‘Adversarial Shot’ at Goldman Raises Stakes for SEC (Update1)

By David Scheer, Joshua Gallu and Jesse Westbrook
April 20 (Bloomberg) -- Robert Khuzami, shortly after becoming the Securities and Exchange Commission’s enforcement chief last year, told Congress the agency must be willing to fight big cases to show it poses a "credible threat."
Targeting Goldman Sachs Group Inc., the most profitable company in Wall Street history, in the SEC’s first contested lawsuit against a major investment bank in more than a decade reflects the enforcement unit’s new combative approach.
The stakes for the SEC are high. While winning high-profile cases may help the agency restore its image after being battered by the financial crisis and its failure to detect frauds including Bernard Madoff’s Ponzi scheme, losing may tarnish the SEC’s reputation. Goldman Sachs said it will "vigorously"
fight the case, which hinges on whether information withheld by the firm should’ve been disclosed to investors.
The lawsuit says: "We’re willing to file big cases, we’re willing to file against the biggest firms, and we’re willing to file about the most complicated stuff," said Mark Radke, a former SEC official now at Dewey & LeBoeuf LLP in Washington.
"With this adversarial shot across Goldman’s bow, other banks will feel immense pressure to avoid being cast in a similar light," said Charles Clark, a former SEC enforcement lawyer who works at Kirkland & Ellis LLP in Washington. Firms "may go to extraordinary lengths to avoid a similar fate."

Sophisticated Investors

SEC Chairman Mary Schapiro, 54, is expanding protection of so-called sophisticated investors such as pension funds, insurance companies and banks after financial companies worldwide lost more than $1.78 trillion since the start of 2007 in the worst economic crisis since World War II.
"The days of ‘buyer beware’ may be changing," said Todd Henderson, a law professor at the University of Chicago. "In light of the financial crisis and the fact that sophisticated investors aren’t just losing their own money but taxpayers’
money, the interest of regulators is higher."
The SEC on April 16 accused Goldman Sachs of creating and selling collateralized debt obligations in 2007 tied to subprime mortgages without disclosing that hedge fund Paulson & Co.
helped pick the underlying securities. Goldman Sachs also didn’t disclose to investors that Paulson was betting against the securities, the SEC said.
The SEC’s Republican commissioners, Kathleen Casey and Troy Paredes, opposed the lawsuit against Goldman Sachs, which was approved in a 3-2 vote, two people with knowledge of the matter said yesterday.

‘Completely Unfounded’

The allegations are "completely unfounded in law and fact," Goldman Sachs said in a statement after the suit was announced. The company said it will fight the claims and "defend the firm and its reputation."
European regulators are following the SEC’s case. Britain’s Financial Services Authority said today it will start a formal probe of Goldman Sachs’s London unit. BaFin, Germany’s financial-services regulator, is requesting information from the SEC about the case.
Khuzami, 53, took the enforcement unit’s helm in March 2009 as lawmakers questioned the SEC’s vigilance and debated its future after Madoff’s fraud and the collapses of Lehman Brothers Holdings Inc. and Bear Stearns Cos. In May, he told the Senate Banking Committee the agency needed to beef up its trial unit to maintain its courtroom clout and credibility.
"We must convey to all defendants in SEC actions that not only do we assemble winning cases against them, but also we are prepared to go to trial and we will win," he said.

Drexel Burnham Lambert

For decades, the SEC brought almost all claims against Wall Street’s biggest investment banks as settled cases. The arrangements let firms avoid legal battles that could damage their businesses. The last time the SEC "went to war" against a major investment bank was against Drexel Burnham Lambert, though there may have been smaller cases in the decade that followed, said Dewey & LeBoeuf’s Radke.
Drexel initially fought the SEC’s 1988 lawsuit, which stemmed from an insider-trading probe, by meeting the agency’s lawyers at the courthouse to voice objections. The firm settled the following year.
The Goldman Sachs case may show lawmakers that the SEC is willing to be more confrontational after U.S. Senator Charles Grassley, an Iowa Republican, said the agency showed too much deference to Wall Street, said Peter Henning, a former SEC attorney who teaches at Wayne State University Law School in Detroit.

Grassley

Grassley faulted the SEC after an agency official discussed potential enforcement cases against Bear Stearns with JPMorgan Chase & Co. in March 2008 as the government pushed JPMorgan to buy the failing investment bank.
The senator also criticized SEC officials for discussing an investigation into Morgan Stanley Chairman John Mack with the firm’s lawyer in 2005 when the company was considering naming him chief executive officer. Mack, who stepped down as CEO in January, wasn’t accused of wrongdoing by the SEC.
Although the agency warned Goldman Sachs last year that it was investigating and might eventually file a complaint over its dealings in collateralized debt obligations, the SEC didn’t alert the firm before it filed the suit on April 16, according to a person close to the company. People within Goldman Sachs interpreted the absence of a warning as a sign that the SEC has become more confrontational, the person said.

‘Biggest Kid on the Block’

"The SEC picked a fight with the biggest kid on the block," said Henning. "That may be part of the message the commission wanted to send. It may help re-establish their reputation."
An effort to demonstrate the SEC’s renewed vigor backfired in September when a federal judge rejected a $33 million proposed settlement with Bank of America Corp. The agency later broadened its claims, forced the bank to overhaul its corporate governance and pay a $150 million fine.
That stumble and the agency’s failures in the Lehman, Bear Stearns and Madoff cases may have emboldened firms, making them more likely to challenge findings by agency investigators, said Jacob Frenkel, a former SEC lawyer now in private practice at Shulman Rogers Gandal Pordy & Ecker in Potomac, Maryland.
"The level of deference the agency has received historically to its cases is a deference it has lost," Frenkel said. "It can only be reestablished through a chain of more successful enforcement cases."