearing from six panelists, Levin concluded that though Goldman Sachs claims to always put clients' interests first, "You don't; you (often) put your own interest first."

Senator Collins. Senator Collins zeroed in on the fiduciary standard, and asked each of the first four Goldman witnesses--Daniel Sparks, Josh Birnbaum, Michael Swenson, and Fabrice Tourre--whether they had a "Duty to act in the best interest of your clients?" Sparks, Swenson, and Tourre replied their duty was to "serve our clients;" Birnbaum, alone replied, "I believe that we did."

Senator Pryor. Senator Pryor followed up on a question first asked by Senator Levin: whether Goldman had an obligation to disclose "adverse interests." Sparks responded very carefully that no disclosure is required regarding its positions, but "we owe them all the information regarding the instrument." Additionally, Sparks stated, "people should focus on the assets and how the deal works," as opposed to Goldman Sachs' positions. When also asked whether Goldman should be obliged, by new regulations, to disclose positions, Sparks replied that doing so would be "very difficult."

In further questioning Senator Pryor asked about the ethical standards followed by Goldman. In replies, Sparks opined that ethics were taken very seriously at Goldman, disclosure documents met the industry standards, and that his main obligation was to "work with clients to help them achieve their objectives." Additionally, Pryor asked Goldman Sachs CFO David Viniar whether he saw any conflicts in the CDOs. The reply, "We try to make products that customers want to buy at a good price."

Senator Tester. Senator Tester followed up on the issue of whose interests were pursued by asking Sparks, "Who do you work for?" Sparks reply included, "It's a very complicated question. If you don't prudently manage your risks, you won't be around to serve clients."

Fiduciary versus Fair Dealing. Throughout, there was a consistent distinction made by the Goldman execs between acknowledgements that disclosures regarding assets and the underlying instruments were important and forthcoming, while disclosures regarding the firm's positions were unnecessary, if not irrelevant. This is a key distinction. The difference between fair dealing/suitability obligations to disclose product features versus the fiduciary obligation to disclose--and to manage in favor of the client--conflicts of interest.

Knut A. Rostad (kar@rpjadvisors.com) is the regulatory and compliance officer at Rembert Pendleton Jackson (RPJ), a registered investment advisor in Falls Church, Virginia, and chairman of The Committee for the Fiduciary Standard. The views expressed here are his own and do not necessarily reflect views of the Committee.

Read more of Knut Rostad's Regulatory Reason blog posts:

What's Truth Got to do With It? January 18, 2010 As Wall Street banks announce their 2009 bonus plans, estimated by WSJ to be $145 billion, what better time is there to discuss whether Wall Street firms can win back the trust of investors?...
The Return of Investor Confidence? In 2010? December 29, 2009 A snapshot of consumer attitudes right now is not a pretty picture and suggests there is a long road to travel before investor confidence returns. ...
Partisanship on Steroids December 14, 2009 Passage of the financial reform legislation in the House is historic and important. It may also be, unfortunately, short-lived in the current, toxic partisan environment. ...
Peter Drucker for Wall Street Czar November 24, 2009 Drucker would advise Wall Street to ask what retail brokers think. About being a fiduciary, brokers might "surprise" execs. Many would say "Bring it on!"...
Too Rich or Too Thin? November 03, 2009 You can never be too rich or too thin: Can we disclose ourselves out of obesity? Can disclosures replace fiduciary duty?...
A Tail is Not a Leg October 16, 2009 As the rhetoric heats up over regulatory reform one is reminded how much political life has not changed all that much since Abraham Lincoln was quoted noting the following: "How many legs does a dog have if you call the tail a leg? Four..." ...
SEC Chairman Speaking the Fiduciary Language September 28, 2009 SEC Chairman Mary L. Schapiro's September 24th speech, before the Financial Services Roundtable, included her most recent public remarks on the fiduciary standard. The Chairman's remarks are important. ...
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