Ethical Pledges "Mere Puffery"
It’s not often that you hear a business publicly admit that its promises to clients are hot air. But Goldman Sachs (NYSE: GS ) has done just that.
Goldman is facing a class action lawsuit alleging it made false claims that:
- It is “dedicated to complying fully with the letter and spirit of the laws, rules, and ethical principles that govern [it].”
- Its “clients’ interests always come first.”
- It is able to address potential conflicts of interest.
The shareholders backing the lawsuit claimed they were defrauded by these statements because Goldman was knowingly involved in illegal activities, as well as other activities involving conflicts of interest, when it made these claims.
Goldman’s defense? It didn’t deny that its statements were false or that it participated in these illegal or unethical activities. Instead, it tried to dismiss the complaints by stating that its assurances were “mere puffery” and non-actionable “statements of opinion.”
The plaintiffs’ case is built on the claim that Goldman made material misstatements and omissions. Let’s review a couple of them.
- Goldman allowed a favored client, hedge fund Paulson & Co., to play a key role in the selection of assets for the Abacus CDO transaction. An internal Goldman memo revealed that the company intentionally hid Paulson’s role in the process from clients. Plaintiffs argue Paulson intentionally selected securities it knew would perform poorly so it could profit from shorting (betting against) the position. Indeed, Goldman’s clients lost approximately $1 billion on the deal, while Paulson banked cash.
- In an attempt to sell low-quality collateralized debt obligations to investors under the Hudson program, Goldman told them that it had “aligned incentives with the Hudson program by investing in a portion of equity.” However, Goldman failed to disclose that it held the entire short position on those CDOs, indicating the company’s expectations that the securities would perform poorly. Similarly, plaintiffs claim that Goldman was involved in conflicts of interest with other CDO programs, in which it knowingly sold securities to investors at inflated prices while holding a significant short position, indicating its intention to profit from the securities’ decline.
In each case, plaintiffs argue that Goldman was guilty of material misstatements and omissions in its communication with investors, consumers, or both. In addition, the company was involved in conflicts of interest that pitted its own interests against those of its customers.
Goldman attempted to dismiss these charges by saying it was protected under the following standards:
- “Expressions of puffery and corporate optimism do not give rise to securities violations.”
- “Allegations of corporate mismanagement without an element of deception or manipulation are not actionable.”
When reviewing the case, however, the presiding judge noted the following limitation on these rules:
- “Optimistic statements may be actionable upon a showing that the defendants did not genuinely or reasonably believe the positive opinions they touted.”
The presiding judge rejected Goldman’s motion to dismiss all but one of the charges against it. He claimed:
Goldman’s arguments in this respect are Orwellian. Words such as “honesty,” “integrity,” and “fair dealing” apparently do not mean what they say; they do not set standards; they are mere shibboleths. If Goldman’s claim of “honesty” and “integrity” are simply puffery, the world of finance may be in more trouble than we recognize.