Knowledge helps protect your nest egg

SEC vs. Goldman

The SEC alleges Goldman Sachs committed fraud when it sold a certain mortgage security to investors in 2007, without disclosing that a hedge fund had a hand in structuring the deal. In fact, the security was designed to fail and the hedge fund bet against it, going "short," and made $1 billion as the housing market fell off a cliff. Buyers of the security took a bath.

Goldman denies the allegations but does admit that it was also shorting the housing market beginning in 2007. The firm claims this was to offset its large holdings of mortgage securities and was just prudent risk management.

It is important to note that the investors who purchased the securities in question were not individuals like you and me. Instead, the buyers were sophisticated investors like pension funds and hedge funds.

This is an important distinction because the SEC has determined that sophisticated investors are aware of the inherent risks of buying securities, and have the experience and resources to make investment decisions. In essence, these sophisticated investors are on a level playing field when dealing with a firm such as Goldman.

What is a short?

Many of us look at investing in the stock market as a good way to benefit if the market rises. This is referred to as taking a long position. If an investor thinks the market has reached a peak and wants to profit if the market declines, this investor will short the market. The mechanics of entering a short position are complicated and actually involve borrowing a security today with the promise of returning the security at a future date. The short investor then buys the security at this future date when the price is either lower (the short investor makes money) or higher (the long investor makes money). Short investors can either make or lose a lot of money.

Short positions can be made for individual stocks, indexes, interest rates, commodities, and virtually any other type of investment. The ability to short a market serves as a damper and helps prevent the market from becoming overheated. Short selling is a closely monitored barometer of the market and is considered to be a healthy option for investors.

Goldman the villain?

The recent congressional testimony by Goldman has caused many to question their basic business model and role in the housing debacle. Let's be blunt: They are basically a trading organization that attempts to profit from changes in markets, up or down. They are good at it and made $3 billion last quarter and $13 billion in 2009.

In addition, Goldman benefited handsomely during the financial bailout of AIG and has numerous alumni serving in high-level government positions, prompting concern about possible conflicts of interest. Their success and these connections make them a deserving target during financial reform discussions.

What is a fiduciary?

Some have questioned whether Goldman had a fiduciary obligation to the investors it was selling to. This is debatable under the current framework. Personally, I am an advocate for the fiduciary standard for all financial professionals advising clients.

Fiduciary comes from the Latin word for "trust." Responsibilities include: (1) putting client interests first; (2) acting with utmost good faith; (3) providing full and fair disclosure of material facts; (4) not misleading clients; and (5) disclosing all conflicts of interest.

How to protect yourself

All investors need to understand that Wall Street, and the brokerage industry in general, are in the business of selling securities. If you're a board member responsible for large assets, they may even pay for an occasional conference in a sunny location. They will often pick up the dinner tab.

In all likelihood, they are only trying to sell you a security or get your business. No one should forget that the relationship is similar to that of an individual and salesperson. Buyer beware!

The Senate is currently debating financial reform legislation that may include a requirement for anyone providing financial advice to be a fiduciary. Until this standard becomes a requirement, do your part to protect your nest egg by requiring a fiduciary relationship from your financial adviser. If you're working with an SEC Registered Investment Adviser (RIA), you are assured of this. Having a fiduciary on your side is the only way to ensure that the advice you receive is in your best interest.

Julee Duhrsen is vice president of operations for Alaska Permanent Capital Management.