SEC v. Goldman Sachs: Are the Shareholders Now Speaking Up?

Today brought us news that federal prosecutors in Manhattan are sniffing Goldman over. Those would be pooches no one wants to get close to, because they bite with criminal charges. No investment bank has ever--repeat, ever--survived criminal charges.

It's also reported that Goldman is thinking hard about settling the recently filed SEC case. That would seem a striking change of heart, considering Goldman's jut jawed defiance at Congressional hearings on Tuesday. But there's a logical explanation for the apparent change of course--the shareholders are rumbling.

We mean the outside shareholders. They don't participate in the employee bonus pool, and receive their profits from share appreciation and dividends. They would take a longer term view of the firm--almost like the partners who owned Goldman before it went public in 1999. As with all investment banks, Goldman's reputation is its principal asset. That's been a depreciating asset in recent weeks, and the stock price has dropped a corresponding 15% or so.

Berkshire Hathaway may be Goldman's largest shareholder, having infused $5 billion in the fall of 2008 as a vote of confidence in the U.S. financial system. Berkshire Hathaway got about 7.6% of Goldman's beneficial ownership, according to Goldman's most recent proxy statement. Large mutual funds and money management firms are also major shareholders. Many of these institutional shareholders can't easily ditch GS stock, because they might hold it as part of an index fund or a basket of stocks needed for an investment strategy. Or else they might hold so much GS stock that they can't dump it all quickly without rippling the market big time. So they're stuck with this puppy, and every downward tick in its price probably ticks them off ever more.

Shareholders have been instrumental in fostering settlement in big government cases. In the late 1980s, the SEC and the U.S. Attorney's office in Manhattan squared off with Drexel Burnham Lambert Incorporated, the leading junk bond firm of its day. The SEC sued Drexel (and its junk bond star, Michael Milken) in September 1988, while a criminal investigation by the U.S. Attorney's Office in Manhattan moved forward. The prospect of indictment loomed for Drexel, and its largest shareholders, including a Belgian financial firm called Groupe Bruxelle Lambert, pressured Drexel's management into settling.

Some 23 years ago, Berkshire Hathaway acquired about 12% of Salomon Inc., another investment bank. Four years later, in 1991, a scandal over U.S. Treasury auction bidding blew up at Salomon. Warren Buffett, Berkshire Hathaway's CEO, became Salomon's Chairman, and steered the firm toward settlement with the U.S. government.

Goldman's large shareholders will likely avoid public comment. But surely they're thinking hard about how to save their investments. In just a couple of weeks, Goldman's legal problems have mushroomed to include not only the SEC lawsuit, but shareholder suits, investigations by foreign regulators, potential lawsuits by customers and now the possibility of criminal charges. A quick settlement with the SEC could reduce the incentive for the U.S. Attorney's office to press ahead. It might also staunch the flow of evidentiary revelations that bursts forth in tabloid fashion just about every day now (was the love life of a Goldman employee ever before so interesting?). While institutional shareholders in America generally maintain a lizard-like impassivity when it comes to corporate governance, a legal crisis that threatens a firm's viability is just the circumstance to inspire them to damage control. The recent past teaches that investment banks can't withstand the tsunami of bad publicity that seems to be engulfing Goldman. There's scarcely a chance that Warren Buffett will comment publicly about Goldman's situation. But you can bet dollars to doughnuts that he and other large GS shareholders aren't holding their peace behind the scenes.