Legal News

Goldman v. SEC: It?s All About Materiality

By Ashby Jones

So, at the end of the day, what’s the SEC’s case against Goldman Sachs going to turn on? We and some others made some calls this weekend and unearthed this: it’s all about materiality.

That is, Goldman will be judged on whether the information it failed to tell its clients about the degree of involvement in setting up the deal by hedge-fund Paulson & Co. was material. In other words, was it something a buyer would want to know before buying. Click here for our story, in Monday’s WSJ. Click here for earlier LB posts.

The SEC says Goldman had a duty to tell two customers betting on mortgage-related securities that Paulson helped select some of the mortgages in the product, and that Paulson was betting the mortgage market would collapse.

But a written response to the SEC dated last September, Goldman argued that the facts about Paulson weren’t material. In the response, Goldman asserted that hedge-fund manager John Paulson, today a famed figure on Wall Street, was nearly unknown when the securities were sold in early 2007, and participants were unlikely to have cared about his role.

Goldman also said in its response that its clients got the material information needed, including the types of mortgages going into the securities.

How do the experts line up? They seem to be split on the issue. Some securities lawyers said the SEC’s 22-page complaint offered strong evidence that Goldman should have disclosed information about Paulson.

For instance, there’s James Cox, a securities-law expert and professor at Duke University Law School.

The complaint says Goldman sought out an independent mortgage-analysis firm, ACA Management LLC, and told participants that ACA was responsible for designing the product.

Cox’s reading of the complaint is that Goldman knew Paulson’s participation was relevant and it needed an outside firm to give the deal credibility. “That strikes me as plain and simple laundering of the deal,” says Cox. “To me, it goes directly to the materiality of the omission.”

Other lawyers not involved in the case said those buying the securities were sophisticated institutional investors presumably able to size up a product’s worth and should be judged by a different disclosure standard.

“This isn’t mom and pop getting taken advantage of,” said Peter Henning, a professor at Wayne State University Law School in Detroit and a former SEC enforcement lawyer. These clients “might not have known about Paulson, but they had to have known that these securities were extremely risky. To say these products were toxic waste is an insult to toxic waste.”

While Goldman says it will fight the charges, lawyers and legal experts are split on whether the case will settle or go to trial. Some uninvolved lawyers said the specter of a jury verdict could drive Goldman to the bargaining table, partly because a finding of liability could spur or move along suits filed by private investors.

At the same time, a settlement is unlikely to cripple Goldman financially, largely because he SEC is limited in its ability to levy huge financial penalties. The SEC, on the other hand, might have a motive to settle, partly that it’s tied up in other messy cases, including a fraud case against Angelo Mozilo, co-founder of former mortgage giant Countrywide Financial Corp.

Still, neither side is likely to budge easily. “The SEC is basically saying, ‘You didn’t put your customers’ interest first,’ and that’s a big allegation,” said Michael Perino, a law professor at St. John’s, who expects a spirited fight. “If it pans out, it’s a severe blow to Goldman and its reputation.”

Full post as published by Law Blog - WSJ.com on April 19, 2010 (boomark / email).