This month’s announcement of the Securities and Exchange Commission’s securities-fraud civil suit against Goldman Sachs is a perfect example of what ails our society today - and why attempted regulatory fixes are in many ways analogous to rearranging the deck chairs on the Titanic.
The pertinent facts are largely uncontested. Goldman Sachs helped its client, the Paulson & Co. hedge fund, create and sell mortgage-based collateralized debt obligations (CDOs) that were designed to fail. This was done for the purpose of giving Paulson & Co. something perfect to bet against (via the purchase of credit default swaps). Being the full-service firm that it is, Goldman then helped sell these designed-to-fail CDOs to its own clients. Goldman collected millions of dollars in fees along the way by helping create the CDOs, helping sell the CDOs and even providing the necessary credit default swaps to Paulson & Co. As the housing market collapsed, the CDOs declined in value. Goldman’s clients who bought into the CDOs lost approximately $1 billion in total. Conversely, Paulson & Co. pocketed approximately $1 billion in total from the swaps it held.
Has Goldman committed securities fraud? Perhaps surprisingly, it’s not altogether clear. Securities law experts are split on the question. Goldman hasn’t been accused of lying to anyone. Instead, the Securities and Exchange Commission is arguing that Goldman violated the law by omitting a material piece of information in its marketing of these securities: namely, that they were designed by another Goldman client (Paulson & Co.) for the specific purpose of losing value. Goldman counters by noting that it disclosed all of the securities’ fundamentals and that the investors purchasing these securities were just as capable of assessing their value and projected trajectory as was Paulson & Co.
Goldman’s argument, under existing U.S. securities regulation, is not a frivolous one. But although Goldman’s behavior might be permissible under U.S. securities law, it most certainly is impermissible under traditional notions of right and wrong. All the disclosure in the world does not absolve someone of the basic moral precept to do unto others as you would have others do unto you. It’s simply morally wrong to sell someone - especially one’s own clients - junk specifically designed to fail, regardless of how many warning labels are attached. A degree in moral philosophy is not needed to see that.
Today, however, a degree in modern moral philosophy might actually get in the way of seeing that. For we live in an age marked by an unprecedented lack of consensus over what “morally wrong” means. Indeed, one of the few vices recognized nowadays is that of being “judgmental,” and perhaps it was this vice that Goldman sought to avoid when it refused to characterize Paulson & Co.’s plans as morally wrongful. Instead, Goldman probably rationalized the proposed course of conduct as a legitimate business strategy within the confines of the law.
Until we regain the ability and courage to make and act upon these basic distinctions between right and wrong rather than merely between “lawful” and “unlawful, we will remain woefully vulnerable to fraud such as this. For all the regulatory reform in the world is no substitute for morality and right reason.
Ronald J. Colombo is an associate professor of corporate and securities law at Hofstra University’s law school.