Do Tepid Rules Invite Banks to Push Envelope?


The Goldman Sachs securities-fraud case has triggered a debate about ethics in the financial industry, with some members saying there should be clearer rules to prevent ethical breaches.

Goldman Sachs
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The Securities and Exchange Commission filed a civil suit against Goldman last week, accusing the investment bank of deceiving investors with a collateralized debt obligation (CDO) instrument put together for an investor who profited from the drop in price of the securities. Goldman has denied the accusations.

The Financial Services Authority—Britain's equivalent of the SEC—announced its own enforcement investigation Tuesday.

A London-based Goldman Sachs private client manager told that only clearer regulation can curb fraudulent practices in the banking sector.

“I think people (at Goldman) know the difference between right and wrong,” said the wealth manager, who asked not to be identified because they weren't authorized to speak about the case. “That’s a big flaw in the system. You need regulation to provide ‘yes’ or ‘no’ answers to that. And until regulators do this, banks won’t stop.”

In summer 2009, the FSA drafted an eight-point "code of ethics," setting out the ethical behavior consumers can expect of investment advisers, including "act honestly and fairly at all times when dealing with clients, to act with integrity, etc." But that has not yet been incorporated into the FSA Handbook.

“If you look at the FSA Handbook, it’s very ‘loose,’” the Goldman manager said. “There (are) no firm rules.This is something they need to do something about.”

Most of the largest investment banks on Wall Street adhere to some kind of internal code of ethics or conduct, outlining business standards that all employees should adhere to. The Chartered Financial Advisor (CFA) designation holds its Code of Conduct as the global, non-profit organization's cornerstone.

Goldman CEO Lloyd Blankfein said in a message to employees this week that “Goldman Sachs has never condoned and would never condone inappropriate activity by any of our people...On the contrary, we would be the first to condemn it and take immediate and appropriate action.”

Goldman’s reputation will be “hit hard,” the London-based Goldman employee said. But the business impact looks minimal at the moment, he added.

“I think (Goldman’s) biggest challenge is ethical,” said Matthew Albrecht, investment banking and brokerages analyst at Standard and Poor’s. “The challenge for Goldman will be—whether or not they’re ultimately convicted of fraud by the SEC—to convince clients that they’re an ethical company. This kind of regulatory accusation flies in the face of the idea that they put clients first all the time."

“Goldman’s claim is that they’re dealing with sophisticated investors,” Albrecht added. “If you can’t find a law that says they have to disclose something, then it’s hard to charge them with fraud.”

Cornelius Hurley, professor and director of the graduate program in banking and financial law at Boston University School of Law, believes Goldman did breach ethics in the SEC case.

“Moreover, it's curious that the SEC charged Goldman but not (John Paulson),” the hedge fund manager the SEC says picked the securities to be used in Goldman’s product, Hurley said.

“To me, from an ethical standpoint, Paulson is just as culpable as Goldman...What is doubly troubling is that the SEC said this is a ‘disclosure issue,’ as though disclosure would have cured this conflict of interest,” he added.

gavel and money

“My analogy is, if you’re driving down highway, then you turn your blinker on to warn the other cars you’re going to spin a u-turn… this still doesn’t give you right to drive recklessly. I’d like to see ethical standards built into the Senate’s regulatory reform bill.”

Over the past two decades, Western governments have deregulated the financial sector.

In 1999, the Gramm-Leach-Bliley Act removed barriers to competition between traditional banks, investment banks, and insurance companies. Then in 2000, the Commodities Futures Modernization Act exempted swaps and derivatives from regulation by both the Commodities Futures Trading Commission and the SEC.

On top of the SEC’s probe and the FSA investigation, Goldman now faces regulatory scrutiny from more European and Asian financial regulators. And the EU is already investigating Goldman over swaps it arranged for Greece in 2002.

President Obama went to New York this week to push financial reform legislation, which Congress is still hashing out.

In his speech, Obama said a “free market was never meant to be a free license to take whatever you can get, however you can get it. That is what happened too often in the years leading up to the crisis."

But some critics believe there are no ethical standards built into the reform bill. And they wonder if regulators have the power to enforce ethical codes anyway.

“Banks are too powerful—more powerful than the government," the Goldman employee said. "The banks are in total control.”