What Goldman Should Tell the Senators
The early questioning in the Senate's hearing on Goldman Sachs centered on the following question: do broker-dealers have a fiduciary duty to act in the best interest of their clients? Both Senators Carl Levin (D-MI) and Susan Collins (R-ME) wanted an answer to this question. They didn't really get what they wanted. It's unclear why, however, because the bankers testifying certainly could have appropriately answered the question.
That answer is related to a post from yesterday, which explained a banker's fiduciary duty. The answer is yes and no, depending on what you mean by "best interests." As a market maker, an investment bank does have a duty to act in the best interest of their clients, but not the way the Senators are looking for. They think Goldman should have informed its clients of its world view of how the market might perform in the future.
Market makers need to provide clients with fair market pricing along with full and accurate information about the securities that they're selling. Goldman was not acting as an investment advisor in the examples the Senators used. As a result its bankers should not have provided clients with their opinions on the future performance of those securities.
Megan McArdle explains one reason why: because Goldman's opinion doesn't much matter. Large sophisticated investors have their own assumptions and beliefs about the market. They would be crazy to assume Goldman is always right about the future. Even the brilliant bankers within the walls of its 85 Broad Street headquarters get things wrong from time to time.
There's another important reason why Goldman -- or any other broker-dealer -- couldn't act in the best interest of its clients in the sense the Senators wish, however. It would literally be impossible. Much of investing is a zero-sum game. There are two sides to each bet. For a bank to favor one party over the other, then it would necessarily harm one of its clients. If it has an opinion adverse to one investor's interests, then it would be doing that investor a disservice by providing that opinion to the other party.
That's why all an investment bank can do is present full information to all investors and allow them to decide whether or not to buy a security. At one point Collins states that Goldman's clients weren't just paying big fees for efficiently conducting transactions, but for their "judgment as well." That's simply false. And any investor who thought Goldman put its stamp of approval on any security it sold would have been incredibly foolish.
Collins went on to suggest that Congress should impose a clear fiduciary duty on broker-dealers. Presumably, she means in the way she suggests -- where a broker-dealer's judgment on a security it sells matters. For the reasons explained, that would be completely nonsensical, because it would make a marker-maker's job impossible. It should remain neutral on performance, and unite investors on both sides of a trade at a fair market price.
It's unclear why Goldman's bankers aren't just carefully explaining this point. Their allusive techniques, which include taking as long as possible to reply to questions, providing vague answers and failing to "recollect" various things, simply makes them look worse. But it does begin to show why so many Goldman alumni find their way to Washington -- they sound more like politicians than bankers.