The Goldman Sachs Defense

Posted in Blog at 11:48 am

The following exchange on the website LinkedIn was stimulated by a question posed by the sales manager for an Indian securities firm, “What are the three most essential skills of an equity sales person?”  The question was posted on April 28, 2010, at the time of the acrimonious Congressional hearings on Goldman, Sachs’ alleged misbehavior in marketing a CDO that was deliberately designed, at the request of a Goldman client, as a shorting vehicle, without telling purchasers of the security that this was the case.  Goldman’s defense was that this was industry practice, and not illegal.  Perhaps not, but as a portfolio manager for many years, I found this defense alarming, and therefore felt it incumbent to put unwillingness to do this to one’s clients as my top criterion for a good salesman.

After reading the testimony of all those Goldman people, I think I’ll put Honesty at the top of the list. Two, Ability to Listen to What the Client is Saying. Three, Independent Analytical Intelligence. To expand upon these:

(1) I don’t want to have to worry about being nailed by my brokers. They can make mistakes, they don’t have to be perfect forecasters, but I don’t want them to shaft me (even by just withholding a key bit of information) in order to help out their own trading operation, or their own corporate finance group.
(2) Brokers who give you the same spiel whether you are looking for something totally different, are in a hurry, or obviously have your mind on something else, are useless. If they think the story is good, they should come back with it when they have your attention. If you don’t like it, and tell them why, they should note for future reference that this is something you don’t buy, period.
(3) I can read the research myself. The broker should be able to analyze it, and he should also be able to tell you how good he thinks it is, and not just parrot back the house line.

Anything else I would consider extraordinary, and not to be demanded, although I will pay more when I find it. For example, having a strategic thinker is a real asset. But you can’t expect this from most salesmen. Exceptional service—as opposed to merely very good service—is a plus, but I don’t kid myself into thinking I’m the only client the salesman has, even if I’m one of the biggest.

This prompted another member of this LinkedIn group to question my analysis:

Question for you Andrew regarding your above Gman comment about honesty. In the case of CDS (which as we know is a zero sum game). Is it common that in the various covenants of a “brokered” CDS contract, there is an exposure of the party on the other side of the trade? I think not? OK, if it’s between XYC and ABC they obviously know, but as Gman is acting as a “broker”, or market maker between two traders, the broker typically doesn’t reveal to each side the other trader’s identity. From what I know, that’s the case..but I may be wrong? Let us know if that’s been your experience.

That depends upon whether I am talking to an institutional salesman or to the trading desk. I don’t necessarily have a client relationship with another organization’s trading desk; I know they are a counterparty, pursuing only their own interest. If I am talking to a broker, however, who claims to be a middleman, and especially to its institutional salesman, who claims to be my representative at that broker’s firm, I expect him not to deliberately try to screw me. Otherwise, what is he for? I can trade directly with a market-maker on the screen or over the telephone, and would have no expectations that this was anything other than an arm’s length transaction.

The broker/salesman tries to develop a personal relationship with the portfolio managers who are potential buyers and sellers of securities. He offers them advice on what he is seeing and hearing from his colleagues and from the marketplace. The PM, even if he works for the most savvy hedge fund in the world (and that is not the sort of buyer we are talking about in the Goldman case), is not in the same middle-of-the-marketplace situation, must necessarily talk to other PMs as competitors, and cannot have access to the same information, which is why he depends upon brokers for some assistance and advice. If his broker fails to tell him that he is knowingly marketing a security that he and his colleagues expect will fall sharply in price, the customer has every reason to feel betrayed.  This is doubly true, when, as here, we are talking about equity sales, where there are so many more variables hidden behind the security.

Traders may be in the game only to maximize the results from their own book, but the reason they are nowadays under the umbrella of investment banks is because it gives them access to more order flow, on more advantageous terms, because the bankers can gain marketing muscle, and because the broker can offer better execution. But the quid pro quo is that the traders shouldn’t try to happily screw anyone who comes near them with the same abandon they could when they worked for specialized firms that offered no other service than bids and offers. Just as their corporate finance people should recognize they are under an obligation not to offer clients deceptive advice so that they are left exposed to a hit on their treasury, a bankruptcy, or a hostile bid.

If all Goldie and its peers can offer today are bids and offers, they should (a) fire all those expensive salesmen and bankers, (b) stop hawking research, and (c) stop pretending they are an investment bank, or anything other than a used car lot for securities. It is the development of amicable business relationships under the guise of offering advice that creates a moral obligation towards your client. Whatever Darwinian universe the traders want to inhabit is their own business, but it should not be allowed to infect the whole firm.

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