The latest government case against Goldman Sachs, and possibly other brokerage firms, regarding alleged conflicts of interest around Collateralized Debt Obligations (CDO), bears an eerie resemblance to similar charges that were brought against many of the same Wall Street players nearly a decade ago, after the last great bubble burst. (If you want to learn about the major crashes throughout history, check out our Crash Tutorial.)

In Pictures: Top 7 Biggest Bank Failures

Bubble Pops
The technology bubble burst quite loudly in March 2000, when the Nasdaq index reached just over 5,000. It then began its long decline over the next two years.

In the aftermath of the bubble, the regulatory authorities in the United States, led by the Securities and Exchange Commission (SEC), and Eliot Spitzer, the Attorney General of New York, targeted the research departments of major Wall Street investment firms. (For background reading, check out Wall Street Post Spitzer and Eliot Spitzer - Man Of A Thousand Scandals.)

SEC Charges
The government charged 10 firms with a conflict of interest, or in legalese "undue influence of investment banking interests on securities research." The SEC alleged that the firms violated the Securities Act of 1933, the Securities Exchange Act of 1934 and countless rules established by the New York Stock Exchange (NYSE), and the National Association of Securities Dealers (NASD).

These violations involved the issuance of fraudulent research reports, or reports that were not based on "principles of fair dealing and good faith," and contained "exaggerated or unwarranted claims." Several firms were also charged with receiving payments for research without disclosing them to clients and failure to supervise the research and investment banking departments.

The Settlement
The SEC settled with the firms involved in early 2003, and the 10 firms paid a total of $875 million in fines and disgorgement of profits, with some pledged to the victims of the actions. Two influential analysts were also banned for life from the industry. (Check out Why is Frank Quattrone credited with contributing to the growth of the dotcom bubble?)

The SEC also attempted to change the way business is conducted on Wall Street as structural reforms and enhanced disclosures were also agreed to by the firms involved in the settlement.

Structural Reforms
The firms involved agreed to a complete separation of research and investment banking areas of the company. While this was always supposed to be the case, additional restrictions imposed included a separate physical location, separate legal and compliance staffs and separate budgeting processes. Also, investment banking was restricted in deciding what companies to cover, and an analyst's pay was no longer based on banking revenues generated - it was to be linked to the accuracy and quality of research.

Enhanced Disclosures
The firms also agreed to disclose in each research report the existence of a possible conflict of interest by the company, and publish quarterly details on the performance of each analyst. The companies also had to fund third-party independent research and make it available to its clients. (Find out more about disclosure in What Would Full Disclosure Mean For The Market?)

The Results
Well, it looks like Wall Street certainly learned its lesson, right? Not quite. Fast-forward seven years and the SEC has charged Goldman Sachs with fraud in structuring a CDO tied to the subprime housing market. The government charges that the company did not disclose relevant facts to investors who purchased this security. The facts omitted were that the CDO had been shorted by a major hedge fund client who had influence in the portfolio selection process and included residential mortgage-backed securities. (Check out The Goldman Sachs Accusation Explained.)

Flawed Approach?
It would seem that there is something wrong with the government's approach to regulation, as the settlement back in 2003 was announced with great fanfare and was supposed to teach Wall Street a lesson. It was hailed as "historic," which certainly implies that it should have some sort of deterrent effect.

William H. Donaldson, the Chairman of the SEC at the time, gushed in the press release:

"These cases reflect a sad chapter in the history of American business, a chapter in which those who reaped enormous benefits from the trust of investors profoundly betrayed that trust. These cases also represent an important new chapter in our ongoing efforts to restore investors' faith in the fairness and integrity of our markets"

The Bottom Line
I think it's fair to say that there is less faith in the fairness and integrity of the market now than ever before. The SEC case that arose after the internet and technology bubble popped ten years ago is becoming a distant memory to many investors preoccupied with the current volatile investment environment. This is unfortunate as perhaps if they had remembered this earlier conflict of interest, they would have been wary of yet another one practiced by some of the same firms.

Catch up on the latest financial news, in Water Cooler Finance: Crying Over Spilled Oil, And Buffett Goes To Court.

Related Articles
  1. Professionals

    4 Ways Companies Can Relieve Workplace Stress

    Workplace stress can cost companies tons of money in lost productivity and absenteeism. Some of that is out of their control, but often they are the cause.
  2. Investing

    Which GOP Candidate Brings What to the Table?

    What are the major GOP presidential candidates' economic plans and how do they differ?
  3. Professionals

    10 Must Watch Documentaries For Finance Professionals

    Find out about some of the best documentaries that finance professionals can watch to gain a better understanding of their industry.
  4. Professionals

    Career Advice: Investment Banking Vs. Corporate Finance

    Read an in-depth review and comparison of a career in investment banking and a career in corporate finance, with advice about which one to choose.
  5. Stock Analysis

    The Biggest Risks of Investing in Berkshire Hathaway Stock

    Learn about the risks of investing in Berkshire Hathaway. Understand how issues of succession, credit downgrade risk and increased regulation could hurt it.
  6. Investing

    Middle Market Investment Banks

    We take a close look at investment banks working with middle market companies.
  7. Investing

    Hetty Green: Invest Like the Richest Woman in the World

    Investors would be wise to emulate the approach to the markets that Hetty Green used to grow her fortune.
  8. Economics

    The 5 Countries That Produce the Most Carbon Dioxide (CO2)

    Learn about the top five countries, China, the United States, India, Russia and Japan, that are the largest contributors to carbon dioxide emissions.
  9. Investing News

    Germany Tech Startups: Keep Them On Your Radar

    Many German companies, which are eager to catch up with the rest of the world by entering the digital age, are investing in tech startups.
  10. Economics

    Benefits of China Changing It's One Child Policy

    China's one-child policy is changing, and investors are looking for ways to cash in. The reform might not have the effects that many anticipate, however.
  1. Is a financial advisor allowed to pay a referral fee?

    A financial advisor is allowed to pay a referral fee to a third party for soliciting clients. However, the Securities and ... Read Full Answer >>
  2. How often do mutual funds report their holdings?

    The Securities and Exchange Commission (SEC) requires mutual funds to report complete lists of their holdings on a quarterly ... Read Full Answer >>
  3. Do financial advisors need to be approved by FINRA?

    The term "financial advisor" can refer to a couple of different roles. It most often refers to a broker-dealer or an investment ... Read Full Answer >>
  4. What is the Social Security administration responsible for?

    The main responsibility of the U.S. Social Security Administration, or SSA, is overseeing the country's Social Security program. ... Read Full Answer >>
  5. Where are the Social Security administration headquarters?

    The U.S. Social Security Administration, or SSA, is headquartered in Woodlawn, Maryland, a suburb just outside of Baltimore. ... Read Full Answer >>
  6. Is the Social Security administration a government corporation?

    The U.S. Social Security Administration (SSA) is a government agency, not a government corporation. President Franklin Roosevelt ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  2. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  3. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  4. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  5. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  6. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!