The widespread media coverage of the Securities and Exchange Commission's case against Goldman Sachs has created some public interest about how Wall Street works. To many Main Street observers, the deal looks pretty shady. There's some possibility that Goldman misled investors, but a new report about Deutsche Bank doing largely the same thing makes it appear that the SEC's case could be based on a mere technicality. Goldman referred to an independent collateral agent having created the portfolio for the security purchased by investors, though a hedge fund manager was also involved. Deutsche Bank employed no such third-party, so there could have been no such deceit on its part.
Whether or not Goldman is ultimately found to have committed fraud, many people who have read some details of the case likely believe that there were ethics violations, given the appearance that Goldman believed the security would perform poorly. Shouldn't an investment bank that creates a security have an obligation to only sell it if the bank believes it will perform well? Not necessarily.
The Role of an Investment Bank
First, it's important to understand the role of an investment bank. It's a glorified middle man. Its job is to bring together buyers and sellers and facilitate a transaction. This involves all sorts of financial products. Here are a few examples:
- M&A: If a firm is looking to be acquired or acquire another, an investment bank can advise it on its options, pricing, etc. It can also solicit offers and facilitate the transaction's closing.
- Equity/Debt Sales: If a company wants to sell some stock or bonds, it can go to an investment bank. The bank can then work with the company to create an offering and find investors to purchase the resulting securities.
- Derivatives: If a company or investor wants some kind of financial exposure, an investment bank can find another company or investor who wants the opposite exposure. It can then create a derivative to satisfy the demands of both parties.