SEC Charges Goldman Sachs with fraud

The SEC's fraud prosecution of Goldman Sachs will yield  a tsunami of coverage.   The complaint demands a trial by jury.  It therefore calls upon  the public - in federal court in Manhattan - to judge the conduct of one of the icons of the financial world - and thus all of what we still call Wall Street.


It illustrates the gap between the ethics of Wall Street and that of the legal profession.  The ABA Rules of Professional Conduct - the model for virtually every state - provide in R. 1.7 that "a lawyer shall not represent a client if the representation involves a concurrent conflict of interest. A concurrent conflict of interest exists if: 
(1) the representation of one client will be directly adverse to another client; or (2) there is a significant risk that the representation of one or more clients will be materially limited by the lawyer's responsibilities to another client, a former client or a third person or by a personal interest of the lawyer."

Further, according to R. 1.10 if one member of a firm has a conflict of interest the entire law firm is disqualified.  That is a law firm cannot be on both sides of a controversy.  But as the NY Times graphic above shows Goldman Sachs bet heavily on both sides of the table - extracting fees from those on both sides of the bet.  Hedging your bets this is called.  Their defense so far centers on  knowledgeable risk-taking by their sophisticated clients, and the claim that Goldman itself bet long and lost.  See Goldman's statement HERE.


For the record - the complaint is HERE.  The SEC's first litigation press release is HERE.  The Times page on the SEC Complaint is HERE.  Times guest commentators on `What the Goldman Complaint Reveals' is HERE.

Securities Reform: Dodd Measure Would Restore Aiding & Abetting Liability

Last September Sen. Arlen Specter introduced S. 1551 which would overturn the Supreme Court's Stone Ridge Investments decision which barred "aiding and abetting" liability in securities fraud cases, as we reported here. Specter held hearings but as a free-standing measure it had little chance of passage.

K. Stewart Evans of Pepper Hamilton reports that [retiring] Sen. Christopher J. Dodd (D-Conn.)’s draft Restoring American Financial Stability Act of 2009 contains a provision (page 795 of 1,136) that amends Section 21D of the Securities Exchange Act of 1934 (15 U.S.C. 78u-4) to overruleStoneridge. It provides:

(g) PRIVATE CIVIL ACTIONS.—For purposes of any private civil action implied under this title, any person that knowingly or recklessly provides substantial assistance to another person in violation of this title, or of any rule or regulation issued under this title, shall be deemed to be in violation of this title to the same extent as the person to whom such assistance is provided.

Evans laments that

the proposed amendment 15 U.S.C. 78u-4 would allow plaintiffs to pursue secondary actors such as accountants, underwriters, lawyers, customers, and suppliers without having to prove they relied upon their statements or representations when purchasing or selling securities.

In an action under Sec. 10(b)(5) of the Securities and Exchange Commission Act a plaintiff must prove (1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation.See Dura Pharms., Inc. v. Broudo, 544 U.S. 336 (2005)."

Evans's alarm is overstated because the reliance element was eased by the Supreme Court in Basic v. Levinson, 485 U.S. 224 (1988). the Court said

“Requiring a plaintiff to show a speculative state of facts, i.e., how he would have acted if material information had been disclosed, or if the misrepresentation had not been made, would place an unnecessarily unrealistic evidentiary burden on the Rule 10b-5 plaintiff who has traded on an impersonal market.”

Thanks to Kevin LaCroix, D & O Diary for the update. Kevin's latest is always available on my blogroll on the right.