The Great Muppet Caper
The artistry of the late Jim Henson made the Muppets an enduring American institution and it’s from his 1991 movie that I borrow the title of today’s article. His characters are on my mind because of the comments of Greg Smith, the London-based derivatives salesman who recently resigned quite publicly from investment bank Goldman Sachs. Among other things, he reported that customers were derogatorily referred to as “Muppets.”
Smith’s letter of resignation was published as an op-ed piece by the New York Times. To quote a couple of sentences “… the interests of the client continue to be sidelined in the way the firm operates and thinks about making money. … The firm has veered so far from the place I joined right out of college that I can no longer in good conscience say that I identify with what it stands for.” Not surprisingly, Goldman takes issue with Mr. Smith’s comments, saying: “The assertions made by [Greg Smith] do not reflect our values, our culture and how the vast majority of people at Goldman Sachs think about the firm and the work it does on behalf of our clients.”
Goldman Sachs was founded in 1869 and is an extremely significant player in global markets. On one hand, its alumni list reads like a Who’s Who in the world of finance, including past US Treasury Secretaries Robert Rubin and Henry Paulson, governor of the Bank of Canada Mark Carney, along with CNBC personality Jim Cramer. On the other hand, negative comments about the firm’s values and culture are nothing new. It was sued by regulators and investors in 1970 related to bonds it underwrote for the Penn Central railroad and, in a post 2008 market crash Rolling Stone article, was described as a “vampire squid.” Goldman was one of the firms which current Treasury Secretary Geithner decided to bail out after the market crash. Soon thereafter it paid $550 million to settle a Securities and Exchange Commission complaint regarding its role in that crash. Although that’s the largest settlement in the SEC’s history, it hardly caused a ripple in a firm which earned nearly $4.5 billion in 2011, a firm which continues to calculate its bonuses just as it did before the settlement.
The SEC was established in 1934 during the Great Depression to regulate all securities activities in the United States. It is responsible for administering the various laws which govern the securities industry including the Investment Advisors Act of 1940. That Act defines the difference between those who primarily offer financial advice and those whose advice is solely incidental to their primary work. That’s an important distinction in Mr. Smith’s case because it also defines in whose best interests he must act. Since his job as an employee of Goldman Sachs was the sale of securities, he had to act in Goldman’s best interests, not his customers’. Only if Mr. Smith had been an Investment Advisor as defined under the Act of 1940, would he have instead owed that fiduciary duty of care to those whom he advised.
Benjamin Graham’s 1949 book The Intelligent Investor is one of the classics in the field and has great relevance here. One quote: “A great deal is at stake in the innocent-appearing question whether “customers” or “clients” is the more appropriate name. A business has customers; a professional person or organization has clients. The Wall Street brokerage fraternity has probably the highest ethical standards of any business, but it is still feeling its way toward the standards and standing of a true profession.”
Those who do business with a brokerage firm (like Goldman) are called customers for a reason, as was noted by some of those who responded to Mr. Smith’s letter. Financial blogger Matt Levine (also a Goldman alum) said: “That’s, like, your job as a salesman: to think about how to build trades that will get your clients to do them and give you lots of money.”
In the movie, Muppet reporters are assigned to travel to London, the last city in which Mr. Smith worked for Goldman. According to his resignation letter, he had served as an advisor to “two of the largest hedge funds on the planet, five of the largest asset managers in the United States, and three of the most prominent sovereign wealth funds in the Middle East and Asia.” Although our clients are nowhere near that size, their investments are important to them so we treat them seriously too. The difference? From our perspective, investments are just one aspect of their entire lives. And, as Registered Investment Advisors, we place our clients’ interests ahead of our own; it’s just the right thing to do.
