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Jun 09, 2011

Goldman fined after huddle probe

Investment bank pays a $10 mn fine and agrees to stop sharing ideas from its huddles with favored clients in consent decree

Goldman Sachs has agreed to end the practice of sharing short-term trading ideas generated from its ‘huddles’ between Goldman analysts and traders with a few favored clients.

In addition, the Wall Street firm agreed to a $10 mn fine in a signed consent decree with the Massachusetts Secretary of State, William Galvin, ending a two-year investigation by Massachusetts into the practices. Goldman Sachs did not acknowledge any wrongdoing in agreeing to the settlement.

The consent decree describes the New York-based firm’s ‘asymmetric service initiative’, an effort to generate additional revenue from equity research. Under the effort, which began in 2006, clients were ranked into four ‘tiers’ based on trading commissions.

Internal documents reported in the consent agreement state that Goldman Sachs produced an additional $199 mn in commissions from the initiative in 2007.

The consent order described one practice in particular, whereby Goldman analysts and sales personnel shared ‘catalyst-driven trading ideas’ with a select group of clients, where  an analyst predicted a stock would move counter to the analyst’s own stated price targets over a short-term, 30-day time horizon.

Galvin claimed that some Massachusetts institutions that were Goldman Sachs clients were disadvantaged by the practice, which they described as unethical, although they did not contend that any fraudulent actions had been committed.

A spokesperson for Galvin declines to name those institutions. ‘We’re only talking about what’s in the consent order,’ says Brian McNiff from the Secretary of State’s office.

‘I don’t know that anyone has figured out a business model’ that works for equity research, says Sandy Bragg, CEO of Integrity Research, a firm that advises institutions on equity research. Goldman’s practice of tiering clients based on revenue is common throughout the industry, he adds.

The practice has grown as a result of the global research settlement that 10 firms, including Goldman Sachs, entered into in 2003 to separate equity research from investment banking.

Bragg says equity research is still viewed as a cost at most firms, one that is covered by an ‘arcane payment mechanism’ based on commissions.

‘There is still a great deal more research capacity than the market really needs… As there is more transparency around the cost of research, it will become more like a normal business,’ Bragg adds.

Goldman’s practice was first reported in the Wall Street Journal in 2009, spawning multiple investigations. A source familiar with the situation says FINRA is close to wrapping up its investigation with regard to ‘huddles’ at the investment bank.

Click here to read the consent decree.