AN IMPORTANT SETTLMENT FOR THE SEC AND GOLDMAN

The SEC settled its landmark action against Goldman Sachs. The bank will pay $550 million, made an unusual admission of having faulty marketing materials, consented to the entry of a fraud injunction and agreed to a series of procedures designed to prevent a reoccurrence of the wrongful conduct. The settlement concludes the SEC’s highest profile market crisis action against a Wall Street icon. It does not end the litigation which will continue as to Goldman employee Fabrice Tourre. SEC v. Goldman Sachs, Civil Action No. 3229 (S.D.N.Y. Filed April 16, 2010). See also Litig. Rel. 21592 (July 15, 2010).

The Commission’s complaint centers on conflicts of interest and a failure to disclose critical information about the origins and formation of a synthetic collateralized debt obligation tied to the sub-prime residential real estate market. The CDO was structured at the request of Goldman client Paulson & Co. to permit the hedge fund to short the sub-prime market. It was marketed and sold to other clients of the bank using materials which stated that the portfolio for the CDO was selected by ACA Management LLC. The role of Paulson was not disclosed. Paulson reaped huge profits, while those who bought an interest in the CDO suffered significant losses. The complaint alleged violations of Securities Act Section 17(a) and Exchange Act Section 10(b) and sought in injunction, disgorgement, prejudgment interest and a penalty.

Although the SEC is entitled to declare victory here, like all settlements, the one here has something for everyone. The Commission can claim that:

• Goldman consented to the entry of a permanent injunction prohibiting future violations of Section 17(a), an antifraud provision;

• The bank made an unusual admission in the settlement papers stating “Goldman acknowledges that the marketing materials for the ABACUS 2007-ACI transaction contained incomplete information. In particular, it was a mistake for the Goldman marketing materials to state that the reference portfolio was “selected by” ACA Management LLC without disclosing the role of Paulson & Co. . . .”

• Goldman will pay a civil penalty of $535 million, which is the largest ever obtained against a Wall Street bank, portions of which will be used to reimburse the purchasers of the CDO; and

• A series of procedures to prevent a reoccurrence of the wrongful conduct will be undertaken by Goldman.

The bank will undoubtedly say little in public. Privately, Goldman can tell clients and investors that it has resolved the action without admitting or denying the fraud allegations in the SEC’s complaint. In fact, the SEC dropped the Section 10(b) fraud claim in the settlement process which it rarely does, particularly at this stage of a case, where only a complaint has been filed. While the bank did admit a “mistake” in the marketing materials, there is no admission that the factual information omitted is material or that those materials were fraudulent. This delimits the use of the statement in private actions, while the settlement precludes the underlying evidentiary materials from becoming available to private litigants through the litigation process.

Goldman can also indicate that the amount of the settlement is less than in many other Commission fraud actions and is probably a fraction of the increase in market cap it will obtain from the rise in its share price which will follow the settlement announcement. The bank can assure employees and clients that it has moved past a difficult situation which, if it continued, would only cause further adverse publicity and divert the attention of its executives from firm business.

The fact that the Goldman settlement has something for everyone does not detract from the achievement for the SEC. Settlements are by definition a compromise. Otherwise, there would not be a settlement. Still, there will be critics. Some will argue that the SEC caved in because the injunction is based on not admitting or denying, rather than an admission. This contention ignores standard SEC procedure which is to settle cases without admitting or denying the underlying facts. What is unusual here is the admission of a mistake by Goldman. Requiring this statement is significant and may in fact signal a new approach by the Commission, moving away from the traditional settlement process and toward a harsher settlement process.

Other critics will claim that the civil penalty is not large enough and indicates that the Commission had a weak case. This ignores the fact that the penalty sets a benchmark since it is the largest against a Wall Street bank and is being used to repay investors. More importantly, it ignores a critical part and perhaps more important part of the settlement which is the procedures the bank must undertake. Those procedures are critical because they require that Goldman correct the processes that permitted the conduct in the complaint to occur and ensure that similar misconduct does not happen again. This is a critical part of the SEC’s mission because it protects investors and the markets in the future.

Likewise, those who would claim that the SEC gave in to Goldman because its case is weak miss the point. Goldman chose to settle and agreed to the entry of a fraud injunction before it even filed a motion challenging the legal sufficiency of the complaint or any kind of responsive pleading. While it is true that the SEC dropped the Section 10(b) claim which is unusual, the Section 17(a) injunction, along with the other components of the settlement, are more than sufficient.

Overall, the Goldman settlement is a good one for the Commission. The SEC can and should claim not just victory, but that it is effectively policing the markets. Goldman can state that it resolved a difficult situation. Nevertheless the settlement does leave two questions. First, what will happen with the case against Mr. Tourre? Second, will the Commission continue to bring market crisis cases against Wall Street players? The resolution of each of these questions is of critical importance to the future effectiveness of SEC enforcement. For today, however, SEC enforcement has obtained an important achievement on the road to regaining its perch as the top regulator of Wall Street.

Note: This Week In Securities Litigation, which usually appears on Friday, will be published on Monday.