What Is Fraud?

By Big Tent Democrat, Section Law Related
Posted on Fri Apr 16, 2010 at 12:56:42 PM EST
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Commenting on the now widely covered SEC civil charge against Goldman (here is the complaint (PDF), Matt Yglesias writes:

The general form of this complaint, that it was wrong for Goldman to make money by betting on the failure of debt-vehicles that in another context Goldman was marketing, has been around for a while. But it’s never been clear to me if there was evidence of actual deliberate fraud, as opposed to something vaguer like an undisclosed conflict of interest.

(Emphasis supplied.) To non-lawyers, non-disclosure of a material fact may not seem like fraud, but under securities laws, it is fraud:

"Rule 10b-5: Employment of Manipulative and Deceptive Practices":

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

(a) To employ any device, scheme, or artifice to defraud,(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security."

I do not know the story behind the Goldman case in detail, but what Yglesias described is a classic "omission of material fact" case which makes up the bulk of securities fraud cases.

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What Is Fraud? | 48 comments (48 topical)

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Heck, that might even be common law fraud (5.00 / 0) (#2)
by andgarden on Fri Apr 16, 2010 at 01:17:21 PM EST

Because I don't have anything better to do. . . (none / 0) (#4)
by andgarden on Fri Apr 16, 2010 at 01:26:37 PM EST

This looks a bit like negligent misrepresentation.


No negligence there (none / 0) (#12)
by scribe on Fri Apr 16, 2010 at 02:33:31 PM EST

If they told their (Goldman's) customers that Goldman (or its executives) were long when in fact they were short (especially if they were selling the customers a long position, that ain't negligent. That's intentional.

A good common-law definition of fraud is

A misrepresentation of presently existing or past material fact, made with the intention that the person to whom it was made rely upon that representation, and that party relies upon that representation to their detriment.

Another way of saying it:

A party seeking to prove fraud must prove the following: 1) a material misrepresentation; 2) made with knowledge of the falsity and with the intent that the representation be relied on; and 3) actual reliance on the misrepresentation to that party's detriment.

I think that no matter how you slice it, Goldman has a problem.


: Indeed, it looks like fraud (none / 0) (#14)
by andgarden on Fri Apr 16, 2010 at 02:59:44 PM EST

But you could imagine one of the underlings (or a 3rd party broker, maybe) just being negligent.

: Fraud-You Betcha (none / 0) (#43)
by norris morris on Fri Apr 16, 2010 at 07:20:24 PM EST

By any other name would be Goldman Sachs. Sell me some stuff you are not representing credibly. In fact hide the facts and risks inherent in your product, and after I've been suckered into buying this from you,
You bet against it in the short market.
This is deliberate fraud,misrepresentation, and
deliberatly selling me out by betting against the very vehicle you sold to me as a worthy buy.
It doesn't take a genius to figure out how criminally deceptive this practice is.

Common law fraud (none / 0) (#13)
by Peter G on Fri Apr 16, 2010 at 02:54:08 PM EST

does not include omissions, material or otherwise, unless there is a fiduciary or other special relationship. (The securities law, and particularly 10b-5, changes that 19th Century-style "caveat emptor"-type rule.) Half-truths, on the other hand, can be treated as a form of misrepresentation, not omission - which is how prosecutors always try to frame it. I have researched this very thoroughly, many times, for appeals in mail fraud cases, because the scope of the federal mail fraud law, according to the Supreme Court, is fixed, as to the meaning of "fraud," as of 1872.


: I defer to you (none / 0) (#15)
by andgarden on Fri Apr 16, 2010 at 03:01:52 PM EST

I was just musing as I scanned through westlaw!

It is under (none / 0) (#17)
by MKS on Fri Apr 16, 2010 at 03:21:30 PM EST

the Ninth Circuit case of Marketing West.

A pure omission where there is no duty to speak is different.

But where you make a representation on an issue, you have to tell the whole truth--no partial representations that are misleading....


Isn't that another way (5.00 / 0) (#19)
by Peter G on Fri Apr 16, 2010 at 03:36:58 PM EST

of saying the same thing, MKS (#17)? What creates that so-called "duty to speak" if not a rule of positive law, a fiduciary duty or some other "special relationship" recognized at (1872) common law?


Activist that I am, I would just go (none / 0) (#21)
by andgarden on Fri Apr 16, 2010 at 03:51:56 PM EST

with foreseeability or some variation thereof. 1872 seems like an odd place to freeze our inquiry, but I'm sure there's some justification from the Court. . .


1872 is when the mail fraud statute (none / 0) (#31)
by Peter G on Fri Apr 16, 2010 at 04:27:35 PM EST

was enacted, incorporating the term "scheme or artifice to defraud." It hasn't been substantively amended since (except for the now-hanging-by-a-thread "honest services" provision). For due process, ex post facto, and separation of powers reasons, there are and can be no "common law crimes," at least not federal crimes, that is, crimes whose meaning evolves over time, to be declared by judges in new cases as they arise. A federal criminal statute, by incorporating a common law term that it does not define, is deemed to capture the meaning of that term as it would have been understood by educated lawyer-legislators at the time of enactment. (This is basic, substantive federal criminal law doctrine, Andy.) Hence, mail fraud law covers only "schemes to defraud" as that term was understood in 1872 (plus, by virtue of a certain phrase in the statute, a bit of the law of "false pretenses," as the S.Ct. decided in 1896).


I don't really see how criminal doctrine (none / 0) (#35)
by andgarden on Fri Apr 16, 2010 at 05:14:06 PM EST

enters into it. I'm thinking of a civil cause of action, where the ex post facto concerns are more limited. Freezing the meaning of "fraud" in 1872 for those purposes is not obviously wise.


Not frozen, except if tied (none / 0) (#36)
by Peter G on Fri Apr 16, 2010 at 05:34:51 PM EST

to a criminal statute (like civil RICO, for example, see the S.Ct. Scheidler cases). I was only talking about the federal crime of mail fraud. Was I not clear about that? Sorry if not.


: I must have misunderstood (none / 0) (#40)
by andgarden on Fri Apr 16, 2010 at 06:06:25 PM EST

No apology necessary.

Legal Parsing Is Useless (none / 0) (#44)
by norris morris on Fri Apr 16, 2010 at 07:27:40 PM EST

Goldman Sachs simply treat their customers deceptively. Then they sell them out by betting aainst them.

It doesn't take parsing the finer legal points to understand that this is actionable behavior.

The more important issue is that Goldman Sachs is so unethical and ruthless a company that it arrogantly risks losing its clients but greed trumps intelligent behavior.


I could imagine that causing a problem (none / 0) (#18)
by andgarden on Fri Apr 16, 2010 at 03:26:47 PM EST

with respect to advertising. I would think that the extent of the required disclosure and need for completeness would be measured by the value (objective???) of the good or service.

Now if BMW repaints a car and sells it as new. . .


It's California (none / 0) (#24)
by MKS on Fri Apr 16, 2010 at 03:59:51 PM EST

For awhile, we had the tort of "bad faith denial of contract." You deny the existence of the contract, and you are liable for puntive damages....

Since done away with by the California Supreme Court, which had created it in the first place.


I admit that I wobble on the concept (none / 0) (#25)
by andgarden on Fri Apr 16, 2010 at 04:03:07 PM EST

of punitive damages in general. I think I would be more comfortable with expansive disgorgement.


Exxon Valdez (none / 0) (#26)
by MKS on Fri Apr 16, 2010 at 04:05:55 PM EST

They should have made Exxon pay the whole award....

And, based on the Supreme Court ruling, whatever that case was, courts here routinely limit all punitive damages claims to a maximum of three times the compensatory damages....

Crummy activist court--ruined so many good plaintiff's cases....


: heh (none / 0) (#30)
by andgarden on Fri Apr 16, 2010 at 04:27:34 PM EST

Not Ninth Circuit (none / 0) (#20)
by MKS on Fri Apr 16, 2010 at 03:37:59 PM EST

Marketing West v. Sanyo Fisher (1992) 6 Cal.App.4th 603, which holds:

In transactions which do not involve fiduciary or confidential relations, a cause of action for non-disclosure of material facts may arise in at least three instances: (1) the defendant makes representations but does not disclose facts which materially qualify the facts disclosed, or which render his disclosure likely to mislead; (2) the facts are known or accessible only to defendant, and defendant knows they are not known to or reasonably discoverable by the plaintiff; (3) the defendant actively conceals discovery from the plaintiff.
....
But the rule has long been settled in this state that although one may be under no duty to speak as to a matter, 'if he undertakes to do so, either voluntarily or in response to inquiries, he is bound not only to state truly what he tells but also not to suppress or conceal any facts within his knowledge which materially qualify those stated. If he speaks at all he must make a full and fair disclosure.

Id. at 613.


I should have mentioned (none / 0) (#32)
by Peter G on Fri Apr 16, 2010 at 04:34:02 PM EST

"active concealment," which is to be distinguished from "failure to disclose." Quite right. However, I need to point out that "Cal.App.2d" refers to an intermediate California state appellate court, not to the Ninth Circuit, meaning the federal appeals court for the West Coast region of the U.S. (or is that what you meant by "Not Ninth Circuit," MKS? At first I thought you meant "Not so in the Ninth Circuit"). I have to assume the Marketing West case is elaborating California state common law, not federal statutory law.


: Yes (none / 0) (#41)
by MKS on Fri Apr 16, 2010 at 06:08:53 PM EST

It was not a Ninth Circuit case...but a California case--which is, true, just an appellate case, but it is widely cited here. So, it describes the Common Law in California, not the entire Ninth Circuit....
I had at first remembered it (incorrectly) as a Ninth Circuit case because the Ninth Circuit had reversed a summary judgment I had obtained based on the (ahem) then-newly decided Marketing West case.
I learned about the common law of fraud in California the hard way....still turned out okay in the long run....

One of the interesting things (5.00 / 2) (#6)
by BDB on Fri Apr 16, 2010 at 01:43:27 PM EST

about this case is that the SEC chose to go with tried and true fraud theories instead of one of the new fangled one.

Is it me or does Yglesias get dumber every day?

10b-5 (5.00 / 1) (#16)
by BDB on Fri Apr 16, 2010 at 03:08:22 PM EST

a wonderfully nimble little rule. It can expand to fit all kinds of factual situations and I was wondering why it hadn't made an appearance in the Wall Street mess. Even if it doesn't come to much, that is the SEC settles for pennies, at least it's made its first appearance, which I think is potentially a good sign.

sometimes I wonder (5.00 / 1) (#23)
by tworivers on Fri Apr 16, 2010 at 03:59:17 PM EST

why people aren't marching in the streets with pitchforks.

: Some people are out with pitchforks (5.00 / 1) (#39)
by Peter G on Fri Apr 16, 2010 at 06:04:11 PM EST

... but unfortunately they are the Tea Party folks, and they're not marching to the left.

: Most of us ... (none / 0) (#37)
by cymro on Fri Apr 16, 2010 at 05:59:18 PM EST

... no longer own pitchforks, I imagine.

Second your recommendation (5.00 / 1) (#33)
by Spamlet on Fri Apr 16, 2010 at 04:50:56 PM EST

of The Big Short. The book is simultaneously sobering and hilarious. Michael Lewis, also the author of Liar's Poker and Moneyball, is a brilliant writer and a national treasure. He lives in my neighborhood, too. Never met him but have considered stalking him long enough to leave flowers at his door. Is anyone here on a Macarthur nominating committee?

: His piece in Vanity Fair on (none / 0) (#42)
by gyrfalcon on Fri Apr 16, 2010 at 07:12:13 PM EST

the Iceland financial meltdown (no pun intended...) was both utterly riveting and screamingly funny.

Maybe fraud, in this case, is the (5.00 / 1) (#34)
by Anne on Fri Apr 16, 2010 at 05:05:27 PM EST

bright, shiny object designed to distract from the NSA whistleblower case, and from the inevitable watering-down of financial services reform.

The timing seems a little too coincidental.

Me, I'm going to distract myself with another viewing of Julie and Julia, and make dinner that will pale in comparison to the efforts of both these women, while I marvel at Meryl Streep's ability to become Julia Child.

: Oh, yes (none / 0) (#45)
by Zorba on Fri Apr 16, 2010 at 07:57:56 PM EST

Loved the movie, and loved Meryl Streep (but then, I love pretty much anything she's in). I'm old enough to remember watching Julia Child's show on television, and Meryl absolutely nails her.

"to make any untrue statement (none / 0) (#1)
by inclusiveheart on Fri Apr 16, 2010 at 01:11:55 PM EST

of a material fact"

GS told other investors that Paulson's interest was long when he was short. Seems like that fits into the "untrue" category.

I think the major material fact here (none / 0) (#3)
by Radix on Fri Apr 16, 2010 at 01:19:19 PM EST

was what this instrument was specifically designed to do, fail. What really irks me is , that you can legally, in the market, design something for no other purpose but to collect the insurance payout, CDS. Can you imagine if a building contractor did this? Why are you building this house, so I can insure it against fire, then burn it down. Much easier than trying to find a qualified buyer don't you know.

: Sort of worse in a way because (none / 0) (#5)
by inclusiveheart on Fri Apr 16, 2010 at 01:39:57 PM EST

it is like getting a bunch of friends to chip in to build the house, putting the insurance policy in your name only, burning it down and collecting all of the loot. And even before all that charging all your friends for contractor's and other management fees etc. while the house is under construction.

Thanks -- (none / 0) (#7)
by Cream City on Fri Apr 16, 2010 at 02:04:15 PM EST

this is helpful, and nicely concise, for a non-lawyer.

Whistleblower (none / 0) (#10)
by gyrfalcon on Fri Apr 16, 2010 at 02:22:54 PM EST

According to something I just heard on CNN, this case stems from a whistleblower at the hedge fund that was constructing the CDOs that Goldman was selling. He's apparently turned over reams and reams of emails and documents.

Like Wilkerson and the Gitmo prisoners, it's too bad he didn't have the stones to do that back when it was happening instead of waiting until it was all over.

: Yeah (none / 0) (#11)
by squeaky on Fri Apr 16, 2010 at 02:33:11 PM EST

Like Wilkerson and the Gitmo prisoners, it's too bad he didn't have the stones to do that back when it was happening instead of waiting until it was all over.
BushCo's SEC chair would have made sure that this crime was punished.. the whistleblower crime of course...

I remember that trend-setting (none / 0) (#22)
by jondee on Fri Apr 16, 2010 at 03:54:02 PM EST

Masturbater of the Universe, (even the universe needs to get off sometimes) Alan Greenspan, brushing off with cavalier insouciance, time and time again, the stated concerns of others about the dangers and degree of fraud on Wall St back in the nineties. And perusual, no one back then - or almost no one - questioned the "wisdom" of that Randian avatar of cupidity as long as they were operating within lapping range of the source of the great trickle down..

If the reality is that we all, like it or not, participate in an interlocking, over-arching "economy" - a system - that is in danger of going into catastrophic runaway if one nexus in the system becomes diseased, then why, other than for reasons based in rampantly perverse, self-deceiving, short-term greed, have we allowed this ultimately self-destructive culture of lies to flourish the way it has, with it's continued beyond-the-reach-of-the-law,, bunch of boys in the inside, ie the Greenspans, Rubins, Summers, Geithners et al?

When Greenspan was still in charge of the Fed (none / 0) (#27)
by tworivers on Fri Apr 16, 2010 at 04:19:21 PM EST

he spoke of "froth" in the real estate market. If that's not the understatement of the century, I don't know what is.

But he was right 70 % of the time, so that makes it ok, right?


: The froth was from (5.00 / 1) (#29)
by jondee on Fri Apr 16, 2010 at 04:23:27 PM EST

him and Summers and Rubin foaming at the mouth once they realized what all that financial lobby money bought for them..

I don't think it is fraud (none / 0) (#28)
by klassicheart on Fri Apr 16, 2010 at 04:22:25 PM EST

I think this is purely political. For those inclined, I highly recommend the book The Big Short by Michael Lewis (also available in audio CD). I listen to this in my car and it is incredibly fascinating (plus all the names in this complaint are actors referred to in the book). But the truth is, many of these so called sophisticated investors did not do due diligence in their investments. The German banks lost big on this particular matter...because they did not investigate what they were buying.

: Due Diligence? (none / 0) (#46)
by norris morris on Fri Apr 16, 2010 at 08:13:55 PM EST

Simple business ethics provide that transparency in fiduciary products should be imperative.
Deception from omission is not a casual act removed of responsibility. Greed is not casual.
It all boils down to one thing. This bunch are crooks who sold garbage to any sucker anywhere for 30 times it's worth, and in many instances it was worth nothing. Derivatives are a fancy name for a bunch of bundled garbage sold deceptively
with knowledge aforethought. Afterthought it was sold short as the sellers knew their products were worthless.

Once you have read the case in detail, assuming (none / 0) (#38)
by masslib on Fri Apr 16, 2010 at 06:03:04 PM EST

you do, can you tell us how strong you think the case is, whether you think there will be more, similar cases, if you expect the DOJ to file a criminal complaint, and what you think the political implications are, how it will effect any reform bill, etc.?

A Reform Bill? (none / 0) (#47)
by norris morris on Fri Apr 16, 2010 at 08:25:52 PM EST

Will only be as good as it is created, but more important is the need for a strong regulatory commission that enforces the law and understands what its watching for.

There are restrictions in law now that have not been enforced for a long time. Our previous SEC lacked the staff equipped with the skill sets to understand what derivatives or sophisticated scams
were. Let alone how the market worked.

The SEC was warned repeatedly about Madoff and did nothing. Both ignorance and laziness in an atmosphere created by political gamesmanship prevailed. The SEC was basically incompetent to understand what was going let alone deal with
enforcing the law.

The prevailing Wall Street chutspah has nearly taken us down, but next time it will be far more serious.


Check out Bill Moyers (none / 0) (#48)
by Spamlet on Sat Apr 17, 2010 at 08:49:45 AM EST

last night, and his conversation with Simon Johnson and James Kwak, for a discussion of how the regulatory approach is basically futile (because of regulatory capture) and of how Wall Street can be controlled only by laws, not by regulations (emphasis added):

The Administration still argues that we should delegate responsibility, going forward, for lots of things around finance. Like how much capital you should have. Delegate that to the regulators. Now, that's crazy. That's not acceptable. That is not what they should do. . . . You've got to put it in legislation. You've got to design the legislation. You've got to go after the things that can be legislated. Congress must not abdicate this responsibility.

: Interesting (none / 0) (#50)
by Big Tent Democrat on Mon Apr 19, 2010 at 09:03:56 AM EST

I need to write about this.

Nahh, he's an ace market timer (none / 0) (#49)
by beowulf on Mon Apr 19, 2010 at 08:54:57 AM EST

Apparently hedge fund trader John Paulson is the whistleblower. The guy's made a fortune off a unique situation, its not like by cooperating he's losing an ongoing income stream.

He's smart to play ball with Uncle Sam. Clearly GS is the villain in this piece, by working with the Feds (after making $3.7 billion thanks to GS), he gets to look like a good guy to the SEC and the public and he'll get to keep his gains.

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