Analogies in SEC v. Goldman Case

Goldman Sachs told customers the terms of a bet would be set by an independent agent but the SEC alleges a competing customer actually played a significant role setting the terms, which may have been more favorable to it. Consensus emerges that the legal issue is whether it is important to the original customers that terms were set by an independent agent or the competing customer, given that they could inspect the terms for themselves.

It can be useful but difficult to find suitable analogies to help think about this. Yesterday on this blog Deric Ortiz asked whether this is akin to any buyer and seller of securities who simply have different views of the bet, whoever set its terms, which are available for all to see; today in The New York Times Binyamin Appelbaum sees a rough equivalence to alleging that an antiques dealer “lied about the provenance, but not the quality, of an old table.”

I’m not sure either of those analogies work.  I’ve come up with other candidates posted below, most of which also seem off for various reasons.  I’d like to invite interested creative readers to take a few minutes to contribute additional nominees.  

1. A casino operator tells gamblers the dice at the craps table were selected by the state gaming commission (but they are actually selected by a competing gambler, and may or may not be loaded)

2. A real estate developer tells buyers of a new co-op that the allocation of shares was determined by an independent licensed surveyor (but they were actually allocated by one of the other buyers)

3. A university tells applicants that admission from its wait list is determined by random lottery (when in fact they are chosen by another applicant)

4. A Dean tells professors that classroom and time assignments were made by the Academic Dean using an algorithm (when in fact they were chosen by another professor)

5. A rare coin dealer tells buyers that coins are appraised by an independent appraiser (but they were actually appraised by a competing collector)

6. An art auctioneer tells bidders that the authenticity of paintings is verified by independent art historians (but that is actually done by a rival bidder)

7. A lottery commission tells ticket buyers that winners are chosen by lot supervised by an independent auditor (but winners are actually chosen by another ticket buyer)

8. The home football team says the opening coin toss is flipped by an impartial referee (but the flip is actually made by a home team booster, using a coin that may or may not be two-headed)

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12 Responses

  1. Jeff Lipshaw says:

    Horse racing bettor X wants to win a boxed trifecta. He influences the track secretary to set up a twelve horse race with the three moderately long-shot horses he thinks will finish 1-2-3 (they are new to this track). The track indeed facilitates that race. Otherwise, all the relevant data appears in the program and the Racing Form. The track never reveals that X had a hand in setting the field. The nature of parimutual betting is a zero sum game; indeed, the horses finish 3-1-2 (hence, the boxed trifecta) and the innocent bettors\’ loss is X\’s gain. Was the fact of X\’s involvement material?

  2. Scott says:

    A legal drafting professor in a “forced curve” section administers a final project to the students, and distributes to each student a scoring rubric to be used to assign the raw scores before curving. The professor gives the class the impression that he designed the scoring rubric himself, when in fact, the professor allowed one of the students in the same class to design the rubric (including the weight to be assigned to each desired skill or competency).

  3. Lawrence Cunningham says:

    Jeff: Thanks for the excellent horse racing analogy! It nicely adds the idea that the competing player induced the operator to rig the bet, raising additional issues, plus the economic feature of the zero-sum game.

    I’d strengthen it by treating the information in the program and Racing Form as a track representation that the field was set by an independent agent. Then to restate in the forms above:

    9. Horse-racing track tells bettors that the fields were selected by an independent racing agent (but the field was actually set by a competing bettor).

  4. Scotty says:

    I like 1, the craps analogy, if the dice are chosen by another gambler who is betting “don’t pass,” i.e., against the shooter.

    I also like 7, the lottery analogy, if the numbers are picked by an insurer who has insured the state against a jackpot.

  5. Andrew Lund says:

    To add to Jeff’s metaphor and expose my limited understanding of handicapping:

    The competing bettor believed that horses who had previously raced on synthetic tracks were more likely to do well when transitioned to dirt (the surface at the track in question) than other bettors commonly believed. He planned to bet the field against the handful of dirt horses he put into the race whom he expected to be overvalued by competing bettors. The track represents to the public that the field was chosen at random, and puts all the normal info into the racing form. Finally, the track supervisor tends to agree with the first bettor’s appraisal of the dirt/synthetic debate and takes out an insurance policy on behalf of the track against the first bettor’s bet but does not take out a policy against the public’s pro-dirt-to-dirt bets.

  6. Jeff Lipshaw says:

    Thanks for the kind words, Larry, but I think the best analogy or metaphor is to Goldman as bookie, as I posted on Saturday over at Legal Profession Blog and my continuing series over the weekend!

  7. Lawrence Cunningham says:

    I appreciate these wonderful contributions.

    On Jeff’s last note (6) and his enjoyable cross-linked post: I see analogizing Goldman to a mere bookie taking bets on both sides of a wager, like a sporting match between two teams. If that’s all that happened, bettors on the losing team have no complaint, nor does the SEC (though state gaming commissions could probe).

    But in our case, the bookie did more. It told one side the game would be played on terms set impartially; it allegedly let the game be played on terms set by bettors on the other side (like having ringers play for their team and second-stringers or injured players for the other?).

    Again to restate: A sports promoter tells fans the game will be e played, and players chosen, according to league rules (but they are actually determined by a competing bettor on the game).

  8. Deric Ortiz says:

    I think Jeff’s analogy seems to be the best at the moment.

    I would suggest some additions to make the analogy a little less lopsided:

    1. Remove ‘innocent’ from modifying ‘bettor.’ I think it’s better to think of X and the other bettors as being equally sophisticated with respect to horse racing.

    2. Add that these horses that are ‘new’ to the track are also known throughout the racing community such that the other bettors are able to make informed judgments about the likelihood of them being successful based on information like pedigree and such (if they are diligent and choose to).

    3. X is not an oracle in the horse-racing industry, in fact, he’s been wrong before just as often as the other bettors.

  9. Deric Ortiz says:

    8. “The home football team says the opening coin toss is flipped by an impartial referee (but the flip is actually made by a home team booster, using a coin that may or may not be two-headed)”

    I like this analogy second best only if we agree that the coin has two sides. The reason I like it is because it, I think, crystallizes my contention. The booster here cannot affect the result of the coin flip. He may think it will be heads or he may think it may be tails but the way it fails is decided by forces greater than himself.

    What does it matter? If I got to check that the coin has two different sides, I would not be intimidated. In fact, they could bring their best booster because no matter how much he wants it to land in favor of his team he is powerless over what actually happens.

  10. Dimitris Andrakakis says:

    Lawrence : I understand you’re looking for analogies here, but I think this can be misleading.

    My opinion, for what it’s worth, is that regardless of whether one can find a good analogy or not, SEC’s concerns are valid and true. The “but they could inspect the terms for themselves” argument has been shown to be misleading and/or dishonest (see for example the excellent “Intractability of Financial Derivatives” on Freedom to Tinker blog).

    Simply put, if the bet could be sufficiently analyzed with reasonable effort, then there wouldn’t be a requirement for an “independent agent”.

  11. Anon321 says:

    Something about the analogies to betting seems to miss the mark. As I understand it, banks like Goldman don’t create financial products with a mindset of “we neither know nor care whether this product will succeed; we’re creating it simply to facilitate betting between investors.” Rather, they create financial products that they expect will be good investment vehicles (with “good” meaning different things in different contexts, but in any event, not designed for the purpose of losing money for anyone who invests in it). As the price of the financial product fluctuates, investors are certainly free to bet against it by selling or shorting it, but that seems quite different from creating a crummy product for the specific purpose of betting against it.

    As such, I’d offer the following analogy. A real estate company builds a new residential high-rise and offers investors the opportunity to buy condominiums in it. The company tells the investors that the building and the units were designed by one of its customers. They don’t disclose that the designer created the building with the hope and expectation that it would crumble so that he could collect on a huge insurance policy that he had taken out on it.

  12. Jon G. says:

    I like Anon321’s reference to insurance (post #11) because it encapsulates the credit default swap (CDS) aspect through which Paulsen made his money. I would tweak the analogy, however, as follows:

    When selling the condos to investors, the real estate company discloses that the building passed a structural inspection by an independent inspector and discloses the identity of the inspector but not the designer of the building. Meanwhile, the inspector, who knows the identity of the building’s designer, is unaware of the fact that the foundation was designed to be, and in fact is, unstable (perhaps he “overlooked” this during his inspection or perhaps he is not the most competent inspector).

    Finally, the real estate company knows, but does not disclose, that the designer purposefully designed the foundation to be unstable (even though it might technically be “up to code”) and that the designer has a large insurance policy on the building with the hopes that it will crumble on the weak foundation. And, we must also assume that the investors do not also purchase insurance and are instead relying solely on the appreciation of their units for profit. Thus, if the building goes down, they lose their entire investment.