NEW YORK (Reuters) - Goldman Sachs Group Inc executives have good reason to be worried about the risk of receiving subpoenas from the Justice Department, and investors should be concerned too.
The U.S. government has a real chance of finding inconsistencies between Goldman executives' testimony to Congress and their internal documents, which means subpoenas could turn into something more serious, lawyers said.
The distractions and the reputational damage from any government action could result in clients hesitating to work with the bank.
There's no evidence of that happening, but it is a risk. Even if the expected subpoenas turn up nothing, they reflect growing political pressure for the United States to do something -- anything -- to punish Goldman for the events of the financial crisis, experts said.
"Goldman is extremely vulnerable," says Harvey Silverglate, an attorney who represented Michael Milken after the junk-bond king pleaded guilty to felony charges in 1990. "The statutes are so vague, a reasonably good prosecutor or a reasonably inventive prosecutor can manage to squeeze anything that might not look so great into a federal felony."
For Goldman, there is a lot that does not look great.
A Senate subcommittee report in April said the bank offloaded much of its subprime mortgage exposure to unsuspecting clients in late 2006 and 2007 as the market was starting to tank. In some cases, it refused to end bad trades with customers, even as clients pressed them to.
Levin forwarded the report to the Department of Justice, and on Friday, the Wall Street Journal reported that Goldman executives expect the Justice Department to issue subpoenas for more information about mortgage-related matters.
Goldman Sachs spokesman David Wells declined to comment. At the time the Levin report was released, Goldman said, "While we disagree with many of the conclusions of the report, we take seriously the issues explored by the subcommittee."
A key question as Justice Department prosecutors review Levin's report will be whether they believe they can prove criminal violations beyond a reasonable doubt.
The Obama administration has had some trouble prosecuting senior corporate executives with ties to the housing meltdown. Prosecutors dropped a probe of former Countrywide Financial CEO Angelo Mozilo after determining his actions did not amount to criminal wrongdoing.
Justice also failed to win criminal prosecutions against two former Bear Stearns executives in 2009.
Two attorneys whose firms are involved in civil litigation against Goldman said that there wasn't enough evidence for a criminal case.
"Prosecutors have been pretty careful not to indict someone unless they have the Raj Rajaratnam wire-tap smoking gun," said one lawyer, who declined to be identified to avoid hurting his client's case. "I'm not sure they have it here."
Justice Department spokeswoman Alisa Finelli declined to comment about Goldman or political pressure on the agency.
Whether or not they believe the evidence unveiled so far warrants a criminal case, lawyers say the Justice Department may take some sort of legal action simply to send a message.
One former federal prosecutor said that the Justice Department might avoid pressing charges against the bank.
"Nobody wants to bring down Goldman," said the former prosecutor, who declined to speak on the record because of current business relationships.
But pressing lesser charges against Goldman Sachs officials might make sense, he said.
"It's going to send a message to the rest of the community that you can't do this kind of activity."
Prosecutors may seize on the difference between what executives said in front of lawmakers at a hearing last spring and what they said in email messages or other documents when the financial crisis was brewing.
In testimony to the Senate subcommittee in April 2010, Chief Executive Lloyd Blankfein said, "we didn't have a massive short against the housing market and we certainly did not bet against our clients."
The subcommittee report said the opposite on both of those crucial points, contending that Goldman's denials "are not credible." Levin said that, in his estimation, "Goldman clearly misled their clients and they misled Congress."
In a chart, the subcommittee shows Goldman holding short positions of $1.5 billion to $13 billion through most of 2007.
Blankfein also said that Goldman lost about $1.2 billion from activities in the residential housing market, while the subcommittee contends it actually earned money.
It's unclear how prosecutors will interpret those discrepancies and turns of phrase.
The Department of Justice probe is the latest in a series of inquiries and investigations into Goldman. The bank paid $550 million last year to settle civil fraud charges with the U.S. Securities and Exchange Commission over a complicated derivatives deal.
The bank did not admit to any wrongdoing as part of that settlement, but acknowledged a "mistake." The Commodity Futures Trading Commission is investigating a Goldman unit, and staffers have told Goldman they intend to recommend the commission bring charges, according to the company's most recently quarterly filing with regulators.
In aggregate, this kind of political pressure is poisonous to a bank, experts said.
Peter Vinella, a director at the consulting firm Berkeley Research Group who specializes in bonds and derivatives, held a senior management position at Drexel Burnham Lambert before its collapse.
Vinella cautions that he does not think Goldman will go out of business, but said the high-profile accusations of dishonesty and double-dealing can wear on a bank's reputation.
He compares the Goldman situation to Drexel's downfall, which happened over a period of four years. Prosecutors first targeted individual employees in 1986. The Securities and Exchange Commission eventually sued the company and the Department of Justice settled felony charges with the firm. Drexel filed for bankruptcy in February 1990.
"What happens in these kinds of instances is usually not immediate," says Vinella. "It's usually this kind of slow, agonizing, belly-wound death."
Eventually, he said, public officials, wealthy clients and talented employees no longer want to be associated with a bank that has garnered so much negative attention. As talented employees leave, clients who once flocked to Goldman for advice on major deals or to obtain financing may no longer see the cachet.
Veteran banking analyst Richard Bove of Rochdale Securities wrote in a note last week that the likelihood for the U.S. and Goldman to keep fighting "does not work for shareholders." He downgraded the bank's shares to "sell" from "neutral."
According to Thomson Reuters data, 19 other analysts advise clients to buy the stock.
Some Goldman customers that spoke with Reuters said they plan to continue doing business with the bank if only to get access to information and attractive deals.
But there are signs that Goldman's stature is waning, including its absence in some of the larger M&A transactions this year and its declines in trading revenue. Since the subcommittee report was released, Goldman's stock has shed 13 percent, representing $10.8 billion in market value.
Said former Drexel executive Vinella, "You want to get bad news over with as quickly as possible and, with Goldman, we're now almost into year three."
Reporting by Lauren Tara LaCapra. Additional reporting by Jeremy Pelofsky in Washington. Editing by Robert MacMillan