State of Financial world !

This is an academic paper I submitted recently, but thought it might give an insight to some of us about how our investment funds are managed. It could apply to your 401K or for that matter any fund you are invested in.

Goldman Sachs (GS):
In the following write up, an attempt to analyze the actions of Goldman Sachs and a brief description of section 17(a), Section 10-b , rule 10-b(5) and section 20(a) of
Securities and Exchange Act of 1934 will be presented

AGENCY RELATIONSHIPS:
As an investment firm, GS underwrites and creates derivatives that are investment grade for its clients. Acting as an agency, GS should act in the best interests of its clients. However, GS omitted or misstated important information regarding the synthetic Credit default obligations (CDO) it created. Though independent third party agents create some of its products, such information regarding the products should be made available to the investors/clients. In this particular case, Paulson &
Co Inc. had a role in creating the CDO that is tied to sub-prime mortgages. While the product was marketed to GS’s clients, Paulson & Co Inc. was actively taking adverse position to the derivative, by betting against it. This leads us to believe that Paulson
& Co. created this CDO with intentions for the CDO to fail. Facts in the case also prove that the CDO was created from lowly rated securities. By promoting the CDO and also supporting the actions of hedge fund firm, GS is in breach of its fiduciary duty. Goldman’s failure to include such information while marketing the product to its principal is a violation of its “Duty of Loyalty”.

FIDUCIARIES: In an Agency – Principal relationship, the agent, when acting on behalf of its principal, has to bind to loyalty, obedience and care as the fiduciary duty. If in case GS intentionally omitted the information from the marketing pitch, then it violates the “duty of Loyalty”, while on the other hand, if it was due negligence or recklessness, then it would have violated “duty of care”. As in the case, EBC I. Inc V Goldman, Sachs & Co., where the client had the reason to trust that Goldman will act in eToy’s interest since they were sharing the profit; in this case, investor has the reason to trust GS as they are collecting commission for managing these funds. Based on these factual allegations regarding the ABACUS issue, the plaintiffs in the two suits allege a "Caremark" claim. In case of eToys, the court ruled against GS motion to dismiss the case for breach of fiduciary duty (Court of Appeals of New York 83 N.E.2D 26, N.Y. 2005).

The following excerpt is taken from a certain lawsuit filed in the state of New York against GS directors.
“147. The Defendants owed and owe Goldman fiduciary obligations. By reason of their fiduciary relationships, the Defendants owed and owe Goldman the highest obligation of loyalty to act in good faith.
148. Defendants violated and breached their fiduciary duties of loyalty, reasonable inquiry, oversight, good faith and supervision. ” (Securities and Exchange Commission)

FULL DISCLOSURE LAWS AND IMPLICATIONS FOR GS & Co:
As a part of the lawsuit, SEC noted that GS & Co misled the investors by representing that ACA selected the portfolio with out disclosing Paulson’s involvement in creating this security. There were two claims made against GS& Co, first of which is violation of Section 17(a) and second being violation of section 10-b and rule 10-b(5).

Section 17(a) from exchange act of 1934, requires that every registered broker-dealer should annually file a “certified” balance sheet and income statement with the SEC and the same should be released to its customers. Neither of which was done by GS & Co. according to SEC’s Claim.

Section 10-b and rule 10-b(5) of the exchange act from 1934: Section 10-b is the antifraud provision of the securities act; while rule 10-b(5) explicitly prohibits any
“(a) employed devices, schemes or artifices to defraud; (b) made untrue statements of material facts or omissions of material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; or (c) engaged in transactions, practices or courses of business which operated or would operate as a fraud or deceit upon persons. “

In this context, GS & Co. knowingly and recklessly misrepresented the facts, thus luring the investors into thinking that the value of security was higher than it really is. In both the claims GS was at fault, thus becoming the target of lawsuit ABACUS
2007-AC1 filed by Securities and Exchange Commission.

On July 15, 2010, GS settled the ABACUS 2007-AC1 for $550 Million of which $300M were in fines to the SEC and the remaining $250M were for compensating the investors.

DIRECTORS AND SHAREHOLDERS:
On April 16, 2010, it was revealed that SEC filed a civil lawsuit with claims against
Goldman Sachs for violating federal securities laws seeking injunctive relief, disgorgement of profits, prejudgment interest, civil penalties and other appropriate and necessary equitable relief in relation to ABACUS 2007-AC1 (Edgar).

Per the Securities Exchange Act of 1934, Goldman Sachs should have disclosed the lawsuit and about the investigation to the shareholders as it has an impact on its true financial condition, business and prospects. SEC issued a wells notice to Goldman Sachs in the fall of 2009 in relation to ABACUS deal. A "Wells Notice" is a letter sent by a securities regulator to a prospective respondent, notifying him of the substance of charges that the regulator intends to bring against the respondent, and affording the respondent with the opportunity to submit a written statement to the ultimate decision maker (Astarita).

With Goldman Sachs not issuing an 8-K disclosing the information to the shareholders and then later omitting the same from 10-Q, both of which were signed by Blankfien and Viniar, shareholders decided to file a shareholder derivative suit against the directors for breaches of duty of care and Duty of Candor. This later became a class-action lawsuit with more shareholders joining. The lawsuit also names Goldman Chief Executive Lloyd C. Blankfein as well as its CFO David Viniar and its president and COO Gary D. Cohn (O'CONNELL). The current class action demands removal of the current directors. Based on the section 20(a) of securities Act of 1934, the individual defendants acted as controlling persons of Goldman Sachs and had the power and authority to act unlawful manner. Hence they are liable for the misdeeds. GS & Co to act unlawfully In Malone V. Brincat (722 A 2d 5, del. 1998), Delaware court held directors accountable for the fiduciary duties of care, loyalty and good faith when disseminating any information to the shareholders. The same ruling could be applied here and the shareholder derivative suit against the directors can be upheld for falsifying the information. Though there is no verdict on this case yet, the shareholders might have a case, if not for the “power” and connections these directors at Goldman Sachs possess.

Bibliography:
Astarita, M. J. (n.d.). Retrieved from http://topics.law.cornell.edu/wex/wells_notice
Edgar. (n.d.). Retrieved from
http://www.sec.gov/Archives/edgar/data/886982/000095012310042391/y8417
0exv99w2.htm
O'CONNELL, V. (n.d.). Retrieved from Wall Street Journal:
http://online.wsj.com/article/SB100014240527487034652045752083019552085
96.html#articleTabs%3Darticle
Securities and Exchange Commission. (n.d.). Retrieved from www.sec.gov: 147. The
Defendants owed and owe Goldman fiduciary obligations. By reason of their fiduciary relationships, the Defendants owed and owe Goldman the highest obligation of loyalty to act in good faith. 148. Defendants violated and breached their fiduciary duties of loyalty, reasonable inquiry, oversight, good faith and supervision.