Goldman probe heralds SEC clamp-down

The US Securities and Exchange Commission's charges against Goldman Sachs could be a sign that the agency is turning up the heat on Wall Street, according to respondents to our web poll last week.

When asked if the action against Goldman was the start of a wave of charges against banks, our readers at first seemed divided on the question but later voted strongly in agreement. Almost three-quarters answered Yes, suggesting that they expect Goldman will not be the only bank brought to heel over the way it marketed products in the run up to the financial crisis.

The securities regulator is accusing Goldman of fraudulently selling a subprime product known as Abacus. It says that the bank claimed the underlying mortgage portfolio had been selected by an independent third party, when in fact it had been put together by a hedge fund client with the specific intention of betting against it.

Goldman certainly has some questions to answer, but it is hardly the kind of case that will rehabilitate the SEC's reputation in the wake of its failure to catch the alleged multi-billion dollar Ponzi schemes run by Bernie Madoff and Mark Stanford, despite both cases sitting in their laps for years. More broadly, the SEC is also on the hook for failing to do more to prevent the financial crisis.

In his report into the agency's handling of the Stanford scam, David Kotz, the SEC's inspector general, noted that it had been guilty of focusing on "slam-dunk cases" that were easy to fight, instead of big cases that involved a lot of work, such as those involving Madoff and Stanford.

This latest action against Goldman puts the SEC in the peculiar position of defending professional investors who used their own discretion -- not to mention their clients' money -- to make a losing bet on the subprime mortgage bubble. Not a victim that many people would have chosen to help draw a line in the sand and show the SEC is now serious about protecting the market from deep, systemic risks.

Indeed, the timing of the charges against Fabrice Tourre, the Goldman vice-president who sold the product, has given rise to some suspicion that it is trying to divert attention from its own failings. The Abacus charges came to light on the same day as Kotz's report into the Stanford case and prompted the inspector general to launch a fresh investigation, this time into the Goldman case.

The SEC is also facing flak from Harry Markopolos, the Madoff whistleblower who is currently promoting his book "No One Would Listen" about his 10-year battle to expose Madoff to the SEC. It makes for damning testimony.

As a quant who had spent years building and taking apart options products at a Boston-based hedge fund, Markopolos knew intuitively that Madoff's numbers didn't add up. His pursuit to expose the truth, he explains in the book, started out as a way to prove to his sales team that it was impossible to build a legitimate product that could compete with Madoff's Ponzi scheme, but ended up as a 10-year Kafkaesque nightmare.

Markopolos first approached the SEC in 1999 with six red flags, starting with the observation that it was a mathematical impossibility for the split-strike strategy Madoff claimed to be using to produce the returns he was advertising -- not just because the returns were too smooth (his performance charts rose at an unprecedented 45-degree angle), but also because there simply weren't enough options in existence to hedge his huge bets.

Despite these and many other red flags, the SEC failed to act for years, even after repeated warnings from Markopolos, who, as it turns out, was not the first to ring the warning bell -- Madoff was investigated by the SEC as long ago as 1992.

If our readers are right in predicting that the Goldman case is the start of a series of actions by the SEC, these charges do not inspire much confidence that a revolutionary new approach is in the footing.

In total, 73% of the 1,148 voters agreed that the SEC's probe into Goldman Sachs heralds a new wave of actions against banks, while 25% disagreed and 2% said they were not sure. 

Photo by AFP.