Goldman Sachs got caught red handed this time. Just the other day an analyst for the global investment bank announced it was upgrading its position on Tesla Motors Inc. to buy from neutral. By itself, a bullish outlook on a stock is not that unusual. Still, Goldman Sach’s surprise stock upgrade on the electric car maker led to a 4 percent rise in Tesla’s stock price.
What happened a day later, however, raised eyebrows and questions about the Wall Street giant’s role in the world economy.
The day after the stock recommendation, Tesla announced it was launching a public offering valued at an estimated $2 billion. The investment banks leading the public offering? Morgan Stanley … and Goldman Sachs.
Perception problem
The deal immediately failed the sniff test and had many investors and Wall Street watchers scratching their heads. The incident raises serious questions about the propriety of big banks being involved in multiple facets of the financial world.
As a secondary stock offering, the Tesla move is not subject to the same blackout regulations that are in place for initial public offerings, which require radio silence. Goldman Sach’s buy upgrade came with a prediction that Tesla would need $1 billion in additional funding. Those funds would fuel an expansion effort designed to increase annual production to 500,000 vehicles by 2018 and have its Model 3 mass-market sedan onto showroom floors in 2017.
While the timing of a buy recommendation followed by a public offering announcement seems suspicious, some analysts defended the investment house as a coincidence.
“The whole question of research overlapping with investment banking has long been a hot topic and one that is regularly looked at by the (Securities and Exchange Commission),” Tom Gorman told MarketWatch.
“I would fully expect that Goldman has such policies in place.” said Gorman, a former SEC lawyer and now a partner at Dorsey & Whitney.
Using a Chinese wall
The crux of the issue is the so-called “Chinese wall.” This provision is designed to protect consumers by having independent research and underwriting divisions within an investment bank.
The Chinese wall is meant to create an ethical barricade to prevent a conflict of interest within a firm. In practice, it is meant to separate the bankers advising companies on offerings or takeovers from the employees advising clients on which investments to make.
The provision is meant to prevent bankers from sharing information that could take shape the work or allow for unfair advantages based on information not yet public.
Goldman Sachs has denied any wrongdoing. In a statement issued after the events, the bank stated, “Our research is independent. We followed all of our standard policies and procedures with respect to our research publication.”
The investment bank has not fared well in the court of public opinion, dating back to the Great Recession. Goldman Sachs took on a number of risky investments, convinced they had made the right bets. When the financial crisis hit, those bets proved devastating. Between October 26, 2007, and November 21, 2008, Goldman Sachs stock price dropped to $53 from $253 before it was bailed out by the federal government.
In recent years, it has worked to improve its image, and this latest incident will not help.
The case may not have been as much of a head-scratcher if it weren’t for the history regarding big banks and Tesla. In February 2014, Morgan Stanley issued a stock upgrade that projected a price target more than twice its price at the time. In the same month, Morgan Stanley announced it was underwriting a $1.6 billion convertible bond offering from the auto maker.
So far there is no clear indication that there was anything illegal about the two seemingly conjoined events. There have been no reports of action being taken against Goldman Sachs by the SEC or law enforcement.
Protecting investors
What can average investors do to protect themselves from seemingly conflicting interests among Wall Street big wheelers?
For one, investors should rely on multiple sources for information about potential investments. Putting all your eggs in one analysts’ basket is risky. Do your own homework. Research investments from various websites, understand the industry in which you’re investing and ask lots of questions.
For two, speak with an impartial financial advisor about the stock or investment in question. Gaining counsel from a third party with no ties to the investment in question ensures far less bias in a potential transaction.
The Tesla and Goldman Sachs case may be much ado about nothing. Regardless, it’s a good reminder to do due diligence before making any investment.
Regards,
Ethan Warrick
Editor
Wealth Authority
