The Biggest Conflict of Interest in Finance?

Maybe this is a naive question, but as Goldman clients get skinned again and again and again and again and again by Goldman’s failed calls — while Goldman itself continues to rack up prop trading profits — I keep wondering just why anyone would take investment advice from a trading firm?

And beyond that, why is it even legal for trading firms to advise clients? Isn’t this the biggest conflict of interest possible? We know firms including Goldman have advised clients to buy junk that the trading arm wants to get off its books.

A few months back former Goldmanite Greg Smith wrote:

What are three quick ways to become a leader at Goldman?

a) Persuading your clients to invest in the stocks or other products that we are trying to get rid of because they are not seen as having a lot of potential profit.

b) Get your clients — some of whom are sophisticated, and some of whom aren’t — to trade whatever will bring the biggest profit to Goldman. Call me old-fashioned, but I don’t like selling my clients a product that is wrong for them.

c) Find yourself sitting in a seat where your job is to trade any illiquid, opaque product with a three-letter acronym.

It makes me ill how callously people talk about ripping their clients off. Over the last 12 months I have seen five different managing directors refer to their own clients as “muppets,” sometimes over internal e-mail. Even after the S.E.C., Fabulous Fab, Abacus, God’s work, Carl Levin, Vampire Squids? No humility? I mean, come on. Integrity? It is eroding. I don’t know of any illegal behavior, but will people push the envelope and pitch lucrative and complicated products to clients even if they are not the simplest investments or the ones most directly aligned with the client’s goals? Absolutely. Every day, in fact.

How is intentionally misleading clients to offload junk not illegal? Is this not a huge regulatory oversight? And why — when there is ample evidence that this has happened before and continues to happen — are so few people talking about making it illegal?

And beyond that is it not blazingly obvious that the supermarket megabank model that puts clients’ interests under a single roof with the bank’s own trading book breeds fraud? Should there not be a new Glass Steagall not only to separate retail from investment banking, but also to separate prop trading from flow trading?

Or are we going to leave the world to the vampire squid?

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40 thoughts on “The Biggest Conflict of Interest in Finance?

  1. Is it a libertarian thing to do to ban free associations between individuals and firms? Under the libertarian model, aren’t we supposed to believe that the muppets would cease to do business with GS under unfavorable conditions?

    • Well, Glass Steagall worked fine for a long time. So some regulated models can work pretty well. Ultimately, in an ideal world, I would like to see a libertarian voluntaryist model. But the reality we are dealing with is anything but that — all these banks have taken huge bailouts, both directly and through monetary policy. These are state-supported banks, running on taxpayers’ money.

    • Even Milton Friedman considered fraud prosecution an integral part of a capitalist system. If I enter a transaction with the impression that I am entering a different transaction, an impression created directly by the person I am trading with, that is reminiscent of a breach of contract (most contracts in the real world are implied).

        • “If both parties, or neither of the parties, knew that the other side had a different interpretation, then there is no binding contract.”

      • If you’re pumping it up as a good investment when the guy across the hall thinks it isn’t? That fits squarely into my definition of fraud.

        That doesn’t fit into my interpretation of a libertarian definition of fraud. The guy across the hall may think whatever he wants. Isn’t an ideal transaction one where each party thinks it gets a good deal? To me, it would only be fraud (in the libertarian framework) if the guy across the hall (with whom you are in contact with) also has the proven power (and makes use of that power) to actually make sure that it is a bad deal. Otherwise, the muppets can freely choose to go elsewhere if they realize GS is savvier than they are.

        • Something else: if we’re discussing in this framework of information vs. power to act, someone prosecuting GS might say there can exist information which might be quasi-equivalent with the power to act. For example, GS knows that JPM will make sure it is a shitty deal. Even in this hypothetical simplified scenario, a GS advocate could still claim it’s just information: JPM may finally choose to pursue that path or not, and even if it does, the consequences might not be those expected by JPM and especially GS.

        • I suppose if your actual view of a product you’re selling is that it’s great, then fine. But if you’re selling junk that the guy across the hall doesn’t want, and you’re pumping it up to be a great product, that is fraudulent. And if the guy across the hall continues to bet against the product you’ve been sold, that is absurd. And there seems to have been a huge history of these things happening. And that is the problem — inherent in the business model of the megabank are huge conflicts of interest.

          In a purely libertarian system, the way to deal with this would be to avoid such businesses like the plague (I know I do). But these institutions have been supported with taxes, so I think they should be stopped.

        • And if the guy across the hall continues to bet against the product you’ve been sold, that is absurd.

          IMO, as I’ve stated, only in the above (your quote) conditions it would actually be a fraud (in a libertarian framework, which is actually not preoccupied with morality). Otherwise, things are not much different from any other transaction on the financial markets, where everyone gets rid of products at prices they believe are too rich. Now of course, it depends on what’s actually in the contract, it would be fraud if the contract states that GS has provided all information it has with regard to the future performance of the product (something like a “morality” clause or something). It would be fun if the regulators mandated for example that every futures transaction must have a description field where the trader must pour his soul out like “I’m sorry that I’ll be kicking your butt in this zero-sum game; here’s why I believe that your butt will be kicked: …” etc.)

        • That doesn’t fit into my interpretation of a libertarian definition of fraud.

          Indeed. In fact, I struggle to see how fraud can fit into a Libertarian belief system *at all*, when all they really care about is whether or not the relevant parties enter into an agreement voluntarily or not.

          If party A is supposed to have a responsibility – be it implicit or explicit – towards the expectations and welfare of party B, then the whole Libertarian system pretty much falls apart.

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  3. Andrew
    Or just run out of cash

    Aziz
    Except the UK never had a Glas Steagal act, and had the same lack of bank failures as the US did, in fact, I believe we had even less

    Unlearning
    Define Fraud? In this context?

    Selling some one a stick of butter and claiming its gold, sure, fraud.
    Selling a Mortgage backed security the guy across the hall wants to get rid of?

    Well, Goldman builds MBS’s, Ford builds Cars, Applebys builds steaks (I assume, British, never been)

    Any restaurant, any, profitable one anyway, has its staff push dishes that are not selling well, and in danger of wastage, or that are quick / easy to prepare, if the kitchen is busy.

    Any Car Manufacturer pushes its dealers to push cars that are not selling well. This goes as far as rationing popular cars, they literally wont ship you a popular car until you sell three unpopular ones.

    What does goldman do different?
    Not saying it doesnt commit fraud, it might, but a lot of accusation apply to virtualy every business on the planet

    • Selling some one a stick of butter and claiming its gold, sure, fraud.
      Selling a Mortgage backed security the guy across the hall wants to get rid of?

      If you’re pumping it up as a good investment when the guy across the hall thinks it isn’t? That fits squarely into my definition of fraud.

      You understand why it’s such an absurd conflict of interest, right? I won’t deal with a market maker that also trades a prop book. Period. I hope others reach this conclusion — cause if they don’t, they’re getting scalped.

  4. It started 10,000 years ago when Grog Sold Ugg a rock by exchanging it for Uggs Spear.

    Unfortunately, Goldman is top of consumers minds due to incessant advertising and promotion. When people think investment they think Goldman.

    Basically advertising is brainwashing. It really should be illegal.

    Advisers going on CNBC is blatant advertising for the brand. People watch CNBC before coming to this site. Sell a lot of cheap products at 1 dollar profit to the gullible majority and you make a fortune. As a Priest once told me. Business is the act of raping your customer. You take a little bit here and a little bit there without them thinking about it rationally.

  5. Since people want something for nothing, why not do business with that company that is the best at appropriating money from other people?

    How else do people believe that they are, “making their money work?”

    It’s called stealing, be it legal or not.

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  9. It seems that the problems generally remain the same… they just get wordier and wordier until someone asks, “What happened?” or “Where’s my money?” and that GS may simply say no one put a gun to your head. It’s a crappy deal and everyone knows it.

      • Sorry not trolling. I am an Aussie and we are very sarcastic.

        The US Muppets are getting great information on investing. Efficient Market Hypothesis. Go figure!

        World News from MarketWatch
        EUROPEASIACANADALATIN AMERICAEMERGING MRKTS
        Europe stocks higher after U.S. jobs, housing data
        European stocks inch lower amid thin volumes

        • Yeah the US economy is doing just fine. Winning the lottery is top of people’s minds. Jello Biafra from the Dead Kennedys had a quote on one of his Albums “One day I hope to win the lottery” It was said in jest to represent the false idol/hopium of the US middle class.

  10. I think the applicable law comes under the rubic of “failure to disclose material adverse interests.” If Goldman is betting against investments it is selling to you, and not telling you it is betting against them, I would say it is doing so against the precepts of the law.

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