Disclosure Delay Costs Goldman - Analyst Blog

Goldman Sachs Group Inc. (GS) has been fined $650,000 by The Financial Industry Regulatory Authority (FINRA) for its failure to disclose within a stipulated time the receipt of Wells Notice by two of its registered representatives.The Wells Notice was issued in relation with the offering of asynthetic collateralized debt obligation called ABACUS 2007-ACI (Abacus).

The two representatives − one Fabrice Tourre and an undisclosed employee − were served the Wells Notice by the Securities and Exchange Commission (SEC). Typically, a Wells notice is, in effect, an indication that the SEC intends to file an enforcement action against the person or entity to whom the notice is addressed.

Any Wells Notice needs to be reported to FINRA within 30 days of receipt. However, it was found that that this information was shared with FINRA after a lapse of over seven months and only following the filing of a complaint by the SEC against Goldman and Tourre in April 2010. While individuals at Goldman knew about the receipt of the Wells Notices, they failed to inform the Goldman compliance unit, which was responsible in providing information to the FINRA.

Goldman has neither admitted nor denied the charges but has assented to the settlement. However, under the settlement, Goldman has consented to review its supervisory procedures and reporting systems and would implement and document any required remedial measures.

Similar to Goldman, UBS Financial Services of UBS AG (UBS) was fined $370,000 in 2007 as it failed to report several broker information to the regulator in a span of three-year.

SEC Charges

The SEC's charges against Goldman Sachs involved an investment vehicle − Abacus 2007-AC1 − comprising subprime mortgage-backed securities. It was created by the company at the onset of the housing bubble burst.

The investors were informed by Goldman that the mortgage bonds would be selected by an independent manager. However, according to SEC charges, Goldman asked its client Paulson & Co. to select those mortgage bonds that they believed were the most likely to decline in value. Once the Abacus portfolios declined as they were bound to, investors lost billions, while Paulson made money from the bets against the mortgage bonds. The executives in question were a part of the US team that structured this product.

SEC Settlement

In July, Goldman Sachs agreed to settle the SEC lawsuit for $550 million. The settlement involved a civil penalty of $535 million and required the company to pay $15 million of profits from the Abacus deal.

FSA Settlement

Goldman has been fined £17.5 million ($27 million) in September 2010 for its failure to comply with the principles of the U.K. Financial Services Authority (FSA). Goldman did not disclose that SEC investigations were being carried on against Mr. Tourre when he shifted to Goldman's UK unit in London and became an FSA-approved person in November 2008.

Companies such as ABN Amro and IKB Deutsche Industriebank AG, a German bank, had made huge investments in Abacus and incurred severe losses. Ultimately, IKB received government support while ABN Amro had to be acquired by Royal Bank of Scotland Group plc (RBS).

Our Take

Run-ins with financial authorities could shatter investors' confidence, even when − or especially when − giants like Goldman are involved. Such issues are also likely to cast a shadow over the financials of the company.

However, Goldman maintains a well managed global franchise with a strong capital base and a leading position in investment banking, capital markets, trading and asset management business. We also believe that with the recovery of the U.S. economy, the company should experience an improvement in credit spreads.

Goldman currently carries a Zacks #3 Rank (Hold), implying no clear directional pressure on the stock over the next one to three months.