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Challenges to Goldman are Still Kept to a Whisper

Gillian Tett, Financial Times
Friday, 23 Apr 2010 | 3:07 AM ET

Deep inside some law firms and consultancy groups in London and New York, some highly sensitive private conversations are under way. The issue at stake is Goldman Sachs. More accurately, whether it makes commercial sense for lawyers and consultants to offer their services to Goldman in the months ahead.

Goldman Sachs
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Goldman Sachs

After all, in the week since the Securities and Exchange Commission launched its broadside against Goldman , a host of juicy details about the bank’s dealings in the collateralized debt obligation world have tumbled out.

Thus far – as my colleague John Gapper pointed out earlier this week – it remains unclear whether all these colorful titbits will ever produce a tangible, successful prosecution in court. The strength of the case against Goldman is uncertain.

But while the legal questions – and political issues – swirl, what is crystal clear is that the SEC action is encouraging other parties to contemplate law suits. Groups such AIG and IKB, for example, are debating this. Others will undoubtedly follow suit.

Thus the fascinating question which confronts some lawyers – or any consultant that might conceivably act as an expert witness in any trial – is what to do next? Should they dance with one of the companies that might be pitted against Goldman, and thus risk incurring the wrath of the so-called Giant Vampire Squid? Or should they presume that Goldman will continue to dominate any future financial world – irrespective of what that might look like – and thus try to avoid alienating the group?

In truth, most law firms and consultancies will probably not decide for many months, and there will probably be a great sense of inertia, as far as most of the big, conservative groups are concerned.

But the fact that this debate is even taking place is fascinating for two reasons. First, and most obviously, it could affect the future of Goldman Sachs. In the past decade, the bank has enjoyed an extraordinary aura on Wall Street and in the City of London, partly because rivals envied its success. “Goldman envy”, after all, was one reason why the top managers of companies such as Merrill Lynch and UBS decided to expand their credit businesses at a crazy pace.

But Goldman’s power has also rested on the same type of nervous fear seen in any high school playground. Irrespective of what Goldman’s clients and service providers have really thought about the bank, most have been reluctant to antagonize the bank, since they feared that Goldman was so powerful that any critic would face some backlash. Hence the fact that so few law firms, consultants – or even bankers – have ever testified in public against the firm, on CDOs or anything else.

The second reason why all this matters is that Goldman’s position is merely a very extreme form of a much wider structural pattern – and problem – that shapes the financial world. Between 2004 and 2007, the world of CDOs and credit derivatives exploded at a stunning pace, creating fat profits for some banks.

But since the product was so new, the pool of accountants, lawyers and bankers who truly understood how it all worked was always extremely small (and by 2005 most were frenetically overworked).

One consequence is that it has been hard for investors to find financiers who could offer independent advice on products since they were usually working for the banks. It has also been hard for investors to find good lawyers if they wanted to sue a large investment bank over, say, a CDO.

To be sure, there are specialist litigation boutiques that focus on launching such suits in the US. However, most of them are not experts in CDOs, and they do not exist in large numbers in Europe. When investors have tried to contact top law firms in London, to launch litigation, the lawyers have often refused to act due to “conflicts” (that is, they were already working for the banks.) It is little wonder, then, that there have been so few successful lawsuits. The near-stranglehold of banks over the legal world has been impressive.

It is unclear whether this will change now. As I said, law firms and investment management groups tend to be a conservative bunch and Goldman’s ability to inspire envy and fear remains formidable.

But as anyone who has ever experienced high school politics knows, sometimes the most important signals about power can be the most subtle ones. Investors would be wise to keep watching to see if those threatened lawsuits actually materialize in the coming weeks and, if they do, to see just how many top lawyers or bankers are ready to do something that few have tried before – wrestle with the mighty Goldman in a public arena.

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