Corporate Governance

Goldman v. SEC: The Settlement Talks Begin

By J Robert Brown Jr.

Settlement talks have apparently begun.

Those who believed that Goldman would fight to the bitter end in its case against the SEC were either  engaging in wishful thinking or were unaware of the dynamics of securities litigation with the Commission.  First, irrespective of what one thinks of the case, the SEC had a potent issue in alleging that Goldman failed to disclose the participation of a short seller in the selection of the reference portfolio.  Goldman's defense, among others, was to argue that sophisticated investors knew what was in the reference portfolio and didn't need to know that the short seller helped selected the securities. 

Many wanted to believe in the viability of the defense.  Its consistent with a philosophical view that large investors don't need to be protected, that they can assess the risks without government intervention.  Its a variation of let the market resolve things.  Of course, if that were true, there would be no need for any protections of the securities laws, at least with respect to sophisticated investors.  With the Goldman hearings a few weeks ago discussing practices in CDOs such as barbelling and the use of stated income loans, the idea that buyers would protect themselves (that they could uncover these practices) was becoming increasingly untenable.  

So Goldman was in a position, for all of the bluster, where it could easily lose the case.  A settlement offers a number of advantages.  First, the SEC typically allows settling parties to neither admit nor deny that they violated the securities laws.  This prevents the settlement from having significant value in private litigation.  If the case went to a verdict, it would strengthen the hand of those bringing private suits.

Second, the SEC has its own reasons for wanting to settle (it could still lose) and so Goldman at this point has maximum leverage to get the lightest possible settlement.  This means two things.  First, it will try to avoid a settlement that admits to fraud under Rule 10b-5.  There are other provisions in the securities laws such as Section 17 of the 1933 Act which would allow Goldman to accept a disclosure violation but not one that amounted to fraud. 

In addition, Goldman will want to negotiate intensely over the amount of any fine or penalty.  These amounts are not set in stone.  The SEC will want an amount that will send a message that it is punishing Goldman but there is a wide range that can accomplish this result.

Settlement talks will go on for awhile.  But they will continue and the case will settle.

Full post as published by The Race to the Bottom on May 07, 2010 (boomark / email).