Ethics_ Goldman Sachs Essay

Goldman Sachs, founded by German immigrants, began as a small humble business looking to succeed. Over time their business strategy changed and they entered into ethical and legal issues they had not encountered before.

In the late 1920s Goldman Sachs began maliciously investing in companies to drive their demand. They coined this term “laddering” from overleveraging them selves and putting the market at risk. Their actions created the bubble that burst in the stock market crash of 1929.

Furthermore, Goldman Sachs engaged in “trading huddles”. Only their preferred customers where chose to participate on this unethical schemes, and the same customers were shot changed on financial profit from unprofitable IPO’s shares. It was clear that Goldman Sachs business focus was not customer based but self-based by the mantras that they use to have: “long-term greedy” and “Filthy rich by forty.”

In 2008 the market once again crashed equally as hard as in 1929 and Goldman Sachs was at the root of the cause. With self-fulfillment and greed in mind, Goldman Sachs used Collateralized Debt Obligations and bet against their clients to increase profitability. Goldman Sachs progressively became more unethical in their dealings, and the SEC took notice. Goldman was accused on two accounts of fraud because of one particular portfolio of securities, named ABACUS, which they dealt with.

After analyzing the case and reviewing the unethical actions and alleged accusations against Goldman Sachs, it is clear that Goldman Sachs was operating unethically. They misrepresented, hid information, and engaged in conflicts of interest with their clients. Goldman Sachs took an unfair advantage with their “toes to the line mentality” on their legal and ethical issues leading the SEC to establish harsher regulations for the banking industry.

Goldman Sachs can become more ethical by adopting Warren Buffet’s front page of the newspaper principles. When a firm finds that its employees needs to convince themselves that their work is adding social value, the firm should questions its ethical practices. The recommendation for a firm when they find themselves condoning unethical actions is to be honest with the regulating entity and its clients. It is likely to reward them in the long run despite the immediate consequences.

Goldman Sachs


In 1869 two German immigrants came to the US and founded Goldman Sachs with the humble purpose of being both an originator and a clearinghouse for commercial paper (Jennings, 73). However, the firm started to gradually drift from its initial business strategy set by its founders and started to provide other services and undertook investment strategies. In the late 1920’s Goldman Sachs created investment companies that it would itself invest in to drive up the market demand. As a result, investors started to invest in the company because of the perceived high demand. With the new proceeds, Goldman would borrow more money and create another investment company and repeat the process. As a result of this action, Goldman contributed to the stock market crash in 1929 and, with a similar strategy, the recent financial crisis in 2008 (Jennings, 73). During the Internet bubble in the 1990’s, Goldman engaged in an activity known as laddering.

Goldman, as the underwriter of a security, would enter an agreement with its best clients to sell a portion of IPO’s shares at a predetermined price after their initial offering. This led to a misconceived demand in the secondary market of the stock due to the predetermined secondary pricing Goldman had set with some of it’s clients. Furthermore, in the 2000’s, Goldman would sell Collateralized Debt Obligations, for which it had a negative outlook, to its clients and issue trading reports, developed through the existing “trading huddles” in the firm, to certain preferred customers that was different from the analyst reports that were issued to the public.

Its practices has been scrutinized and particularly its “toes to the line” on legal issues. In most cases, Goldman and its clients are the two main parties involved, and it is the clients that usually end up with the short end of the stick. Goldman’s actions are partly explained by the mantras that they use to have: “long-term greedy,” and “Filthy rich by forty.” This paper is relevant for current business leaders because it presents a case where a successful firm has come under great scrutiny due to its unethical actions and questionable practices. Bending the rules and pushing the envelope continuously to be a profitable firm has put Goldman in an unfavorable light in society. The paper will further discuss the ethical and legal issues Goldman has run into through its practices and will provide a general recommendation for how a business can avoid and deal with unethical practices.

Analysis of Relevant Legal and Ethical Issues

Initial Public Offerings

Goldman created a synthetic demand in its IPOs through selling a portion of the IPO shares to its clients at a predetermined price higher then the initial price. This caused the price of the IPO shares to rise due to manufactured demand by Goldman (Jennings, 75). The Securities and Exchange Commission filed a complaint against Goldman alleging that they had violated Rule 101 of Regulation M under the Securities Exchange Act of 1934, which states:

“Rule 101 of Regulation M, among other things, prohibits underwriters, during a restricted period (the five-day period preceding the determinations of IPO prices and prior to the completion of distributions of IPO shares), from directly or indirectly bidding for, purchasing, or attempting to induce any

person to bid for or purchase any offered security in the aftermarket” (SEC).

Goldman clearly attempted to induce, or induced, certain clients to bid for or purchase offered securities in the aftermarket through its laddering practices, which clearly violates Rule 101 of Regulation M. Goldman agreed to settle with the SEC by paying a fine of $40 million without admitting or denying the allegations (SEC).

Some of the unethical practices present in Goldman’s laddering activities were: * Misrepresentation- Goldman inflated the price of the IPO shares consciously through the manufactured demand and the price of the shares were misrepresented. * Lying- Goldman Sachs lied to some of its best clients and had them pay higher price than the initial price under the laddered IPOs. * Violating Rules – Clearly making money from laddering is a violation of rules and therefore Goldman paid a heavy fine when they were caught engaging in this illegal practice

Collateralized Debt

In order to understand Goldman’s involvement in CDO’s it is pertinent to explain the security. Collateralized debt is simply an Asset-Backed Security, which means that there is a physical asset backing the security under contract. For example, a house serves as collateral for a mortgage and the bank has the right to claim the house in the event that the borrower defaults on the loan. A security is considered any investment contract that gives the owner evidence of indebtedness or business participation. Notes, stock, bonds, debentures, warrants, subscriptions, voting trust certificates, rights to oil, gas, and minerals, and limited partnership interest are all example of securities (Jennings, 728). A Collateralized Debt Obligation is a variety of fixed-income assets that are pooled together to create one security.

In 2008, many of these CDOs became completely worthless because they were filled with sub-prime mortgages that defaulted, and Goldman was a big player in the CDO market. ABACUS was one particular CDO deal in which Goldman had created and sold. Fabrice Tourre, a vice president at Goldman Sachs at the time, put together the ABACUS CDO to be sold to clients. Tourre intentionally filled ABACUS with subprime mortgages so that Goldman could take a short position on the security, which means betting against its success, in order to profit. This CDO deal became infamous because the SEC uncovered a few emails written by Tourre. In one of the emails Tourre wrote:

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“More and more leverage in the system. The whole building is about to collapse anytime now … Only potential survivor, the fabulous Fab [rice Tourre] … standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implication of those monstrosities [sic]!!!” (Quinn)

The SEC filed a civil action suit against Goldman and Tourre for their conduct under the ABACUS deal. The SEC’s complaint charged Goldman and Tourre with violations against Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Exchange Act Rule 10b-5 (SEC). Each of the following rule of law states, among other things:

“It shall be unlawful for any person in the offer or sale of any securities … (2) to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made… ” (SEC)

” POSITION LIMITS —As a means reasonably designed to prevent fraud and manipulation, the Commission shall, by rule or regulation, as necessary or appropriate in the public interest or for the protection of investors, establish limits (including related hedge ex­ emption provisions) on the size of positions in any security-based swap that may be held by any person.” (SEC)

“It shall be unlawful for any person … (a.) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statementsmade, in the light of the circumstances under which they were made, not misleading, …”
 (Taft Law)

Goldman clearly violated Section 17(a) by not including the information that their ABACUS securities were based on poor mortgages. They violated Section 10(b) by taking a large short position in the Abacus deal. Lastly, they violated Rule 10b-5 by omitting material fact of their short position in the security. Furthermore, the SEC prohibits any analyst from issuing reports on securities that run contrary to the analyst’s true beliefs about the securities. Goldman denies betting against clients in an 8 page letter to it shareholder signed by CEO Lloyd Blankfien as well as President Gary Cohn. Goldman claims that they were protecting themselves and Blankfien said, “…Certainly we did not know the future of the housing market” (SEC). Goldman agreed to pay a fine of $550 million and admitted that it failed to disclose vital information in their marketing of ABACUS securities.

Goldman’s actions did not reflect honesty, integrity, or responsibility. Some of the ethical issues present in the ABACUS deal are:

* Taking unfair advantage – Goldman consciously made poor recommendations to their clients in order to sell the Abacus CDOs so they could make a profit on their short position. * Engaging in Conflict of Interest – Goldman stated: “We may trade, and have existing position, based on trading ideas before we have discussed those ideas with you”(Jennings 80). Despite this argument, they had a significant incentive to market and sell the securities in order to profit. * Hiding or Divulging information – Goldman used another firm to create the Abacus CDOs in order to distance themselves from the trade conflicts that would arise by shorting the CDO. They also omitted crucial information about the security, which was the knowledge of the amount of high-risk mortgage securities in the Abacus CDO. * Violating Rules- Goldman was charged with securities fraud, as explained by above, and did not look out for the best interest of their clients.

Trading Huddles

Goldman’s first obstacle with their trading huddles activities came from their Fundamental Strategies Group of analysts. The group consisted of Goldman analysts employed by their Securities Divisions. These groups of desk analysts were not regulated by the SEC rules because they did not involve “GIR [Global Investment Research Division] equity research analysts.” The SEC have strict guidelines that, “prohibits an analyst from issuing reports on securities that run contrary to the analyst’s true beliefs about the securities.” (Craig) Goldman did not break any statutory laws with the Fundamental Strategies Group since they were not covered in the SEC ruling. From the uprising, Goldman’s executives sent an email to all their clients, explaining their “Trading Ideas” and advice. The email was meant to elucidate the firm and public’s “conflict of interest” policy. In the message, Goldman stated, “You should not consider Trading Ideas as objective or independent research or as investment advice.

When we discuss Trading Ideas with you, we will not be acting as your advisor (including, without limitation, in relation to investment, accounting, tax or legal matters) and the provision of Trading Ideas to you will not give rise to any fiduciary or equitable duties on our part” (Sorkin 1). In the case of Goldman vs. Common Wealth of Massachusetts, the court ruled, “Goldman failed to reasonably supervise GIR equity analysts’ communications to prevent and detect dissemination by GIR equity analysts of certain unpublished short term trading ideas” (SEC) and were held accountable to Section 204 (a)(2)(J) of the Act, which in part states that:

“The secretary may by order…. deny, suspend, or revoke, any registration … if he finds (1) that the order is the public interest and (2) that the applicant or registrant (J) has failed reasonably to supervise agents, investment adviser representatives or other employees to assure compliance with this chapter” (SEC).

Goldman failed to supervise its agents to guarantee compliance with the act. The court ruled that Goldman must have a policy that allows a GIR equity research analyst to identify an unpublished report and follow its publication through more than 14 persons. Furthermore, Goldman will be required to disclose in their Terms of Use Agreement that the amount of GIR equity research report varies from client to client (Stempel). “Goldman agreed to pay a fine of $10 million and stop giving favored clients trading ideas developed at internal gatherings known as “trading huddles”” (Stempel). In addition, they were charged with not dealing in with honesty with all clients and took advantage over others, known as fair dealing with clients.

While all companies try to balance on the line of pursuing profits and maintaining a moral conduct, Goldman Sachs was unable to keep their balance. After the reports of intentionally avoiding regulation from SEC Regulation AC, requiring equity research analysts to certify that their issued reports represents their actual views (SEC), the company crossed ethical boundaries. With their Fundamental Strategies Group, Goldman as a whole company condoned unethical action. Instead of following the regulation of the SEC they went around it. Some of the ethical issues present in the case were:

* Taking unfair advantage – one part of the firm issued equity research reports to the public and another part of the firm did also engage in equity research but came to a different conclusion. However, the latter report was only issued to certain clients. By releasing one view on a subject and taking another position themselves, thereby taking unfair advantage. * Violating rules – even though their Fundamental Strategies Group were not violating any laws or regulation, they failed to follow the SEC Regulation AC

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Recommendation and Conclusion

The cases mentioned above are only a few of the instances where Goldman has been scrutinized by government entities and the public. Its continuous practice of “toes to the line” on legal issues has many times resulted in lawsuits against the firm. As we can see, the legal issues they are pushing are unethical, however, they are not violating those laws. Instead, they are charged with other violations that result from operating at the line of illegal practices. Their reputation took a hit due to multiple SEC allegations and fines. To avoid these ethical situations Goldman Sachs should use the ethical principles that are taught. For example, they should have used Warren Buffet’s front page of the newspaper test in the case with the IPOs. Goldman Sachs should ask itself if they would be indifferent of their actions if the public would know that they intentionally manufactured demand for their IPOs. A partial reason for their unethical conduct was due to rationalizing; when they were confronted about their actions they proceeded by rationalizing and labeling their actions in order to avoid the ethical dilemmas.

In the ABACUS case, Goldman stated that their clients are “qualified” and “sophisticated” enough to make market risk decisions. They most likely rationalized their actions by saying that the system is unfair and “if we don’t do it, someone else will”. In their case with trading huddles, it was a practice carried out by other firms, however, not to the same degree as Goldman. They waited until the lawyers told them it was wrong and rationalized by thinking “It’s a gray area”. Goldman Sachs’s pushed the limit of both the letter of the law, and the spirit of the law when dealing with its clients. Goldman’s history of brushing past ethical decisions have created many problems for the firm in the past years. It is clear that pursuing this strategy has not been to their benefit. A business should not have to argue how its actions add social value; it should be clear by the actions themselves.

Therefore, if a business finds itself engaging in activities that do not pass Warrant Buffet’s Front of the Newspaper test it should reconsider its actions and business model. A red flag should rise when employees convince themselves that they are adding social value, as in the case with Tourre, or if employees feel any discomfort with their actions. If a company finds itself condoning unethical actions and violating the law, the best solution is to make an action plan on how to present their violations to the regulating government entity most truthfully and inform their clients of the unethical conduct with an apology. Despite that these measures might have a negative impact on the firm, it is highly likely be a short-term effect. The longstanding trust built up from their honesty and confrontation of the unethical actions could be beneficial to the firm’s future reputation.

Work Cited

Craig, Susanne. “Goldman’s Trading Tips Reward Its Biggest Clients.” The Wall

Street Journal. 24 Aug. 2009. Web. 23 Mar. 2012. . “Goldman Sachs & Co.: Lit. Rel. No. 19051 / JANUARY 25, 2005.” U.S. Securities and Exchange Commission (Home Page). Web. 28 Mar. 2012. . Quinn, James. “Goldman Sachs, Fabrice Tourre and the Complex Abacus of Toxic Mortgages.” The Telegraph. Telegraph Media Group, 16 Apr. 2010. Web. 25 Mar. 2012. . “Rule 10b-5 — Employment of Manipulative and Deceptive Devices.” Law School » University of Cincinnati College of Law. Web. 28 Mar. 2012. . “SEC Charges Goldman Sachs With Fraud in Structuring and Marketing of CDO Tied to Subprime Mortgages.” ; 2010-59; April 16, 2010. Web. 28 Mar. 2012. . Sorkin, Andrew. “DealBook.” Mergers, Acquisitions, Venture Capital, Hedge Funds. 12 Jan. 2010. Web. 28 Mar. 2012. . “Statement by SEC Chairman: Proposal of Regulation AC.” Statement by SEC Chairman: Proposal of Regulation AC (Harvey L. Pitt). Web. 28 Mar. 2012. . Stempel, Jonathan. “Goldman Fined $10 Million, Agrees to Stop Trading Huddles.” Reuters. Thomson Reuters, 09 June 2011. Web. 28 Mar. 2012. .

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