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Corporate Governance: What Are the Solutions?

Corporate Governance: What Are the Solutions?. Economics 437. The SEC Allegation Against Goldman Sachs. In early 2007 Goldman, acting as a “placement agent,” sold a package a CDO package to IKB Germany and Royal Bank of Scotland Adviser that picked the underlying (mortgages?) CDSs was ACA

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Corporate Governance: What Are the Solutions?

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  1. Corporate Governance: What Are the Solutions? Economics 437

  2. The SEC Allegation Against Goldman Sachs • In early 2007 • Goldman, acting as a “placement agent,” sold a package a CDO package to IKB Germany and Royal Bank of Scotland • Adviser that picked the underlying (mortgages?) CDSs was ACA • Paulson prepared his own list and communicated directly with ACA • ACA was led to believe that Paulson was buying the CDO package • Paulson, in fact, shorted a similar CDO package • Result: • Paulson made $ 1 billion; IKB and RBS lost $ 1 billion • GS was paid $ 15, but lost $ 90 million on the deal

  3. What is a CDO? • Normally a set of cash flow instruments such as a collection of bonds or a collection of mortgages. • The SEC complaint reads as though ABACUS was a CDO collection of mortgages • That’s not correct • ABACUS was a collection of CDSs • The makes all the difference in the world • A collection of CDO made up of CDSs is known as a “synthetic CDO” • A synthetic CDO must have “another side”….if a CDS is an insurance contract, someone must have sold that insurance contract and thus must be betting against the “synthetic CDO.” By inference, the seller of the CDSs should be assumed to be a Goldman Sachs customer. Who else would it be?

  4. Who picked the portfolio contained in ABACUS? • ACA picked the securities, an independent investment advisory company. • They were given Paulson’s list and did speak to Paulson at GS’s requirest. But they picked only about ½ of the list Paulson gave them and rejected the rest, adding many of their own. • Why would it matter if Paulson were assumed to be long or short? Paulson was a minor crank, at the time. Normally you don’t reveal to the market which way you are planning to go – long or short

  5. Who Were The Buyers? • There were three: • Royal Bank of Scotland • Huge bank • Considered themselves experts in CDOs, advertised themselves as such • IKB Germany • Considered themselves experts in CDOs, advertised themselves as such • Goldman Sachs • These buyers are all considered “exempt” purchasers (professional investors who have their own research departments and advisors)

  6. Meanwhile, Back to Corporate Governance

  7. Why There is a Problem? • Shareholder is the principal • Management is the agent • Shareholders’ (economic) interests my be dramatically different that the (economic) interests of management • Acquisitions for “growth” or “diversification” • Executive compensation

  8. Possible Solutions • Term limit for outside directors • One Term – cannot be re-elected • Term could be 8, 10, 12 years • Pay • Deferred stock • Received only two years after director leaves the board • Emphasize “disclosure” not prohibitions

  9. End

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