Prominently displayed in large font on page 1 of the Goldman research report on Tesla:

"Goldman Sachs does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision."

(I put this in the reply to a child, but I felt it was relevant enough to reply directly to the parent.)

If you want to evaluate the quality of Goldman's research analysis on its own merits, this blog post picks out the core of the valuation argument (from mere hours before the IPO announcement)... http://www.zerohedge.com/news/2016-05-18/goldman-compares-te...

The only way they get from a $125 base case to the final $250 valuation is by assigning a disjoint probability to the idea that even if Musk doesn't build Steve Jobs-level hype, he would build Maytag Repairman-level hype around electric vehicles; therefore, they can double the probability that there is an above-fundamentals scenario. Whether or not a wall was broken, this is kind of ridiculous.

(And, regarding walls: http://www.cnbc.com/id/100774459)

Do you think that putting a disclaimer of your sketchy behavior excuses your sketchy behavior?

That's par for the finance world. They will sell you shit with a smile as long as it pays commission even though they would never touch it (or are even short it).

Kind of like "collateralized debt obligation", a.k.a. shit wrapped in shit.... circa 2008.

For anyone whose knowledge of this starts and ends with The Big Short, CDOs are not inherently bad. They're just a structure for divvying up assets based on risk. The problem up to 2008 was that the risks were downplayed/hidden by the banks and the credit rating agencies.

We do the equivalent of CDO to our networks at Google. (Ie tcp can't deal with packet loss, so needs the best tranche; especially if user facing. Some long running copy operations with fountain codes only care about total throughput, not lost packages, so get the `equity' tranches.)

If someone is thinking citation needed: http://www.sec.gov/spotlight/enf-actions-fc.shtml

Aren't they by definition short any security they're selling you?

No - when they sell you a security, the assumption is they were long until then (holding it) and then either disposed of their entire long position or disposed part of it (in which case they continue holding it long.)

The case where they are selling you something and are SHORT the product is a special case which requires more work usually. The most egregious case was the ABACUS deal (http://www.theworkingeconomy.com/simple-explanations-of-econ...) where Goldman was actively short the product and needed a dumb customer to unload the other side (enter Fabulous Fab and his widows orphans: http://www.reuters.com/article/us-goldman-emails-idUSTRE63O2...)

No, not if they are just acting as a broker.

Seems to me that depends on the actual quality of the report. If the report is substantively useful, and not hopelessly biased, then I don't see anything too sketchy about this.

Anyone reading a Goldman research note is going to be savvy enough to be aware of the conflict.

The equity research department is firewalled off from the deal teams doing the offering. It would be unethical if the people who published the research note even knew anything about the offering.

That is true. Also, Goldman Sachs is so experienced with conflicts of interest that they are just very good at handling them. You see Goldman Sachs experiences so many conflicts of interest all the time that they have obtained expertise in handling these conflicts that people like me and you cannot even imagine.

The modern Goldman banker is a unique creature with a conscience that is so complex and evolved that he can earnestly and passionately defend two positions that would seem to me and you completely opposite.

... Ok I have stopped laughing now and I am starting to get angry so I might as well get back to work ...

You are conflating the investment banker and the equity research analyst, which have legally mandated information sharing firewalls. Also this potential conflict is clearly and openly disclosed, e.g. "This company publishes research and also seeks to do investment banking business with Tesla".

Further, Goldman conducted a secondary share offering for Tesla as recently as summer 2015, so it was exceedingly obvious to anyone who makes investment decisions based on the research that this conflict exists.

I have worked at several wall street firms and also worked for firms in silicon valley, and I frankly noticed more numerous and blatant conflict of interest situations in silicon valley.

EDIT/UPDATE: Prominently displayed in large font on page 1 of the Goldman research report on Tesla:

"Goldman Sachs does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision."

Shouting "I have a massive conflict of interest" at the top of my lungs does not negate the fact that I should not be trusted.

No, but it makes it clear to what might be an otherwise unaware reader that that's the case, which is the whole point.

Also, even if I don't trust you, your research paper might still be informative.

I thought it was an ancient quandry, but it appears the quintessential description was only penned in 1954

https://en.wikipedia.org/wiki/The_Scorpion_and_the_Frog

I would say more similar to the farmer and the viper. There's only one party that's getting the bad end of the deal.

https://en.m.wikipedia.org/wiki/The_Farmer_and_the_Viper

No contest to the claim that there are conflicts of interests in silicon valley, but the firewall / chinese wall between research and banking groups is pretty spotty, despite all the formal processes to try to maintain it.

Personally saw tons of sketchy things going on with MDs on IB side influencing research analysts ratings.

Probably a reference to this: http://fortune.com/2016/04/11/goldman-sachs-doj-settlement/

beautiful.

> It would be unethical if the people who published the research note even knew anything about the offering.

Whether something is unethical is not evidence for or against something happening, it just informs your opinion on whether it happened. Given Goldman's past behavior, I wouldn't let it inform my opinion too much in the direction that they worked in an ethical manner.

Sadly, humans are very good at rationalizing their unethical. The rule of thumb seems to be that whenever there's something unethical but profitable (in terms of money or power), absent any non-moral kind of stopping force (like risk of getting caught and jailed, or social ostracism), a lot of people will be doing that unethical thing. You don't have to go further than to your local grocery store to notice that.

> Sadly, humans are very good at rationalizing their unethical.

Humans are also very good on disagreeing on a fundamental level about what is and isn't unethical in general, before even considering rationalizing their own behavior.

That's true, but sometimes that disagreement also stems from one or both parties rationalizing ;). Like a lot of people who hate being lied to, but have absolutely no resistance from lying to others, and would defend their behaviour if you said to them that lying to people is generally unethical.

But my point is, ethics is not a very strong thing, and alone it doesn't stand much chance against free money lying on the table.

(What I think people miss is that moral behaviour has to be actively maintained in people, otherwise it slowly erodes. This concept goes against the zeitgeist of contemporary western societies though, because it implies there is a standard to hold oneself to.)

> This concept goes against the zeitgeist of contemporary western societies though, because it implies there is a standard to hold oneself to.

The zeitgeist of modern western societies very strongly holds that there is a standard to hold oneself to (it rejects some elements that used to be commonly held to be part of the consensus standard, and adds some that were not, and people who still hold to the rejected elements often portray the new reality as "no standard", when its really just that the dominant standard is now different from their preferences.)

That's the theory. However, that wall doesn't really exist in practice at any bank that provides both equity research services and investment banking services. The entire reason for offering both services is the comflict of interest. "No conflict, no interest".

source: I used to be an analyst in the equity research department at a broker dealer.

It's been at least, what, 8 years since Goldman Sachs was involved in any sort of financial crisis involving malfeasance. And for a 147 year old company, 8 years is a really long time.

I mean, come on. How would you even think they might be doing something unethical at this point?

"It's been at least, what, 8 years since Goldman Sachs was [caught] in any sort of financial crisis involving malfeasance."

FTFY

But that's false. It hasn't been 8 years since Goldman has been caught.

Here's one from 2014 where the research division promised favorable research coverage in exchange for investment banking business:

http://www.usatoday.com/story/money/markets/2014/12/11/finra...

Here's one from 2011 where they promised to stop having "huddles" with some of their clients where they exchanged insider information:

http://www.reuters.com/article/us-goldmansachs-huddles-idUST...

Here's 2015, where one of their associates used his contacts at the Fed Reserve (where he worked for 7 years right before coming to goldman) to gain confidential regulatory info:

http://www.forbes.com/sites/antoinegara/2015/10/28/goldman-s...

Again 2015, when they got caught transmitting incorrect and incomplete data on 1/5th of their trades to FINRA (who monitors their activity to watch for violations of federal rules and regs):

http://www.bloomberg.com/news/articles/2015-07-27/goldman-fi...

Really.. just type goldman fine {year} into google. There's a lot of it.

You're joking, right? (I'm seriously asking.)

(strictly speaking, I'm being bitterly sarcastic)

Poe's law in action.

I'm old enough to know better. I have no excuse.

Isn't the rule in the us the "appearance of conflict of interest", which is even stronger than actual actual collusion?

It is for judges, and I think for government officials in general, but not in the private sector as far as I know.

Who actually audits that? Is there proof?

Better firewall would be not even to exist within the same company.

Ya, maintaining the Chinese wall between research and investment banking is a pretty central function of compliance and is regularly audited by the SEC.

The last few decades demonstrate the SEC is much closer to a rubber stamp for bad behavior than a meaningful entity.

What do Chinese have to do with the SEC?

Answers are more helpful than downmods.

From Wikipedia[0]:

> Chinese wall is a business term describing an information barrier within an organization that was erected to prevent exchanges or communication that could lead to conflicts of interest. For example, a Chinese wall may be erected to separate and isolate people who make investments from those who are privy to confidential information that could influence the investment decisions. Firms are generally required by law to safeguard insider information and ensure that improper trading does not occur.

...

> The origin of the phrase is the Great Wall of China.

[0] https://en.wikipedia.org/wiki/Chinese_wall

Yeah, I didn't see anything about SEC in there.

That page also quotes a California Superior Court opinion that found the term was a "piece of legal flotsam which should be emphatically abandoned". The same opinion also found:

> The origin of the use of "Chinese Wall" in the context of confidentiality is unclear. Evidently, the term was casually coined in some appellate opinion, then picked up and used without question or explanation by courts and commentators.

Can you point to an SEC regulation, or other law, that refers to a Chinese Wall? Like, is there a more specific, technical definition? Wikipedia refers to Chinese wall departments in companies; do you know where to find more information about them? Perhaps links to their enforcement and compliance documents?

You're taking that quote WAY out of context. That was an ethnic-Chinese judge criticizing the specific phrase, and preferring that "ethics wall" be used instead.

'He maintained that the "continued use of the term would be insensitive to the ethnic identity of the many persons of Chinese descent"'

The article mentions, but does not specifically name, regulations implemented after the 1929 stock crash; it also specifically names Title V of the Sarbanes-Oxley Act of 2002. The SEC is responsible for the enforcing the provisions of the latter.

The damning part is this:

> then picked up and used without question or explanation by courts and commentators

This indicates (and was also said) that the term has no lawful basis; it is industry cargo cultism that had been copied around without basis for years.

It is an informal term that refers to very real regulatory requirements.

I'm having trouble visualizing such a wall. Is a wall referenced? Or is just a metaphor for some vague rules that may or may not be followed? Is there a turnkey fire/Chinese wall product on the market?

it works just like a industrial grade router firewall - the router is connected to a gas main, which directs a stream of gas over the back the of router where the rj45s go into, and a flame continuously burns any nasty hackers attempting to hack into your system.

home router systems don't have such a feature.

edit: matt levine used to work at goldman and he posted a piece that has a description of how goldman's multiple chinese wall systems works:

> Nor will [the research analysts] get any hearty back-slaps and high-fives from the bankers, because any banker who walked onto a research floor would be vaporized by powerful lasers long before he could raise his hand for a high-five.

> Remember, bankers can't just call up analysts. Their phones would explode.

https://www.bloomberg.com/view/articles/2016-05-19/goldman-p...

OK, so what I gathered from that article is that it is super illegal for researchers to talk to bankers. So much so that they cannot call or email each other over official company channels, but if they do want to talk, they can just step outside the office and use their cell phones.

The wall sounds as effective as LIBOR's blind auctions.

yup. obviously there are limitations. how do you even plan to 100% restrict that information? i guess you can lock up the research analysts and bankers in monitored cells after work...

Generally, the rules and regulations that apply to the relationship between the Research and Investment Banking departments of a firm include:

- FINRA1 Conduct Rule 2711;

- NYSE Rule 472;

- SEC Regulation AC (Analyst Certification);

- SEC Rules 137, 138, and 139 under the Securities Act of 1933.

The Global Settlement of 2002

The Global Research Analyst Settlement (“Global Settlement”) is an enforcement agreement first announced in December 2002 and finalized on April 28, 2003, among the SEC, NASD (now FINRA), the NYSE, the New York State Attorney General and ten of the then-largest investment banking firms in the United States (the “Settling Firms”, the big 8 US banks plus UBS and Credit Suisse). The Global Settlement addressed issues related to conflicts of interest between the Research and Investment Banking departments these firms that became apparent during the “dot com” boom and then bust of the late 1990s and early 2000s.

As part of the Global Settlement, the Settling Firms agreed to several rules designed to prevent abuse stemming from pressure by investment bankers research analysts to provide favorable coverage specific issuers or securities. The Settling Firms were required to separate their Investment Banking and Research departments from each other both physically and with information "firewalls". Additionally, the budget allocation for Research was to be independent of Investment Banking. Research analysts were also prohibited from attending pitches and road shows with investment bankers during the advertising and promotion of initial public offerings (IPOs). Finally, research analysts’ previously issued ratings about issuers had to be disclosed and made available.

In addition to these regulatory actions, each Settling Firm was enjoined from violating the statutes and rules that it was alleged to have violated. The Settling Firms were also required to pay fines to their investors, fund investor education and pay for independent third-party market research. The total fine paid by the Settling Firms was approximately $1.435 billion, of which $387.5 million was restitution to harmed investors. The Global Settlement was amended in March 2010.

Sarbanes-Oxley

The Sarbanes-Oxley Act of 2002 required the SEC to address conflicts of interest involving research analysts and investment bankers. In response to Sarbanes-Oxley, the NASD and the NYSE established rules and safeguards to separate research analysts from the review, pressure and oversight of investment banking personnel. These rules are intended to ensure the integrity of research, and to protect investors from being misled as a result of a failure to disclose potential conflicts of interest.

> Who actually audits that? Is there proof?

ISO 9001 requires that there's a document stating "persons from group A do not talk to persons from group B". Auditors will: a) check that said document exists b) maybe, maybe (if the auditor is really, really thorough) check whether a random person of group A or group B knows about this document

That's the extent of typical auditing: assuring that a process is defined and cursory testing whether people actually know about a process and its definition. In no way does any auditing assure that the process is in any way actually followed in practice.

Exactly.

https://en.m.wikipedia.org/wiki/Glass%E2%80%93Steagall_Legis...

The GS audit department, of course. They are also firewalled.

"Firewalled off" meaning what?

Is it an easily discoverable crime if they breach that firewall?

This sort of thing brings LIBOR to mind for me ...

/naive scepticism

Oh that's good. I feel safe knowing that investment bankers are highly scrupulous and would never mention anything in the halls or in the lunchroom that might compromise their integrity.

Backroom meetings over cigars and a game of poker are so old school. Todays rage is just chatting:

http://qz.com/246325/goldman-sachs-aims-to-end-the-era-of-ho...

if u cud see ur way to a small drop there might be a steak in it for ya

We’re just not, we’re not allowed to have those conversations on [instant messages]

The upside to GS for Tesla to issue stock 3% higher is pretty minuscule, if anything (GS probably priced their take at a 20 day trailing average price, or whatever). The downside is enormous, and compliance and the SEC are crawling over the place. Plus, the issuance is going to take place at whatever price investors think the stock is worth. If investors think there's a big conflict of interest, they'll price that in.

> the SEC

Hahaha, that's a good one! As though investment banks are afraid of regulators[0].

[0] http://www.thisamericanlife.org/radio-archives/episode/536/t...

> The downside is enormous

Like what, exactly? I mean, it's not like they'd have to pay a massive fine or go to jail.

correl(smoke, fire);

0

...in our post-prejudicial world.

Or both departments within Goldman both reached the same conclusion independently: the stock is currently very undervalued.

If Tesla sells (heh, and builds) every one of their pre-ordered model 3's, that's over $14b in revenue.

The only question is, are they going to be able to do it. If both departments at Goldman think the answer is "YES", then what they have done is absolutely reasonable.

Tesla sold 50 000 cars last year, and have a $28bn market cap. Ford sold 6 million vehicles, had the fourth best selling car in the world (the Focus), and have a market cap of $51bn.

So Tesla:Ford ratio on market cap is 1:2, but on sales numbers it's 1:100. Granted, the Model S is more expensive than an average Ford, so let's call it 1:50.

How is that undervalued? It looks pretty darned overvalued to me.

Difference in company maturity, same reason startups get valued at higher multiples than public companies. Everyone knows what Ford is and for the most part doesn't think they have much of a shot to make enough significant changes to, say, 100x their revenue within 5 years. Tesla, on the other hand, has about as good of a shot at doing that as any public company, so to some investors its worth pricing that growth opportunity in.

>Everyone knows what Ford is and for the most part doesn't think they have much of a shot to make enough significant changes to, say, 100x their revenue within 5 years

You'd have to be insane to believe that Tesla is going to be making $400BB within 5 years.

Yes, there's some fudge factor when trying to estimate what a company like Tesla might look like in the future, but it still should be based on potential financials.

"Should" is a personal normative statement. The very nature of the market is that my "should" is different from your "should", which is also different from everyone else's. You are free to disagree with anyone and everyone, but the price is the price is the price, defined only by the prevailing "should"s of the last two people who came close enough to agreeing on the current price to actually make a transaction. In fact, the only reason that transaction went through is because those two "should"s fundamentally disagreed on the future price, or they wouldn't have taken opposite sides on that transaction.

> How is that undervalued?

If you believe that electric and autonomous car is the future and that Tesla will dominate the electric and autonomous car market, especially starting in 2020 already selling 1 million car a year with 2 new even more affordable models ?

Not saying that is realistic, but if you are buying the stock of the global number 1 car maker of 2030, that is probably a good deal.

Goldman isn't making the $2b investment in Tesla - they are being paid by Tesla to manage the sale of $2b worth of new shares to the public.

That said, I think its very unlikely there is any link between the offering and their analysis.

Any link between the offering and the analysis would most likely be in violation of Insider Trading regulations. Both their work on the deal, and their research department's analysis would be considered material non-public information, and thus couldn't be shared with the other group, until publicly announced.

Just the kind of thing GS seems to get fined for on an annual basis...

the big assumption is that they will deliver the car at a profit.

"they're selling at a loss but making it up on volume"

How's that possible?

It's a joke

Economies of scale[1].

A simple example is, imagine making pizzas for your neighbors, and it takes you 15 minutes to make dough for 1 pizza, and at a $10/hr wage, that's $2.50 per pizza in dough labor costs. Now, imagine it only takes you 20 minutes to make dough for 5 pizzas. That's $3.33 in dough labor costs for 5 pizzas, or $.66/ea.

1. https://en.m.wikipedia.org/wiki/Economies_of_scale

You should read catch-22.

What in the world does catch-22 have to do with economies of scale, and why the down-vote (if that was you)?

Milo Minderbinder immediately came to mind for me too.

https://en.wikipedia.org/wiki/Milo_Minderbinder

It's a quote from the book and no it wasn't me.

Right, but that only means you generate less revenue while selling at a loss.

No. It means that at the 5 pizza scale, if you're selling your pizzas at $5 (assuming $3.00 ingredient and labor costs other than dough), rather than a $.50 loss per pizza ($5.00 - $3.00 - $2.50), you're now making a $1.34 profit per pizza ($5.00 - $3.00 - $.66).

But the stated premise is that they're selling at a loss. Economies of scale don't permit you to generate profit while selling at a loss.

The point of an economy of scale is that, once reached, it can lower costs (think quantity discounts), which means what was a loss at lower quantities can become a profitable business.

Secondary offerings don't significantly affect the stock price and research notes don't make the bank much money, so the outrage is a bit misplaced. If a bank wanted to make money by breaking the rules, they'd have M&A talk with their prop trading desk.

Banks no longer have prop trading desks as a result of the Volcker rule.

Isn't this exactly what's supposed to happen at big banks? I thought we wanted the equity research department to be separate and not conflicted with capital markets?

Out of curiosity, what are your thoughts when YC personnel hype the latest batch of startups here on HN shortly before Demo Day?

To suggest these are similar (which, to be fair, you are not explicitly claiming) seems to be to not understand the nature of what the banks are doing.

In investment banks, as a client you pay the research department for objective research into a security. By preparing research that is intentionally untrue, in order to benefit a deal team, there is a violation of duty from the seller of goods (the equities analyst) to the paying client (money manager). In today's world, that violation of duty is not only moral but legal as well.

The equivalent here would be you, as an angel investor, hiring a YC representative as an investment advisor on what companies to invest in, and the YC rep pumping whichever company in the YC program they wanted to get money for, without even disclosing conflicts of interest.

That same YC representative giving publicity to the general public ahead of demo-day has no financial conflict of interest at all. I have a hard time seeing what moral (much less legal) duty they have to not publicize their portfolio companies.

There's an argument about YC reps giving favorable publicity to some but not other companies being unfair signaling, and disadvantaging the companies who are given less hype time. I don't know if I agree with that argument, but I think it's a valid point to discuss. Furthermore, YC partners are locked out from investing in YC companies for a period of time, for a similar reason, so the argument gets stronger.

I feel for the grunts that worked through the night writing that note. They'll probably get a nice bonus though.

I'm unclear why that's bad form. Pumping a stock while you are selling it is bad form. Say it's great and that you intend to offer to buy some seems kind reasonable to me.

They are selling it. Goldman Sachs is selling the stock on behalf of Tesla.

Why is it bad form to research a company and then decide based on your findings to invest in it? (I am an outsider to the world of finance and clearly I am failing to understand something)

At a simple level, they are researching the company and then publishing their findings to convince others to invest in the company. Generally, the more demand there is for the shares, the more money the investment bank makes for conducting the share offering. So, the research arm has something of a (perceived, at least) motivation to publish research which supports a high level of demand.

Goldman Sachs Research in this instance is a defined term that carries a whole lot more weight than research you or I would do to determine if we should invest in a stock.

Analysts are required to genuinely believe what they are saying, or at least aren't allowed to say one thing in public research reports, and another in private. Their research is considered Material Non-Public Information until it is published, and thus cannot share it with anyone in their firm that is outside the research department until they release it to the public.

I'm not too familiar with the Research / IB relationship or ethics of it but I'm curious about how this would affect the general market if they did know about it. Do people blindly follow Goldman's research advice and thereby increase the share price and give Goldman a higher commission or something?

i wouldn't say that people blindly follow the research at big investment firms, but they take it seriously. i had invested for years and just used company reports, yahoo finance, motley fool, and media articles. when i invested in tesla i ended up getting morgan stanley's research. i couldn't believe how well done it was. the media and the other resources are a joke in comparison. one of the key things is they have models into the future that project sales and profit and have dcf analysis. if you want to bring down income inequality, you should make a napster for financial research.

> you should make a napster for financial research.

MarketBrief is sorta this (YC S11)

I think its likely that "everyone" following Tesla knew an offering was coming. I'd go as far as thinking its likely Bob Lutz knew the offering was coming soon. GS research could easily have known without illegal backroom whispers.

Thought this was appropriate: http://fooledbyrandomness.com/equality.pdf

Can you ELI5 what a research note is, and why this is suspicious?

Goldman advised investors to "Buy" Tesla (i.e. their "opinion" is that the stock is a good investment and should increase in price - quotes because of a well-documented positive bias of sell-side analysts) just before underwriting Tesla's offering (i.e. taking fees for successfully selling all new shares).

Goldman Researchers advised investors while Goldman Investment Bankers underwrote a deal. These guys (and gals) aren't standing around a water cooler chatting about their work with each other for exactly this reason. It's highly unethical, and illegal to share this sort of information before it's public.

You mean unethical in the same way that Goldman investment advisors were trying to make their clients buy instruments that Goldman traders were desperate to sell during the financial crisis?!

"Investment Bank" are words that should absolutely, when used in tandem, inspire feelings of incredulous contempt.

"Insider Trading House" was a little too on-the-nose.

Why?

Oh you know me, just another random Glass-Steagall fan.

Investment banking existed under Glass-Steagall. Investment banks were just restricted from participated in commercial banking.

You mean 24 hours before the announcement? The offering itself isn't for a while, right?

yes but the announcement can move the stock

where? sorry I cannot find this info, can you share your source/article?

Why do you distrust Goldman, but not Tesla? You know that investment banks don't play those games in a vacuum, right? Both parties a guilty.