Americans love it when the large and powerful get their comeuppance. So it should be no surprise, perhaps, when twelve-year Goldman Sachs veteran Greg Smith's resigns from the firm in a flurry of allegations in the pages of the New York Times a Mardi Gras-style celebration erupts.
Smith makes his case that at Goldman, "The interests of the client continue to be sidelined in the way the firm operates and thinks about making money." The responses have been immediate and sharp. Washington Post financial columnist Steven Pearlstein seems to speak for many, when he says Smith accused “the image-battered investment bank of shamelessly putting its interests ahead of its customer.”
The problem is much of such commentary is more about "piling on" and obscuring important truths than about elucidating them. Smith charges, essentially, that Goldman rewards any legal conduct that generates profits. This includes persuading clients to invest in vehicles that Goldman wants to dump; getting clients to trade whatever is most profitable to Goldman, and trading “any illiquid, opaque product with a three-letter acronym.” He also is offended by Goldman managers who, he believes, view their own customers as dupes. (He says the British term ‘Muppets’ was the expression of choice.)
Goldman's immediate response seems calibrated to not take the Smith letter seriously. It rejects the allegation and speaks about an internal survey of Goldman managers. Pretty thin gruel. A Bloomberg opinion piece which has been reported to be popular at Goldman focused on Smith's naivete. “It must have been a terrible shock when Smith concluded that Goldman was actually primarily about making money." Even thinner gruel.
What's been almost entirely missing is a discussion of why Goldman, according to Smith, was not violating federal regulations. The answer lies in the huge difference between the minimum requirements of the sales or broker standard that brokers must meet as opposed to the far higher fiduciary standard that most all customers or clients expect and that SEC registered investment advisers must meet.
A version of this blog first appeared on the website of the Institute for the Fiduciary Standard, where Mr. Rostad is president.
One notable exception: WSJ columnist Holman Jenkins does reference this difference in a March 16 posting and offers one alternative. Jenkins notes, "When Goldman is making markets or taking the contrary side of a complex transaction requested by a customer, Goldman is clearly looking out for itself."
Goldman traders, like brokers not registered with the SEC, are supposed to look out for themselves and put the interests of their firms first. This is their duty. This is what they do. However, what they are permitted to say is another matter again.
Like industry peers, Goldman is permitted to say that its brokers or traders are trusted advisors and dedicated to their clients' best interests. Are clients who hear and see these claims repeated incessantly, "Muppets"? Are Goldman customers “Muppets” because they believe the plain meaning of the plain language of their trader or broker? By his reckoning Smith did not resign because he believed Goldman broke the law; he resigned because he believed Goldman broke its word. Regularly. For instance, Goldman’s promise to clients that their interests “always come first,” and to employees, that “integrity and honesty are at the heart of our business.”
Brokers and traders meeting the "fair dealing" standard, among other things, are not required to act in their client's best interest or in a prudent manner, disclose all conflicts, either avoid conflicts or disclose and manage the conflicts such that the investors’ best interests are still served, disclose all fees and expenses and control investment expenses. In sharp contrast, fiduciaries have legal obligations of loyalty, due care and good faith and are required to fulfill these duties.
If Smith says correctly that Goldman has broken no laws, from a regulatory perspective he is saying that Goldman traders meet the minimum requirements of the low fair dealing standard that explicitly permits firms to put their interests ahead of investors’. The bad behavior is not that Goldman traders put their own interests first. The bad behavior is that Goldman and other firms put their own interests first and at the same time regularly and clearly say or suggest otherwise— that they put investors’ interests first. This is a violation of trust, not a violation of regulations.
Yes, Americans like seeing the large and powerful getting a comeuppance for behaving badly.
Piling on Goldman for being brash and arrogant may be understandable. That does not make it useful or important. Better yet, reminding all investors seeking investment advice of the huge difference between the requirements of sales brokers and fiduciaries would be both useful and important, as would urging the SEC and Department of Labor to proceed making fiduciary rules that provide equal protection under the law so retail investors no longer have to face sales brokers who are permitted to do one thing, yet say something very different.