Here’s Their Chance

The SEC has no sense of humor about insider trading.

I’ve covered the entire country in the past few months speaking to various organizations and promoting The Vigilant Investor. There’s always a Q&A at the end of the speech. On the list of the top five questions that I get after those speeches is: “Why hasn’t anyone been prosecuted for the actions that led to the subprime crisis and the Great Recession that followed?” I explain that many criminal charges require proof of a culpable mental state, and that prosecutors may have decided that they cannot prove an intent to defraud. Still, the masses are crying for a prosecution. A story from Reuters suggests a target that, while not related directly to the sub-crime crisis, might satisfy those who want to see a millionaire in handcuffs.  According to Felix Simon of Reuters:

What on earth did Hank Paulson think his job was in the summer of 2008? As far as most of us were concerned, he was secretary of the US Treasury, answerable to the US people and to the president. But at the same time, in secret meetings, Paulson was hanging out with his old Goldman Sachs buddies, giving them invaluable information about what he was thinking in his new job.

The first news of this behavior came in October 2009, when Andrew Ross Sorkin revealed that Paulson had met with the entire board of Goldman Sachs in a Moscow hotel suite for an hour at the end of June 2008. He told them his views of the US and global economies, he previewed a market-moving speech he was about to give, and he even talked about the possibility that Lehman Brothers might blow up. Maybe it’s not so surprising that Goldman Sachs turned out to be so well positioned when Lehman did indeed do just that a few months later.

Today we learn that the Goldman meeting in Moscow was not some kind of aberration. A few weeks later, on July 28 2008, Paulson met with a who’s who of the hedge-fund world in the headquarters of Eton Park Capital Management — a fund founded by former Goldman superstar Eric Mindich.

The secretary, then 62, went on to describe a possible scenario for placing Fannie and Freddie into “conservatorship” — a government seizure designed to allow the firms to continue operations despite heavy losses in the mortgage markets…

Paulson explained that under this scenario, the common stock of the two government-sponsored enterprises, or GSEs, would be effectively wiped out…

The fund manager who described the meeting left after coffee and called his lawyer. The attorney’s quick conclusion: Paulson’s talk was material nonpublic information, and his client should immediately stop trading the shares of Washington- based Fannie and McLean, Virginia-based Freddie.

When we found out about the Moscow meeting, I asked how on earth Paulson thought such behavior was OK. But now I think he was downright pathological in giving inside information to his old Wall Street buddies. And the crazy thing is that we have no idea how many of these meetings there were, or how long they went on for — the only way that we ever find out about them is when reporters like Sorkin or Bloomberg’s Richard Teitelbaum manage to find a source who was in the meeting and is willing to talk about what happened.

Given that it’s taken two years since the release of Sorkin’s book for the Eton Park meeting to be made public, it’s fair to assume that there were other meetings, too — possibly many others. Paulson was giving inside tips to Wall Street in general, and to Goldman types in particular: exactly the kind of behavior that “Government Sachs” conspiracy theorists have been speculating about for years. Turns out, they were right.

Paulson, says Teitelbaum, “is now a distinguished senior fellow at the University of Chicago, where he’s starting the Paulson Institute, a think tank focused on U.S.-Chinese relations”. I’d take issue with the “distinguished” bit. Unless it means “distinguished by an astonishing black hole where his ethics ought to be”.

Those are serious charges, and Investor’s Watchdog has no facts with which to confirm or refute them. But I’d be surprised if the SEC does not have an investigation into Paulson’s conduct. Whether such an investigation ever results in enforcement action will depend upon whether those who received information from Paulson traded after receiving that information. If they did, and they profited, I predict an insider trading case that makes the front page of the Wall Street Journal.  I do not know whether Paulson’s communications might be legally protected. But anyone who traded on the basis of information they learned from Paulson could claim no such protection. The SEC has no sense of humor about insider trading. They are loathe to let it slide. If they can prove a case, they will.

Leave a Reply