Does the Goldman Sachs Injunction Apply to Goldman?

A judge approved the settlement between Goldman Sachs and the SEC
A judge approved the settlement between Goldman Sachs and the SEC

Now that judge Barbara H. Jones has approved the settlement between Goldman Sachs (GS) and the Securities and Exchange Commission, and with additional details in hand that weren't available the first time I attempted to explain the consequences of the Goldman injunction, let's take a closer look at the injunction part of the settlement.

What's gotten most coverage is the $550 million fine, which is generally dismissed as meaningless to Goldman, even if large for the SEC or in an absolute sense. It turns out the injunction is somewhat similar -- potent in a normal world, but less so in Goldman's.

What the Injunction Means

The injunction forbids Goldman from violating Section 17a of the Securities Act in the future, a prohibition that seems odd given that no one is claiming Goldman did violate Section 17a. Yes, the SEC's suit accused Goldman of violating that law, but in the settlement, Goldman admits and denies nothing.

A couple of securities law experts explained to me, however, that firms don't agree to such injunctions if they haven't done anything wrong. Agreeing is a kind of tacit admission of wrongdoing and a black eye in the securities world. Indeed, judges don't grant prohibiting future bad acts if in fact there had been no prior bad acts. That's why, one of the experts said, injunctions can have formal findings that the firm getting an injunction did break the law, even if the consent accompanying the order neither admits nor denies wrongdoing.

But not in this case. Goldman avoided that particular result when the SEC agreed that findings of fact and findings of law would not be made as part of the order. If those findings were in the order, they would have included a statement that Goldman violated Section 17a. Another striking omission from the injunction is a prohibition against violating Section 10b-5 of the Exchange Act.

The SEC's original suit alleged violations of both Section 10b-5 as well as Section 17a, and both sections prohibit essentially the same conduct. So, why is only 17a covered? Was 10b-5 negotiated out by Goldman because, notwithstanding the forward-looking nature of the injunction, agreeing to it is a kind of tacit admission of wrongdoing that could aid investors that are suing Goldman? Investors can't sue under 17a, just 10b-5.

Other Major Consequences Just Won't Apply

If Goldman violates section 17a in the future, the SEC could go after it for contempt of court rather than have to prove a fraud case, which is considerably easier. That risk applies to all securities, not just the mortgage CDOs covered by the remedial measures Goldman and the SEC agreed to. That additional risk means Goldman is likely to take additional steps to tighten up its practices, beyond those in the consent agreement.

An injunction like the one Goldman agreed to technically means that Goldman, Sachs & Co., the Goldman group's broker-dealer, faces expulsion from the securities industry. Like all players in the securities industry, Goldman's broker-dealer is a member of the Financial Industry Regulatory Association (FINRA), and according to a securities law expert, the injunction is a statutory disqualification from FINRA membership. Without being in FINRA, a firm essentially can't function in the securities industry.

However, FINRA can grant a waiver from disqualification and undoubtedly will in this case. World markets would convulse if Goldman were kicked out of the financial industry. While it's possible to argue on the merits that Goldman doesn't deserve to be kicked out because of the injunction, and that a small firm in the same situation would be granted the waiver as well, it's worth noting that FINRA really can't consider refusing the waiver. FINRA declined to comment on this issue, despite repeated requests.

Waiver From "Bay Boy" Provisions Likely

Similarly, Goldman faces injunction-triggered consequences overseen by the SEC, namely the "bad boy" provisions, which prohibit, among other things, Goldman from making forward-looking statements. The SEC will also undoubtedly grant Goldman a waiver from those consequences, as it has done in the past.

However, as the securities law experts explained, that nearly automatic waiver is more because by the time the waiver application is considered, the consent agreement and any administrative proceeding the SEC chooses to bring will have resolved all the SEC's issues with Goldman, so that the SEC will already be satisfied that Goldman deserves the waiver. The consent/administrative proceeding smoothing the way for the waiver generally happens for companies affected by the "bad boy" provisions.

Although the public and the market are unlikely to care, by agreeing to the injunction Goldman took a hit to its reputation within the industry, according to the securities law experts. I'm not sure how meaningful that reputational damage is from an enforcement standpoint. To the extent that it increases companies' resistance to agreeing to an injunction, I guess it helps the SEC claim the injunction as a "win."