Notes, Views, and the Occasional Provocation March / April 2010 

The recently filed civil complaint in SEC v. Goldman Sachs & Co. opens a window into institutional finance during some of the most tumultuous days in U.S. market history. As it turns out, that world is not so different from the one that individual investors confront every day.

Back at the office, we have embarked on a spring cleaning and will soon be updating our furnishings and computer hardware – a renewal, if you will, in honor of spring. May your own spring be just as rejuventating.

Warm regards,

Milo Benningfield

The Perils of Customers Who Are Not Clients
Is a customer also a client? Not when it comes to financial services. more

From the BFA Blog
Highlights from our blog at more

BFA Media Quotes
Recent media quotes. more

The Perils of Customers Who Are Not Clients
The world of institutional finance is supposed to be different than what the average individual investor gets to experience. The allegations in the recently filed SEC v. Goldman Sachs & Co et al, show this isn't always the case.

The heart of the case is whether Goldman Sachs adequately disclosed certain facts about an investment known as a synthetic collateralized debt obligation ("CDO"). Putting aside the esoteric details, here's what happened:

A customer walked into a bank. They were greeted by a personable salesperson who offered to sell them an investment product so complicated that even he did not understand it. To enhance the pitch, the salesperson – a "registered representative" of the bank – advertised that the product was highly rated by an independent third party. The customer bought the pitch, purchased the product, and watched it plummet in value.

Goldman Sachs contends that the purchasers, mostly large European banks, were sophisticated investors who should have done their own research on the CDO. Fair enough. The commercial banks are big boys and, in any event, shouldn't have been betting their customers' deposits at the derivatives race track.

But this "sophisticated-investor" defense is telling. What it says is that Goldman Sachs, historically one of the most trusted advisors to the world's largest corporations, treated the European banks as customers, not clients.

Though often used interchangeably, "customer" and "client" have important differences. "Customer" comes from Latin meaning "habitual" or "custom" and has traditionally been applied to arms-length transactions involving commodity goods and services such as the purchase of groceries, gasoline, or a haircut. "Client" can also mean someone who buys goods or services, but is derived from the Latin "cliens," meaning "one who is dependent on another" and has traditionally referred to people served by professionals such as lawyers and accountants.

Professionals sometimes treat clients like commodities, and customers sometimes find their interests better served than clients, but the duties owed to each class could not be more different. The world of "customers" is characterized by transactions in which caveat emptor, or "buyer beware" is the guiding principle. By contrast, "clients" receiving professional services typically benefit from a "fiduciary duty" that requires the professional upon whom they rely to put their interests first at all times.

For well over a hundred years, Goldman Sachs was a professional-service firm structured as a partnership like law firms and accounting practices. The firm derived most of its revenues from investment banking, which meant advising corporate management on a variety of critical corporate transactions such as raising capital and acquiring new businesses. In the 1980's, Goldman cemented its reputation as a trusted advisor by being the only large investment bank that refused to help "raiders" take over companies with hostile bids and leveraged buyouts.

In 1999, Goldman abandoned its partnership structure to become a publicly traded corporation, Goldman Sachs Group, Inc. Within a decade, investment-banking fees had declined from almost half the firm's revenue to less than 10%. Meanwhile, profits from proprietary trading rose to more than three-quarters of revenue, prompting some commentators to characterize the firm as a "hedge fund masquerading as a bank."1

Did Goldman's change in ownership structure and increased emphasis on trading cause the problems plaguing it today? Despite all the negative headlines, it's still difficult to say. What we can say is that a parallel transformation in retail finance has left many individual investors swimming in the same dangerous waters as the European banks in SEC. v. Goldman Sachs.

In 1999, the repeal of the 1930's Glass-Steagall Act allowed banks for the first time since the Great Depression to merge speculative activities such as proprietary trading and securities underwriting with their traditional depository activities. Banks went from being stodgy institutions intent on guarding customers' deposits to "financial supermarkets" where "cross-selling" became the goal. Even bank tellers were trained and incentivized to spot opportunities to sell customers everything from mortgages, insurance, and mutual funds.

Today the world of retail finance is dominated by nationwide distribution channels staffed by approximately 630,000 "registered representatives" – a.k.a., stockbrokers, financial consultants, insurance agents, etc. – whose duty of loyalty runs not to their customers, but to the financial institutions themselves. These registered reps have a duty to recommend "suitable" investments – in other words, not a complete lemon – but not necessarily the best one for a customer's circumstances.

Unbeknownst to most investors, there is, in fact, a subset of professional investment advisers who, like doctors and lawyers, are legally obligated to put clients' interests before their own. Regulated by the SEC and similar state agencies, these "registered investment advisers," or RIA's, have a statutory "fiduciary duty" imposed on them by the Investment Advisers Act of 1940. The trouble is, there are only about 40,000 state and federal RIA's in the U.S., making them difficult for many investors to find.

The current push for regulatory reform offered a rare opportunity to remedy the dual set of standards for financial advisers and impose a fiduciary duty on each and every one. However, the proposals never made it onto the table, leaving consumers to fend for themselves in a caveat-emptor world. As the case of SEC v. Goldman Sachs illustrates, it is a perilous world, for individuals and institutions alike.

In a now-infamous email by Goldman Sach's registered rep Fabrice Tourre, quoted by the SEC in its complaint, he admitted that even he did not understand what he was selling:

More and more leverage in the system, The whole building is about to collapse anytime now . . . Only potential survivor, the fabulous Fab[rice Tourre] . . . standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities!!!2

There are even reports that Tourre joked about selling investments he expected to decline to "widows and orphans." In an email to a girlfriend, he boasted, "'I've managed to sell a few abacus bonds to widows and orphans that I ran into at the airport, apparently these Belgians adore' the complex investments." 3

Tom Wolfe, author of the 1980's Bonfire of the Vanities, and Oliver Stone, creator of the 1980's character Gordon Gekko in Wall Street, must be green with envy that they couldn't create the character Fabrice Tourre. The founders of the general partnership formerly known Goldman Sachs & Company must be rolling in their graves.

back to top

From the BFA Blog
You can access our blog at, or by going directly to the home page of our website at You can also click on the link below to go directly to the post.

Watering & Weeding
It's spring! So time for a gardening metaphor.

back to top

BFA Media Quotes

The New York Times, March 25, 2010
Milo was quoted in Tara Siegel Bernard's article "Start Saving Early, and Keep an Eye on Shifting Needs," which discusses the flexibility that needs to built into any long-term financial plan. Quoted throughout the article, Milo noted that many people have become disenchanted with long-term planning: "Financial planning is being sold to them, and they see it as a purely quantitative process using variables over which they don't have the least bit of control. And that breeds cynicism."

He noted that in any good plan a balance must be struck between current wants and future needs: "I don't want 20-year-olds to say, 'My dream is to go to Paris, but I can't because I have to put aside $100,'" Mr. Benningfield said, adding, with a chuckle, that it might discourage future Hemingways. "Sometimes deferring gratification temporarily could mean deferring it forever. Mortality, disability, divorce, kids, mortgage, all of that stuff may get in the way." Read the article.

BusinessWeek Online, March 10, 2010
Milo was quoted in Ben Steverman's article, "Small Investors Remain Wary After 69% U.S. Stock Bounce," which discusses how individual investors have remained skeptical of stocks despite one of the biggest market rallies in history this past year. Milo noted, "Nobody believes the rally is real." Read the article.

Thank you for reading. Please look for our next newsletter in June.

Best regards,

Milo Benningfield

1 "Unraveling the Profit Puzzle at Goldman Sachs," PBS NewsHour report by Paul Solman, February 11, 2010.

2 SEC v. Goldman Sachs complaint, paragraph 18.

3 "E-mails Show Goldman Boasting As Meltdown Unfolds," Associated Press, April 24, 2010.

back to top

Copyright 2018 - Benningfield Financial Advisors