Berkshire Hathaway’s investment in Goldman Sachs at the height of the financial crisis represented a major vote of confidence that enabled Goldman to raise additional equity from investors.  The September 2008 deal involved $5 billion in Goldman Sachs perpetual preferred stock along with five year warrants to purchase approximately 43.5 million shares of Goldman common stock at $115 per share.  The preferred stock carries a dividend rate of 10% and is callable at any time at a 10% premium.  Despite the recent drop in Goldman Sachs common stock, Berkshire’s warrants remain in the money. While Goldman could almost surely refinance Berkshire’s $5 billion preferred stock investment at a lower rate, having Warren Buffett’s endorsement in the current environment may be priceless.

Confidence Unshaken

In an interview with Bloomberg, Berkshire Hathaway Director Thomas Murphy states that Mr. Buffett is “not concerned with the investment at all” and continues to have great confidence in Goldman.  Mr. Murphy spoke to Mr. Buffett after the SEC charges against Goldman were announced on April 16.  This follows an interview with Berkshire Hathaway Director Ron Olson last week prior to the SEC charges in which Mr. Olson stated that Berkshire’s investment was a bet on Goldman’s integrity.

Goldman’s Response to SEC Complaint

Over the past week, Goldman’s response to the SEC charges has  more clearly taken shape.  Last week, we provided a summary of the SEC charges and recommended that Goldman take quick action to address the charges and to hold individual employees accountable.  The most serious charge involves the claim that Goldman led ACA to believe that the Paulson & Co. hedge fund was taking a long position on the synthetic CDO deal known as Abacus.  The SEC did not charge Paulson with any wrongdoing.

Earlier this week, The Wall Street Journal reported that Paolo Pellegrini, one of the top executives at Paulson & Co., told SEC investigators that he personally informed ACA that Paulson had a bearish outlook for the CDO.  The SEC complaint made no mention of Mr. Pellegrini’s statement.  The SEC has indicated that a full accounting of the investigation will occur “at the appropriate time”.

Fraud or Poor Judgment?

Whether the charges against Goldman amount to fraud largely rests on the charge that the firm misrepresented the nature of Paulson’s role in the transaction.  As Mr. Murphy stated in the Bloomberg interview, all of the major players involved in the transaction were very sophisticated buyers and sellers.  ACA obviously knew about Paulson’s involvement in selecting the collateral for the CDO.  If Goldman did not lead ACA to believe that Paulson was long, as the SEC complaint alleges, the government’s case will be much weaker.

The conduct of Fabrice Tourre, including several embarrassing emails, indicates the poor judgment and immaturity of a junior level employee who apparently had a major role in the transaction.  In a session sure to produce some political fireworks, Mr. Tourre is scheduled to testify before Congress next week along with Goldman CEO Lloyd Blankfein and others from the firm.

It is likely that Mr. Buffett has been briefed on the situation by Goldman’s management.  While Berkshire has an obvious economic stake in the outcome of the investigation, the potential impact to Berkshire’s reputation would be more significant if Mr. Buffett’s support ends up being misplaced.  Berkshire shareholders should have some confidence that the situation is not as dire as indicated by the SEC charges if Mr. Buffett is willing to publicly support Goldman’s management at this time.

Disclosure:  The author owns shares of Berkshire Hathaway.  No position in Goldman Sachs.