On Goldman and disclosure…
One of the big issues that has popped up since Friday’s surprising announcement by the Securities and Exchange Commission that it was charging Goldman Sachs with fraud is whether Goldman should have been more forthcoming in their routine SEC filings that an investigation was pending.
On Saturday, Bloomberg reported that the investigation began 9 months ago. In today’s Heard on the Street column, the WSJ also dates the Wells Notice to July 2009. Reuters reported that the SEC had issued a Wells Notice six months ago. But whatever the correct date is, one thing is very clear: there was no mention of this in any of Goldman’s filings.
Since we tend to spend a lot of time here at footnoted taking deep dives into the filings and routinely report on regulatory actions like Wells Notices, we decided to put this issue under the proverbial microscope. As with a lot of things in SEC filings, it all boils down to an issue of materiality: was the existence of the Wells Notice material enough to Goldman that it required disclosure? The rules on materiality are pretty vague and it’s now clear that Goldman’s attorneys came to the conclusion that the Wells Notice was not material, even if the market seems to disagree.
Given Goldman’s size and the amount listed in the complaint, reasonable people can certainly argue that the Wells Notice was not material, even if other companies routinely file 8Ks for far less serious interactions with the SEC, like responding to a comment letter or an informal investigation.
At a breakfast this morning at the National Press Club that Theo attended, David Z. Seide, a partner with Curtis, Mallet-Prevost, Colt & Mosle in Washington and former Assistant US Attorney in Los Angeles said, ”This is a bet-the-franchise kind of thing, it’s their whole business model.” And that’s the job of a disclosure attorney, “you have to look into the future and figure it out,” he added. George B. Curtis, a partner at Gibson Dunn & Crutcher in Washington, DC., a former Regional and Deputy Director of the SEC’s Division of Enforcement between 2006-2009, noted that “There’s no bright line.”
If Goldman’s argument was that the Wells Notice was not material, they may see some challenges from other very large companies that have disclosed Wells Notices in the past. A quick skim of Morningstar Document Research of companies over $50 billion in market cap that have disclosed the existence of Wells Notices in the past turns up General Electric (GE), Bank of America (BAC), UBS (UBS) and units of both Berkshire Hathaway (BRK.A) and of JP Morgan Chase (JPM).
If disclosing a Wells Notice was material enough for these companies, why was it not material enough for Goldman?
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April 19th, 2010 at 11:22 am
While the idea of receiving a Wells Notice strikes fear in the hearts of GCs everywhere, Wells Notices are not per se material. It may depend on what Goldman believed the likelihood that charges would have been brought at the time the Wells Notice was received; how close they may have been to potentially settling the matter; that the charges would be civil and not criminal; how many other Wells Notices they had received in the past, whether they disclosed any of those and whether any of those turned into charges; how big the potential exposure was from the potential civil charges; etc. Also, if they did feel the receipt of a Wells Notice was material, it’s more likely that they would have disclosed it in the Legal Proceedings section of a 10-Q or 10-K filing, and not an 8-K. Not a huge difference for the public (except for timing), but securities lawyers care about this kind of stuff.
April 19th, 2010 at 12:50 pm
Footnotes are like computer data. GIGO. If GS didn’t disclose, you must acquit.
There was no glove found so no wrong was seen. Buried in the trade flow.
Where was “nonprofit newsroom ProPublica” during all this? No free financial reporter-analyst willing or able to dig into this and/or Madoff types? PP gets $10M year to dig into other scandals in the making. Guess social wrongs take priority over $.
http://www.washingtonpost.com/wp-dyn/content/article/2010/04/19/AR2010041901127.html
See also NY Post’s take about needed >10% of firm’s asset rule:
Goldman had already been slapped with an SEC subpoena as far back as August 2008, an indication the bank was under formal investigation, according to The Wall Street Journal.
ME WORRY? CEO Lloyd Blankfein reassured investors and said the allegations aren’t “based in fact.”
But Goldman apparently was under no legal responsibility to spill the beans on either action, even though that would have given investors an early warning that its stock might tank.
SEC regulations say information about legal proceedings doesn’t have to be made public if the amount involved doesn’t exceed 10 percent of a firm’s assets.
Goldman’s assets are an estimated at $849 billion.
“It’s a horrendous rule . . . a joke,” a former SEC official told The Post.
Charles Elson of the University of Delaware, said, “In an age of heightened transparency . . . receipt of that notice should have been disclosed.”
But Goldman is just fine with the rule.
“The receipt of Wells notice could have led to any number of outcomes or nothing at all,” spokesman Samuel Robinson said.
http://www.nypost.com/p/news/national/goldman_bosses_hid_feds_probe_9GsXz0QxmqRMCDRgB8kL7M#ixzz0lYaIzhcd
April 19th, 2010 at 1:48 pm
The movement in the stock price implies that the market thought it was material. To the extent it can affect future business operations, it may be material. I’ve even seen companies that get these notices because their suppliers are being investigated disclose them in the SEC filings. The question of materiality is tricky, but I think that responsible companies should disclose any non-routine governmental investigation, especially one that has to do with securities.
April 19th, 2010 at 9:26 pm
Why should a company have to disclose a frivolous, politically-motivated Wells Notice that was likely to go away?
The heart of your false drama is a synthetic CDO, which is an option. It’s no different than a bet on the Super Bowl placed legitimately through a Vegas Bookie. The outcome of a synthetic CDO “bet,” like a Super Bowl bet, is the personal fortune of people or institution placing the bet, no one else. You can’t trade options on Wall Street without demonstrating you know the basic risks.
The options market – regardless of the regulatory authority, CBOE, CFTC, whatever – is about two sophisticated investors being matched up, without necessarily knowing each other, who want to take opposing sides of a trading idea.
No one who buys an option cares or needs to know who’s writing it. No one writing the option cares who’s buying it. No one has to inquire about the motivation of the other side. It’s definitional. Could you imagine what would happen if every option traded every day required additional disclosure before each specific trade other than the basic nature of game? The market wouldn’t work.
You might learn something important if you took time to explore the reasons why other large-cap companies disclosed Wells Notices while Goldman chose not to. Harry Markopolos could teach you a thing or two about drawing inferences from a database with an incomplete dataset. Common sense is king.
In this case, politics trumped common sense to destroy shareholder value.
April 19th, 2010 at 9:39 pm
@Matt: Not quite following your politics argument here or why you find the need to throw Harry Markopolos into the mix. I prefer to focus on things I actually know something about, which is SEC filings. Here at footnoted, we read hundreds of them a day so we feel pretty confident when we say it’s uncommon not to disclose a Wells Notice, no matter what the rules say. But feel free to educate me — and the rest of footnoted’s readers — on why companies like GE, Bank of America, JPMorgan, and Berkshire have all disclosed Wells Notices in the past. I’m all ears.
April 19th, 2010 at 11:23 pm
@Michele: Certainly you can’t be blind to the political angle of this story. Main Street is livid at the Wall Street bailout and the public hasn’t enjoyed a perp walk comparable to Milken’s in decades. No politically-starved AG or AUSA has yet found a way to (1) find the sacrificial lamb that will advance him/herself and at the same time (2) provide political cover for the regulatory agencies, the Senate Banking Committee and other pols whose blindness to reality created this mess, and (3) deliver the storybook dénouement that has followed every financial crisis since we were born (Think “Do You Sincerely Want to Be Rich,” “The Greatest Train Robbery Ever” (S&L crisis) to name but two).
At this point, this case sounds like a politically-motivated regulator is attacking the lowest hanging fruit with a fly-swatter. Which firm is the most obvious target and most hated for its apparent invincibility? Henry Paulson said at one point that AIG’s failure posed no risk to GS. So then why did the government guarantee all their billion dollar bets with AIG? Sound public policy? The future of the financial system? Paulson said GS didn’t need the money, so then what was the reason GS’s bets were honored? I can think of many that strain credulity. Certainly you’ve surveyed the animosity toward GS on the ‘net, the bailout as corporate socialism, professed champions of the free markets turning to taxpayers to preserve their gilded lives.
There’s an old saying to the effect, if you’re going to kill the king, you’d better succeed. Why go after GS for the financial equivalent of not telling the guy betting on the Colts that someone else was betting on the Saints in the last Super Bowl?
This reminds me of the Feds going after Al Capone for tax evasion. They couldn’t get him on anything else? With all the evidence gathering power of the federal government, they best they can come up with on GS is a dubious CIVIL fraud, not even criminal? Who was hurt in this alleged fraud? No widow or orphan. No grandma. Another sophisticated investor, professional money manager, now complaining because they couldn’t perform the sort of due diligence you do on a daily basis. (Now if you want to argue their ignorance contributed to the financial meltdown, then the issue is the rules that enabled them to do this, and not basic disclosure of what an option is – and derivatives are nothing more than privately-negotiated options among sophisticated investors.)
In the past, the SEC has rarely stepped in to protect sophisticated investors from dealing with their own kind on such a basic issue as understanding the risks involved in making side bets. Are they now going to go after every Vegas bookie who gives his own opinion on whether a quarterback had fully recovered from an injury? Maybe today the SEC is playing the Monday Morning Quarterback to Markopolos, who ranted and raved about Madoff only to be ignored.
I don’t begrudge you shamelessly plugging a Morningstar database. Some of them are very good at specific purposes, for example helping mutual fund investors understand how owning a handful of funds doesn’t make a diversified portfolio if they all invest in the same stocks, asset classes, market sectors, etc.
But as a shareholder in some of the companies you mention, I can tell you some obvious differences.
JPMorgan and BAC were issued Wells Notices after a long investigation into an alleged bid-rigging scheme in the muni-bond market. GE reported a Wells Notice for its accounting treatment of certain derivatives (ever wonder how a company could always consistently beat street estimates?).
Alleged accounting irregularities are always material to disclose, as are disputes involving deception of taxpayers (think Orange County).
But a buyer’s remorse dispute involving GS brokering a deal between two sophisticated investors who by definition had to be aware of the risks? I don’t think so.
April 20th, 2010 at 2:19 am
One of Goldman’s “arguments” in their “defense” regarding the ABACUS disclosures is that their “boilerplate” disclosure is no different than anyone else’s (in their view, a perfectly legal argument). In other words, “everyone else did it this way, so why not us?” That particular argument has drawn a good bit of skepticism and derision (“Just because everyone else did it that way doesn’t mean you should have done it that way.”)
Now, Goldman’s “failure” to disclose the receipt of a Wells Notice (and their explanation thereof — in their view, a perfectly legal argument), while other companies in the past have disclosed the receipt of a Wells Notice, seems to be accompanied by the same skepticism and derision. In other words, “everyone else did it this way, why not you?”
Kind of damned if you do, damned if you don’t, no?
April 20th, 2010 at 5:02 am
I believe this may have been the reason for the “bad press” risk being included in their latest report for the first time. Blankfein’s voicemail on Sunday evening seemed to stress that the main problem with the SEC’s action was the bad press that it would generate.
April 20th, 2010 at 11:08 am
@ Bleached: Thanks for reminding me of that “bad press” disclosure, which I wrote about here last month for DealBook.
April 20th, 2010 at 11:40 am
Regarding Wells Notices that get disclosed and those that don’t, it’s hard to say that “it’s uncommon not to disclose a Wells Notice” when you only hear about the ones that do get disclosed and not about those that never saw the light of day. Many government investigations, subpoenas and the like never go anywhere. The government typically never tells you when the case is “closed.” So, you could get a notice of some kind of investigation out of a U.S. Attorney’s office and never ever hear about it again. If you disclose it, it then gets re-disclosed in your Legal Proceedings section year after year with no expiration date. If the government never tells you that it’s “over” it’s hard to take it out of your disclosure since there’s no reason to think charges could not be filed tomorrow other than the fact that you’ve heard nothing about it since you received the original notice years ago and the personnel at that agency has changed. (And, for obvious reasons, you’re not going to call that U.S. Attorney’s office to ask whether the case is closed so that you can go ahead and take it out of your public filings.) That’s why a large company that receives a lot of these won’t disclose every single one. There’s no benefit to the investor for the Legal Proceedings section to resemble a phone book. If it’s material, it gets disclosed. If it’s not, it doesn’t. And for this particular one, just because the market reacted to the charges last week doesn’t mean that the market would have reacted in the same way to hearing about a Wells Notice six months ago. Receipt of a Wells Notice and receipt of a civil complaint are very different events. It’s easy to look at this with 20:20 hindsight and say that something was a slam dunk because the stock dropped 12%, but those of us who make these kinds of judgment calls on a regular basis know it’s never that simple and there are good reasons why you don’t just disclose everything that comes in the door.
April 20th, 2010 at 2:36 pm
The market reaction was like all market reactions: Sell first, ask questions later. I believe the market reaction to the financial crisis was to dump 5/3rds stock (FITB) some 80+% over the course of several months. On what basis? Fear of the unknown. Since last April, the stock is up some 300%. Rational? No, but that’s the way markets behave.
April 21st, 2010 at 3:30 pm
@Some educated guess: Fair enough point. I was only able to count what has been disclosed as to what hasn’t been disclosed so I have no idea how many other companies with market caps > $50 billion have not disclosed Wells Notices. But my guess is that most companies — or at least their in-house counsel — would probably opt to err on the side of caution here.
April 22nd, 2010 at 11:42 am
What makes tracking Wells Notices so difficult is that the SEC doesn’t publish a list of who receives them, and many are resolved after the SEC declines to prosecute once the statute of limitations expires. Lots of turnover in staff at the SEC, limited resources to prosecute claims, insufficient evidence to prevail at trial. Corporate lawyers take these factors in to consideration when weighing whether or not to disclose. Also keep in mind, if a company were to disclose what it thought was a frivolous Wells notice that was likely to go away, and the result was a hit to the stock, this itself could spawn a shareholder suit. This puts a company between a rock and a hard place. Company lawyers typically know the worst case scenario they are dealing with, and this informs their decision. When we learned today that Pelligrini (of Paulson’s firm) told ACA that Paulson would be taking the side of the other bet, it looks as though Goldman lawyers made the right call.
April 24th, 2010 at 10:02 am
Matt, if the public was “livid” and demanding a “perp walk” and prosecutors/regulators considered Goldman an “obvious target”, doesn’t that make it *more* likely that a Wells Notice could lead to a civil complaint? Which, in turn, makes it *more* material and *more* important to disclose to investors?
I get that you want to whine about how unfair this prosecution is and trot out the familiar ISDA talking points, but you’re making the case for the other side here.