Business managers have a crucial role to play in regulating the affairs of the company to make more profits for the shareholders and the investors. The top management must take concerted efforts in promoting higher productivity in the companies. Some of the strategies adopted in the process involve efficient management and prudent investment. However, in the conduct of these processes, business managers must not contravene established rules, ethical considerations, or industry practices. The law abhors any uncompetitive, unethical, or unlawful practices, especially in handling clients’ money (Scott, 2009). Investment companies are the most widely scrutinized companies to ensure that they do not misappropriate the investors’ money or use it in risky or tad investments (Malley, 2013). In the foregoing discussion, the write up will examine a major case that involves ethical conduct in business transactions. The analysis will explore some of the salient issues that direct how companies relate with the stakeholders on the basis of contract law, policy formulation, legal compliance, and the consequences of default. The case of Goldman Sachs brings to light the attendant challenges in regulating ethical conduct in a business and the legal inadequacies in regulating some business practices.
Elements of a Contract
A contract outlines the relationship between parties who intend to get into a legally enforceable and binding agreement. Generally, a contract incorporates the elements of an offer, acceptance, consideration, legal binding, and capacity (Ewan, 2005). An offer is the introduction by the offeror to enter into relations with another party. The respondent party then agrees to enter into the proposed relationship by accepting the terms of the contract. The contract may be vernal or written and it contains the terms expressly or impliedly agreed upon by the parties. In arriving at a binding agreement, the contract must specify the consideration, consideration is what either party to the contract gets or gives as pertains the agreement. The law is clear that such consideration only ought to be adequate but not necessarily sufficient. It is expected that the parties to the contract must both demonstrate competence and capacity to enter into the relations. Capacity is usually determined on the basis of maturity and sanity. A person above the age of majority and mentally stable can enter into a contract with another one. Once the parties enter into a contract, they purpose to undertake all that pertains to the contract and discharge their duties diligently and in good time. The contract is legally enforceable and permits an aggrieved individual to seek legal redress in the form of damages, rescission, or specific performance, as the case may be.
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The elements of a contract contribute in developing a binding agreement between the parties and protect the rights of both parties. To begin with, contracts are framed in clear, certain, and specific terms. Except for the implied terms, the remaining contents of the contract are usually express and are open to the broad and purposive rule of interpretation. Parties cannot go wrong on what the contract states. In the event of a controversy or disagreement, the contract provides interpretation clauses that direct the parties or a third party on how to construe the various terms of the contract to promote coherence. With regard to protecting the rights of the various parties, the contract offers various forms of redress such as rescission, damages, or specific performance. Under these forms of redress, the parties can seek remedies when the other party fails to live up to their promises. Courts can interpret and enforce contracts to protect the interests of the different parties or to meet the intention of the contractors.
The elements of the contract describe the nature of the relationship between the parties and allows them to prescribe the mode of handling disputes. Legal capacity ensures that the parties are mature enough to undertake the obligations under the contract. In the event of a dispute, the legal capacity makes it possible for the parties to stand trial in a court of law. Besides, legal capacity imports an element of maturity. It therefore eliminate the aspect of undue influence and coercion (Fergus, 2006). Therefore, the specific elements of the contract control certain aspects of the association, and ensures that the parties can control certain outcomes in the course of their engagement. The definite terms and remedies available under the law of contracts allows the parties to develop a binding agreement and protect their rights.
Case Analysis: Goldman Sachs and Lehman Brothers
Elements of the Contract
In the case of Goldman Sachs, the contract involved underwriting. The investors were to originate the contracts for a mortgage financing. Under the contract, the investors accepted the terms provided by the company in relation to the amount of interest their respective investments could yield. Besides, the contracts outlined the mode of resolution of disputes, if any arose. The contract did not specify the manner of termination of the contractual relationship and what rights the investors had. However, the investors relied on common business practice on repaying the investors in case the company erred. In the event of financial improprieties, the company was liable in damages or reimbursements, depending on the gravity of the mistake.
Lehman Brothers borrowed significant amounts of money from individual investors to fund its mortgage program in a leveraging process. Under the agreement with the loaners, the company was to invest the money prudently and the profits could trickle down to the investors. The company had insured the money and undertaken to engage in efficient business operations that would profit the stakeholders. There were no clear provisions for the termination of the contract. However, the contract provided for redress in the form of financial reimbursement in case the company erred in the discharge of its mandate.
Products Offered and the Laws Governing them
Goldman Sachs is an investment bank that specializes in financial advisory and investments in profitable ventures (Goldman Sachs Inc.). The company offered mortgage services to the public in which partner companies were invited to underwriting various clients into the program. The company facilitated people to acquire houses in the United States in the famous housing boom of the early 2000s in the country. The company is incorporated as a bank, hence amenable to regulation by the Federal Reserve System and other banking laws. The laws regulate shareholding, number of directors, minimum capital requirements, deposit insurance, and winding up procedures. The laws also prescribe certain penalties on non-compliance.
Lehman Brothers is a financial services firm based in the United States. The corporation specializes in offering financial advisory services including investment advice and insurance. In the discharge of its mandate, the company offered mortgage services in which it financed various people to acquire houses in the United States. Under the underwriting contract, the company enabled many people own homes by providing financing to the various real estate firms. Lehman Brothers is a financial services firms and it is regulated by the financial services authority, the banking laws, and is amenable to regulation by the SECC and the Federal Reserve System (Lehman, Inc.). The laws regulate the manner of investments, company formation, insurance, and shareholding (Thorp, 2010). However, the company was not subject to the risk insurance provisions as the other deposit taking financial institutions. Accordingly, the company had a greater leeway on how it investments its money, sometimes endangering the book equity value.
The Logic behind the Contracts
The contracts were designed to outline the relationship between the various parties to the contract. Contracts outlined the specific duties of the parties under the contract. For instance, the investment firms would source for viable business opportunities, conduct a review of its profitability, invest the money wisely, and once the profits accrue, transfer the same to the shareholders. Besides, the contracts specified the specific remedies that the parties were entitled to and the nature of resolving disputes when they arose (Parfit, 2010). Besides, the fact that contracts were in written form, they cleared any ambiguities that may emerge in the course of the discharge of the various contractual obligations. Besides, the contract provided for the initiation of the work arrangement between the investors and the management of the company. The contract outline factors such as the amount of investment to be made and the returns on such investments. Besides, the contract provided for the termination of the contract and what rights the parties enjoyed in either case.
The Issue in the Two Cases
Lehman Brothers took deposits from investors to invest in the mortgage sector. At first, the company made vast gains in attracting many clients on board. The activity resulted in a profit boom in the first few year of trading. As the trading progressed, the company underwrote more subprime contracts, a factor that endangered its prospects. The investing in high risky and non-collateralized customers caused the company enormous losses (Loughrey, 2013). In the end, the company was unable to maintain its book equity to the non-performance of some of the mortgage loans. As the 2008 financial crisis depended, the company was unable to redeem the value of the investments it had and fell into losses. Besides, the company was not subject to the deposit insurance rules as other deposit taking companies such as banks. The company did not insure its deposits adequately insure itself. In the end, the company suffered massive losses, leading to its liquidation and subsequent winding up. In the entire process, the investment advisors did not undertake due diligence, leading to the underwriting of more subprime mortgages.
On the other hand, Goldman Sachs underwrote many shoddy housing loans that were backed by lower credits. In the end, the company suffered massive losses due to the nonperformance of the loans. In the case of the Goldman Sachs, the company did not perform due diligence before it made the investment decisions. In the process, the company misled the investors that the loans were stable and they proceeded to make multiple investments into the venture that finally became unfruitful. The misinformation caused the investors huge losses. In the end, the company was found liable for unethical conduct and fined several billion dollars. The case is one of the biggest in history and is a good subject for study on ethical conduct in business transactions.
Development of the Issue
In both cases, the facts that led to the development of the case and its subsequent prosecution in court was the massive losses suffered by the investors in the companies. In the case of Goldman Sachs the investors lost a lot of money but the company was not wound up. In the case of Lehman Brothers, the company went under due to its inability of the company to maintain its equity book (Kay, 2012). The corporation was found wound up. In the winding up proceedings and before the liquidation proceedings, the investors lamented about the conduct of the company in the entire investment saga. In the case of Goldman Sachs, the company made huge losses. The investors filed a complaint about the nature of investments the company made and how the misconduct led to huge losses. At court, the settlement process involved the company paying huge fines due to the investors who lost their money.
Weaknesses of the Contractual Clauses
In the case of Lehman Brothers, the contract did not provide for full disclosure of the investment decisions made by the company. The company undertakes to perform all the investment decisions and does not allow for public participation of the stakeholders. In the process, the investors can be easily misguided on the investments the company is making. The inability by the public to scrutinize some of the actions by the company leaves a lot of leeway in what the company can do. In the process, the company misguided the investors on the nature of investments it was making. The contract did not allow the stakeholders to demand specific answers on the activities the company as undertaking. The only recourse open to them was in withdrawing their investments.
In the case of Goldman Sachs, the contract did not outline the specific nature of investments the company can make. Despite making general provisions on investing in mortgages, the company did not outline the specific or extents to which the company can underwrite mortgage loans. In the process, the company ended up making tad and risky ventures that drove the company to greater losses. As a result of the deficiencies in the contract, the company betrayed the trust of the company and engaged in various investment malpractices that caused the investors huge losses.
Analysis of the Verdict in Goldman Sachs
The verdict in the Goldman Sachs case is better than the outcome in the Lehman Brothers case. Despite the huge fines imposed on the company, the financial situation was ultimately salvaged and the company remained operational. As compared to the outcome in the Lehman Brothers cases, the conclusion of the case in the Goldman Sachs scenario afforded the investors a chance to recoup their investment. Besides, the company continued trading without closing shop and leading to the loss of many jobs.
The determination of the case in Goldman Sachs was aimed at rectifying the investment flaws in the company. In the process, the company was forced to pay hefty penalties towards reimbursing the investors of the company. The determination of the company brought out the unethical practices in the investment. In response, the company was punished for the poor conduct. I think that the determination of the case in this manner was ethical and respected the wishes of all the stakeholders. Most importantly, the decision ensured that the company remained operational. However, the decision was lacking in various aspects. For instance, there was no determination on what could be done to the directors who propagated the misdeeds. In addition, the decision did not prescribe how the company must operate in the years to come. The umpire in the case was only interested in the determination of the present cases, without any regard of the welfare of future contractors with the company.
In the case of Lehman Brothers, the determination to liquidate the company and finally wind it was not ethical. The cases did not consider the individual needs of the different investors who had put money in the company. There was a need for the court to intervene in the process before the case deteriorated. At the time the court made the liquidation order, it would have issued other interim measures to protect the stakeholders in the business. The courts were only interested in resolving the dispute without much emphasis to the future of the stakeholders who depended on the company. For instance, the court did not consider what would happen to the employees of the company. In my view, the determination of the case in was unethical and it failed to regard various issues that confronted the stakeholders of the company. In my opinion, the situation would have been salvaged by massive capital injections in the company or a change of management. Besides, the insurance companies would have underwritten the company until it was profitable again instead of plunging the fate of employees and investors into uncertainties.
The Operations in Relation to CDO and LIBOR
In investments, companies are required to compartmentalize debt obligations according to their levels of risk (O’Brien, 2007). In practice, companies must strategize how they will manage their debt obligations by categorizing them on the basis of their risks. Higher risky investments are grouped together while the lower risk investments are grouped on their own. In principle, the higher risky investments attracts lower rates while the lower risk investments attract higher returns. In the internal management of the company, the company must balance the higher and lower risk tranches to maintain the equity books.
In the case of Lehman Brothers, the company maintained higher risk tranches as compared to the lower risk tranches. In the end, the company made huge losses. The policies and regulations were weak and did not offer a better opportunity for the company to balance between the contract terms and what was actually executed. Investors were bound to the contract terms that permitted the company to undertake any actions it deemed necessary without the need to inform the investors. As a consequence, the company made investment blunders due to huge underwriting of non-performing loans, leading to massive losses and the eventual collapse of the company.
On the other hand, Goldman Sachs bound it investors in a contract that permitted the company to undertake financial review, investment analysis, and prudent investment. The policies articulated in the contract allowed the company to undertaken all the active management decision without alerting the investors on the step taken. However, the company failed in discharging its mandate under the contract an instead led the investors into believing that the investments were low risky and the investors would reap good profits. However, the investments turned out to be shady, leading to huge losses. The company failed to meet the obligations under the investment contract and occasioned huge losses to the investors.
In general, the benchmark for tranching loans according to their risks was low. For example, it is unthinkable how a reputable company such as Goldman Sachs would fail to undertake due diligence about all the collateralized debt obligations. In the process, the company underwrote many high risk mortgages in the hope that the situation would improve. The same case happened to Lehman Brothers who taught they would take up a huge chunk of high risks investments without a pinch. The benchmark for the bank reference rates (LIBOR) was also low in either cases, leading to big losses. A higher benchmark for example, would have made the partner companies in the Lehman Brothers case review their operations to ensure that the investments were viable.
Settlement versus Litigation
Most business would opt for an in-house settlement instead of litigation. In settlement, the company’s reputation would not be tarnished. In litigation, the matters play out in open court where the media may pick up the news and spread to the entire world. In the process, the company may lose potential investors. Besides, the matter may be thrown out of proportion by the commentators, a factor that may hurt the business considerably. In addition, settlement has the advantages of flexibility, time conscious, cheap, and upholds the relationship between the parties. Also, going to court would mean that the company will open up the possibilities for various people to approach the court using the same precedence. In the end, the company may be forced to pay up more damages to all the aggrieved parties. The aspect of regulators backing off in the USA with regards to the case reiterated the aspirations of the players for the matter to be settled out of court. Any interventions by the regulators would have sparked a formal and legal process that would have seen the matter play out in court. The regulators accorded the parties to pursue alternative dispute resolution methods.
Analysis of the Judgment
The case of the Lehman Brothers went to court in two instances. The first instance involved the liquidation claim and the second claim involved bankruptcy. The liquidation claim arose after the company was unable to meet its short-term financial needs. For the purposes of this discussion, the discourse will consider the bankruptcy claim. In the bankruptcy claim, the court ruled that the company be would up and the assets from the company be divided among the shareholders in the ration of their contribution. The court also authorized the takeover of some of the company’s assets such as the plaza that was bought by Barclays. In the end, the shareholders were able to salvage some of their contribution towards the company.
The judgment by the court brought an end to the working relationship between the parties. The investors bore the brunt of the judgment as they had to forego some of their share of contribution. The investors lost a lot of money in the process. The management of the company too went of business. Subsequently, they lost their source of employment. It is expected that should there be any other reason for engaging in the future, a majority of the present shareholders would not want to deal with the company. The incident negatively affected the relationship between the two parties and brought to an end a long working engagement.
In the court, the judgment was based on the ethical conduct and contravention of investment laws and insurance. The company flouted many invest rules by creating inaccurate tranches of the loan portfolio. Consequently, the company underwrote several high-risk loans that eventually failed to mature, leading to massive laws. Besides, the company failed to insure itself adequately. Despite the fact that the law did not make it mandatory for the company to register itself as any other deposit taking financial firms, the company was nevertheless expected it take out insurance against the hazards of financial impropriety (Coffee, 2006). This way, the company would have avoided the massive losses it bore. Besides, had the company conducted due diligence, it would averted the present crisis by avoiding higher risk loans.
The decision of the court negated the policies and rules of the regulators. On it part, the court was only concerned with addressing the woes of the investors as opposed to addressing the underlying challenges of administration. On the other hand, the regulator would have insisted on jailing the culprit managers who contravened investment regulations. The regulators demanded that a company ought to insure itself against the perils of financial impropriety and abide by proper management practices. Under this arrangement, the company was required to enforce proper risk analysis measures before underwriting any loans. In the exercise, the company would avoid making massive losses that eventually caused its downfall. The rules also require that the creating of the loan portfolio must be balanced by taking stock of the high risk and low risk investments. Through a balanced act, the company could have easily avoided getting into a fix.
Conclusion
The two cases of Goldman Sachs and Lehman Brothers explore some of the ethical challenges in running a business. In the two cases, the analysis examines how unethical decisions led to massive losses to the investors. Besides, the exercise threatened the welfare of the employees of the respective companies. In law and principle, companies are required to be in touch with the stakeholders, especially the investors, and update the on the various decisions they are making. Importantly, a company must conduct due diligence on any investment choice to ensure that the company does not make tad or risky investments that may lead to losses. From the foregoing, it is apparent that the company excluded the participation of the stakeholders in the decision-making process. As a process, the investors were blind the entire process and only realized the misdeed once the matters escalated. The case also highlights some of the major challenges in undertaking investments. In most cases, the company offer close-ended contracts that do not clearly outline the manner of involvement in the decision-making processes of the company. In future, it may be necessary for the companies to draw contracts that allow them to take an active role in the management. Through this, the investors will be kept abreast with the management strategies in the company and devise a good way of responding to them.
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