[Retracted: see Update]
Business Ethics and Legal Ethics are notoriously the titles of two of the world’s shortest books. When they intersect, things get complicated.
For example, it was clearly unethical for Goldman Sachs to take money from California to sell California bonds to one set of customers while advising another set of customers to effectively go short California’s paper in the CDS market. As the underwriter, Goldman had a clear business obligation to California and its bond buyers not to damage their interests. But if Goldman was careful to maintain a “Chinese wall” so that no confidential information provided by the state leaked from the underwriting folks to the CDS folks, that might have been what’s sometimes called an “eighteen-year-old transaction”: barely legal.
On the other hand, perhaps not everyone at Goldman was completely meticulous. Even if a rough sketch of the crooked deal didn’t involve any lawbreaking, it’s possible that some minor detail, insignificant in itself, crossed some line. And a judge and jury aren’t likely to be very sympathetic to the plea that Goldman planned to cheat the taxpayers of California fair and square, and therefore shouldn’t be hammered for a mere technicality. That sort of plea works for honest people, but not so well for clever crooks.
The only way to find out whether a crime had been committed, and if so which one and by whom, would be to impanel a grand jury and start asking for documents and testimony. That would be extremely inconvenient for Goldman; word would be sure to leak (it’s illegal for the prosecutor to reveal information presented to the grand jury, but there’s nothing secret about the mere fact that a grand jury is sitting on a given case).
And of course in the current state of affairs a criminal conviction against the firm itself could easily be the death of a company that lives on its reputation and the belief of others that it will remain a going concern. Therefore, even the threat of a criminal conviction would drive up the prices of CDSs on Goldman’s paper, making it harder for Goldman to borrow, feeding fears that Goldman might go under, driving up the price of the CDSs even higher … just what happened to Lehman, with Goldman (reportedly) helping and the Goldman alum at the Treasury watching benignly and not interfering. Too bad, so sad!
And there’s no way for anyone at Goldman to be sure that the firm, or some of its employees, wouldn’t be convicted. If the prosecutors manage to catch some Goldmanite with his pants down – padding his expenses, for example – they’re then in a position to offer him leniency, or even immunity, in exchange for testimony against other individuals or against the firm. That sort of “testimony bargaining” – absolutely routine in all complicated cases, and indispensable in drug cases – is like judicial torture. It’s very good at getting people to tell everything they know, and sometimes things that they don’t know, for example because they aren’t true. In that sort of situation, even the innocent (perhaps especially the innocent) can be utterly terrified, and far from their peak in ongoing business dealings.
Now it would be really wrong – a gross violation of legal ethics – to use a criminal inquiry to extort a civil settlement. But it’s not unheard of to dismiss a white-collar crime case on condition that the defendant make restitution to the alleged victim, which can be done without any admission of guilt. And if the Attorney General never says to anyone “I want to open up a grand jury to shake down Goldman for as much money as possible” – if he says only “This deal stinks. I think we ought to figure out whether there was any legal wrongdoing involved” – well, it would be impossible to prove any wrongdoing on his part. After all, who knows what evil lurks in the hearts of men?
At the same time, California’s treasurer could go into court on the civil side with a suit for damages, claiming that Goldman’s conflict of interest represented a breach of the duty of fair dealing, or some sort of insider-trading violation. Good theory? Bad theory? I’m sure that, for enough money, we could find experts to testify on either side of the question. The discovery process would be a further burden for Goldman, and the publicity would be worse. Not only would Goldman’s willingness to give its customers the shaft in order to make a buck be constantly in the news reports – which might convince some bond issuers to take their business elsewhere – but if it turned out that Goldman had indeed screwed the pooch civilly, though not criminally, in the current atmosphere a jury might hit it for a telephone number, including the area code. A press release stating that California was demanding $5 billion in actual damages and $50 billion in punitive damages (it doesn’t hurt to ask) would make Goldman’s transaction partners nervous, driving up the price of its CDSs … well, you get the picture.
Now again, it would be wrong – a violation of legal ethics – to file a lawsuit merely for extortionate purposes, without good-faith belief that the suit had merit. But how is the Treasurer to know whether the suit has merit or not before filing the suit and undertaking discovery? Is it certain that Goldman has done nothing that would justify an award of damages to the state? Surely not. And if it just so happened that the mere threat of the lawsuit was enough to make Goldman pony up something, then the Treasurer could magnanimously accept the offer, or perhaps make a counter-offer.
In that context, the Treasurer and his lawyers would have no obligation to restrict their settlement demands to the expected present value of the award they could reasonably forsee; a fair settlement is any settlement the parties agree to.
All things considered, if I were the Goldman general counsel, and if the operating side of the business didn’t have anything more to say for itself than the flannelmouth it offered the LA Times, I wouldn’t be sleeping very well, and I’d be telling the CEO that if the firm can get out of this for anything south of a gigabuck it ought to count itself lucky.
Oh, what a tangled web … Honesty may not be the best policy, but it is a hell of a lot simpler than the alternative.
Footnote In Over My Dead Body set in the late 1930s, Rex Stout has his character Nero Wolfe tell the head of an international banking firm that when a bandit holds up a banker, the banker gives up, not merely his wallet and wristwatch, but his shirt and pants as well, because as a banker he is incapable of undertanding that some bandits set limits to their rascality.
I don’t think the firm in the story was called “Goldman, Sachs.”
Update My friend who does this stuff for a living says I’m talking through my hat: Goldman’s behavior was routine, and not directed at California specifically. If analysts who work for underwriters get criticized for pumping the securities of their firms’ investment-banking clients, then they can’t reasonably be criticized for bashing those securities. [I’m still puzzled about why they aren’t “conflicted out” of commenting at all, but apparently those aren’t the rules this game is played under.]
Meantime, Brad DeLong isn’t happy with the quality of the original news story.
That’s enough for me; file this post under “verbally clever, but wrong.”