Stockbroker Arbitration: Goldman Sachs Ordered to Pay

New York, NYA large financial institution was recently ordered by a stockbroker arbitration panel to repay money lost by investors in a Ponzi scheme. Victims of the Ponzi scheme claimed the financial firm was partially responsible for investor's losses in the stock fraud.


Goldman Sachs was ordered by the Financial Industry Regulatory Authority (FINRA) to pay more than $20 million to settle claims related to a hedge fund. According to the New York Times on 6/25/10, the hedge fund's creditors alleged that Goldman Sachs should have known that Bayou Hedge Fund—a clearing brokerage client—was involved in illegal activity and may have been involved in a Ponzi scheme.

FINRA's arbitration panel found Goldman responsible, since Goldman handled Bayou's trading activities from 1999 through 2005. In 2005, Bayou's CEO and CFO admitted to making false statements about the company's profits. That same year, Bayou's former executive, Samuel Israel III, pleaded guilty to defrauding clients out of more than $400 million.

In 2008, Israel faked his own suicide after being sentenced to 20 years in prison for fraud.

The complaint, filed in 2008, alleged Goldman had access to Bayou's trading records, which showed the company's losses, and Bayou's marketing materials, which claimed that the company made a profit. Creditors argued that Goldman had access to those records and should have known that Bayou was involved in fraudulent activities.

In 2004 Goldman put a Bayou fund at the top of its list of money losers and ranked two other Bayou funds slightly lower on the same list. Furthermore, the complaint alleged, Goldman was warned by an outside firm about Bayou.

Investors lost approximately $250 million when the Bayou hedge fund collapsed.

Goldman claimed to be aware of Bayou's activities and argued that it was not responsible for investigating account holders.

Ponzi schemes are illegal investment schemes in which investors are paid with funds contributed by newer investors. Because funds based on Ponzi schemes have very few legitimate earnings, they require a continuous supply of new investors to pay previous investors. They can survive for a long time, but tend to collapse when they fail to recruit new investors or when a large number of investors cash out at the same time.

The New York Times notes that this FINRA case marks the first time that a bank, acting as middleman, has been accused of helping a fund involved in a Ponzi scheme and has subsequently been fined for those actions.

The Wall Street Journal notes that two Goldman Sachs units—Goldman Sachs Execution & Clearing LP and Spear Leeds & Kellogg LP are responsible for paying the award.