Why Goldman Sachs agreed to pay the SEC's $550 million fine.

Commentary about business and finance.
July 16 2010 10:10 AM

Goldman's Best Trade Ever

Why the Wall Street firm agreed to pay the SEC's $550 million fine.

Lloyd Blankfein, chairman and CEO of The Goldman Sachs Group. Click image to expand.
Lloyd Blankfein of Goldman Sachs

Goldman Sachs has long been known for being a sharp trader. And the settlement announced with the Securities and Exchange Commission on Thursday seems like a great trade. Goldman agreed to pay $550 million to settle charges that it had misled investors about mortgage-related products. How is this a smart trade for Goldman, its top executives, and its shareholders? Let us count the ways.

First, Goldman CEO Lloyd Blankfein traded a settlement for his job. When the SEC complaint was unveiled in April, Goldman blustered that the charges were bogus and it would fight them to the finish. But as the months passed, Goldman's image and shares continued to suffer from the ongoing probe. The longer it went on, the more questions were raised about the ability of Blankfein and his management team to lead the company. Goldman's brass clearly came to several related conclusions: The firm's image had been damaged. A lengthy probe would cause more damage. And even a complete exoneration, were it ever to come, wouldn't help them all that much. With the settlement concluded, Goldman can return to focusing on the future. And if Goldman continues to rack up great results while avoiding trouble, Blankfein will be secure in his post.

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Second, Goldman traded a settlement for a better story line. It can now claim both deniability—it didn't do anything wrong—and a less harsh official view of its actions—what it did do isn't what the SEC originally said it did. SEC settlements are like kabuki theater: The Wall Street firm is allowed to tell the public and its employees that it didn't really do anything wrong. As the Goldman release notes: "The firm entered into the settlement without admitting or denying the SEC's allegations." This language also allows the SEC and everybody else to conclude that, yeah, the subjects of the investigation probably did something wrong—otherwise they wouldn't be paying a fine and settling. In this instance, Goldman traded cash for the ability to deny wrongdoing and for a downgrading of the bad acts that it neither admitted nor denied. The original complaint made allegations of fraud, saying that Goldman made "materially misleading statements and omissions" in marketing structured financial products. But the settlement acknowledges that Goldman's misdeeds were more like sins of omission. The firm acknowledges that "its marketing materials for the subprime product contained incomplete information."

Third, Goldman traded a small amount of cash for a huge stock gain. The cost of the settlement is $550 million, which is what Goldman can make in a few good weeks. But consider the tangible immediate return. On Thursday, the stock opened at $140. Friday morning, it's set to open at $150, in large measure because investors are relieved that the investigation has been settled. So for agreeing to pay $550 million, Goldman saw its market capitalization increase by about $5 billion. That's a nine-fold return on investment in a single day.

 A final note about the number: The $550 million figure was symbolic. Coincidentally—or not—that was the amount of the bonus that former junk-bond king Michael Milken made in 1986. Milken was forced to pay a then-record $400 million fine to the SEC in 1990. So the $550 million figure allowed the SEC to trumpet the fine as the biggest penalty ever paid on Wall Street. "Half a billion dollars is the largest penalty ever assessed against a financial services firm in the history of the SEC," said Robert Khuzami, director of the SEC's Division of Enforcement. That's true. But, here, again, Goldman made a smart trade. Adjusted for inflation, Goldman's fine isn't the largest in history: $550 million in 2010 dollars is worth only $330 million in 1990 dollars.

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Daniel Gross is a longtime Slate contributor. His most recent book is Better, Stronger, Faster. Follow him on Twitter.