Goldman Image Further Tarnished

Our friends at Goldman Sachs are at it again. On March 1, 2011, the SEC charged Rajat Gupta (http://sec.gov/litigation/admin/2011/33-9192.pdf), a former member of the board of directors of Goldman, with insider trading. Gupta had resigned last year just before news broke of his alleged involvement in the Galleon insider trading ring.  The SEC charged that Gupta helped Galleon rack up more than $17 million in profits and avoid losses on illicit Goldman trades during 2008, thanks to information Gupta fed Galleon founder Raj Rajaratnam. Gupta also made Galleon $570,000 by leaking information from a 2009 Procter & Gamble board meeting. The insider trading charges allegedly violate the securities acts and the Investment Company Act of 1940.

Fortune online has been all over the story (http://finance.fortune.cnn.com/2011/03/01/sec-charges-raj-gupta-as-insider-trading-bust-widens/). Fortune provides an interesting chart on Gupta’s role on four boards and his compensation. The amounts are staggering with a total compensation of $2.3 million. Who would have thought board members could make so much given they are not full-time employees of the company. No wonder CEOs routinely pull in pay packages of $20 million and more.

The ethical question is what is the responsibility of a board of directors for the insider trading practices of a member of its board?  Should board’s reign in such practices? Heightened responsibilities for board members now exist in the post-Sarbanes-Oxley era that has established strict corporate governance requirements.  All members of the audit committee must be independent of management. The New York Stock Exchange requires that a majority of the members of the board should be independent as well. I believe members of the board should avoid even the appearance of a lack of independence especially with these amounts of compensation. Actions of those like Gupta impair the integrity of the board.

Last fall, P&G chief Bob McDonald had defended Gupta before a shareholder named Helga Schwab at the company's annual meeting. He did this months after the Wall Street Journal reported securities regulators were investigating Gupta's alleged tipping off of Berkshire Hathaway's $5 billion investment in Goldman at the height of the 2008 financial crisis. In Gupta's last betrayal of Goldman's boardroom confidences, he told Rajaratnam in October that the board had been told the firm was on track to lose almost $2 a share for the fourth quarter ending the next month – a result that would shock Wall Streeters who were expecting the firm to continue profiting from the meltdown and make $2.50 a share. Accordingly, Galleon dumped 120,000 Goldman shares on Oct. 23 at prices around $100 a share – $24 above their close on Dec. 16, when the firm announced its fourth-quarter losses. Their insider-driven early exit saved the Galleon funds $3 million, the SEC said.

As for Goldman, its involvement with Gupta comes on the heels of an SEC investigation and finding on July 15, 2010, that the firm misled investors in a subprime mortgage product just as the U.S. housing market was starting to collapse. Goldman agreed to pay $550 million and reform its business practices. In agreeing to the S.E.C.’s largest ever penalty paid by a Wall Street firm, Goldman also acknowledged that its marketing materials for the subprime product contained incomplete information.

Goldman Sachs has arguably been the most successful firm on Wall Street for decades, with some of the world's biggest private equity and hedge funds and investment bankers and traders who practically minted money. Its reputation was beyond reproach until the subprime mess. Now, its tarnished image stands as a symbol of the hubris on Wall Street that exists. The firms were taken down a notch as the  five largest U.S. investment banks, with combined liabilities or debts of $4 trillion, either went bankrupt (Lehman Brothers), were taken over by other companies (Bear Stearns and Merrill Lynch), or were bailed-out by the U.S. government (Goldman Sachs and Morgan Stanley) during 2008. Further, government-sponsored enterprises Fannie Mae and Freddie Mac either directly owed or guaranteed nearly $5 trillion in mortgage obligations. They were placed into receivership in September 2008. For scale, this $9 trillion in obligations concentrated in seven highly leveraged institutions can be compared to the $14 trillion size of the U.S. economy (GDP) or to the total national debt of $10 trillion in September 2008.

As a nation, we continue to suffer economically, both on a personal-financial level and as an economic power, in part because of fraud and deceit. I have blogged many times before about the loss of our moral compass. The actions of Wall Street have been vilified before and will continue to be under the microscope because we cannot retain our position as the world’s economic leader so long as the engineers of capitalism continue to steer the train off the tracks.