The underlying problem in the Goldman Sachs case is conflict of interest in the financial world, rather than the fraud charge, which raises difficult questions about who knew what, when.
The U.S. Securities and Exchange Commission has charged Goldman, Sachs & Co. and one of its employees, Fabrice Tourre, with civil fraud, alleging that they should have disclosed to potential investors the conflicted position of Paulson & Co., a hedge fund, in an offering of mortgage-backed securities. The SEC has not charged Paulson, though some investors may sue.
Paulson took part in discussions about which securities would be chosen for the offering. But ACA Management LLC was the company to whom the selection of the portfolio was delegated.
Goldman says that Paulson had in 2006 "indicated its interest in positioning itself for a decline in housing prices." Indeed Paulson was known for its dim view of the mortgage market; when the bubble burst, its proprietor, John Paulson, was highly praised for his foresight in betting against residential mortgages.
Mr. Paulson's firm may indeed have been an odd choice as an adviser to help recommend some good mortgage assets for a new offering, but it might still have suggested some of the better ones. Instead, it apparently bet against the securities in the new portfolio.
Goldman took part in the offering, and says it lost $90-million (U.S.)
Paulson's hedge-fund activity was inconsistent with its role as an adviser. It was at the very least a potential conflict of interest, and may have been an actual one. This is the problem at the core of the SEC's allegations, and this is a larger ill that regulators should be focusing on, one that arises in manifold ways in the financial world. If the charges go to trial, disputes about who knew what when may eclipse the central impropriety in these events.
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