In the years I have opined on these pages, I've devoted a fair amount of space to the Securities and Exchange Commission. Whether it was critiquing a regime change, calling for a bigger budget or trying to comprehend the regulator's vacillating stance with regard to adoption of International Financial Reporting Standards, the commission has served as a rather convenient editorial subject.
But the past 18 months have not been particularly kind to the commission. It has been lambasted for ignoring more than a decade's worth of warnings about Bernard Madoff and his company's consistent and unrealistic returns, and accused of missing several chances to pursue Texas financier R. Allen Stanford, who is charged with running a Ponzi scheme similar to Madoff's. Recently, a scathing 2,000-plus-page report stated that the SEC basically sat on its hands during a 2008 accounting fraud at Lehman Brothers. And in a humiliating scandal, it was forced to reveal that a number of its employees spent more time surfing the Web for porn than pursuing white-collar criminals.
This is not exactly a track record that instills confidence as the commission recently filed fraud charges against Goldman Sachs. According to the SEC, Goldman structured and marketed something called Abacus 2007-AC1, collateralized debt obligations linked to the performance of subprime mortgage-backed securities, which, to be kind, could be labeled as risky. Goldman allegedly didn't tell investors important information about the CDO, especially that a major hedge fund, Paulson & Co., had helped select the risky portfolio and then shorted it, in essence betting that its value would sink.
The fact that Goldman marketed mortgage-backed securities while betting that those securities would decline in value was hardly a secret. Goldman, along with other investment houses, have been doing that for years. And to be clear, the practice, while arguably vile, is not necessarily illegal. But what the regulator is charging is that Goldman created and marketed CDOs that were deliberately designed to fail, so that high-profile clients could make money off said failure. Goldman, however, contends that it lost more than $90 million on Abacus 2007-AC1 and earned just $15 million in fees. It also contends that it provided extensive disclosure to clients.
It is against this murky backdrop that the SEC gets an opportunity to mend a tattered reputation and be taken seriously in its 70-year-old mission statement of being the investor's advocate.
But already, there have been missteps out of the gate - most notably, a split 3-2 verdict amongst the commissioners on whether to file against Goldman. The voting went along party lines, with SEC Chairman Mary Schapiro siding with Democratic Commissioners Luis Aguilar and Elisse Walter. To me, that signals that the case may not only be roiled with partisan politics, but that the charges may not be as strong as initially thought.
Either way, Goldman represents what many feel is a make-or-break case for the regulator, with potentially career-altering consequences for Schapiro and her hand-picked enforcement head, Robert Khuzami. Adding to the SEC's Goldman headache are a pair of lawmakers who are urging the SEC to expand its probe of the fraud to determine whether any Goldman-based mortgage securities backed by American International Group were fraudulently created, thereby rendering the $13 billion in payments for failed securities made by AIG to Goldman illegal gains.
When Schapiro assumed office last year, she promised a top-down cleanup of the agency. For better or worse, the Goldman case will serve as a barometer of that progress - or just another blown opportunity for a agency that cannot afford another.
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