I am in, at best, queasy semi-agreement with my friend Frank Partnoy’s views in a new FT column. He argues that since Wall Street can’t be policed with hard regulatory rules, it is only through lawyers emboldened by morality tales like the SEC’s allegations against Goldman Sachs that we will see Wall Street mend its ways.
A trillion dollars or more of CDOs could face similar litigation. Goldman did two dozen deals under the Abacus label; the SEC’s case involves just one. ProPublica, a non-profit news group, recently identified 26 CDOs sold by various banks in which Magnetar, a Chicago hedge fund, allegedly bet that portions would fail. Magnetar has denied any wrongdoing.
Many lawyers previously thought such deals were bulletproof. Now, simplified, they look vulnerable. The SEC, by blazing a trail, has shown plaintiffs’ lawyers how they might frame private cases. (If you sue Goldman, they will come.) The potential damages are huge: on average, these CDOs lost more than a billion dollars each. This is why bank shares fell so sharply on Friday.
… [T]he case demonstrates a more effective way to police bankers, because Wall Street cannot outrun a judge. That simple point has been part of Anglo-American common law jurisprudence for centuries. The US judge Oliver Wendell Holmes advised that the law was a prediction about what a judge would do. If bankers consider only whether they are complying with specific legal rules, they will create “alegal” transactions – deals that fit the letter of the law but violate its spirit. But they cannot be certain about how a judge might assess their conduct. That worry, not a rule, is what will make bankers tell clients about the presence of a fox.