Rationalization

“It depends on what the meaning of the word ‘is’ is.”
Bill Clinton, August 17, 1998 grand jury testimony.

The SEC charged Goldman Sachs & Co. with fraud on April 16th. It gets a little complicated (as these stories usually do these days) but basically Goldman was hired by a hedge fund, Paulson & Co., to create a collateralized debt obligation (CDO) pool so Paulson could “short” or bet against it. Goldman then took the investment and sold it to its retail clients, knowing the hedge fund’s plan and the likelihood that the CDO would drop in value. The SEC contends that Goldman should have disclosed the conflict. Goldman, and many others writing commentary about the case, say that this is the way the market works – Goldman technically did nothing illegal.

This case is a great illustration of what is wrong with Wall Street.

If we expect every transaction we enter into with a Goldman Sachs, Merrill Lynch, Morgan Stanley, and all the other firms to be a cat and mouse game of ‘What are you NOT telling me?’ then how can investors ever be sure that they are going into a transaction with all the facts on the table? If every interaction with your financial advisor was subject to the measurement of whether what they were doing was “technically” illegal or not, how comfortable would you feel?

Many years ago investment banking and brokerage firms were partnerships, and the managers invested their own money along with their clients. As publically traded corporations, they became larger and larger, and lost sight of their original objectives: serve the client first and foremost. Now their financial incentives are structured to encourage short-term profits for incentive bonus plans and risk taking to increase the possibility of big rewards. If they’re right, they win. If they’re wrong, we lose.

As legislative debate drags on in Congress over Senator Dodd’s financial reform bill, we may have missed the best opportunity to cut through the legal rationalizations and protect the consumer. The original bill required a fiduciary standard of care for ALL financial advisors. That would mean that EVERYONE would have to act in the best interest of his or her clients at all times. Instead, the revised bill requires the SEC to conduct another study on the various effects of extending the fiduciary standard to brokers.

It’s amazing what some people can rationalize away sometimes.

Jeannette A. Jones, CPA, CFP ®
jjones@taaginc.com
http://www.taaginc.com/