April 17, 2010
The SEC, Disclosure, and the Goldman Complaint
Posted by Mae Kuykendall
The SEC complaint filed against Goldman is a disclosure case.  Yet critics of Goldman and of other investment banks charge these institutions with having played too many roles, creating conflicts of interest, and with having designed terrible products.  How well, then, does the question of role complications and bad products fit with disclosure law? 
The definition of materiality, which is a critical element in the case, is mostly fashioned for public markets.  One of the principles is that investors, or proxy voters, should not have to examine an entire disclosure document to find a fact that, joined with certain other facts, becomes material to a reasonable investor, or shareholder. 
How well does this same principle apply to sophisticated players?  The defense for Goldman is that the buyers could examine a given C.D.O. and make an investment judgment based on its actual composition.  They shouldn't need to know all the influences on selecting the portfolio to decide what risk level they wanted to bear.   The premise has been assessing risk.  If you see really risky assets, you know that the selection of risky assets was a choice.  You also know that some people think they're too risky for the pricing.  You know that some people short them.  Betting is understood.  
The first paragraph of the complaint ends with this sentence:  "Synthetic CDOs like ABACUS 2007-AC1 contributed to the recent financial crisis by magnifying losses associated with the downturn in the United States housing market."  It's important to tell stories in legal documents, but this sounds a bit like the opening note in a large story of causation, recklessness, and bad investment products.  
Thus, an observer might conclude that the SEC approach to disclosure here is to use its own court filings as a medium in which to offer an interpretation of a moment in financial history.  Court filings become official additions to the cottage industry of books, blogs, editorials, and magazine articles generated by the meltdown. 
In this view, the complaint is the SEC 's effort at disclosure through making known its contribution to a telling, and management, of the intersecting plot lines in the financial crisis of 2008.
So the case may or may not fare well as a disclosure issue under Section 10 (b). Its other prospects lie in the use of the legal system as a forum in which to circulate an accounting of financial disaster framed in moral terms. 
The chances of success, in the sense of tying up the multiple plot lines into a neat resolution of a set of moral and ethical accounts, satisfying to the public, are another matter.

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