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For Goldman Sachs, This Has Been a Challenging Period

Posted by Larry Doyle on January 12, 2011 7:35 AM |

What is a reputation worth?

I have always maintained that people and institutions ultimately have the reputation that they deserve. While there are always instances of misunderstanding or miscommunication, reputations are not built upon individual instances or single interactions. Reputations develop over time.

The last few years has been a period of time during which large holes have been blown in the heretofore seemingly impenetrable fortress known as Goldman Sachs. Now Goldman is on the defense to repair those holes which have exposed the unseemly innards of its firm. What have we learned? What is the most glaring hole? Let’s navigate as the Financial Times highlights, Goldman Tries to Answer Its Critics:

“For Goldman Sachs, this has been a challenging period.”

Wall Street is not known for understatement, but Goldman’s summary of the year just gone – contained in a wide-ranging report on internal reforms unveiled on Monday – is one of the biggest euphemisms in recent memory.

In the past 12 months, Goldman has gone from being the world’s most admired and feared investment bank to having to rebuff civil fraud charges, endure a political furore against its way of doing business and face public hostility towards its pay practices.

The internal report by Goldman’s business standards committee – portions of which have been seen by the Financial Times – was aimed at answering its many critics by changing its oversight structures and financial reporting.

Gerald Corrigan, the group’s co-chairman, called its 39 recommendations, which include the creation of several internal committees, a change in how it reports results and interacts with clients, “pretty damn aggressive stuff”.

The committee itself was a sign that Goldman had to react to public pressure. It was formed in May, a month after the Securities and Exchange Commission alleged Goldman had defrauded investors in a mortgage-backed security. When Goldman settled, paying a $550m fine in July, the SEC said that in setting the penalty, it had taken into account the bank’s efforts to reform its ways.

(I highlighted the specific topic of reputational risk for Goldman Sachs in a CNBC interview last March.)

Goldman’s $550 million fine may have appeared steep, but I honestly believe it was a cheap price to pay for Goldman and the entire industry to gain regulatory cover on the potential–dare I say likely– improprieties embedded in the structuring and distribution of CDOs (collateralized debt obligations) on Wall Street. Will America ever truly learn what happened with these deals? Will we ever learn of the true relationships between the CDO managers and Wall Street dealers? Will we ever unearth how the pools of collateral were selected for these deals and how that information was shared –or not shared–with investors? I am not optimistic that either the SEC or FINRA has the wherewithal or the inclination to truly go after the industry on all these questions and expose potential frauds in the process. But I digress, back to Goldman Sachs and its internal review.

Goldman executives said that the more radical changes were in the nitty-gritty.

Goldman will, from now on, discuss investors’ “suitability” for particular products instead of relying on the old and simplistic division between “retail” and “professional” investors – one of the flashpoints of the SEC probe.

What does Goldman mean that “from now on” it will discuss investors’ suitability for particular products? Upon reading that, how can one make any other assumption than that Goldman is admitting that it has not utilized the “suitability standard” to this point. What are the implications for Goldman in making this admission? Our Investing Primer highlights:

Legal Dilemmas
What does the law have to say about unsuitable investments? If an investors goes into an investment purely on his or her own initiative (known as execution only) and no one has advised the person to do so, there isn’t much the law can do. On the other hand, if a broker or bank advises an investor into an unsuitable investment, that financial professional could be liable for the investor’s losses, provided the person can prove the investment really was unsuitable and that the broker or advisor did not make the risks clear.

Goldman may have hoped it was repairing its reputation while putting a whole host of issues behind it with the release of this internal review. With that statement regarding suitability, though, it may have just opened an entirely new beehive.

Whether it was the marketing of CDOs or arbitrarily utilizing the suitability standard, Goldman may be taking the heat  — but every firm on Wall Street was playing these games.

Larry Doyle

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I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own and not those of Greenwich Investment Management. As President of Greenwich Investment Management, an SEC regulated privately held registered investment adviser, I am merely a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.

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