What Goldman owes its clients

By Ben Stein, contributor


NEW YORK (Fortune) -- Now, for a few words about finance.

First, the notion is getting around, especially from the edit page of the glorious Wall Street Journal, my employer back when Hector was a pup, that it is kosher for investment bankers to trade against their clients. This all comes up in the context of the story coming out about how Goldman Sachs (GS, Fortune 500) underwrote substantial securities backed by mortgages, sold them to pension funds and others with the mighty GS imprimatur on the prospectus, and then sold them short massively --directly and through credit default swaps.

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Ben Stein

The story coming out from the friends of Goldman Sachs and of Wall Street generally is that Goldman Sachs is a trading house, that any client should know that, and that the client buys from Goldman Sachs knowing that it might trade against him and screw him up any possible way so as to make a buck.

This is a nice fantasy and a tough guy version of how the world works. The problem is that it is contrary to law and common decency. When Goldman Sachs underwrites securities, it tells its customers that it stands behind those securities; that, as my securities law expert Russ Ferguson of Georgetown University Law School put it to me this week, Goldman Sachs is "adding value" for the buyer by selling him the underwitten securities.

Obviously, Goldman can put any disclaimer it wishes in the boilerplate of the offering documents. But as underwriters, it has a duty to deal fairly and honestly with its buyers, and to deal as a fiduciary, putting clients' interests first if the buyer is a client of the firm. It holds itself out to the world that way, too. It holds itself as "adding value" when its works for a pension fund or any buyer by selling him securities. Read the annual report.

That is, it, Goldman, has a legal duty to not take advantage of the people to whom it acts as a fiduciary. It also has that duty because of the way it presents itself to the world -- with all of its leaders' talk about the Goldman Sachs "culture". They don't present that culture as the value system of Louis "Lepkele" Buchalter of Murder, Incorporated or of Meyer Lansky or Bugsy Segal or The Purple Gang. They sell the company as a prestige house with solid, client-driven values. If they act to betray that trust, it's illegal.

Obviously, it's different if Goldman is trading with a hedge fund or a canny wealthy trader who is not a client, who takes all kinds of risks. But when underwriting and selling to clients, such as pension funds, Goldman has a legal and moral duty to not sell junk unless it is marked as junk, to not do trades that will surely harm its customers in underwriting and to not tell whopping lies. In fact, it has a duty of good faith and fair dealing in all it sells, whether to clients or not.

It would be different if Goldman had in its annual report in big letters, "We will rob you any way we can." But it doesn't. As long as it doesn't, and as long as it is an underwriter, its law is not supposed to be the law of the underworld.

Second point: I really have to laugh when I read about the complaints coming out of Wall Street when Mr. Obama proposed limits on proprietary trading by big banks and investment banks. I had to laugh even more when market experts said the bank stocks' fall last week was because the banks would no longer be able to make profits consistently with their trading for themselves.

Simple fact: if the banks' proprietary trading had been consistently profitable, they would not have needed to be bailed out by the taxpayers in 2008. If proprietary trading were a bankers' perpetual motion machine of profitability, they would not have needed to be rescued by you and me.

Let's get real here. Banks as casinos do not deserve to be saved by taxpayer money. If they want to be casinos, let them move to the Las Vegas Strip. But as long as they are banks, with the red phone at the ready to call Uncle Sam for salvation, they should not be able to also make wagers with the gain going to them and the loss going to the taxpayers. Mr Obama has it totally right.

Ben Stein is a lawyer, writer, actor, and economist. From 1988 to 1996 he also taught securities law at the Pepperdine University School of Law. To top of page

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