"The greatness and the genuine trait of your thought and writings lie on the fact that you positively and interestingly make use of philosophical thoughts and thoughtfulness in order to deeply and concretely cogitate about America's social issues. . . . This does not mean that your thought is reducible to your era: your thought, being inspired by issues characterizing your era . . . , overcomes your era and will still likely be up to date even after your era, for future generations." Bruno Valentin

Friday, November 21, 2014

Wall Street Banks in Commodities Businesses: An Inherently Unethical Conflict of Interest

Writing to the bank’s board of directors, an executive at Goldman Sachs wrote that the bank’s commodities division would achieve higher value “if the business was able to grow physical activities, unconstrained by regulation and integrated with the financial activities.”[1] According to Sen. Carl Levin, Goldman’s goal here is “to profit in its financial activities using the information it gains in the physical commodities business.”[2] The integration could be achieved in part by using the bank’s access to nonpublic information from the banking or trading operations to manipulate the price of a commodity by artificially restricting or adding to supplies through ownership at the production or storage stages. This structure contains a conflict of interest. Because resisting the temptation to exploit the conflict would put the Goldman bankers at odds with the bank’s financial interest, I contend that reliance by the public on intra-bank firewalls (i.e., policies) separating the commodity businesses from the bank’s trading operations is too weak to protect the public, including buyers of the commodity.

Sen. Levin’s subcommittee focused its investigation on Goldman’s ownership and management of an aluminum storage company, Metro International Trade Services, which held nearly 1.6 million metric tons of aluminum—roughly 25 percent of the amount of aluminum used in North America (85% of LME-warranted aluminum used in the U.S.).[3] Under Goldman’s direction, Metro paid companies storing aluminum at Metro’s warehouses to move the aluminum from one Metro warehouse to another. One effect of such a Merry-Go-Round move is a lengthening of the queue, which in turn is associated with a higher price (premium) of the commodity on the market. In short, Goldman could manipulate the commodity’s price as needed by the bank’s proprietary and counterparty positions in the commodity (i.e., in the trading operations of the bank), thus integrating the revenue streams in the overall interest of the bank.

To suppose that such a potentially lucrative conflict of interest would go untapped by a private company whose principal aim is to profit borders on the absurd. Accordingly, we can say that the conflict itself—as it was structured as of 2014—is inherently unethical. To put this point differently, it would be unethical to permit Goldman to have such a structure. By analogy, situating an alcoholic in an apartment next to a liquor store can be said to be unethical because doing so subjects the person to a strong temptation. Abstractly speaking, the unnecessary acceptance of a temptation that would harm others renders a structural conflict of interest inherently unethical—meaning that the sordid nature does not depend on the conflict being actually exploited. Hence, society, acting through its government, has an ethical right and even an obligation to deconstruct such structures. The obligation is not only to protect third parties from getting harmed from the structure being exploited, but also to relieve the party subject to the temptation from it. By analogy, both the people living near the liquor store and the alcoholic are in need of protection from the alcoholic; waiting for the alcoholic to lapse under the strain of the temptation (which is in the structure itself—living next to the liquor store) would be unethical because the harm could foreseeably have been obviated by situating him or her somewhere else (i.e., getting rid of the structure itself).

Unfortunately, people (and our elected representatives) tend to minimize the baleful tendency in a structural conflict of interest. Put another way, we give human nature too much credit in being able to resist temptations that are inherent in how two roles are related (i.e., arranged, or structured). We naively assume that CPAs are more interested in giving honest audit opinions than in retaining existing clients. We assume that rating agencies will rate bonds accurately rather than overstate a rating to realize more revenue as more of the bonds are sold.

 Even in just going to a Starbucks to ask if there are any other coffee shops in the area, we unconsciously assume that the Starbucks’ employee will look the other way on the prospect and admit that a locally-owned coffee shop is just down the street. If putting someone in a conflict-of-interest situation is unethical, then it is unethical to ask the question at a coffee shop. To act ethically, we would go to another line of business near the Starbucks rather than to the coffee shop itself to ask the question. I realized this point only last week when I asked a clerk at a Shell gas station if a Mobil station is near (Mobil stations don’t charge for air). In particular, I realized that I could not trust such a clerk were he or she to answer in the negative. As this does not depend on the particular clerk, the conflict of interest is structural. Moreover, besides being a faulty choice for me to get accurate information, subjecting the clerk to the temptation to lie to me is for me to act unethically whether the clerk lies or not. In other words, the sordid nature of the conflict of interest does not depend on the clerk exploiting it at my expense.

In short, we can conclude that it is unethical for a business to buy aluminum from Metro International as long as it is owned by Goldman Sachs (assuming the bank is also trading in aluminum or in aluminum-backed or related securities) because subjecting another party to a temptation to harm others is unethical both to the other party and those who may be harmed. It is unethical for Goldman’s stockholders, board, and managers to be involved with a bank that structurally contains the conflict of interest. Lastly, it is unethical for legislators to look the other way rather than deconstruct the structure; those public officials insufficiently protect parties that would be harmed should Goldman managers exploit the conflict. Perhaps more amazing, such officials also fail to protect the people at Goldman Sachs from being subject to an all-too alluring temptation. At the very least, accepting campaign contributions from the bank should include the obligation to protect the bank from itself.  

[1] Sen. Carl Levin, “Opening Statement,” Wall Street Bank Involvement in Physical Commodities Hearing, Permanent Subcommittee on Investigations, U.S. Senate, November 20, 2014 (accessed November 21, 2014)
[2] Ibid.
[3] Ibid.