The SEC Strikes At Goldman While the Iron is Hot

On Friday, the SEC charged Fabrice Tourre and his employer, Goldman Sachs, with fraud. It is common to charge the employer, under the doctrine of respondeat superior ("let the master answer") wherein the employer can be responsible for the actions of its employees. This is sometimes known as "going after the deepest pockets".

Also on Friday, Democratic Senator Blanche Lincoln unveiled a sweeping derivatives regulatory bill, which in spite of alleged attempts to craft a bipartisan bill, had no Republican lawmaker support for the legislation.

Without opining on the culpability of Mr. Tourre or Goldman (The Baseline Scenario makes strong arguments against the firm here, while Goldman makes strong responses here), I think there are a few bigger picture concepts to take note of.

1. The timing of the accusation largely coincides with the need for votes to pass financial regulation. Of the handful of financial regulatory bills currently circulating, there is very little in the way of bipartisan support. Although I am fully supportive of implementing prudent regulation to promote long-term stability within the financial system, we must take care not to pass reactionary rather than visionary legislation.

2. These allegations are a big win for the Democratic party. It is no secret that Obama's approval ratings have dropped precipitously. It is also no secret that Wall Street bankers seem to rank with pedophiles and traitors as the most-hated segment of society. While the Republicans have been chasing Wall Street donations (see WSJ article here), Mr. Obama is attempting to position himself as a champion of the people against the banks. The Democratic party is incented to push for an overly restrictive bill in order to discourage Republican support. Come mid-term elections, they may poignantly declare "why vote for so and so when they refused to regulate fraudulent companies…do they really have your best interest in mind?". My fear is that the resultant political banter may take away from the larger issue of an appropriate regulatory backdrop.

3. Where will the money come from? Taken to its logical conclusion, there is simply not enough available money in global financial institutions to make investors whole for the losses that they incurred. If litigation were pursued on all levels, we would see clients suing their investors, investors suing investment banks and ratings agencies, ratings agencies and investment banks suing mortgage lending companies, mortgage lending companies suing the appraisers and the individuals that committed representational fraud, etc. By no means am I arguing that legal recourse should be foregone, but in a room where everybody is shooting at each other, the only winner is the funeral home. We have a messy situation on our hands.

Altogether, this is an unfortunate and complicated situation. Its impact has the potential to be much more far-reaching that the single outcome ("deny and settle" seems to be the mainstream PR response.