Wall Street and the Financial Crisis: Anatomy of a Financial Collapse


C. Failing to Manage Conflicts of Interest: Case Study of Goldman Sachs

    (7) Goldman's Proprietary Investments

When reviewing the conflict of interest issues related to Goldman's mortgage related activities in 2006 and 2007, another issue examined by the Subcommittee was the extent to which Goldman's Mortgage Department was engaged in proprietary trading. |2780|

In 2007, Goldman was not a commercial bank, and proprietary trading was not illegal. The issue that concerned the Subcommittee was the extent to which its proprietary activities may have contributed to the conflicts of interest that affected how Goldman operated. |2781| In a recently issued "Report of the Business Practices Committee," Goldman reaffirmed as its first business principle: "Our clients' interests always come first." |2782| Contrary to that statement, however, Goldman documents showed its employees repeatedly expressing concern about the firm's interests, but rarely mentioning or placing a priority on the interests of its clients. In fact, after Goldman announced record profits for its Mortgage Department in the third quarter of 2007, when many of its clients were suffering substantial losses from the mortgage investments they purchased from Goldman, Peter Kraus, co-head of the Investment Banking Division, wrote the following to Goldman CEO Lloyd Blankfein: "I met with 10+ individual prospects and clients . . . since earnings were announced. The institutions don't and I wouldn't expect them to, make any comments like ur good at making money for urself but not us. The individuals do sometimes, but while it requires the utmost humility from us in response I feel very strongly it binds clients even closer to the firm, because the alternative of take ur money to a firm who is an under performer and not the best, just isn't reasonable. Clients ultimately believe that association with the best is good for them in the long run." |2783|

The tension between Goldman's efforts to make money on behalf of itself versus on behalf of its clients raises a number of conflict of interest concerns, particularly when its efforts to profit from shorting the mortgage market or particular RMBS or CDO securities occurred simultaneously with its efforts to market mortgage related securities to its clients.

Goldman's Proprietary Activities. Until recently, when asked about the extent of the firm's proprietary activities, Goldman generally claimed that its proprietary investments contributed only approximately 10% of the firm's profits. |2784| In January 2011, however, Goldman announced in an SEC filing that it was changing the categories under which it reported income. Goldman added a new category called "Investments and Lending" to segregate the firm's proprietary investment income from the income it derived from activities undertaken on behalf of clients. |2785| Based on earnings reported in January 2011 for Goldman=s full fiscal year 2010, the proprietary investment income recorded under "Investments and Lending" accounted for $7.5 billion, or about 20% of Goldman's net revenues. |2786| Goldman did not specify how it defined proprietary investments and lending for purposes of its earnings report, nor what desks or activities contributed to the total, how it calculated the reported amount, or why it was double the amount cited a year earlier.

To date, three Goldman units have been identified as engaging explicitly in investments on behalf of the firm. One, based in New York, is called Goldman Sachs Principal Strategies or "GSPS," which Goldman is reportedly in the process of dismantling. |2787| The second is the Global Macro Proprietary Trading Desk, which had traders in New York and London and reportedly invested in foreign exchange markets, interest rate markets, stocks, commodities and other fixed income markets. |2788| The third, according to Goldman, is the Special Situations Group or SSG, which is reportedly engaged primarily in long term investments on behalf of the firm and clients, with little short term trading or sales activities. |2789|

Proprietary Activities in the Mortgage Area. In the mortgage area, until 2005, Goldman had a dedicated proprietary investment desk in the Mortgage Department called the Principal Finance Group, often referred to as Principal Investments. |2790| According to Goldman personnel, that desk specialized in long term investments on behalf of Goldman in assets such as distressed mortgages and credit card and energy receivables, but only rarely engaged in short term trading. |2791| In 2005, Principal Investments was folded into the Special Situations Group (SSG), which was then a Goldman business unit located in Asia and not part of the Mortgage Department. |2792| After Principal Investments personnel moved to SSG, the Mortgage Department operated without a desk that was explicitly dedicated to proprietary trading during 2006 and 2007.

When asked whether the Mortgage Department engaged in proprietary activities during 2006 and 2007, Goldman executives and traders in the Mortgage Department generally resisted providing a direct answer, declined to identify any proprietary trades or investments, and declined to estimate or calculate how much of the Mortgage Department=s 2007 revenues or profits were proprietary.

When asked about particular transactions, Goldman executives or traders often described them as examples, not of "proprietary trading," but "principal trading" in which Goldman acted as a market maker. Goldman personnel told the Subcommittee that to fulfill the firm's role as a market-maker, Goldman used its own capital to amass an inventory of assets in anticipation of customer demand, and acted as a "principal" when building that inventory. They indicated that the mortgage related assets were acquired for the purpose of accommodating existing or anticipated client buy and sell orders and not to produce proprietary profits for the firm.

At the same time, several Goldman executives and traders told the Subcommittee that all of Goldman's trading desks, including those in the Mortgage Department, were given discretion to trade some amount of the firm's capital within certain limits. |2793| Daniel Sparks told the Subcommittee: "We told [the Firmwide Risk Committee] what we wanted to do, and they told us how much we could do." |2794| Joshua Birnbaum said that the amount of proprietary trading that a desk was allowed to do depended upon certain risk limits, but could not recall a specific or typical dollar amount of any risk limit assigned to the Mortgage Department as a whole or to any of its trading desks for proprietary trading purposes. |2795| Goldman's Chief Risk Officer Craig Broderick told the Subcommittee that the firm did not distinguish between "proprietary" versus other types of risk, because the aggregate risk levels would be the same. |2796| Mr. Broderick said that the firm's proprietary trading, outside of GSPS, was "embedded" in the routine business conducted by various trading desks and was not specifically segregated as "proprietary." |2797|

Until enactment of the Dodd-Frank Act in 2010, federal securities law contained no statutory or regulatory definition of proprietary trading by banks and generally did not require firms to identify or monitor their proprietary investments. |2798| The Subcommittee investigation found that the terms "proprietary" and "prop" were commonly used in the financial services industry to describe business performed on behalf of, or for the benefit of, a financial firm itself, while the term "flow" was used to refer to market-making transactions involving, or for the benefit of, the firm's customers. |2799|

A number of internal Goldman documents in 2006 and 2007, used the terms "prop" and "flow" when referring to mortgage related activities. In a 2006 email to Goldman senior executives, for example, Mr. Sparks, the Mortgage Department head, used the terms when criticizing a decision by Morgan Stanley to move its most experienced mortgage traders from its mortgage department's "franchise" desk to a dedicated proprietary desk. |2800| Mr. Sparks argued against Goldman=s doing the same by claiming exposure to customer trades or "flows" made mortgage traders "more effective" in their proprietary trades:

    "Morgan Stanley is going overboard by taking most of their experienced and known traders out of the franchise. We should keep our franchise leaders in the seats and continue to allow them to take prop views B the customer flows they see make them more effective." |2801|

This email shows, not only that Mr. Sparks and other Goldman executives used the terms "prop" and "flow," but they also knew Goldman mortgage traders were handling both customer and proprietary transactions at the same time.

In November 2007, Mr. Sparks received an email from the Mortgage Department's business manager, John McHugh, indicating that proprietary trades made up a substantial portion of the Department's activities. |2802| In the email, Mr. McHugh provided Mr. Sparks with a draft of the Department's 2008 business plan which included a description of the projected business activities of the Structured Product Group – the Mortgage Department trading desk that then handled RMBS, CDO, and other mortgage related trading activities. Under the heading, "Prop vs. Flow," the draft plan stated: "Prop/flow components of SPG Trading will be roughly equal." |2803| Under another section entitled, "Assumptions/ Initiatives in ABS [Asset Backed Security] p&l [profit and loss]," the draft business plan stated:

  • "Good prop opportunity capitalizing on selling pressure, selective distressed asset purchases.

  • Expect prop flow split to be roughly 50/50." |2804|

The draft business plan suggests that fully half the 2008 SPG and ABS activities were expected to involve proprietary investments.

When the Subcommittee asked Mr. Sparks about the "prop/flow components of SPG Trading" in the Department's 2008 draft business plan, Mr. Sparks indicated that he was not sure what his business manager meant and was unable to estimate what percentage of the SPG Trading Desk's activities was spent on proprietary trades. |2805| In a later written response to Subcommittee questions about the email, Mr. Sparks wrote: "‘Prop' or ‘proprietary' can mean different things to different people." He continued that Mr. McHugh=s email appeared to use "prop" to refer to investments made with a longer holding period, such as months or years, while "flow" seemed to refer to investments with a shorter holding period:

    "Defined this way, both ‘prop' and ‘flow' trades can involve customers, although sometimes the term ‘proprietary' is used to describe business that does not involve a customer. (Sometimes proprietary is used to describe any activity that involves use of a firm's own capital.)." |2806|

Goldman's Net Shorts As Proprietary Investments. Goldman's practice of embedding its proprietary trading activities within the ordinary trading conducted on its market-making mortgage trading desks, together with its unwillingness to estimate its proprietary activities, made it difficult to determine the extent of the proprietary trading that took place within the Mortgage Department from 2006 to 2007. |2807| Nonetheless, many of the transactions undertaken by the Mortgage Department from late 2006 to late 2007 appear to have been undertaken to advance the financial interests of the firm, rather than primarily to make markets for clients.

Several factors suggest that transactions undertaken to build and profit from Goldman's two large net short positions in 2007 were completed for Goldman's own benefit, rather than on behalf of its clients. First, the two net short positions – totaling $10 billion in February and $13.9 billion in June 2007 – were far larger than a financial institution would establish simply to meet anticipated client demand. |2808| Second, the magnitude of the risk attached to those short positions was also outsized. As indicated earlier, the Mortgage Department typically contributed only about 2% of Goldman's total net revenues, yet in 2007, it was allowed to continually exceed its permanent Value-at-Risk (VAR) limit and incur up to 52% of firmwide risk. The Subcommittee uncovered no evidence to suggest that Goldman incurred and sustained that disproportionately high level of risk to accommodate client demands or to hedge positions taken on to accommodate clients.

A third factor indicating the net short positions were proprietary in nature was how long Goldman held onto them. For example, the Mortgage Department maintained a $9 billion ABX AAA short for six to nine months in 2007. While that short was initially used to hedge certain long positions held by various Mortgage Department desks, it was retained even after those long positions were sold off or written down. Mr. Sparks later described the ABX AAA short as "disaster insurance" in case the subprime market collapsed. |2809| The Subcommittee found no evidence indicating that the $9 billion short was maintained over such a long period of time to accommodate client demand.

A fourth factor indicating Goldman's net short positions were proprietary in nature was the Mortgage Department's affirmative effort to solicit clients to buy RMBS and CDO assets in its inventory. |2810| The Subcommittee saw no evidence that this sales activity was undertaken to accommodate client demand; to the contrary, the documents show that the Mortgage Department's sales efforts took place amid a deteriorating mortgage market and waning investor interest in mortgage related products. |2811|

Still another indicator that the Mortgage Department's net shorts were proprietary was that, when clients expressed interest in acquiring certain short positions, Goldman at times refused to accommodate their requests. For example, in June 2007, when Goldman began building its second large net short position, its Mortgage Department refused client requests to purchase the short side of CDS contracts with Goldman: "Really don=t want to offer any [shorts to customers]" and "too late!" |2812| On another occasion in March 2007, a Goldman employee told Goldman's Chief Risk Officer Mr. Broderick that the Mortgage Department was no longer buying subprime assets: "Just fyi not for the memo, my understanding is that desk is no longer buying subprime. (We are low balling on bids.)." |2813| Refusing client requests and lowballing bids to avoid purchases indicate that the Goldman Mortgage Department was not acting as a market maker to accommodate client demand.

Perhaps the strongest indicator that Goldman's large net short positions were proprietary investments are the statements made by Goldman's own executives and traders. Goldman's head ABX trader, Joshua Birnbaum, described the Department's decisions in February and June to build and profit from its net short positions, not as efforts to accommodate anticipated client demand, but as investments made on behalf of the firm to produce large profits:

    "Whereas execution of strategies has clearly been a concerted team effort, I consider myself the initial or primary driver of the macro trading direction for the business. I would highlight 3 major calls here:
    1. Dec-Feb: ... The prevailing opinion within the department was that we should just ‘get close to home' and pare down our long. ... I concluded that we should not only get flat, but VERY short. ... [W]e all agreed the plan made sense. ... [W]e implemented the plan by hitting on almost [every] single name CDO protection buying opportunity in a 2- month period. Much of the plan began working by February when the market dropped 25 points and our profitable year was underway. ...
    3. Jun-Jul: the BSAM [Bear Stearns Asset Management failure] changed everything. I felt that this mark-to-market event for CDO risk would begin a further unraveling in mortgage credit. Again, when the prevailing opinion in the department was to remain close to home, I pushed everyone on the desk to sell risk aggressively and quickly. We sold billions of index and single name risk such that when the index dropped 25pts in July, we had a blow-out p&l [profit & loss] month, making over $1Bln that month. ...

    We made money: a) taking large directional views, the direction of which we changed several times, b) ... betting the bad names would get much worse vs. the good ones, c) shorting CDOs, d) capturing the index to single name basis ... among other things." |2814|

In a later presentation put together to propose a new compensation arrangement for the SPG Trading Desk's trading activities, Mr. Birnbaum was unequivocal that the net shorts the desk had acquired were not hedges to offset risk, but "outright" short investments to produce profits:

    "By June, all retained CDO and RMBS positions were identified already hedged. ... SPG trading reinitiated shorts post BSAM [Bear Stearns Asset Management] unwind on an outright basis with no accompanying CDO or RMBS retained position longs. In other words, the shorts were not a hedge." |2815|

In his 2007 self-evaluation, Michael Swenson, head of the Mortgage Department=s SPG Trading Desk, described the net short positions undertaken by the firm in this way:

    "It should not be a surprise to anyone that the 2007 year is the one that I am most proud of to date. ... extraordinary profits (nearly $3bb [billion] to date). … I directed the ABS desk to enter into a $1.8 bb short in ABS CDOs that has realized approx. $1.0bb of p & l [profit and loss] to date. … [W]e aggressively capitalized on the franchise to enter into efficient shorts in both the RMBS and CDO space."

Mr. Swenson's description of the net short position he "directed" to be built in CDOs and the resulting $1 billion in profit makes no reference to client demands. Mr. Salem, a trader on the ABS Desk, was equally clear in his 2007 self-evaluation that the desk made a deliberate bet on the direction of the mortgage market: "Mike, Josh, and I were able to learn from our bad long position at the end of 2006 and layout the game plan to put on an enormous directional short." |2816| Each of these three Mortgage Department employees played a key role in building the firm's net short positions. Their own statements indicate that they perceived acquiring the 2007 net short positions to be for the benefit of the firm, and not to build an inventory of assets to respond to anticipated client demand.

Other internal documents also portray the net short positions as decisions made by the firm to advance its own financial interests. In an internal presentation to the Goldman Board of Directors regarding the "Subprime Mortgage Business," for example, the Mortgage Department wrote that, in the first quarter of 2007, "GS reverse[d] long market position through purchase of single name CDS and reductions of ABX." |2817| In September 2007, the Goldman Board of Directors summarized its mortgage business this way: "Although broader weakness in the mortgage markets resulted in significant losses in cash position, we were overall net short the mortgage market and thus had very strong results." |2818| Talking points prepared for CFO David Viniar prior to a March 2007 earnings call with analysts stated: "The Mortgage business' revenues were primarily driven by synthetic short positions." |2819| In an October 2007 letter sent to the SEC, Goldman wrote:

    "[W]e are active traders of mortgage securities and loans and ... we may choose to take a directional view of the market .... For example, during most of 2007, we maintained a net short sub-prime position and therefore stood to benefit from declining prices in the mortgage market." |2820|

In an October 2007 internal presentation to another Goldman unit, Chief Risk Officer Craig Broderick wrote:

    "So what happened to us? ... In market risk B you saw in our 2nd and 3rd qtr results that we made money despite our inherently long cash positions. – because starting early in ‘07 our mortgage trading desk started putting on big short positions ... and did so in enough quantity that we were net short, and made money (substantial $$ in the 3rd quarter) as the subprime market weakened." |2821|

In a November 2007 email to his colleagues, Goldman CEO Lloyd Blankfein wrote: "Of course we didn't dodge the mortgage mess. We lost money, then made more than we lost because of shorts." |2822| None of these internal documents suggests that the Mortgage Department's net short transactions were undertaken to accommodate existing or anticipated client trades.

In January 2011, the new Financial Stability Oversight Council (FSOC) issued a study that focused, in part, on criteria that can be used to distinguish between proprietary and market making activities. |2823| Applying those recently developed criteria to the Mortgage Department's 2007 activities also supports viewing that activity as the result of proprietary rather than market making activities. For example, the Mortgage Department was building its net shorts with the expectation that they would appreciate in value rather than provide assets to facilitate customer transactions; the position created risks out of proportion to those necessary to accommodate customer demand; the Mortgage Department actively and aggressively solicited clients to build its short positions; the Mortgage Department accumulated an unpredictable inventory profile in terms of volume and in relation to customer demand; and it had a relatively low inventory turnover with the bulk of the profits derived from inventory appreciation when Goldman covered its shorts.

Advocating More Proprietary Trading. One last set of documents shines additional light on the role of proprietary investments in the Goldman Mortgage Department in 2006 and 2007. As indicated earlier, for several years, Goldman's Mortgage Department had a proprietary trading desk, Principal Investments, that was explicitly and exclusively dedicated to engaging in transactions for the benefit of the firm. In 2005, it was moved to the SSG unit. Internal Goldman documents show that some in the Mortgage Department wanted to revive that desk, increase the amount of proprietary trading in the mortgage area, or claim a greater share of the proprietary profits created by the Mortgage Department for the firm.

In August 2006, for example, the CDO Origination Desk proposed that Goldman establish a formal proprietary trading fund or proprietary trading operation within the Mortgage Department to conduct mortgage related transactions on behalf of the firm. In an August 2006 email, Peter Ostrem, the CDO Origination Desk head, made the proposal to Mr. Sparks, the Mortgage Department head:

    "Let's do our own fund. SP [Structured Product] CDO desk. Big time. GS [Goldman Sachs] commits to hold proportion of equity outright. This could be big. ... I need real leverage. Got some structured ideas too. When can we talk strategy for an hour or so?" |2824|

Mr. Sparks responded: "Next week. In the meantime calm the blank down." |2825| Later the same day, he later wrote to Mr. Ostrem: "Not going to happen." |2826| When asked about these emails, Mr. Sparks told the Subcommittee that Goldman decided not to allow the Mortgage Department to set up its own hedge fund or explicit proprietary trading desk. |2827|

In March 2007, after a series of large trades with the Harbinger hedge fund on the ABS Desk, Deeb Salem, an ABS trader, emailed Mr. Birnbaum, Mr. Swenson, and Mr. Chin with a proposal for a proprietary CDO:

    "Am I crazy to be thinking we might want to grow the harbinger trade and do our own abs desk cdo. There'll be so much juice in it. It would blow out. We could sell supersenior and maybe some equity. Then the remaining mezz would be a cover of a couple hundred million of our cdo short. Haven't crunched the numbers, but I'm guessing we'd effectively cover well north of 1000 plus own some call rights. Or we also keep the equity and own it for free.

    To select the portfolio, we look at the underlying rmbs deals in our cdo shorts. And replicate that as best as possible." |2828|

Mr. Birnbaum replied: "I like it." |2829| Mr. Swenson responded: "Love it we will give dan [Sparks] a heart attack." |2830| Two months later, in June 2007, Mr. Swenson wrote Mr. Salem: "Talk to me now things are developing - dan wants you to be the epicenter of the subprime universe which is not a bad position to be in." |2831| Mr. Salem replied:

    "That's fine. My number 1 concern is that it[']s traded by the right people bc [because] the opportunity is huge. It's a product that needs to be traded as a prop product. ... U need to be in charge and we need prop minded guys involved." |2832|

That same month, however, the Bear Stearns' hedge funds collapsed due to losses from their subprime holdings. In July, the mass ratings downgrades took place, and the RMBS subprime market began to shut down as well. The Subcommittee saw no evidence that the proprietary CDO proposed by Mr. Salem was carried out.

In July 2007, Mr. Birnbaum, Goldman's head ABX trader, remarked that Goldman was giving John Paulson, the head of the Paulson Partners hedge funds, "a run for his money" in shorting the mortgage market, and claimed Goldman was "No. 2" behind the Paulson hedge funds in profiting from a massive net short position. |2833| In October 2007, Mr. Birnbaum drafted a proposal that the SPG Trading Desk be compensated in accordance with a hedge fund model, rather than through Goldman's bonus pool, so the desk could obtain a portion of the proprietary profits it was generating. |2834| He discussed the proposal with other Mortgage Department personnel, but did not present it to senior management. |2835| The Mortgage Department personnel who helped build the net shorts nevertheless received substantial compensation for their 2007 efforts. |2836|

Proprietary trading was not prohibited by law in 2007, and Goldman was free to and did engage in billions of dollars in mortgage related trades for its own account. The Goldman case study also demonstrates how proprietary trading, when undertaken at the same time as trading on behalf of clients, can give rise to conflicts of interest between the bank's financial interests and those of its clients. The new proprietary trading and conflict of interest restrictions in the Dodd- Frank Act are designed to address and reduce these conflicts.


2780. Until its repeal in 1999, the Glass-Steagall Act prohibited banks from engaging in proprietary trading. Glass- Steagall Act, Section 16. The Act's prohibition on proprietary trading was weakened over the years and finally repealed by the Financial Services Modernization Act of 1999, P.L. 106-102 (1999). Since Goldman did not become a bank holding company until 2008, neither the Glass-Steagall prohibition nor its repeal affected its activities during the time period examined by the Subcommittee. [Back]

2781. Financial institutions that trade for their own accounts at the same time that they conduct trades on behalf of their clients may experience conflicts of interest. See, e.g., 4/23/2010 letter from John Reed, former Chairman and CEO of Citigroup, to Senators Merkley and Levin ("When a firm is focused on market gain through proprietary trading, it too often will employ every available device to achieve those gains B including take advantages of clients and putting the firm at risk."); In re Merrill Lynch, Pierce, Fenner & Smith, Incorporated, Exchange Act Rel. No. 34-63760, Admin. Proc. 3-14204 (Jan. 25, 2011) (settling allegations that Merrill Lynch's proprietary traders misused information about their customers' trading); 7/19/2005 speech by Annette Nazareth before the Securities Industry Association Compliance and Legal Division Member Luncheon (discussing increased potential for conflicts of interest). In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act, P.L. 111-603, restored the prohibition on proprietary trading by banks, subject to certain exceptions. See Section 619, amending the Bank Holding Company Act of 1956, to be codified at 12 U.S.C. §1851. Regulations implementing Section 619, also known as the Merkley-Levin provisions after the Senators who authored them or the Volcker Rule after former Federal Reserve Chairman Paul Volcker who championed the ban, are due by October 2011. [Back]

2782. 1/2011 "Report of the Business Standards Committee," at 1. In May 2010, at Goldman's annual shareholders' meeting, CEO Lloyd Blankfein announced the formation of a Business Standards Committee to conduct an extensive review of the firm's business standards and practices to determine the extent to which the firm was adhering to its own written "Business Principles," and to make appropriate recommendations. Id. The Committee's January 2011 report provided recommendations in the areas of Client Relationships and Responsibilities, Conflicts of Interest, Structured Products, Transparency and Disclosure, Committee Governance, and Training and Professional Development. [Back]

2783. 9/26/2007 email to Mr. Blankfein, "Fortune: How Goldman Sachs Defies Gravity," GS MBS-E-009592726, Hearing Exhibit 4/27-135. [Back]

2784. See, e.g., 1/21/2010, The Goldman Sachs Group Inc., 4Q 2009 Earnings Call Transcript, Q&A (David Viniar states that, in most years, proprietary trading accounts for "10% roughly plus or minus a couple of percent."), http://seekingalpha.com/article/183723-the-goldman-sachs-group-inc-q4-2009-earnings-call-transcript?part=qanda. [Back]

2785. 1/11/2011 Goldman Form 8-K filed with the SEC (announcement of change in reporting categories). Goldman's change in its reporting categories implemented one of the recommendations outlined in Goldman's "Report of the Business Standards Committee" published in January 2011. [Back]

2786. See 1/19/2011 Goldman press release on 2010 earnings, available at www2.goldmansachs.com. [Back]

2787. Subcommittee interview of David Viniar (4/13/2010). See also "More Goldman Traders to Exit for Funds," Financial Times (1/9/2011). Goldman may be eliminating the desk in response to the Dodd-Frank prohibition on proprietary trading. [Back]

2788. See "Goldman to Shut Global Macro Trading Desk," New York Times (2/16/2011). Goldman may be eliminating this desk in response to the Dodd-Frank prohibition on proprietary trading. [Back]

2789. Subcommittee interview of Darryl Herrick (10/13/2010). To the extent that its activities are limited to long term investments, the SSG unit would not be affected by the Dodd-Frank prohibition on proprietary trading which applies only to trading accounts used "principally for the purpose of selling in the near term (or otherwise with the intent to resell in order to profit from short-term price movements)," and does not affect long term investments. See Section 619(h)(6). Under Section 620 of the Dodd-Frank Act, banking regulators are also conducting an 18-month review of all permitted bank investment activities, both long and short term, to gauge the risk of each activity, any negative effect the activity may have on the safety and soundness of the banking entity or the U.S. financial system, and the "appropriateness" of each activity for a federally insured bank. [Back]

2790. Subcommittee interview of Darryl Herrick (10/13/2010). [Back]

2791. Id. [Back]

2792. Id. [Back]

2793. Subcommittee interviews of Mr. Sparks (4/15/2010); Mr. Birnbaum (4/22/2010); and Mr. Broderick (4/9/2010). See also 12/17/2007 email from Michael DuVally to Mr. Sparks, "WSJ Responses," GS MBS-E-013821884 ("Some traders are allowed to express their own market views using the firm's capital."). [Back]

2794. Subcommittee interview of Daniel Sparks (4/15/2010). [Back]

2795. Subcommittee interview of Joshua Birnbaum (4/22/2010). [Back]

2796. Subcommittee interview of Craig Broderick (4/9/2010). [Back]

2797. Id. Goldman's Chief Financial Officer David Viniar provided similar information in response to questions from the Financial Crisis Inquiry Commission, indicating that Goldman did not specifically "break out" its proprietary trading from its other business results. See FCIC Hearing, Testimony of David Viniar (7/2/2010), www.fcic.gov. [Back]

2798. The Dodd-Frank Act defines "proprietary trading" as "engaging as a principal for the trading account of [a] banking entity . . . in any transaction to purchase or sell, or otherwise acquire or dispose of, any security, any derivative, any contract of sale of a commodity for future delivery, any option on any such security, derivative, or contract or any other security or financial instrument that the appropriate Federal banking agencies ... may, by rule ... determine." 12 U.S.C. ' 1851(h)(4). The Act further defines "trading account" as one used for "near term" trading or for capturing profits from "short term price movements." Section 1851(h)(6). These provisions are subject to further refinement through implementing regulations. [Back]

2799. See, e.g., description of proprietary trading in Deutsche Bank's 3/26/2008 Form 20-F filed with the SEC at 24 ("Within Corporate Banking & Securities, we conduct proprietary trading, or trading on our own account, in addition to providing products and services to customers. Most trading activity is undertaken in the normal course of facilitating client business. For example, to facilitate customer flow business, traders will maintain long positions (accumulating securities) and short positions (selling securities we do not yet own) in a range of securities and derivative products, reducing this exposure by hedging transactions where appropriate. While these activities give rise to market and other risk, we do not view this as proprietary trading. However, we also use our capital to exploit market opportunities, and this is what we term proprietary trading."). [Back]

2800. 4/13/2006 email from Mr. Sparks to Messrs. Cohn, Sobel, and Mullen, "Morgan Super Traders Worry Hedge Funds," GS MBS-E-016187625. [Back]

2801. Id. See also Glenn Bedwin, International Research Director, Thomson Financial, Trading for Investors Forum, Financial News Supplement at 14 (2004) (noting the value of "information [banks] gain from looking at the flow going through their desk"). [Back]

2802.  11/16/2007 email from John McHugh to Mr. Sparks, "FICC 2008 business plan presentation to Firm," GS MBS-E-013797964. [Back]

2803. Id. [Back]

2804. Id. [Back]

2805. Subcommittee interview of Daniel Sparks (10/3/2010). [Back]

2806. Daniel Sparks response to Subcommittee QFR at PSI-QFR_GS0452. [Back]

2807. The difficulties associated with distinguishing between proprietary trading and market making activities are examined in a recent study by the new Financial Stability Oversight Council (FSOC), an intra-governmental council established by the Dodd-Frank Act, comprised of ten regulators in the financial services sector, and charged with identifying risks and responding to emerging threats to U.S. financial stability. See FSOC FAQs, www.treasury.gov; 1/2011 "Study & Recommendations on Prohibitions on Proprietary Trading & Certain Relationships with Hedge Funds & Private Equity Funds" (hereinafter "FSOC Study"), at 22-44. The FSOC Study observed: "Absent robust rules and protections, banking entities may have the opportunity to migrate existing proprietary trading activities from the standalone business units that are presently recognized as ‘proprietary trading" into more mainstream ‘sales and trading' or other operations that engage in permitted activities." Id. See also "Proprietary Trading Goes Under Cover: Michael Lewis," Bloomberg, (10/27/2010) (quoting a bank trader who reportedly said "from here on out, if he wants to take a proprietary position ... he will argue that he bought the position because a customer wanted to sell the position, and he was providing liquidity"). [Back]

2808. These totals include Goldman's net shorts from both its mortgage trading and CDO securitization activities. [Back]

2809. Subcommittee interview of Daniel Sparks (4/15/2010). [Back]

2810. See, e.g., documents cited in Section C(4)(b) (sales efforts to reduce Goldman's $6 billion long position) and Section C(5)(a)(iii) (sales efforts to reduce Goldman-originated RMBS and CDO securities), above. [Back]

2811. See, e.g., emails noting difficult sales environment. 1/31/2007 email from Mr. Sparks to Mr. Montag, "MTModel," Hearing Exhibit 4/27-91 (making "lemonade out of some big old lemons"); 3/9/2007 email from Mr. Sparks to Mr. Schwartz and others, GS MBS-E-010643213, Hearing Exhibit 4/27-76 ("team is working incredibly hard and is stretched"); 3/27/2007 email from Mr. Ostrem to Mr. Bieber, GS MBS-E-000907935, Hearing Exhibit 4/27-172 (congratulating Mr. Bieber for "an excellent job pushing to closure these deals in a period of extreme difficulty"); 6/11/2007 email from Mr. Montag, GS MBS-E-001866144 (after a sale of Timberwolf securities, telling the sales team they had done an "incredible job B just incredible"). [Back]

2812. 6/10/2007 email from Michael Swenson, "CDS on CDOs," GS MBS-E-012568089; 6/13/2007 email from sales, "CDO protection," GS MBS-E-012445931. See also 9/7/2007 Fixed Income, Currency and Commodities Annual Individual Review Book, Salem 2007 Self-Review, GS-PSI-03157 at 71 (in his self-evaluation Mr. Salem wrote that his desk sold short positions on single name CDS contracts only to customers that could provide Goldman with useful information: "We were very aggressive with pricing and only shared risk [short positions] with smart guys if they gave us insight on names to go short or go long in return."). [Back]

2813. 3/2/2007 email exchange between Mr. Broderick and Patrick Welch, GS MBS-E-009986805, Hearing Exhibit 4/27-63. [Back]

2814. 9/26/2007 EMD Reviews, Joshua Birnbaum Self-Review, GS-PSI-01975, Hearing Exhibit 4/27-55c. Mr. Birnbaum's comments indicate that Goldman's proprietary activities extended to its CDO activities. As explained earlier, while Abacus 2007-AC1 was undertaken in response to a client request, Hudson 1 was conceived by the Mortgage Department as a way to transfer risk associated with poorly performing ABX assets in its inventory. Goldman supplied 100% of the CDS contracts that made up Hudson's assets, took 100% of the short side, and profited at the expense of the Hudson investors. In October 2006, Mr. Ostrem, head of the CDO Origination Desk, wrote to Mr. Sparks that a client was upset, because it knew "Hudson Mezz (GS prop deal) is pushing their deal back," clearly identifying Hudson as a "prop" or proprietary transaction. 10/16/2006 email from Mr. Ostrem to Mr. Sparks, GS MBS-E 010916991, Hearing Exhibit 4/27-59. See also 2/25/2007 email exchange between Peter Ostrem and Matthew Bieber, at GS MBS-E-001996601, Hearing Exhibit 4/27-95 (Mr. Ostrem proposed allowing a hedge fund to include assets in Anderson and then short them, but Mr. Bieber thought Mr. Sparks would want to "preserve that ability for Goldman"); 12/29/2006 email from Mr. Birnbaum to Mr. Lehman, GS MBS-E-011360438, Hearing Exhibit 4/27-5 (when discussing certain proposed CDO deals that would generate $1 to $3 billion in short positions and reference certain RMBS securities, Mr. Birnbaum stated: "On baa3 [RMBS securities with credit ratings of BBB-], I'd say we definitely keep it for ourselves. On baa2 [RMBS securities with BB ratings], I'm open to some sharing to the extent that it keeps these customers engaged with us."). [Back]

2815. 10/3/2007 "SPG Trading B 2007," presentation prepared by Joshua Birnbaum with input from other SPG employees, but which was not ultimately provided to senior management, GS MBS-E-015654036, at 44 [emphasis in original]. Mr. Birnbaum reaffirmed his analysis in a 2010 written response to Subcommittee questions. See Mr. Birnbaum's response to Subcommittee QFR at PSI_QFR_GS0509. [Back]

2816. 9/7/2007 Fixed Income, Currency and Commodities Annual Individual Review Book, Salem 2007 Self-Review, GS-PSI-03157, at 71. [Back]

2817. 3/26/2007 Presentation to Goldman Board of Directors, "Subprime Mortgage Business," GS MBS-E- 005565527, Hearing Exhibit 4/27-22. [Back]

2818.  9/17/2007 Board of Directors Meeting Financial Summary, GS MBS-E-009776907, Hearing Exhibit 4/27-42. [Back]

2819. 3/9/2007 email from Sheara Fredman to David Viniar and others, GS MBS-E-009762678, Hearing Exhibit 4/27-16. When preparing a later internal presentation, in October 2007, Dan Sparks was even more blunt: "The desk benefitted from a proprietary short position in CDO and RMBS single names." 10/5/2007 draft of "Business Unit Townhall Presentation, Q3 2007," prepared by Mr. Sparks, Hearing Exhibit 4/27-47. Mr. Sparks removed this phrase from the final version of the presentation and told the Subcommittee he had been mistaken to include it in the earlier draft. [Back]

2820. 10/4/2007 letter from Goldman to the SEC, GS MBS-E-009758287, Hearing Exhibit 4/27-46. [Back]

2821. 10/29/2007 presentation by Craig Broderick to the Tax Department, GS MBS-E-010018512, Hearing Exhibit 4/27-48. See also 10/5/2007 draft presentation by Mr. Sparks, for a Business Unit Townhall meeting, GS MBS-E- 013703468, Hearing Exhibit 4/27-47 ("The desk benefited from a proprietary short position in CDO and RMBS single names."). [Back]

2822. 11/18/2007 email from Mr. Blankfein, "NYT," GS MBS-E-009696333, Hearing Exhibit 4/27-52. [Back]

2823. 1/2011 "Study & Recommendations on Prohibitions on Proprietary Trading & Certain Relationships with Hedge Funds & Private Equity Funds," at 22-44. [Back]

2824. 8/10/2007 email from Mr. Ostrem to Mr. Sparks, "Leh CDO Fund," GS MBS-E-010898470. [Back]

2825. Id. [Back]

2826. 8/10/2007 email from Mr. Sparks to Mr. Ostrem, "Leh CDO Fund," GS MBS-E-010898476. [Back]

2827. Subcommittee interview of Daniel Sparks (10/4/2010). [Back]

2828. 3/3/2007 email from Mr. Salem, "Another idea . . .," GS MBS-E-012511081. [Back]

2829. Id. [Back]

2830. Id. [Back]

2831. 6/7/2007 email from Mr. Swenson to Mr. Salem, "Fyi," GS MBS-E-012444245. [Back]

2832. Id. [Back]

2833. 7/12/2007 email from Mr. Birnbaum, GS MBS-E-012944742, Hearing Exhibit 4/27-146 ("He's definitely the man in this space, up 2-3 bil on this trade. We were giving him a run for his money for a while but now are a definitive #2."). [Back]

2834. See slides prepared by Mr. Birnbaum, "SPG Trading B 2007," GS MBS-E-015654036 -50. [Back]

2835. Mr. Birnbaum response to Subcommittee QFR at PSI_QFR_GS0509. [Back]

2836. Mr. Birnbaum, for example, received $17 million in 2007. Subcommittee interview of Joshua Birnbaum (4/22/2010). [Back]

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(6) Analysis of Goldman's Conflicts of Interest D. Preventing Investment Bank Abuses

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