Sebastian Mallaby had an excellent column in the Washington Post questioning the Securities and Exchange Commission’s case against Goldman Sachs. At the crux of that case is the allegation that Goldman Sachs misled investors in a particular financial undertaking by not informing them that hedge-fund superstar John Paulson was taking the opposite bet. The SEC stance is that this information was important (“material”) and that the investors might not have proceeded had they known it.
Set aside for a moment today’s news stories that those investors may well have been informed of Paulson’s role. While Mallaby notes that there is always someone on the other side of a trade, he proceeds to consider the SEC’s argument in Paulson’s case:
There’s a superficial case here: Even if investors don’t mind that somebody else is on the other side of the trade, maybe they wouldn’t want to bet against a superstar. But at the time of the deal, Paulson was a low-profile player whose name would not have set off alarm bells.
Who were the superstars of the time? Firms like Bear Stearns, Lehman Brothers, and AIG. Would it have been material and adverse to find out you were betting against them?
It is certainly true that, ex post, you don’t want to have bet against someone who mostly wins. The problem, of course, is identifying such people ex ante.