The SEC accused Goldman with violating Section 10(b) of the Exchange Act and Section 17(a) of the Securities Act. Both are anti-fraud provisions. Like most anti-fraud statutes, Section 10(b) requires the government to prove a fraudulent intent. The first subsection of Section 17(a) also requires proof of fraudulent intent. But the second and third subsections of 17(a) do not require any proof of intent to defraud. This makes accusations based on the second and third subsections much easier to prove—and perhaps easier for Goldman to stomach.
In fact, subsection 17(a)(2) does not even employ any form of the word “fraud” or “deceit.” It makes the sale of a security or a derivative unlawful if a material omission renders the sale merely “misleading.”
The SEC’s claim against Goldman based on this subsection is its strongest and easiest to prove.
Goldman might accept a settlement if the civil charges requiring fraudulent intent or claiming a scheme that operated as fraud were dropped, a source said. That would leave open the charge of merely negligently “misleading” the investors in the Abacus deal. A source close to the matter indicated that this would be far more palatable to the company since it does not explicitly implicate Goldman in fraud.
The SEC has recently shown a willingness to cut this kind of deal. In February, the SEC settled a backdating case against Michael Byrd, the former CFO and later COO of Brocade Communications Systems, Inc.
Initially, the SEC had charged Byrd with violating both Section 10(b) and Section 17(a). In the settlement, the Section 10(b) charges were dropped, as was any charge based on the first part of Section 17(a).
The only surviving allegations--including a number of charges not involved in the Goldman case--were those that do not require proof of fraudulent intent. An earlier Brocade backdating settlement followed a similar pattern.
When it comes to the Goldman case, however, the SEC is playing its cards very close to its vest. It surprised Goldman by filing the lawsuit without pursuing further settlement negotiations. And virtually nothing about the settlement terms it is seeking have leaked out to the media.
Importantly for Goldman, most federal courts hold that Section 17(a) does not give rise to private actions. This means that Goldman would not be making itself more vulnerable to class-action lawsuits from outside investors even if it actually admitted to the charge of misleading omissions in the Abacus deal. Only the SEC is empowered to bring suit under Section 17(a).
The extent of Goldman’s monetary liability will not necessarily be affected by the exact charge it settles. So Goldman could still wind up paying a huge fine—some have estimated the fine could amount to $1 billion, the highest ever paid by a single firm. But if Goldman could avoid copping a plea to fraud, while perhaps limiting its vulnerability to class action investor lawsuits, it would likely agree to a deal.
Goldman does not seem confident that a deal will definitely be reached. As CNBC.com reported last week, sources say Goldman is still preparing a full-fledged defense even as talks with the SEC continue. The firm has been posturing behind the scenes, indicating that it believes it could uncover weaknesses in the government’s case during the pre-trial discovery phase. But it would prefer a settlement that dropped the fraud charges under the terms outlined above, sources say.
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