Story from my own past: I was the first person in my family to go to college. My daddy was a Teamster, so we didn’t really have a lot of lawyers in our immediate circle. So after college, I took a job as a paralegal at a law firm to see for myself what lawyers really do, before I made the decision to commit to law school.
The lawyers at the firm knew why I was there and were very supportive, giving me a chance to see what all the different practice areas were. I even got to write part of a brief, a brief about being a “market maker.” That’s the term Lloyd Blankfein keeps throwing around to excuse Goldman’s Sach’s behavior with the Abacus securities issue.
Rule 10 b-5 of the Securities Exchange Act prohibits short swing insider trading in a security. It defined “insider” as an owner of more than 10% of a given security. However, Sec. 16(d) of the Act, exempts those who hold themselves out at “market makers” in that security. The thing is, the Act didn’t really define market making, though it had been a fact of the financial world for a long time.
So, a partner in the firm set me the task of calling up as many brokerage houses as I could find and asking brokers and traders what they thought a market maker was, I spent two weeks non-stop telephoning and kept notes from each conversation. Then I looked at what was common to most and came up with a real-life based definition and wrote it up. I was thrilled to learn that a couple paragraphs from my internal memo were included in the brief.
Our side won, and to my amazement, the district court quoted my paragraphs vebatim. [Sorry, I looked for 2 days but could not find the district court decision in linkable form.] I decided to go to law school. A couple years later, and during a period of great self doubt because the student editor of my law review note told me that scholarly writing should not sound like a newspaper article –evidently, writing in the vernacular offended her idea of lofty impenetrability – I got a call from the partner who had allowed me to contribute to the brief. He told me to look up 738 F.2d 73. I found out that that the Second Circuit Court of Appeals had adopted what I called a “common sense” definition of a market maker.
So, when I tell you that I know what a “market maker” is, it’s not just me that thinks so, it’s also the Second Circuit Court of Appeals.
What is a Market Maker?
A market maker is an entity that holds itself out as willing to be the buyer or seller of last resort if you can’t find someone to be the other side of your trade. Let’s say you client needs cash for a sudden emergency and has to liquidate its position in WidgetCorp. You place a “sell” order with a minimum price on it and expect some “buy” order out there to match up with it when the maximum buy price intersects with your sell price.
Instead, “crickets.” In a non-cash emergency situation, you would leave that sell order hanging around, or withdraw it and re-offer in a day or two, but your client needs to complete this deal today. What can you do?
You can go to a market maker in WidgetCorp securities. The market maker agrees in advance that it will buy or sell the securities of those products in which it makes a market, no matter what. It publishes the prices at which it will buy or sell, these tend to not be bargains. Brokers can find out who is making a market in what securities by looking at the listings published by the National Quotation Bureau. Bonds are listed on “yellow sheets”, stock quotes are on “pink sheets”. Back when I was doing my research, pink sheets and yellow sheets were actual bound paperback listings on colored paper (think telephone yellow pages), but now are on the Net.
Market Makers provide ‘liquidity in the market,” which is just another way of saying you will always be able to buy and always be able to sell stocks and bonds of those corporations for which a market is made, which makes those securities more attractive and decreases price volatility. Not all securities are liquid, by a long shot. So, market making is considered a good thing.
Was Blankfein describing market making by Goldman Sachs in the issuance of the Abacus securities?
Not that I can see. Market making is something that occurs AFTER a security is issued, which is why it is governed by the Securities Exchange Act of 1934. Unless I am totally confused by the press accounts [I admit I have not had time to watch the entire C-SPAN of the Senate hearing], what Blankfein was describing is Goldman acting as an “underwriter” of the new security issue. This is governed by the Securities Act of 1933.
The 1933 Act has two basic objectives:
- to require that investors receive significant (or “material”) information concerning securities being offered for public sale; and
- to prohibit deceit, misrepresentations, and other fraud in the sale of securities to the public
Anyone who is an issuer, underwriter or dealer is covered by this rule. Investment banks act as underwriters for the initial public offerings of new securities by agreeing to buy any part of the new issue that doesn’t sell otherwise. This is done via a contract called a "firm commitment."
This is consistent with the story of how Goldman got stuck with so much of the long position in the Abacus deal, they could not find any buyers, so they had to buy the rest of the offering.
Was Blankfein confused?
Somebody is confused, that’s for damn sure, or somebody is trying to fudge. I find it very hard to believe that a person could rise to be the head of the biggest badass-est investment banking house in the world, and not know the basics of securities law. I used to teach a class in corporations to undergrad business majors and MBA candidates, and they had no trouble learning this stuff. You’d think that in order for a guy to be worth millions and millions of dollars in annual compensation, he would at least be required to know the basics of his own industry.
Or maybe he does know, and just thinks the rest of us are stupid?
[Earlier posts in this series and related links at FDL's Foreclosure Fraud Resources]