Question

In 2006 the investment bank Goldman Sachs was approached by a major hedge fund that was
pessimistic about the outlook for house prices. Goldman helped the fund to construct a complicated
deal that would pay off if a $2 billion package of low-grade residential mortgages declined in value.
Goldman then approached some banks that it knew were optimistic about the prospect for house
prices and who might therefore be prepared to take the other side of the bargain.

In the event, house prices slumped, many of the house owners defaulted on their mortgages, and
the hedge fund made a profit of around $1 billion. The banks on the other side of the transaction
lost heavily. Goldman’s role in the transaction subsequently came in for heavy criticism. One
criticism centered on the fact that Goldman shared the hedge fund’s concerns about the housing
market and in 2007 had circulated internal warning memos to its traders. Some therefore
questioned whether it was ethical for Goldman to take a pessimistic view on housing in its own
trading positions and at the same time continue to sell what it regarded as overvalued securities to
its customers. There were also questions about what Goldman was legally and ethically obliged to
reveal. Although one of the banks was heavily involved in choosing the package of mortgages and
rejected many of the suggested contents of the package, none of them was aware that the
mortgages had originally been proposed by the hedge fund manager and therefore could be
particularly toxic.

A senate subcommittee that investigated the deal lambasted Goldman for “unbridled greed” and
suggested that the firm had operated with “less oversight than a pit boss in Las Vegas.” When the
SEC announced that it was charging Goldman with fraud and material omissions and
misrepresentations, the market value of the bank’s stock declined by about $10 billion, far more
than any penalty that Goldman might be expected to pay. Investors, it seemed, believed that the
damage to Goldman’s reputation was much more important than any fine. Three months later the
bank admitted that the marketing material linked to the package of subprime mortgages was
“incomplete” and agreed to pay a $550 million fine.

The event raised several difficult ethical questions. When an investment bank is employed to give
advice on a new issue or a merger, it is essential that the client can trust the bank to give an honest
and impartial view. But the situation becomes less clear-cut when the bank is acting as a middleman
or trading securities. Much of the debate on the Goldman deal therefore centered on whether the
bank was simply an intermediary between sophisticated traders or whether it had deeper responsibilities. *

Ethical behavior of managers is the key for the shareholders. Please read the article: “Goldman Sachs Causes a Ruckus” that describes the controversial involvement of Goldman Sachs in a mortgage-backed securities deal in 2006. When this involvement was revealed, the market value of Goldman Sachs’ common stock fell overnight by $10 billion. This was far more than any fine that might have been imposed. Explain. Can you comment on other examples from the real life about the unethical behavior of managers and the its consequences?

Answer 1

Example of unethical behavior:

Unethical behavior in business refers to the failure of the company to rise to acceptable standards of business practices. This can be seen in any type of businesses. The real life example that I have taken is satyam computer services scandal affecting the Indian based company satyam computer services. The main reason for the scam was because of its chairman ramalinga raju who falsified the accounts of the company. This person is said to have manipulated the accounts worth 14,162 crores in several forms. In 2015, this person was convicted with several other members.

The company’s CFO also had a role on this who has been later arrested. The consequence was that the price of the share fell down to a very poor rate. The company which was trading in peak in 2008 at $29.10 fell down to $1.80 in 2009. The jobs of the employees of the company were also a big question mark.

The later result:

On 13 April 2009, via a formal public auction process, a 46% stake in Satyam was purchased by Mahindra & Mahindra owned company Tech Mahindra, as part of its diversification strategy. Effective July 2009, Satyam rebranded its services under the new Mahindra management as "Mahindra Satyam". After a delay due to tax issues Tech Mahindra announced its merger with Mahindra Satyam on 21 March 2012, after the board of two companies gave the approval. The companies are merged legally on 25 June 2013.