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Second Circuit primed to, once again, decertify class action against Goldman Sachs

Hoping that the third time's the charm, pensions and other investors suing Goldman Sachs argued before the Second Circuit for the third time in 12 years in order to get their claims of securities fraud certified.

MANHATTAN (CN) — The case, which is 12 years old, has been before the U.S. Supreme Court and has wound its way through several federal courts, but pensions seeking more than $13 billion in damages from Goldman Sachs may be no closer to class certification now.

On Wednesday, the Second Circuit Court of Appeals again seemed primed to decertify a class action securities lawsuit against Goldman Sachs, as judges wrestled with whether the investment bank lied to investors about conflicts of interest on securitized mortgages leading up to and during the Great Recession.

The case originally was filed in 2011 by the Arkansas Teacher Retirement System a year after Goldman Sachs settled with the Securities and Exchange Commission and paid a $550 million fine — the largest penalty against a Wall Street firm at the time.

The pension and other investors claim Goldman put certain clients’ interests ahead of others’ regarding its holdings of collateralized debt obligations, securities that at that time often were comprised of subprime mortgages. The suit also claims Goldman Sachs misstated its holdings in those risky securities and therefore inflated its stock price.

In one such transaction cited by investors, known as the Abacus transaction, Goldman admitted it had allowed a favored client to participate in the asset selection process for a collateralized debt obligation (CDO) without telling other investors the client held a short position and hoped the underlying mortgages would fail.  

The day the SEC took action against Goldman Sachs in 2010, the bank’s stock fell from about $184 to $160.

The case has twisted itself into knots over the last 12 years as it wound its way through various federal courts, including the highest in the land.

In 2021, Goldman Sachs successfully petitioned the Supreme Court to decertify the class action complaint, arguing that it was undisputed at the time that its share price was inflated when the misstatements allegedly were made and that the stock drop was unrelated to the conflicts of interest regarding CDOs.

The Second Circuit also had twice before decertified the class action, with attorneys for Goldman stating throughout the years that granting class certification in this case would be a “cheap ticket” and “boon for plaintiffs,” since most class action securities cases settle once certification is granted.  

Government attorneys have not sided with either party in the complaint but have sought clarification on how securities statements can be used in such class action lawsuits.

In this latest iteration, brought about since a federal court again certified the class action complaint, Goldman Sachs argued that its statements to investors in 2010 “could hardly be more generic” and lacked price import. The bank’s corrective disclosures after the SEC settlement, according to Goldman, were not related to the “longstanding statements about Goldman’s values and risks” but about the specific government enforcement action.

The pension and other investors, on the other hand, argued in its briefs that Goldman’s statements about its conflict of interest polices and systems were not merely generic but rather a “peculiar risk” to the bank’s business model. “As the market commentary reflects, the disclosures showed uncontrolled conflicts of such significance as to risk serious damage to the firm’s reputation and its bottom line,” the pension’s brief stated.

During oral arguments, which went well over the ten minutes per side the court had allotted, the three-judge panel walked well-tread ground on whether Goldman’s business model lent itself to conflicts of interest, and whether the bank’s statements were overly generic.

“Seems like we’ve been here before,” U.S. Circuit Judge Richard Sullivan joked at the beginning of the arguments.

Indeed the court had been, and Sullivan — who has previously taken Goldman Sachs’ side — seemed again swayed by the bank’s arguments, noting that if a company disclosed that it intended to comply with the spirit and letter of federal laws but had an employee under investigation by the U.S. Attorney’s Office, that company would need to disclose the identity of that employee.

“What was the truthful statement that they should have made?” Sullivan, a Donald Trump appointee, later asked the attorney representing the pension funds. “They should have said ‘we have actually had a bunch of conflicts that we have identified but we’re not disclosing’?”

Thomas Goldstein, of Goldstein Russell, answered that the bank should have told investors that they didn’t have the extensive procedures in place to prevent such conflicts of interest.

“So, if you say something about having procedures in place and you know that there are certain problems, even if they’re isolated, you need to disclose them or you have to say that statement is no longer true?” Sullivan asked.

“I think that you have to tell the truth,” Goldstein answered.

The other two judges on the Second Circuit’s tribunal were less inclined to the bank’s side. Senior U.S. Circuit Judge Richard Wesley, who was appointed to the bench by George W. Bush, noted that it was publicly reported in various publications, from the New York Times to Rolling Stone, that Goldman might have conflicts of interest since the bank represented individuals and was itself a market maker. “And the stock didn’t move” after those statements, Wesley noted.

Goldstein noted a SEC action is considered more credible than news reports, and that is why the investment bank’s stock dropped after the settlement but not after those reports.

Kannon Shanmugam, who represents Goldman Sachs in this case, noted the bank’s statements were merely generic promises to investors. “This was a conflict warning, it was not a warranty that conflicts would not arise,” he argued. “The whole point was to warn [investors] about the risks.”

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