Slouching Towards Wall Street… Notes for the Week Ending Friday, 13 April 2012
Rome wasn’t destroyed in a day.
In what looks like one of the most transparent shakedowns of the year, the SEC and FINRA are splitting a $22 million settlement wrung from Goldman Sachs over “trading huddles,” the meetings at which Goldman analysts would gather to generate trading ideas to pass on to their best customers (DealBook, 12 April, “Goldman Fined $22 Million Over Trading Huddles.”) This is on the coattails of the State of Massachusetts, which extracted a $10 million payment from Goldman last year over the same behavior.
The huddles are sessions where, according to the SEC’s allegations, “research tips” were “passed inappropriately to its biggest clients,” allegedly giving Goldman’s most lucrative relationships an edge in the marketplace — particularly, giving them a trading edge while specifically denying other Goldman clients access to the same information. The allegations include tipping favored clients that a research report was about to be issued — thereby allowing the client to front-run a Goldman research recommendation, sure to be market-moving news — and issuing trade recommendations that diverged “from ratings printed in Goldman’s widely circulated long-term reports,” which meant Goldman’s loyal customers would be left holding a losing bag, while favored high-flying clients profited at their expense.
The SEC charged that the huddles “created a serious and substantial risk that analysts would share material, nonpublic information concerning their published research,” and that Goldman’s internal controls around its research in general, and the trading huddles in particular, were “deficient.”
The fine is a small number for Goldman. More to the point, a $22 million payment, from a firm of the size and clout of Goldman Sachs, tells us the regulators could find no specific violation associated with the behavior. We are loath to say this, because we also do not like the look of the Goldman huddles — we can not see how any firm could prevent this practice leading to improper disclosure of pending research, or to selectively issuing trading calls that conflict substantially with Goldman’s published research, both of which are violations. By definition, the selective dissemination of research disadvantages those customers who do not receive the call, or who receive it later than others. A firm of the magnitude of Goldman has the ability to induce customers to buy or sell millions of shares of stock. The huddles allegedly closed the majority of Goldman’s customers out of the loop of up-to-the-minute information — clients said they had no idea the huddles even existed, and were upset that they did not get the same access. It does not take an SEC examiner to see that secretly telling only one small group of customers to sell something that all the other customers own may be improper.
SEC enforcement head Khuzami is continuing to march down the path he claimed on his first day in the job, when he issued a statement saying he was going to seek more settlements, and bigger ones. We hated that statement at the time, and we hate it even more now, particularly when the best he can do here is half of a $22 million check. The very thought that the watchdog of America’s capital markets has promised only to bark, and never bite, is like having a new sheriff coming to a lawless town and announcing that he has blanks in his gun. Will no one rid us of this un-meddling priest?
But the fecklessness of the SEC does not let Goldman off the hook. The sorry state of financial regulation in this country has been obvious for many years. The decrepitude of Goldman Sachs has become apparent much more recently.
We do not refer to the notorious OpEd pieces from the poisoned laptop of Greg Smith (NY Times, 14 March, “Why I Am Leaving Goldman Sachs.”) The piece generated a fair bit of Schadenfreude among Goldman outsiders — Wall Street pros and average Joes alike grimaced approvingly and said “There’s one dude who tells it like it is!” For us, though, the piece was not remarkable for its content, but for the fact of its appearing at all.
Goldman is one of those awfully well-run institutions that always looked impervious to the vagaries of human nature. Its official history is chock full of prudent stewardship, careful and solicitous client service, and a broad vision of itself as a global citizen. The reality is not that this is a lie, but that Goldman is no longer what it was. The foundation has started to crumble, and the process may be irreversible.
We remember a glossy report issued by a major consulting firm back in the 1980’s. The report extolled the management wisdom of a major financial firm, saying the firm possessed a deep culture of responsible management. So well run was the firm, said the consultants, that it would take a large number of poor management decisions, made on many levels, and consistently over a long period of time for the firm to ever fail. The firm was Bear Stearns, and it had just gone public in 1985 when these reports were distributed. Bear went on for many successful years, but the stewardship and risk management that had brought it to its successful IPO was not passed on to successive generations.
We argue that the very fact of all these private banking firms going public completely undid the risk management side of the equation. The IPO was a mechanism, not for making the public partners in the banking firms’ success, but for laying off the risk on the public marketplace. With the risk sold to the public, the bankers and traders were free to go overboard. Lehman and Bear are but the two most extreme outcomes, but the notion of stewardship no longer underpins our financial markets — not for its participants, and not for its regulators — and that is the true tragedy.
A firm like Goldman does not collapse suddenly, does not fail all at once. But there are worrying signs. We have always known Goldman to have a powerful compliance culture, driven by partners who understood only too well the value of their franchise. Thus we were perplexed by emails that came out during Congressional hearings, calling Goldman’s own transactions “sh**y deals.” We were shocked by the email rant of one young Fabrice “Fabulous Fab” Tourre. How could a firm with Goldman’s reputation for risk management allow such communications to circulate? More to the point: how was it that Goldman employees did not think twice before committing these messages to writing?
There are two glaring issues around these emails. One is that the employees appear not to have cared that they were creating documents that would become part of the firm’s permanent record — available for regulatory review, and for discovery in legal proceedings. The other is that the employees are clearly telling each other that their own firm is generating illegitimate transactions and foisting them on unwitting customers. Even a member of a Congressional panel could see that.
As part of the bargain basement settlement, Goldman has agreed to a “comprehensive review” of its policies governing research and the dissemination of research calls and trading ideas to clients. We submit that Goldman needs a “comprehensive review” of lots more than that.
Happy Friday the Thirteenth, Goldman Sachs.
New York Times columnist Nicholas Kristoff reports that Goldman Sachs financed the nation’s leading child prostitution website website (New York Times, 31 March, “Financiers and Sex Trafficking”). “The biggest forum for sex trafficking of under-age girls in the United States appears to be a Web site called Backpage.com,” owned by a shadowy entity which is itself owned — so Kristoff — by private equity financiers “including Goldman Sachs with a 16 percent stake.” Kristoff says Goldman “began working frantically to unload its shares” in the website once Kristoff started inquiring about their investment. A Goldman representative told Kristoff “we had no influence over operations,” the implication being that a passive investment was more All Right than if they had taken an active role in management. Perhaps this seeks to change the issue from profiting from the underage sex trade, to a debate about Goldman’s generally overweening management style. Goldman, which is used to telling the US government what to do, is positioning itself as a kinder, gentler corporate citizen. Having made a passive investment in a highly lucrative business, they allowed the founders full operational latitude. In the world of corporate governance this is called Progress.
Kristoff cites industry observers who claim Backpage.com “has 70 percent of the market for prostitution ads.” Those who have followed the Backpage story now know the actual ownership structure, thanks to Kristoff’s own earlier reporting. Village Voice Media is the parent company of the eponymous alternative New York City newspaper. It is a private company half-owned by two individuals, with a sprinkling of passive investors holding most of the other fifty percent — a sizeable chunk was held by Goldman, but other investment funds also owned bits of the entity.
In fairness to Goldman (and as Kristoff points out) the investment bank bought into the media company six years before they acquired the website, and Backpage.com is used for a broad variety of advertising. Kristoff explains “this is a tiny investment by a huge company, and I have no reason to think that Goldman’s top executives knew of its connection to sex trafficking.” We agree. Goldman apparently agreed as well, as they quickly rid themselves of the tainted investment. We think this is an unfortunate outcome and wish the story would not end here.
Goldman has made a substantial effort in supporting women’s initiatives. As Kristoff observes, “its 10,000 Women initiative does splendid work supporting women in business around the globe.” Given Goldman’s clout and visibility, we would like to see them lend support to the efforts to close down Backpage and other venues that provide access to this sorry marketplace.
Numbers are obviously difficult to come by, but by any measure — and by any stretch of the imagination — the sex trade is frighteningly lucrative. An important report in this field comes from Cornell University’s school of Industrial and Labor Relations (3-1-2005, “Forced Labor and Human Trafficking: Estimating the Profits”). It estimates worldwide profits from the sex trade at US$ 33.9 billion, half of that being realized in industrialized nations. According to the report’s data and methodology, the sex trade in industrialized economies has by far the highest profit margins, with average profits per trafficked victim of US$ 67,200, as compared to Latin America, for example, where the average is a mere US$ 18,200.
Speaking of Latin America, for all its progress in human rights, Brazil has made a recent contribution to the never-ending story.
As discussed by one of Brazil’s leading journalists, Miriam Leitao (O Globo, 7 April, “Em Nosso Nome” — “In Our Name”) Brazil’s supreme court has affirmed a lower court decision exonerating a man of raping three 12 year-old girls, on the grounds that the girls were prostitutes.
Brazil has positioned itself as a leader in social progress and human rights issues. They passed a law criminalizing domestic violence against women and set up women’s advocacy offices in cities across the country. They signed a global accord against sexual exploitation of children and passed laws aimed at protecting the rights of children and adolescents. They have even put through a constitutional amendment requiring full documented salary and benefits for domestic workers, a major social and economic change whose full economic reverberations are yet to be felt.
The United Nations High Commissioner for Human Rights criticized the Brazilian court’s action as a revocation of the human rights of minors, but so far the supreme court is sticking to its guns. Leitao quotes a female government minister’s observation in favor of the dismissal, saying the girls were not “naïve, innocent or unaware about sex.” Clearly the government believes it is in the national interest to perpetuate the image of Brazil as a fun place to visit. This, in a country that raises eyebrows each year at video images of half-clad pre-pubescent girls shaking their hips in the Carnaval samba competitions. It should be noted that, in response to a wave of international finger wagging over the incident, the supreme court issued a statement last week saying this decision “does not institutionalize child prostitution,” an odd statement, coming as it does from the nation’s Precedent Setter of Last Resort. One wonders how lower courts are to view this judgment, in light of the court’s own demur.
Brazil appears to have just missed the party. President Rousseff made the pilgrimage to Washington earlier this month to sit with President Obama — and a number of her countrymen and –women were miffed that all she got was lunch, instead of the lavish state dinner that would have been thrown for the heads of state of India, China or Russia (the RICs in the BRICs). No sooner did President Rousseff return home — and no sooner did Brazil’s highest court sign off on adults having forced sex with minors — than President Obama’s Secret Service advance guard ran into difficulty with local professionals in the Colombian city of Cartagena (yes, that Cartagena, the fabled global capital of the narcotics trade, now apparently a respectable city where global political summits are held). The ruckus appears to have erupted over a billing dispute. As reported by CNN at the weekend (“Obama Wants ‘Rigorous’ Investigation of Secret Service Prostitution Claims”) the story came to light when “one of the women did not leave in the morning. A hotel manager tried to get in the room and eventually the woman emerged and said they owed her money.” If only they had been able to come to terms amicably. Clearly, the US team did not have sufficient translators or cultural attaches, otherwise this misunderstanding could have been avoided.
This is another argument in favor of expanding cultural education for foreign service staffers, not to mention modern language curriculum in America’s elementary and high schools. If only the Secret Service agents had learned Spanish in high school, perhaps this embarrassment could have been avoided.
We wonder whether the disparity in estimated profitability of the sex trade across economies is a function of the figures being expressed in dollars. A study of profitability expressed in local buying power would be more revealing of how the activity fits into the economy, and a host of other variables would need to be factored in to identify the societies that are most susceptible to criminal activity, or most likely to respond to law enforcement and legislative initiatives. This is the knottiest of problems, and one that has been part of human history ever since there was such a thing as history.
We think Kristoff hit the wrong side of the target in his latest “revelation” of Goldman’s involvement with Village Voice Media. We wish he had led off instead with his acknowledgment that this was a relatively tiny, passive investment in a private company, and that it was not until six years after the investment was made that management acquired a service that advertises a broad range of goods and services — including its unfortunate flogging of trade in underage sex slaves.
We share Kristoff’s outrage at Backpage, but we also think Goldman is in a unique position to help. We applaud Kristoff’s crusade to bring this phenomenon to light. As to Goldman’s involvement, the firm that for generations has prided itself on good citizenship has an opportunity to come out swinging on the right side of one of the major social issues affecting the entire world. There are credible organizations that do tremendous good in this area, who help free children from the sex trade and who provide counseling and support to help children and young women get their lives back. The more we journalists bash Goldman over an unfortunate investment, the less likely they are to want to engage.
Just because they are Goldman Sachs, doesn’t mean everything they do is necessarily evil. As Kristoff points out, they have made a considerable contribution to women’s entrepreneurship. And many Goldman executives are ongoing major donors to organizations that perform work of great value to society — like the Republican and Democratic parties, for example. We would love to see Goldman jump in and make a difference here, where nothing would work like influence and money, both of which they have in abundance.
We’re little black sheep who have gone astray…
Not unlike the underclassmen who thronged the tables down at Mory’s, the tiny tent town in the middle of New Haven Green has been ordered to vacate. “Occupy New Haven” is in the midst of a court fight over whether it has the right to continue to occupy the middle of the broad square at the heart of the fabled town. We have a particular interest in this story, as Heddgeye’s home office occupies the Taft Mansion, on Whitney Avenue, directly across from the hallowed Yale campus. The founder of the New Haven encampment is urging the residents to call it quits, saying “recent crime reports and negative media attention are getting in the way of Occupy’s message” (NBC Connecticut, 12 April, “Occupy New Haven’s Founder Says ‘It’s Time To Go’”), but eight other members of the encampment are suing the city, claiming the Green is not owned by the City of New Haven, but by a private trust, and that the city therefore has no jurisdiction to force them to leave.
We remember the same argument about the status of the camp-out at Zuccotti Park, ground zero of the Occupy Wall Street movement. With springtime here, we predict the occupiers will be flooding the streets once again.
The media never knew how to handle OWS — and were clearly scared by dealing with a phenomenon they could not control, pigeonhole, or pander to. For the past few months the media have purposely kept quiet about the movement, because they are no longer clowning around in public. It was all fun and games down at the mainstream media, as long as they could smirk that “they don’t even have a list of demands,” or pretend that two or three random and noisy racists who popped up at the periphery of the encampments were indicative of the heartbeat of the non-movement. Closer to home, we are fascinated at the lack of media coverage accorded Occupy the SEC — the OWS working group that turned out a detailed analysis of the proposed Volcker Rule. Running to well over 300 pages, the report remains one of the most thorough and cogent analyses produced during the SEC’s comment period. No wonder the media are reluctant to talk about it. They probably don’t understand it.
The Daily Mail reports a woman, known as “the Chinese Nick Leeson,” has been sentenced to death for rogue trades in connection with a scam that cost an investment fund some ten million pounds (6 April, “Chinese ‘Nick Leeson’ Rogue Trader Sentenced to Death.”)
Wang Caipang, who together with her brother, Wang Guanglin, were convicted of fraudulently drawing the money out of investors’ funds over the course of several months in 2010, was sentenced to death by a court in Wenzhou, in Zhejiang province. The court ruled the pair were guilty of the “crime of fraud of financing.”
Caiping, whose brother is still at large, reportedly tried to negotiate with her investors in late 2010 after losing millions in what were alleged to be unauthorized trades in gold. The investors instead turned her over to the police. This is reportedly in connection with a new initiative from Beijing against unregistered private lending schemes, many of which have caused investors’ money to vanish. Caiping is required to serve two years in prison prior to being executed, and observers say such a sentence is generally commuted to lifetime incarceration. Given what we imagine to be the conditions in a Chinese prison, we expect the commuted sentence is perceived as being the harsher penalty.
Any chance of getting Khuzami to rethink his position on settlements?
Email me when ComplianceEdge publishes or recommends stories