Goldman hasn’t disputed the basic facts in the SEC’s narrative: (1) that the company allowed its client Mr. Paulson, who famously made billions betting that subprime mortgages would default, to play a role in the selection of a portfolio of the worst imaginable subprime mortgages that would be packaged into a collateralized debt obligation, and (2) that the bank failed to disclose to clients to whom it sold those CDOs that it had, in effect, let the fox into the henhouse. Goldman claims its sophisticated clients wouldn’t have cared about such information or considered it important, but if that’s the case, why did Goldman conceal it? Goldman collected millions of dollars in fees from Mr. Paulson, who bet against the doomed securities, and from the clients who invested in them.
• Why was a firm like Mr. Paulson’s allowed to choose the securities in the CDO it was planning to bet against? Although Mr. Paulson’s firm may have been smart to bet against subprime mortgages, this deal was like shooting fish in a barrel. Who else gets this kind of access, what does Goldman receive in return, and are their roles disclosed? (Though Mr. Paulson hasn’t been accused of any wrongdoing, it would be interesting to know how much money from the Troubled Asset Relief Program paid to Amercan International Group, Goldman and others ended up going to him.)
• Who at Goldman was responsible for giving Mr. Paulson such extraordinary access and then failing to disclose it? Surely it wasn’t Mr. Tourre, the 31-year-old Stanford graduate named as a defendant in the SEC suit. Who did he report to? What was the hierarchy of oversight? In other words, where does the buck stop?
• Legal issues aside, does Goldman really believe this deal meets its own standards of integrity, fairness, and professionalism? The notion that purchasers of the securities wouldn’t care about Mr. Paulson’s role already fails the common-sense test. Such an argument would be far more persuasive if it came from the clients who bought them rather than Goldman. And it’s no excuse that other firms were carrying out similar deals with comparable disclosure.
• If Goldman concludes such a deal didn’t meet its standards, it needs to acknowledge that and take whatever steps are necessary to prevent it from happening again. Someone has to be responsible and held accountable, perhaps even a highly valued and revered high-level official. Goldman needs to do this before it is forced to do so by a court, regulators or Congress. This will be painful. It takes courage, objectivity, vision, and perhaps most of all, humility.
• How will Goldman prevent such conflicts in the future? What is it doing internally to restore a culture of integrity? If Mr. Tourre or any other employee thought he was caught in a “surreal” situation, to whom could he take such concerns and get a fair hearing?
• The SEC suit isn’t Goldman’s only potential scandal. The Wall Street Journal reported last week that Goldman director Rajat Gupta is being investigated as part of the sprawling Galleon insider-trading investigation. In the article, Goldman declined to comment on whether Mr. Gupta informed the company about having received a notice from prosecutors. What does Goldman know about possible leaks of inside information? Why, when Mr. Gupta told Goldman in March he wouldn’t be standing for re-election, did Goldman chief executive Lloyd Blankfein issue a public statement lavishing praise for his service? And why, for that matter, wasn’t Mr. Gupta asked to resign immediately? Mr. Gupta hasn’t been accused of wrongdoing, and Goldman is right not to prejudge him. But that doesn’t mean Goldman should ignore the evidence or that someone under investigation is entitled to a board seat.
• Are there other investigations we should know about?
These may well be isolated incidents, confined to a few individuals, their timing an unfortunate coincidence. If so, Goldman has all the more reason to get ahead of the scandal, get the facts and disclose them. It may require swallowing some pride and suffering some criticism. It’s also the right thing to do.
—James B. Stewart, a columnist for SmartMoney magazine and SmartMoney.com, writes weekly about his personal investing strategy. Unlike Dow Jones reporters, he may have positions in the stocks he writes about. For his past columns, see: www.smartmoney.com/commonsense