The Generals Who Ended Goldman Sachs' War

Last Wednesday at around 3 p.m., the Securities and Exchange Commission and Goldman Sachs settled an epic, seismic battle — one waged over whether the storied investment bank defrauded investors in a transaction that regulators said Goldman had built to self-destruct.

Getty Images Demonstrators from Code Pink for Peace hold photographs of Lloyd Blankfein, chairman and CEO of The Goldman Sachs Group, and demand he be jailed with other executives before a hearing of the Senate Homeland Security and Governmental Affairs Investigations Subcommittee on Capitol Hill.

The final terms of the settlement were hashed out over the telephone. On one end, Gregory K. Palm, Goldman’s general counsel, agreed to the exact language his bank would use in statements about the settlement. As one of the longest-serving executives of the bank and a Goldman shareholder, Mr. Palm also had his own reputation and his personal fortune on the line.

On the other end, the S.E.C.’s director of enforcement, Robert Khuzami, was joined by his old friend and deputy, Lorin Reisner. Mr. Khuzami, a former in-house counsel at Deutsche Bank, was well-versed in the inner workings of Wall Street deal-making.

In the end, Goldman

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[GS  Loading...      ()   ] decided to steer clear of a protracted and damaging trial by paying a $550 million penalty, which the S.E.C. went out of its way to describe as the largest ever against a Wall Street firm. Goldman acknowledged that its marketing materials for the deal in question, known as Abacus, were lacking, and it agreed to greater disclosure around such transactions in the future — a concession that affects the entire financial community and could eat into some of the lush profits firms earn on complex deals engineered in the shadows.

For all of the lawyers on the phone, a court trial would have been a career-capping event. The case centered on Abacus, a mortgage deal that Goldman created in part to allow a prominent hedge fund manager, John Paulson, to bet against the housing market — something that might not pass muster with the average juror.

But, in many ways, in the years leading up to the settlement, Goldman had already been on trial. Ever since the financial crisis reached its most perilous chapter in the fall of 2008, ushering in a series of huge federal bailouts of Wall Street, Goldman’s swagger had been tested and its reputation with clients, investors, some of its own alumni and the public had been soiled.

And after the S.E.C. filed its fraud case on April 16, Goldman was forced into the court of public opinion time and again as Congressional leaders and examiners grilled its chief executive, Lloyd C. Blankfein, and its other leaders about how the firm treated its clients and how it conducted business.

The bank’s response to its critics and its legal strategy consisted largely of testy defiance and stubborn belligerence. Like a trader in a heated valuation dispute, Goldman’s legal team argued nearly to the end that it was completely in the right. It was a strategy that led other lawyers across the industry to snicker; they thought that Goldman was courting disaster by trying to win a battle of wills in today’s anti-bank environment.

But Goldman managed to give up less than some people thought it might have to; the penalty was relatively manageable for a firm that gushes money, and when the deal was announced on Thursday, the bank didn’t admit to engaging in fraud.

“After a long history of losing, this is a major victory for the S.E.C. and the enforcement division,” says Barry Ritholtz, who, as the head of Fusion IQ, a financial research firm, also oversees a closely followed financial blog, The Big Picture. “In general, it’s better for the investing public when the cop is on the beat and actually paying attention.”

For Goldman, says Mr. Ritholtz, the case has been an embarrassment and a setback.

“Look, they were the firm on Wall Street that avoided the subprime collapse, and they could have come out of this with their reputation enhanced,” he says. “Instead they came out with: ‘O.K., let’s get this right: You played fast and loose with the rules and dumped stuff on your clients and created products in order to get short? I mean, it’s harder to get sleazier than that outside a boiler room. But we don’t yet know if that has caused lasting damage to Goldman’s reputation.”

Goldman declined to comment about the settlement beyond its statement on Thursday, in which it said: “We believe that this settlement is the right outcome for our firm, our shareholders and our clients.”

Mr. Khuzami took to the cameras when the S.E.C. sued Goldman, and early on he became the face most associated with the case. A graduate of the University of Rochester and the Boston University School of Law, he joined the United States Attorney’s Office in Manhattan in 1990.

Another lawyer — Lorin Reisner — joined the same office that year, and the two became pals. For months, they had to share a computer while they waited for their office to order more.

But Mr. Khuzami stayed much longer than Mr. Reisner — 11 years — and he rose through the ranks to eventually run a securities and commodities fraud unit for the office. He also prosecuted those responsible for the 1993 World Trade Center bombing. He left the prosecutor’s office in 2002 to join Deutsche and was tapped last year by the S.E.C.’s chairwoman, Mary Schapiro, to be the agency’s enforcement chief.

Mr. Khuzami joined the S.E.C. when its own reputation was in tatters. Analysts and legislators had castigated the agency as doing little to curb Wall Street’s excesses and to monitor questionable activities in the years before the financial crisis.

Well aware of all this, Mr. Khuzami came into the agency with priorities that included streamlining staffing and practices in enforcement, as well as formalizing procedures to encourage witnesses to come forward.

Because Deutsche had issued securities similar to those in the Goldman case, Mr. Khuzami had to recuse himself from a portion of the S.E.C.’s mortgage investigation involving Deutsche. And he called on Mr. Reisner to add muscle to many of the S.E.C. cases, especially the one involving Goldman.

Some people close to Mr. Khuzami and Mr. Reisner joke that they are like Tweedledee and Tweedledum. When Mr. Khuzami travels, Mr. Reisner runs many of the enforcement unit’s daily operations.