Goldman Sachs reached a $5.1 billion settlement with the Department of Justice earlier this week. That is a big chunk of change. It wipes out more than half a year’s earnings. And Goldman agreed to a “statement of facts” that (as per DoJ):

describes how Goldman made false and misleading representations to prospective investors about the characteristics of the loans it securitized and the ways in which Goldman would protect investors in its RMBS from harm.

So this sounds like a car manufacturer admitting they told customers their cars had lower emissions than they actually did.

In one sense, this is a step forward. We aren’t seeing settlements where the company “neither admits, nor denies”. Goldman is admitting to a set of facts, and the key statement here is “false and misleading representations”.

Or are they? When you read the statement and settlement, it’s clear Goldman’s lawyers (the best that money can buy) didn’t actually agree to label their actions as “false and misleading representations”. That is the DoJ’s interpretation of the facts, but the FT has gone ahead and reported that Goldman admitted to mis-selling. What Goldman actually said is that they are “pleased to have put these legacy matters behind us”.

Funny story, the people who created those “legacy matters" are still around. By the way, I don't mean to pick on Goldman, it's just that this settlement was conveniently agreed to last week. The other cases aren't too different.

Making false representations in securities offerings is a crime. Depending on the severity, it can and should lead to criminal prosecution. Now, I can understand why the DoJ lawyers might think they’ve got their man. The statement of facts that Goldman admitted to listed several such misrepresentations:

Goldman told investors in offering documents that “[l]oans in the securitized pools were originated generally in accordance with the loan originator’s underwriting guidelines,” other than possible situations where “when the originator identified ‘compensating factors’ at the time of origination.” But Goldman has today acknowledged that, “Goldman received information indicating that, for certain loan pools, significant percentages of the loans reviewed did not conform to the representations made to investors about the pools of loans to be securitized.”​

Translation: We told customers there weren’t any rotten apples, but really we knew a third of the fruit had worms swimming in them.

For example, Goldman has now acknowledged that in late 2006 it conducted an internal analysis of the underwriting guidelines of Fremont Investment & Loan (an originator), which found many of Fremont’s guidelines to be “off market” or “at the aggressive end of market standards.” Instead of disclosing its view of Fremont’s underwriting, Goldman has acknowledged that it “[u]ndertook a significant marketing effort” to tell investors about what Goldman called Fremont’s “commitment to loan quality over volume” and “significant enhancements to Fremont underwriting guidelines.” Fremont was shut down by federal regulators within several months of these statements.

Translation: We found out one of our orchards was putting a lot of rotten fruit in shipments, but we decided to tell everyone they were committed to shipping quality apples.

Oh yeah, and our tainted apples put the fear of god in everyone and millions of people out of work and millions of people lost their homes.

Some of the actions described were taken by entire committees of senior bankers charged with reviewing the quality of the mortgages. They knowingly ignored reports and warnings that suggested the mortgage pools had a large number of bad loans which did not meet the state's standards for the pools.

In an encouraging sign, DoJ is talking about prosecutions:

The settlement expressly preserves the government’s ability to bring criminal charges against Goldman, and does not release any individuals from potential criminal or civil liability. In addition, as part of the settlement, Goldman agreed to fully cooperate with any ongoing investigations related to the conduct covered by the agreement.

That should scare them! But the thing is, there is no indication the DoJ is actually pursuing any such prosecutions. And as I’ve discussed before, the statute of limitations is running out on many of these cases.

Now let’s imagine what would have happened if, instead of selling billions in MBS, Goldman employees had been selling fake concert tickets. Well, they’d be going to jail, just like these guys. But none of the people who were engaged in selling shoddy MBS are headed for jail, nor are any of the mortgage brokers/bankers who originated those shoddy loans.

Heck, if they’d written software to buy up concert tickets online and scalp them, they’d be serving probation, like these guys. But since the financial crisis didn't involve anything nearly as important as tickets to a football game, no one is about to get probation in this investigation.

Hell, if they’d been commercial truck drivers and had stolen cargo from their employers, they’d be going to jail, like this guy. But no one who collected bonuses knowing they were based on revenue generated from securities fraud is headed for jail.

Shucks, if you’re a commercial truck driver and change lanes illegally, your license would be suspended. Yet none of the individuals who have been implicated of either gross negligence, or fraud have lost their securities licenses.

You probably have a theory about why no one’s been prosecuted (apart from the odd low-level drone).

I have a theory too. And it goes like this.

All the prosecutors at the Justice department and the SEC are lawyers with graduate degrees. When they look at people at large investment banks, they see, in many cases, versions of themselves. It’s tough to throw yourself in jail, and you always want to go easy on yourself.

It’s much easier to be tough on some kid selling counterfeit tickets outside a baseball game.

He cheated nice people out of their money, what a good-for-nothing thug. Never even went to college. Deserves to be in jail. My kids would never be caught selling fake tickets. Let’s throw the book at him.

Just as race plays a role in our criminal justice system, class undoubtedly does as well. That's partly why boiler room operators get the book thrown at them.

Some punks from the five towns thinking they can sling bonds. What a fraud. That guy wearing tasseled loafers, he looks like a stand-up guy, I'm sure it was a mistake, he can't have meant any harm.

So kids selling counterfeit tickets go to jail. While guys in suits (and a few gals) selling bum securities keep selling them.

And let's be clear, if the facts carry the DoJ interpretation (false and misleading statements), then it's just like selling fake tickets. This isn't your usual investment case where a client lost money in a bad market and we are arguing over whether they pushed their broker to buy risky tech names or not. The DoJ is saying Goldman’s employees knowingly made false statements while selling securities. Everyone who has ever taken a securities licensing exam knows that is a crime.

But instead of individuals paying for the crimes DoJ says they engaged in, what happened is that their company paid a multi-billion dollar fine. That didn’t come out of their pockets, it came out of shareholders. If we’re being generous, we could say that it reduced their salaries some. And yes, Goldman’s board did reduce the CEO’s salary by 4%. From $24 million to $23 million. Now that’s what we call accountability.

The thing is, reducing someone’s salary a few percent doesn’t really send a message. I doubt Blankfein will be forced to engage in significant belt-tightening because he’s making $1 million less this year.

The real reward in the business is the opportunity to continue playing the game so that next year you can collect another multi-million dollar payout. If people were sent to jail, were given probation, barred from the industry, or had their licenses suspended, that might send a message. The last remedy doesn’t even require a conviction in court. FINRA, the “self-regulatory organization” that awards securities licenses, could suspend licenses based on a hearing. Under FINRA’s sanctions guidelines, negligent misrepresentation can lead to a 2 year suspension. Intentional misrepresentation could lead to a lifetime bar. So FINRA can take away the ability of individuals to continue working in this industry. And at one time, prosecutors did insist on such lifetime bans for senior executives.

We don’t seem to have a problem with taking away truckers’ licenses if they make a mis-step, why isn't the same true for bankers?

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@subirgrewal