Levin Aims to Ban Banks From Betting Against Customers

WASHINGTON—Lawmakers are considering legislation that would ban investment banks from betting against their customers in many circumstances, in a further ripple effect for Wall Street from Goldman Sachs's troubles.

In a statement to The Wall Street Journal, Sen. Carl Levin (D., Mich.) said he is drafting legislation to prevent conflicts of interest by "prohibiting companies from taking the opposite side of the deal for their own account," at least when they are marketing investments they have created themselves.

Mr. Levin and his co-sponsor, Sen. Jeff Merkley (D., Ore.), are aiming to propose an amendment as soon as Monday to the financial-overhaul bill being debated in the Senate.

At a Senate hearing last month in which senators grilled Goldman executives, Mr. Levin focused much of his scrutiny on a handful of deals where he said that Goldman was both constructing subprime-mortgage securities and effectively betting they would fall in value.

Those deals, which carried names like Timberwolf and Hudson, are somewhat different from a 2007 transaction called Abacus that is the subject of civil-fraud allegations by the Securities and Exchange Commission. In Abacus, a hedge fund, rather than Goldman itself, took the "short" side of the transaction, betting the mortgages would decline.

In all of the transactions, a fundamental issue is how much obligation Goldman had—or should have had—to protect its customers' interests. At the Senate hearing, Goldman witnesses frequently spoke in general terms of the firm's role as a "market maker," someone who matches buyers and sellers and can take positions on his own. A market maker's duty to customers is limited.

Mr. Levin says that despite the firm's rhetoric, Goldman's role in the deals under scrutiny was as a securities underwriter or "placement agent," which carries a broader obligation to disclose details about the product. Goldman Sachs doesn't disagree that it was a placement agent in those transactions.

In Timberwolf and similar deals. Mr. Levin says Goldman failed to provide a "full, fair and honest" accounting of its interests. "We believe we acted appropriately in these transactions," said Goldman Sachs spokesman Samuel Robinson.

In the Abacus deal, the SEC suit says Goldman should have told clients that the hedge fund had a significant hand in designing the security it was betting against. Goldman denies wrongdoing, saying that information wasn't material to investors and it had an obligation not to reveal the hedge fund's positions to outside parties.

The proposal by Sens. Levin and Merkley reflects some frustration in Congress over the value of additional disclosure. Rather than put even more legal language in offering documents, the senators are proposing to bar outright a type of transaction that they feel is inherently abusive.

However, J.W. Verret, a George Mason University law professor who testified before a Senate subcommittee last week on bankers' duties to clients, said the proposal would hinder banks from hedging their risks. "This bill really hamstrings investment banks," he said in an interview. "It's putting them between a rock and a hard place."

The Securities Industry and Financial Markets Association declined to comment on Mr. Levin's proposal.

Thomas Hazen, a University of North Carolina law professor who has written a treatise on securities law, predicted there would be opposition from investment bankers to such a far-reaching change.

In addition, he said the Levin-Merkley approach could have shortcomings.

"This seems to be a reasonable way to get at the most problematic aspects of the conflict situation, but it depends on how they define being on the other side," Mr. Hazen said. If the provision isn't carefully drafted it could be possible for bankers to sidestep the prohibition by using multiple transactions, he said.

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