The Goldman Uncertainty Principle of Securities Regulation

I wish I had bandwidth to cover the Goldman-Facebook egg-on-its-face fiasco long form, but since other able writers are all over this story, I suspect NC readers will not find coverage wanting.

However, I could not let this remark pass without comment. From the Wall Street Journal:

Goldman Sachs Group Inc. slammed the door on U.S. clients hoping to invest in a private offering of shares in Facebook Inc., because it said the intense media spotlight left the deal in danger of violating U.S. securities laws.

On the surface, this looks like doublespeak of a very high order. The US is a rule based legal system, which means a violation of securities laws is a violation of securities laws, or more precisely, a violation of law can be determined by mapping a fact set against statutes, regulation, and case law. So the idea that legality has anything to do with media coverage is spurious.

But perversely, Goldman’s truthiness is an accurate account of the real state of affairs. Goldman sees that securities regs operate in the world of Schrodinger’s cat, where legality is in an indeterminate state until someone takes the trouble to look. And that remains true of what happened during much of the crisis. Tom Adams and I have written long form of the abuses that took place in CDOs, including probable market manipulation, lack of arm’s length pricing, and collusion by CDO managers, and we have argued separately that CDOs were the driver of the toxic phase of the subprime bubble. But no one seems willing to go there because the forensic work looks to be too daunting.

So the corollary of the Goldman uncertainty principle is: make anything so complicated that mere mortals are deterred from understanding a product or a business practice, and no one will open the box wide enough to see whether it is legal or not.

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  1. ShinjukuBaby

    Yves, I think it is an issue of legality having to do with media coverage to the extent that the coverage could constitute a “general solicitation” under Reg D. “General solicitation” isn’t defined in Reg D, though there is a body of no action letters.

    1. Yves Smith Post author

      Yes, I know that’s the argument, but I don’t buy that. What might motive the generally limp-wristed SEC to act is that the deal got a ton of not very favorable coverage that embarrassed the officialdom: flouting the spirit of the Volcker Rule, the fact that Goldman had turned the deal down for its own fund but was happy to fob it off on private clients, the general specter of how many ways Goldman was taking fees, the size of a “private” offering (again if technically permissible).

      The fact that the offer was limited to certain Goldman high net worth clients (over $20 million in net worth, IIRC), which is a finite universe to begin with, and distribution of the offering document would presumably be controlled in the normal fashion (confidentiality agreement, limited distribution, either via password protected website or numbered physical copies) would seem to take care of the “public offering” part.

      Even though there are no action letters, having done a lot of private transactions,”offering” is pretty well understood to mean distribution of an offering document which includes a detailed description of actual securities offered, and the usual prospectus-style description of the business.

      So I think this is BS. Either Goldman decided it wanted out of the limelight in the US (as in it decided further coverage would be more negative, that the PR costs outweighed the merits of the deal, at least in the US) OR it actually did get pressure from the officialdom. But Obama has been so bank friendly and is now keen to signal that he is moving to the “center” and being nicer to big corps that I deem this very unlikely.

      1. ShinjukuBaby

        Thanks for your thoughtful comments, Yves. I didn’t mean to suggest that GS is not acting badly in this offering; I think they are. As a matter of law I think their explanation could be correct, but I think that you are probably correct that it’s merely the reason they are offering to the public.

        If Goldman’s decision to cancel the offering is a result of a desire to get out of the limelight, I wonder if they will accomplish that. A Reg S offering is likely to get as much press and many of the negative factors you note will still exist.

      2. Justicia

        Thank you, Yves. This story triggered my BS detector and you’ve just confirmed that it’s still quite accurate.

      3. Steve

        I think you are off base. I have been a party to several transactions where the SEC has threatened a “cooling off” period as a result of this type of publicity (actually much less publicity). Which would result in a delay of weeks or months in the transaction. So GS would have two choices, get delayed because all relevant information is not included in the offering material (i.e. the press clippings), or go offshore. The latter is clearly more attractive.

    2. Yves Smith Post author

      Another reason GS may have scuppered the US offering: the media attention may have led to so many inquiries from its US clients that it was at risk of pissing a lot off. You don’t want to annoy investors with $20M+ at your shop. They are nice meal tickets.

      1. fmt

        This sounds like the best reason to me. They already had a hard time keeping number of investors under 499 (lots of clients vying for the deal) and when the word got out through media frenzy they probably took a hard stance (against the leakers) by denying investment to anyone. Kind of like let other clients deal with the bad apple(s) without GS taking on the heat.

  2. rjs

    off topic, and maybe a stupid question, but you lead with “I wish I had bandwidth to cover” this; ive seen others complain about not having bandwidth also; is there really some kind of limit imposed on how muh one can post, or is that just a general euphemism suggesting you dont have time to?

    1. Yves Smith Post author

      You clearly don’t have an idea of how much time it takes to turn out posts…..and I’m faster than most (save the typing part).

  3. T. Rex Bean

    Ha! Thank you, Ms. Smith. Even I, a babe in the financial woods, was struck by their explanation.
    In sum: “It’s really not legal but we were going to do it until it attracted all this attention. Now we can’t.”

  4. Conscience of a conservative

    This feels very media driven. In my view, what likely happened is that Goldman passed this by their lawyers & the SEC, got the all clear, and then the media and blogosphere got hold of this, and this story goes viral and is suddenly worse than ABACUS.

    While I think there are some legitimate issues here the story feels over-blown.

    That said I believe
    the SEC should just eliminate the private placement system or severely restrict it, and then we have the problem solved. The big reason to private placement is to pretend that anyone with a million dollars is a sophisticated hedge fund who doesn’t deserve any protections and to avoid any standard of fiduciary responsibility. Of course since grandpa sold the factory and left some money to grand-ma it means that she’s now a financial wizard.

  5. Cynthia

    It’s bad enough that US taxpayers are subsiding Goldman’s IPO of Facebook, but it’s even worse that Goldman is barring them from participating in this IPO. Some have speculated that Goldman is doing this to get around insider trading laws here in the US. Regardless of the reason, this is just one more piece of evidence that Goldman is an organized crime unit that has got federal regulators where it wants them — completely under its thumb!

    1. Cynthia

      oops — my sentence should read: … US taxpayers are subsidizing, not subsiding, Goldman’s IPO of Facebook,…

  6. aletheia33

    “no one seems willing to go there because the forensic work looks to be too daunting.”

    does this mean that prosecutions have not been undertaken and suits have not been filed simply because there are NO lawyers out there interested enough in the problems to challenge the legality of the abuses mentioned?

    why is this? naive moi needs clarification here. lack of resources for anyone outside a big “white shoe” law firm to do this, and those law firms all work for the banks?

    it seems kind of bizarre (so what’s new) that while quite a few lawyers around the country are altruistic enough to be fighting the foreclosure abuses as hard as they can on the ground, there is “no one” in new york who has the gumption or resources to undertake the challenge at the other end.

    i hope yves or someone can clarify if i’ve misunderstood.

    tangential ramble from here on:

    i’m so in the dark. i noticed when TARP went down, it was made quite clear in the media that no one knew what the assets under discussion were really worth, or perhaps even what they actually consisted of. am i correct in thinking that the continued failure to address this black entity is slowly playing out year by year as still no one yet knows, and perhaps there will never actually be any consensus on, an actual value of the financial products etc. so blithely traded?

    to me the likely answer would seem to be zero (at least for the bubble-y parts), but that assumes the ultimate complete separation, where concrete assets, the homes, supposedly were at least part of the real value, of concrete from imaginary. it appears it is going to take a very long time for any consensus to be possible on the value of the involved homes. this we know already. but just how this consensus will finally be reached does not seem to be at all known either. the parties that caused the problem are trying to control the outcome, but given that they were massively, collectively stupid in ignoring the basic nature of what they were trading in the first place–i.e. the home–how effective can we assume they will be in achieving that control?

    all this also prompts the strange recognition that ultimately, what the market actually did was (from a certain odd perspective) quite simple– fail to quantify something that cannot be quantified: the sweat and time and caring that goes into a real person buying and patiently earning a real shelter for his/her self, loved ones, pets, possessions, dreams, loves, self-esteem, settlement in place, and so on and on.

    is it a lesson of history that elites die when they become too cut off from the society that has elevated them? as in versailles and other examples of decay of courts and dynasties across time and the world? maybe the current elites divorced from identification or rootedness in any particular society or culture, forming their own culture without allegiance to any legally sovereign state, nomadically, opportunistically occupying homes in places around the world that are not really homes, cannot thrive beyond a certain point because they become unable to discern the values, and the nature of the values, that are generally held by the rest of the human race.

    1. Yves Smith Post author

      How is anyone going to get the information ex subpoenas? For private litigants, it takes pretty deep pockets to fund private litigation, and most of the people hurt by CDOs are broke (the monolines, small stuffees like towns in the Arctic circle) or have ongoing relationships with the Street or are loath to sue.

      And even if you get the info, you still need the help of insiders to interpret it. I was lucky enough to get some input but there are probably only 75 people who worked on dealer desks who had a full view of what happened, and maybe another 200-300 in the entire world who understand CDOs intimately enough to be good guides. Virtually all of them do not want to ruin their chances of getting highly paid indoor work by turning on the industry.

      1. aletheia33

        thanks yves for this clarification and for your patience with my cluelessness. i could not have guessed that the number of “experts” who would even have the ability to work constructively on the problem of seeing justice done regarding this form of abuse of trust is so small.

        and that not a single one of those who are able is willing is not surprising i guess, but nonetheless terribly sad. i would think that if just one of those qualified people became so willing, he/she could have a major impact on the current situation, to the benefit of a large number of present and future victims.

        and it is still phenomenal, hard to take in, no matter how many times one recalls it, that such huge numbers of people around the world became so misled into buying so much stuff of which their understanding was absolutely nil.

      2. decora

        “Goldman sees that securities regs operate in the world of Schrodinger’s cat, where legality is in an indeterminate state until someone takes the trouble to look.”

        ha ha ha this is brilliant.

        it makes sense of bubble people.

        nothing is right or wrong. there are only probabilities of rightness and wrongness.

        you cannot know where someone is, and how fast they are moving, precisely, at any one moment in time. only a hazy wave function of ‘i dont recall’s.

      3. Conscience of a conservative

        Facebook needs to be put in perspective. At worst this is about getting around the max share-holder requirement. Abacus was about clear conflicts. I think Goldman was smart enough to have passed this before the SEC before proceeding.

        My sense is that the media got ahead of the SEC on this, there was egg on the face of regulators, and they did an about face. In the end the key clients have over-seas relationships and this means nothing.

        If I had to have a take-a-way on his, is that the distinction between private placement and public offering needs to go away, or the bar for deciding an investor is “sophisticated” needs to be raised by a factor of 10.

  7. readerOfTeaLeaves

    So the corollary of the Goldman uncertainty principle is: make anything so complicated that mere mortals are deterred from understanding a product or a business practice, and no one will open the box wide enough to see whether it is legal or not.

    ‘Complexification’ is a feature, not a bug.

    1. david

      Great Post,

      Aristotle dealt with this issue in his “sophistical refutations.” The sophists had school where they taught their philosophy. The sophists thought that the human mind could not percieve reality, hence because nothing is real, there is no truth, and no lies, only communication effective in obtaining a result, or ineffective. The tools of the sophist’s trade were complexity, misidentification, ampliboly. As Aristotle put it, the real is simple, but it takes a great deal of complexity to make the sham appear real. The sophists aspired to use perception to separate the people from their interests, or as Thrasymachus explained, “to take the people’s property, not retail, but wholesale.” They designed sophistical systems to take peoples property and rights. Today Harvard, Yale, Princeton are schools of sophistry. In the interests of the wealthy, they study how to suppress the people.

      1. dejavuagain

        Not that I doubt this, but do you have some type of reference or citation to this:

        “As Aristotle put it, the real is simple, but it takes a great deal of complexity to make the sham appear real.”

  8. Cynthia

    If I were Mark Zuckerberg, I’d refuse to have such a corrupt and fraudulent bank like Goldman Sacs handle Facebook’s IPO. Instead, I would seek out an honest and respectable community bank or credit union to handle Facebook’s IPO. Which makes me think that Mark Zuckerberg is aspiring to become a white-collar corporate crook like Lloyd Blankfein is. But this wouldn’t surprise me in the least given what I’ve read about Mark Zuckerberg and especially what I sense about him.

    1. Francois T

      Which makes me think that Mark Zuckerberg is aspiring to become a white-collar corporate crook like Lloyd Blankfein is.

      In his case, it’s a matter of galaxy-sized ego that makes him immune to shame and appearance.

      After all, what can one expect from a guy whose biz card read:

      “I’m CEO…bitch!”

      1. Cynthia

        Francuis T,

        Let me point out that what Mark Zuckerberg and Julian Assange share in common is that they are both well-known byproducts of the Information Age. Other than that, the two couldn’t be more different. Asaange wants to limit the privacy of the powerful and dilute power for the many, while Zuckerberg wants to limit the privacy of the powerless and and concentrate power for the few. This explains why Time Magazine chose Zuckerberg over Assange to be its Person of the Year, despite the fact that Assange was by far the top choice among Time readers. This happened because Mark Zuckerberg and Time Magazine are very much part of the corporate power structure that rules over the rest of us. The same thing can’t be said about Julian Assange and WikiLeaks.

  9. MichaelC

    “and we have argued separately that CDOs were the driver of the toxic phase of the subprime bubble”.

    It follows that the toxic foreclosure phase today and the toxic origination phase yesterday are linked.

    How many ’06-07 mortgages resulting from the Magnetar fueled lending are jamming up/undermining the courts today?

    If they were the driver of the lending phase they’re also driving the foreclosure abuses.

    The enablers on the front end (the banks) and the servicers (the banks again)on the tail end are one and the same. It was a design feature that the servicers would profit on the collapse. For that to work the borrowers couldn’t get too uppity and the courts needed to look the other way till the foreclosure bulged passed.

  10. Fraud Guy

    Since Dodd Frank passed, I have heard a number of Goldman and ex-Goldman people say something to the effect:

    “Goldman Sachs would love to move its business headquarters to Singapore to benefit from the more friendly regulatory environment there. Only the PR and HR issues are stopping them.”

    The closing of the Facebook deal to U.S. investors is a well aimed shot across the bow of U.S. law makers, policy makers, and regulators, basically saying, “Hey, we don’t need the U.S., and remember, we’d just as soon move to Singapore.” It wasn’t the original plan, but that’s how it’s worked out.

  11. Cynthia

    Not even high-frequency trading is fast enough to be considered quantum in nature. The Goldman guys are claiming that what they are doing is quantum in nature in order to hide the fact that they are engaging high-frequency fraud. Too bad that Heisenberg and the other founding fathers of quantum mechanics aren’t around to tell all the fraudsters at Goldman Sachs that what they are doing is about as quantum as the egg on their faces!

  12. gepay1

    What I don’t understand is where the money to Facebook comes from? – to make it worth 50 billion or whatever.

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