Brendan Mcdermid/Reuters
Goldman Sachs has already received subpoenas from unnamed regulators investigating its mortgage securities operations. Now, federal prosecutors appear to be interested in those operations as well, and subpoenas could follow.
If so, this would signal a new and potentially more threatening inquiry into its conduct during the financial crisis.
Goldman paid $550 million last year to settle civil charges by the Securities and Exchange Commission over its structuring of a collateralized debt obligation known as Abacus that regulators said was designed to fail. But the size of that settlement may pale in comparison if federal prosecutors find sufficient evidence to pursue criminal charges.
The Senate Permanent Subcommittee on Investigations recently sent a referral to the Justice Department about Goldman’s conduct, a move that appears to have set the stage for a criminal investigation. The Wall Street Journal reported on Friday that Goldman Sachs executives were soon expecting the firm to receive subpoenas.
Goldman’s mortgage securities operation is fairly well-trod ground, having been dissected by the S.E.C., the Financial Crisis Inquiry Commission and Congress over the last two years. The firm has produced millions of pages of documents in connection with these earlier investigations, so it is not clear what is left to be learned about its conduct.
If Goldman does receive Justice Department subpoenas, that would indicate that prosecutors have found enough information about potential criminal conduct in the subcommittee’s report — and perhaps elsewhere — to take the case to the next level by requiring the production of even more documents.
Subpoenas alone would not mean that the Justice Department is poised to file any charges against Goldman or its executives, but the specter of the agency taking such action would certainly weigh on the firm.
While an inquiry could end once the firm responded to any subpoenas, here are some thoughts on how an investigation of Goldman may develop.
Who Would Be in Charge?
The first question that would be answered from a subpoena is which office in the Justice Department would conduct a grand jury investigation. The subcommittee’s referral was sent directly to the attorney general, Eric H. Holder Jr., and he would determine who in the Justice Department would be responsible for the case.
Two likely candidates are the United States attorney for the Southern District of New York and the Justice Department’s Fraud Section, which is based in Washington.
Preet Bharara, the United States attorney in Manhattan, is currently riding high after the conviction of Raj Rajaratnam, the head of the Galleon Group hedge fund, for insider trading, and his office is generally viewed as pre-eminent in securities fraud prosecutions.
Goldman’s headquarters is in New York, so it would be logical for the United States attorney’s office there to investigate the firm’s actions. On the other hand, any wide-ranging investigation of Goldman would demand significant resources, and there is the possibility that the United States attorney’s office would not handle the case on its own, given its continuing insider trading prosecutions and investigations related to expert networks, which are also demanding attention.
A potential hurdle to conducting the investigation in New York is that one area of inquiry may concern whether Goldman’s officers, including the firm’s chief executive, Lloyd C. Blankfein, testified truthfully before the Senate Permanent Investigations subcommittee about the firm’s mortgage securities operation.
Senator Carl Levin of Michigan, the subcommittee’s Democratic chairman, has said he believes the witnesses from Goldman were misleading in their testimony.
The testimony took place before the subcommittee in Washington, so that would be the only jurisdiction in which the federal court would have venue for any prosecution for perjury or making a false statement to Congress.
Who conducts a Justice Department investigation may also indicate the type of charges being considered. If federal prosecutors were to use a grand jury in Washington, then the more likely focus would be on possible perjury charges and perhaps false filings by Goldman with the S.E.C. A New York grand jury, on the other hand, would be more likely to investigate Goldman’s mortgage securities transactions, which largely originated there.
What Would Subpoenas Seek?
The first step in any fraud investigation is to gather as much evidence as possible that can be used to establish criminal intent. A violation of the antifraud provisions of the federal securities laws requires the government to prove the defendant acted “willfully,” so while there is rarely a dispute about what happened, the crucial issue is almost always about what the parties intended.
It is not clear what documents Goldman has that it did not produce to the government in the earlier investigations. Prosecutors would be expected to seek e-mails, text messages and any recorded conversations that have not been turned over because they could reveal what employees were discussing in structuring transactions and dealing with other parties, an important component to proving fraudulent intent.
The next phase of an investigation, if it were to reach this point, would be to call witnesses to the grand jury if prosecutors believed the documents and other evidence produced by Goldman furnished a foundation for proving criminal violations. While records are often crucial to providing the structure for any prosecution, live witnesses are needed to bring a case to life.
And this would be where the major sticking point is likely to be. The greatest challenge to pursuing any prosecution of Goldman and its officers related to its mortgage operation would be proving intent to defraud, if the case involves mortgage securities sales to clients, or intent to mislead Congress, if a perjury or false statement case is under consideration.
Establishing that Goldman committed any crime would be based on the knowledge and intent of all of its employees, which can be aggregated into the collective knowledge of the organization. But it would be crucial, in my opinion, for prosecutors to identify culpable individuals within the firm to show that they acted to benefit Goldman so that the firm could be held responsible.
To make a criminal case out of the mortgage activities, prosecutors would need at least one credible witness from inside the firm to point the finger at Goldman and its executives to show the company’s culpability, proving that it was more than just a sharp operator.
An earlier case against two Bear Stearns hedge fund managers for securities fraud related to the collapse of the mortgage-backed securities market, which ended in their acquittal, foundered in large part because prosecutors relied exclusively on e-mails to prove the fraud, with no witnesses to testify about the managers’ intent.
It would be almost impossible to successfully prosecute Goldman or any officers based on hostile witnesses from the firm, especially when e-mails and internal communications can be subjected to conflicting interpretations. Typical of most white-collar prosecutions, the government would need to build a case against lower-level employees in the hope they could provide incriminating testimony about their superiors.
If the S.E.C.’s continuing civil fraud case against a Goldman employee, Fabrice Tourre, arising from the Abacus C.D.O. deal, is any indication of how hard individual employees will fight charges, the Justice Department may have a difficult time lining up witnesses against senior officers to make a criminal case.
Is Goldman Too Big to Charge?
Any criminal charges against Goldman for securities fraud would be likely to jeopardize its continuing operations. The S.E.C.’s securities fraud case against the firm, filed in April 2010, involved only civil charges, yet the company’s stock price slumped significantly. The Wall Street Journal’s article on Friday about the potential Justice Department subpoenas also had a negative impact on the firm’s stock, so imagine what any actual criminal charges might do to it.
The so-called Arthur Andersen effect will be on the minds of prosecutors if the investigation were ever to reach the point of possible criminal charges against the firm. There would be concern, much like after the accounting firm Arthur Andersen was convicted for its role in the Enron scandal, that a case against Goldman could put the jobs of innocent employees at risk and cause substantial losses for investors who had nothing to do with any possible misconduct in the firm’s mortgage operation.
The device most commonly used these days to deal with corporate criminal liability is a deferred prosecution agreement, under which a company admits that violations occurred but any charges are dismissed once it completes the conditions of the agreement, like adopting internal reforms and appointing an outside monitor.
Whether that would satisfy prosecutors, who are under pressure to pursue criminal charges against Wall Street for the financial crisis, or be acceptable to Goldman, which has resisted all claims that it acted improperly, is very much an open question.
Indeed, even thinking about a possible criminal case at this point is getting far ahead of where things stand. Yet if Goldman does receive grand jury subpoenas, I think they will reflect the Justice Department’s interest in conducting a fairly broad inquiry of the firm’s conduct during the financial crisis and its aftermath.
It is unlikely there is a “smoking gun” document out there waiting to be discovered, given how many other agencies have rummaged through Goldman’s records.
But if prosecutors can identify individuals whose conduct comes close to the line of securities fraud, then they may well turn up the heat on them to see if a case can be built against senior management and the firm itself. For those looking for a quick decision, however, that is unlikely to be forthcoming.