Fraud & Investigations

Goldman Sachs self-evaluation calls for disclosure of operations

Posted on Thursday, January 13, 2011

After Goldman Sachs escaped the financial crisis with hardly a scratch, the legendary Wall Street bank learned last year that the biggest risk to its business was in Washington.
Regulators and lawmakers bloodied the firm, slapping it with a massive fraud suit alleging that it betrayed its clients and calling top executives to Congress for a pillorying. The bank lost tens of billions of dollars in shareholder value.
With the start of 2011, Goldman is trying to turn the page on a bad year. On Tuesday, the bank publicly released a long-awaited self-evaluation calling for a host of changes to how it does business - namely, disclosing more information about its finances and its operations to its investors and its banking clients, especially regarding how it trades its own money.
"These men have clearly learned their lesson," said banking analyst Richard Bove, who once said top Goldman executives might have to resign because of the allegations against the firm.
Goldman sailed through the financial crisis, only to emerge stronger and with fewer rivals - which was, to its critics, a testament to the billions of dollars in bailouts afforded to the bank by taxpayers.
But last year, the bank faced allegations far more dangerous than the notion that its executives profited at taxpayer expense - charges that they profited at the expense of the bank's clients.
The Securities and Exchange Commission asserted in a civil lawsuit that the bank had committed fraud against financial firms that had hired it for assistance. And lawmakers investigating Goldman said that it made a routine practice of secretly betting against the financial interests of its clients. Goldman settled the SEC suit by paying $550 million and acknowledging a "mistake" in failing to tell clients certain information.
In its report Tuesday, the bank acknowledged that its clients' trust had been tested. In surveys, "Clients raised concerns about whether the firm has remained true to its traditional values," the report says. "Clients said that, in some circumstances, the firm weighs its interests and short-term incentives too heavily."
Goldman said it would communicate more clearly in any given transaction about other types of business that the clients might want to consider. For instance, if the bank is selling an investment product to a particular client, it could issue a reminder that other clients might be betting against that product.
Goldman's continued powerful role on Wall Street was evident with its recent participation in a $500 million investment in Facebook, which will give its best clients a rare opportunity to put money in the social networking Web site before its possible initial public offering.
But to Christopher Whalen, co-founder of Institutional Risk Analytics, Goldman's work on the Facebook deal is evidence that Tuesday's report was "mostly window dressing."
Whalen argues that Goldman is helping Facebook skirt securities law by creating special investment vehicles that allow Facebook to keep its number of investors at fewer than 500. Securities law requires that companies with 500 or more investors release financial information to the public.
Since news of the Goldman deal broke, Facebook has made it clear that it will begin releasing financial information to the public next year.
Another threat that emerged last year for the bank was the passage of the Dodd-Frank financial regulatory reform bill.
Goldman has said that the two biggest effects of the bill on its business will be limits on trading and investments in hedge funds and private equity funds with the bank's own money and increased regulation of the market in complex financial instruments known as derivatives.
The new regulations have raised questions about Goldman's business model - which some suspect has long been driven by speculative bets rather than traditional investment banking and brokerage work.
But Bove, the analyst, said that the release of financial information from Goldman on Tuesday accompanying the report made clear that wasn't the case.
"It validates the company's argument that they were not making money on their proprietary investments," Bove said. "For decades, the concept of Goldman Sachs was that it is a hedge fund, not a brokerage firm. What these numbers showed is that it is a brokerage firm, and it is not a hedge fund."
By Zachary A. Goldfarb, Washington Post Staff Writer

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