Warren Buffett may understand the complex derivative at the heart of the fraud suit against Goldman Sachs (GS) “better than most,” as he put it this past weekend, but I’m not sure he understands the securities laws or the legal definition of fraud.
Buffett mounted a vigorous defense of Goldman, the embattled firm in which he is a major investor, arguing that the identity of the investor betting against the collateralized debt obligation — hedge fund manager John Paulson — would have been irrelevant to the investor betting on the underlying subprime mortgages. “For the life of me, I don’t see whether it makes any difference,” Buffett said at the Berkshire Hathaway (BRK.A) annual meeting. This point has been echoed by many of Goldman’s defenders, who note that the firm has no duty to disclose the identity of counterparties to trades in which the firm stands in the middle.
But that argument is a straw horse. The SEC didn’t file a fraud case because Goldman failed to disclose Paulson’s identity to potential counterparties. As the SEC itself said, “Goldman Sachs failed to disclose to investors vital information about the CDO, in particular the role that a major hedge fund played in the portfolio selection process and the fact that the hedge fund had taken a short position against the CDO.” The essence of the alleged fraud is that Goldman let the short seller choose some of the underlying subprime mortgages, failed to disclose that, and instead promoted the idea that an independent third party chose those securities. This is the material fact at the heart of the SEC’s case. (Berkshire Hathaway did not return calls seeking comment.)
With last weekend’s Kentucky Derby in mind, let’s consider a horse racing analogy. There are just two horses and two betters. The promoter offers you the opportunity to bet on one horse. Someone else is betting on the other. He doesn’t tell you that the other better chose the two horses in the race, and picked one horse with no chance of winning. Instead, he says the horses were picked by an independent racing federation. You bet and lose. Would you feel that was fair?
I doubt it. Perhaps this is why most people seem to intuitively understand the SEC’s case, unlike supposed experts like Buffett and others with a vested interest in seeing the SEC fail.
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The Hole in the Buffett Defense: http://bit.ly/95VQra via @addthis
I think he understands, but is betting that we won't! @SmartMoney The Hole in the Buffett Defense http://bit.ly/9c2f15
Piggybank: The Hole in the Buffett Defense http://bit.ly/9lcpaF
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