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Mr. Smith Goes To ...

Lost Faith in Goldman Sachs “Culture”
By Wayne Jett © March 20, 2012

     A young executive resigned from Goldman Sachs, the giant international investment bank, after 12 years during which he advanced to head U. S. equity sales to Europe, the Middle East and Africa. Having starred in the bank’s recruitment of new talent, Greg Smith concluded the firm culture no longer placed its clients’ interests above maximizing its own profits.

      Two questions remain unanswered despite Mr. Smith’s widely read opinion piece in The New York Times: (1) did he ask the right question about the worthiness of his employer, and (2) what took the Stanford graduate and Goldman staffer (by definition, one of the world’s smartest people) so long to catch on?

Client-Care, 2000-2002, Goldman-Style

      If he ended 12 years at Goldman Sachs on March 14, 2012, Mr. Smith joined the firm in March, 2000. We know now that was a very momentous time for Goldman, for its clients, and for all U. S. investors.

     As previously chronicled here and in The Fruits of Graft (Launfal Press, Los Angeles: 2011), beginning in early March, 2000, Goldman permitted its clients (mostly hedge funds) direct access to its trading platforms. The clients could perform their own trades and take direct responsibility for reporting trades to regulators as required by law.

      With this access to trading platforms, Goldman’s clients promptly began falsely reporting their short sales as long sales. By doing this, the clients “avoided” or, some would say, violated the “up-tick rule” of federal securities law governing short sales. Coincidentally, March, 2000, marked the onset of the great stock market crash of 2000-2002, which finally hit bottom in October, 2002. Again coincidentally, the crash bottomed about the same time (1) Goldman withdrew its clients’ direct access to trading platforms, and (2) the clients stopped marking their short sales as long sales.
      Falsely reporting short sales as long sales enabled Goldman’s clients to drive down share prices of target firms in two primary ways. First, they could sell shares short at any time without waiting for an up-tick in share price of another party’s trade. Second, they could trick long investors into thinking that other long investors were dumping their holdings; the sales by Goldman’s clients looked like long sales because they occurred without waiting for up-ticks. Illicit gains from these deceptive trading practices must have measured many billions of dollars.

Goldman-Care, SEC-Style

     The Securities & Exchange Commission did nothing to punish Goldman’s clients for the illicit trading and reporting found in what might have been the biggest case of trading fraud in SEC history. In March, 2007, Goldman itself agreed to pay a $2 million fine for failing to exercise proper supervision of the trading platforms, but otherwise admitted no wrongdoing.

     To avoid hard feelings on Goldman’s part, the SEC repealed the up-tick rule as antiquated only two months after the settlement. This regulatory accommodation paved the way for Goldman’s high-frequency-trading practices, which front-run trades in U. S. financial markets to this day.

Teachable Moments in Law and Ethics

    All of this brings back the question: why did Mr. Smith frame his concern with Goldman Sachs as failing to put its clients’ interests first? Perhaps he was unaware during the first two years of his work at Goldman that the firm’s clients were failing to comply with federal securities law to the severe disadvantage of other investors in the markets. Perhaps Mr. Smith also missed the revelation on July 4, 2009, that Goldman developed and used highly confidential software codes which were capable “in the wrong hands” of manipulating prices on stock exchanges worldwide.

    Even if Mr. Smith did not know of Goldman’s conduct during the crash of 2000-2002, however, surely he learned of it sometime during the next ten years before his resignation. If he did learn of those facts before his resignation, his complaints against the firm’s “culture” should have addressed compliance with duties under law rather than mere ethical lapses in client relations.

The Bottom Line

    Mr. Smith took 12 years to be offended by Goldman’s “culture.” He was slow to comprehend the problem foreseen by the brightest people in the world, who avoided such employment as a matter of principle, regardless of the money.

      Make no mistake, however, Mr. Smith’s willingness to leave Goldman Sachs and to say something rather than nothing is commendable, regardless of what the financial press may write. Though he didn’t exactly violate the unwritten rule of the financial sector against speaking of trading fraud, he did more than most are willing to do. ~