SEC Action Is Not Populism, It Is the Rule of Law

I have a lot of respect for fund manager Doug Kass. His latest piece, “The Ramifications of the Goldman Sachs Case,” contextualizes the current push for financial reform, and it provides a succinct indictment of the practices that helped ignite the recent financial panic. However, I disagree with Kass’s casual link between the SEC’s charges of fraud against Goldman Sachs (GS) and America’s increasing populist anger:

“The death of shadow-banking, securitizations and structured products ushers in the age of populism.”

Kass himself clarifies that the SEC charges are about a lack of disclosure and not about the the financial instrument involved (in this case a synthetic collateralized debt obligation or C.D.O.). Financial reform may indeed kill the future of these kinds of financial instruments, but at their core, the specific charges against Goldman Sachs do not translate into an elimination of the C.D.O. (some may of course argue that the SEC has de facto eliminated the C.D.O.).

Instead of acting on populist rage, the SEC is simply enforcing the rule of law, a refreshing development. This enforcement action may appear populist only because for so long we have grown accustomed to an era of lax regulation and loose enforcement. Granted, the split vote along party lines to sue GS will add to the assumption (and accusation) that this charge is just an act of populism. However, I think of the SEC as normalizing the playing field and swinging the pendulum back from an unstable extreme.

Kass also claims:

“The SEC suit is another example of the type of public outcry we should continue to expect in the years ahead. This outcry stems from the growing perception of an ever widening schism in the U.S. between the haves (the Goldmans) and the have-nots (the rest). Never before have the wealthy and large corporations been held in such contempt by the average American.”

I think it remains to be seen whether the SEC becomes an agent of popular outrage. The agency will quickly lose its credibility if it acts outside existing law just to prove its mettle to the public. The SEC will also risk losing too many high profile cases if it extends itself past prudent application of the law.

The SEC’s mission revolves around disclosure. This Goldman case falls well within the bounds of this mission:

“The laws and rules that govern the securities industry in the United States derive from a simple and straightforward concept: all investors, whether large institutions or private individuals, should have access to certain basic facts about an investment prior to buying it, and so long as they hold it…

…The SEC oversees the key participants in the securities world, including securities exchanges, securities brokers and dealers, investment advisors, and mutual funds. Here the SEC is concerned primarily with promoting the disclosure of important market-related information, maintaining fair dealing, and protecting against fraud.”

(Note, like Kass I am making absolutely no judgment or prediction on the legal outcome of this case. Click here for my first opinions on this case and a technical review of Goldman’s stock).

Be careful out there!

Full disclosure: long GS shares, long GS put spread

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