Is Goldman Sachs Really a Market Maker? Examining the Implications of the SEC Suit

Goldman Sachs, one of the most prominent and controversial financial institutions in the world, has been in the news lately due to a lawsuit filed by the Securities and Exchange Commission (SEC) over its role in the Abacus deal. The allegations made by the SEC have raised serious questions about the firm's status as a market maker, and whether it has acted in the best interests of its clients.

Goldman Sachs representatives have testified before the Senate's Permanent Subcommittee on Investigations, characterizing the firm as a market maker, denying fiduciary status, and displaying apparent bewilderment at the senators' questions about legal or ethical obligations to place clients' interests first. However, the charges leveled against Goldman by the SEC suggest that the firm often acted as more than a traditional market maker, and may have engaged in market manipulation.

The primary responsibility of a market maker is to maintain an orderly market by matching buyers and sellers of a security and to stand ready to buy or sell for their own account when there is a price imbalance. In this classic role, the market maker promotes efficient markets.

However, if the charges leveled against Goldman by the SEC are true, the firm's actions would be diametrically opposed to those expected of a market maker. Whereas traditional market makers promote price and market efficiency, a firm like Goldman, as an active trader for its own account, can maximize its opportunity for profits by promoting price and market inefficiency.

Goldman's unparalleled access to information about buyers and sellers when the firm is engaged by both parties in the same transaction, along with its superior knowledge of the underlying securities in the products it structures and packages, creates an information asymmetry that allows the firm to trade ahead of other market participants, its own clients included.

The Abacus deal that is the subject of the SEC lawsuit provides a good example of the potential conflicts of interest that can arise in such situations. The complaint alleges that Goldman improperly withheld material information from the buyers by not revealing the role of the short seller in picking the securities that went into the deal. It also appears that Goldman took large short positions in deals it facilitated while at the same time actively soliciting clients to go long in the same deal.

This is a conflict of interest that provides a huge incentive for Goldman to take advantage of its superior position of knowledge by sharing as little information as possible with either counterparties or clients in order to gain a trading advantage that, in turn, promotes inefficient and volatile or disorderly markets.

The fact that Goldman may not have acted as a true market maker has serious implications for its clients, who may have been misled into thinking that they were receiving impartial advice from a fiduciary. It also has implications for the broader financial system, which relies on the efficient functioning of markets to allocate resources and promote economic growth.

The Goldman investigation is being credited with pushing financial reform legislation forward. Although the Senate now seems motivated to ensure a reform bill passes, it remains to be seen whether legislators will apply what they learn from this case study and enact reforms to address the conflicts of interest, inadequate disclosures and systemic risks to market efficiency that exist when firms like Goldman can simultaneously wear so many hats with so few regulatory checks and balances and minimal regard for the consequences of their actions for their clients and the markets.

In conclusion, the allegations made by the SEC against Goldman Sachs raise serious questions about the firm's status as a market maker and its willingness to act in the best interests of its clients. If the charges are true, the firm may have engaged in market manipulation and promoted inefficient and volatile markets. This has serious implications for both its clients and the broader financial system, and highlights the need for reforms to address the conflicts of interest and systemic risks that exist