If someone wants to make an investment, such as in stocks, bonds, or a certificate of deposit, should she not do so because the seller wants to sell and therefore buying the investment is too risky?
If you think these are ludicrous perspectives on commonplace transactions, you are right.
But fundamentally, that is the essence of the SEC's allegations against Goldman Sachs it in the Abacus transaction involving subprime mortgages.
The Abacus deal required some parties to be "long" the deal (meaning they think the investment will increase in value) and others to be "short" the deal (meaning they think the investment will decrease in value). The SEC alleges that Goldman Sachs didn't disclose material information by not disclosing the name of the investor who was "short" the deal.
The "long" investors specialized in mortgage investments, managing billions of dollars, and as Warren Buffet said about the incident, knowing who the "short" is in the deal is irrelevant to making a proper investment decision.
Putting it another way, if you buy (taking the "long" position) a stock through your broker, you never know who the seller (analogous to taking the "short" position) is. Does that mean you shouldn't buy the stock until you know the name of the seller? Why would that matter? Clearly, the SEC doesn't think that is important since billions of shares a day are traded in the United States without the buyer knowing the identity of the seller.
This reflects a fundamental fact about economic transactions: the buyer and seller have different views on the items being bought/sold, and transact with one another to allow each to have their own view realized. Differences of opinions are fundamental to many economic transactions, particularly financial ones.
Even Bill Clinton concluded that Goldman Sachs broke no laws in the Abacus deal.
Moreover, it is worth noting how unusual the SEC's process was in deciding to bring the case. Goldman Sachs last spoke to the SEC in September 2009, and next heard from the SEC in April 2010 when the lawsuit was announced. Normally, the SEC notifies a party of its intent to sue them and then tries to negotiate a settlement before publicly disclosing the case.
Adding to the unusual nature of the case, the SEC's commissioner voted 3-2 to commence the lawsuit, with the three Democratic commissioners voting in favor of the suit and the two Republican commissioner opposing it. Again, such a partisan split isn't the norm for such prominent SEC suits.
If the SEC lawsuit against Goldman is so baseless, and was pursued in such an unusual manner, what might have motivated the agency to bring the case as it did?
First, one of the relatively unreported aspects of the matter - and a scandal of first order in its own right - is that on the same day the SEC announced its suit against Goldman, the SEC posted to its website, buried in a hard-to-reach link, an investigative report in its handling of the Bernie Madoff ponzi scheme.
The report revealed that the SEC's investigative arm had recommended that its enforcement arm pursue Madoff for orchestrating a ponzi scheme, but the enforcement division declined to do so because it preferred easier to win cases against more prominent firms. Literally, the SEC's shocking negligence cots investors many billions of dollars in a real, unambiguous fraud.
But that story got lost due to the sensational charges against Goldman Sachs. So the case against Goldman allowed attention to be deflected from the SEC's failure.
In addition, the partisan nature of the commissioners' vote highlights that the suit against Goldman serves a useful purpose for Democrats seeking to pass their financial services regulatory bill.
The SEC's gambit worked. It hid the Madoff report and whipped up the frenzy against Wall Street to help secure Senate approval of the new regulatory bill.
Only a small thing like justice got trampled in the process.
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