Brokers' Bets Against Clients: Should this be Illegal?

Dr. Sankarshan Acharya
University of Illinois (U.S.A.)
and Research Center for Finance and Governance (India)

March 1, 2005. Revised April 14, 2011 and March 14, 2012

Congressional permanent subcommittee on investigations has today made a case of perjury against the CEO of Goldman Sachs for lying under oath to the Congress.

The Goldman Sachs CEO had stated in his testimony under oath that his firm did nothing wrong, contrary to evidence gathered by the Congress that it was betting against its own clients.

"Betting against" meant that Goldman Sachs did not actually have the mortgage securities which it sold short to its clients. To make such bets, Goldman Sachs had to know that the values of mortgage securities it sold to its clients would almost surely fall and the clients would be forced to liquidate the same at losses with the benefits accruing to Goldman Sachs.

In a memo to the US Congress, dated March 1, 2005, I had argued that such short bets by brokers and dealers against their own clients were breeches of trust and illegal. I have also argued in formal papers that short-selling is suboptimal, economically inefficient and unconstitutional. I have, therefore, argued for banning the Frankenstein monster of short-selling that was the root cause of the Great Depression.

The Congress indeed banned short-selling of certain financial securities to contain the domino of rapidly falling prices of financial firms during 2008. The step taken by the Congressional Subcommittee on Investigations today admits that the breech of trust induced by short selling is illegal.

Yahoo today highlights the importance of this Congressional action. It says that betting against clients should be illegal, even if it is not so now, because Goldman Sachs has precipitated the financial meltdown by making such bets.

Here is Bloomberg Interview with Senator Levin
Levin Interview on Goldman Sachs Investigation
April 14 (Bloomberg) -- Senator Carl Levin, a Democrat from Michigan, talks about Goldman Sachs Group Inc.'s communication to clients and Congress about the firm's bets on securities tied to the housing market. He speaks with Carol Massar and Matt Miller on Bloomberg Television's "Street Smart." (Source: Bloomberg)

"To put the problem in the simplest terms, the interests of the client continue to be sidelined [at Goldman Sachs] in the way the firm operates and thinks about making money. Goldman Sachs is one of the world’s largest and most important investment banks and it is too integral to global finance to continue to act this way. The firm has veered so far from the place I joined right out of college that I can no longer in good conscience say that I identify with what it stands for." Greg Smith, New York Times

Goldman Did Exactly What Sen. Levin Said,” Cohan Says

By Aaron Task | Daily Ticker – 8 hours ago
Goldman Sachs has a lot of friends in high places, including many former Goldman execs. But the company has also made a few enemies along the way to becoming arguably the most powerful firm on Wall Street, including the Chairman and Ranking Republican on the Senate Permanent Subcommittee on Investigations.
"In my judgment, Goldman clearly misled their clients and they misled the Congress," Sen. Carl Levin (D-MI) said yesterday as he and Sen. Tom Coburn (R-OK.) released a two-year study on the financial crisis and its cause.
Generally speaking, Sen. Levin has accused Goldman of selling clients mortgage-backed securities (MBS) while at the same time holding a "huge short" position in the MBS market in 2007. "They gained at the expense of their clients, and they used abusive practices to do it," he said.
In a statement, Goldman denied any wrongdoing; still, its shares were down 2.4% in recent trading vs. a 0.8% decline for its peer group, as measured by the Financial Select SPDR (XLF).
In the accompanying video, Dan and I discuss the fallout from Sen. Levin's report with William Cohan, author of Money and Power: How Goldman Sachs Came to Rule the World.
"Based on my investigation...there's no question Goldman did exactly what Levin said: bet against the mortgage market at the same time it continued to sell mortgage-backed securities," Cohan says. "It sure looks wrong to me. If what they did is not against the law, it should be against the law."
Sen. Levin reportedly plans to refer the case to the Department of Justice, meaning Goldman CEO Lloyd Blankfein and other executives could be charged with perjury.
"I'm not a lawyer [but] I know that…documents they produced to Sen. Levin show a very different scenario then what Lloyd Blankfein was talking about under oath to Sen. Levin's committee a year ago," Cohan says.
The real crime here is that much of what Goldman is accused of doing -- and what firms did more generally in the years leading up to the financial crisis -- was standard operating procedure on Wall Street and done with at least the tacit approval of so-called regulators.
"The scandal is not what's illegal, it's what's legal," Cohan laments.
Aaron Task is the host of The Daily Ticker. You can follow him on Twitter at @atask or email him at