In any area of commerce other than the securities industry, words like "honesty", "integrity" and "fair dealing" leave no room for confusion. Nor do representations that "our clients interest always come first". Or "we are dedicated to complying fully with the letter and spirit of the laws, rules and ethical principles that govern us." When we hear or read those words, we take comfort in the high, impeccable standards of those in whom we are asked to trust.
According to a shareholders class action lawsuit filed in the United States District Court for the Southern District of New York (In re Goldman Sachs Group, Inc. Securities Litigation: Master File No. 1:10-cv-03461), Goldman Sachs made those representations and others. It did so in response to the fallout from large transactions in synthetic CDO's. The complaint alleges that Goldman's annual reports repeatedly touted "The Goldman Sachs Business Principles," which included the following statements:
1. "Our clients' interests always come first. Our experience shows that if we serve our clients well, our own success will follow."
2. "We are dedicated to complying fully with the letter and spirit of the laws, rules and ethical principles that govern us. Our continued success depends upon unswerving adherence to this standard."
3. "Integrity and honesty are at the heart of our business."
The complaint alleged that Goldman Sachs' conduct in certain CDO transactions made these statements materially false and misleading.
Goldman sought to have the complaint dismissed on various legal grounds. Of particular interest to me was its position concerning the statements about its core values of honesty and integrity. Here's the view expressed by its lawyers, in their memorandum urging the Court to dismiss these claims:
"Further, the vast majority of the supposed "misstatements" alleged in the Complaint -- e.g., regarding the firm's "integrity" and "honesty" -- are nothing more than classic "puffery" or statements of opinion that, under well-settled law, cannot give rise to a securities fraud claim."
For those not well-versed in legal-speak, "puffery" has been described by one legal scholar as vague statements of corporate optimism that is often characterized as "so obviously unimportant to a reasonable investor that reasonable minds could not differ."
So, does Goldman's legal position mean that investors should not rely on statements concerning its core values? Not according to U.S. District Judge Paul A. Crotty, who rejected these claims in an opinion filed June 21, 2012. Judge Crotty can hardly be accused of being an activist judge with liberal credentials. He was appointed to the bench by George W. Bush and began active service on April 15, 2005.
Judge Crotty characterized Goldman's legal position as "Orwellian." In a particularly scathing note, he observed "[I]f Goldman's claim of "honesty" and "integrity" are simply puffery, the world of finance may be in more trouble than we recognize."
That is precisely the issue.
Investors need to understand they are in "more trouble" than they realize. Many brokers and advisors show little constraint in making statements they cannot possibly support. The daily grist of these "financial experts" is that they can help you secure your retirement by finding fund managers with investment skill who can "beat the markets." They don't disclose the compelling, peer-reviewed data indicating that evidence of this "skill" is exceedingly rare. In those few who appear to have it, after management fees and trading costs, even they are unlikely to beat their benchmark. The nail in the coffin is that this elusive skill does not persist, and relatively few top performing fund managers are able to repeat their outperformance in the following year, much less over the long term.
I guess it's all just "puffery."
Dan Solin is a senior vice president of Index Funds Advisors. He is the New York Times bestselling author of The Smartest Investment Book You'll Ever Read, The Smartest 401(k) Book You'll Ever Read, The Smartest Retirement Book You'll Ever Read, and The Smartest Portfolio You'll Ever Own. His new book is The Smartest Money Book You'll Ever Read. The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein. Furthermore, the information on this blog should not be construed as an offer of advisory services. Please note that the author does not recommend specific securities nor is he responsible for comments made by persons posting on this blog.