SEC Proposes Restricting Financial Firms From Betting Against Financial Products Sold to Investors

The SEC has taken steps to prevent financial firms from betting against their packaged financial products that they sell to investors. Its proposal, introduced this week, also seeks to prevent the types of conflict witnessed in last year’s civil lawsuit against Goldman Sachs through a ban on third parties being able to set up an asset-backed pool allowing them to make money from losses sustained by investors.

The proposal comes following a report by US Senate investigators accusing Goldman of setting itself up to make money from investor losses sustained from complex securities that the financial firm packaged and sold. It would place into effect a provision from the Dodd-Frank Wall Reform Consumer and Protection Act, which requires that the commission ban for one year placement agents, underwriters, sponsors, and initial buyers of an asset-backed security from shorting the pool’s assets and establishing material conflict. Restrictions, however, wouldn’t apply when a firm is playing the role of market-maker or engaged in risk hedging. The SEC also wants the industry to examine how the proposal would work along with the “Volcker rule,” which would place restrictions on proprietary trading at banks and other affiliates.

SEC’s Securities Case Against Goldman
The SEC accused Goldman of creating and marketing the ABACUS 2007-AC1, a collateralized debt obligation, without letting clients know that Paulson & Co. helped pick the underlying securities that the latter then went on to bet against. Last year, Goldman settled the securities case with the SEC for $550 million.

In settlement papers, Goldman admitted that it did issue marketing materials that lacked full information for its ABACUS 2007-AC1. The financial firm said it made a mistake when it stated that ACA Management LLC “selected” the reference portfolio and did not note the role that Paulson & Co. played or that the latter’s “economic interests” were not in line with that of investors. The $550 million fine was the largest penalty that the SEC has ever imposed on a financial services firm. $250 million of the fine was designated to go to a Fair Fund distribution to pay back investors.

Volcker Rule
Named after former Federal Reserve Chairman Paul Volcker, the proposed rule is designed to limit the kinds of high-risk investments that helped contribute to the recent financial crisis. It would also restrict the financial firms’ use of their own money to trade. reports that overseas firms with businesses in the US may also be subject to these limits on proprietary trading. Per Dodd-Frank, October 18 is the deadline to establish rules to execute the provision.

Volcker Rule May Be Extended to Overseas Banks With Operations in the U.S., Bloomberg, September 16, 2011

SEC moves to limit firms’ bets against clients, Reuters, September 19, 2011

Volcker Rule Delay Is Likely, Wall Street Journal, September 12, 2011

More Blog Posts:
Goldman Sachs Reports $3.4 Billion in “Reasonably Possible” Losses from Legal Claim, Institutional Investor Securities Blog, March 2, 2011

Goldman Sach’s $550 Million Securities Fraud Settlement Not Tied to Financial Reform Bill, Says SEC IG, Institutional Investor Securities Blog, October 27, 2010

Goldman Sachs Ordered by FINRA to Pay $650K Fine For Not Disclosing that Broker Responsible for CDO ABACUS 2007-ACI Was Target of SEC Investigation, Stockbroker Fraud Blog, November 12, 2010

Contact our securities fraud attorneys to request your free case evaluation. Shepherd Smith Edwards & Kantas LTD LLP represents clients throughout the US.