But by the time of Weinberg’s death, things were changing, even on the question of whether investment bankers should continue to sit on corporate boards. Increasingly, the SEC and the judicial system were reinterpreting securities laws pertaining to trading on inside information, making it increasingly less desirable from a legal point of view for investment bankers to continue to sit on the boards of their clients. In August 1968, a court of appeals ruled that senior officers of the Texas Gulf Sulphur Company had violated the law by trading in the company’s stock without disclosing their knowledge of a big mineral discovery the company had made in Canada. Shortly thereafter, the SEC filed an administrative action against Merrill Lynch alleging that fourteen of its executives had passed inside information about an expected earnings decline at the Douglas Aircraft Company to fourteen other investment firms. (The case was settled with penalties all around.)
Then a small investor in the Penn Central Transportation Company, the nation’s largest railroad, sued Howard Butcher III, a Philadelphia investment banker who served on the board of Penn Central and twenty-nine other companies, claiming he had “secret information” about the financial performance of the railroad and had urged his firm’s customers to sell their stock in Penn Central, thereby depressing the stock price unfairly. Butcher promptly resigned from the boards of the thirty companies on which he served, with the lawsuit setting off a nationwide debate about whether investment bankers were using the information they learned while serving as corporate directors in an illegal way. For Butcher, “attitudes about the role of investment bankers” on the boards of companies had “change[d].” But John Loeb, the senior partner at Loeb, Rhoades & Co., disagreed. “If you take an ethical approach toward life, you’re usually ahead of the rules,” he told the New York Times in December 1968. Weinberg, not surprisingly, defended the practice. “I’ve been on boards for 40 years and there’s no vice to having an investment banker on a board,” he said. “Basically you’ve got to be honest”—invoking the familiar Wall Street refrain in matters related to potential conflicts of interest.
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WITH WEINBERG’S PASSING, there was no question that Goldman Sachs was Levy’s firm. When asked in a deposition when he became the senior partner of Goldman, Levy testified, “Since Mr. Sidney Weinberg’s death in July of 1969.” One of his first orders of business was to celebrate the firm’s hundredth anniversary. This was done in a particularly low-key fashion, without any publicity, at a Bank of New York office building (for some unknown reason), on December 15, 1969. Along with speeches, the partners dined on shrimp cocktail, “assorted crackers,” Duchess potatoes, and broiled Delmonico steak à la maître d’hôtel. For dessert, the group had lemon sherbet, Curaçao, and butter cookies.
In addition to the hundred-year-old firm, Weinberg had also bequeathed to Levy a passel of unexpected problems in Goldman’s commercial paper business, the short-term, unsecured loans that had given Marcus Goldman his start in lower Manhattan. By 1969, Goldman was, by far, the largest commercial paper dealer on Wall Street and had proven itself expert at placing, for a fee, the short-term obligations of its clients with institutional investors, many of which were banks and insurance companies. The business was a low-margin, steadily profitable one and, since the Depression, had not posed any problems for Goldman since no companies had defaulted on their commercial paper obligations, in part because—generally speaking—by the late 1960s only the biggest companies with the best credit ratings had access to the market, given that the obligations were senior unsecured, low-yielding debt.
Suddenly this safe, boring business got scary. On the evening of December 27, word began to leak out that the Mill Factors Corporation, described as the “Tiffany” of finance companies and a “Cadillac” of its industry, was in serious financial difficulty—thanks to unexpectedly large losses in its loan portfolio—and would likely file for bankruptcy protection. The company, with grand offices at the New York Life Building on Madison Avenue, suggested that the losses in its loan portfolio would more than wipe out its profits for the year. Creditors were scrambling to figure out what the size of their losses would be. Other finance companies had already started circling the company to see if they could pick up its assets on the cheap.
Goldman Sachs had long been the chief commercial paper underwriter for Mill. Indeed, just three months before the calamitous announcement, Goldman had sold $1 million of the company’s commercial paper to New York Life, which was not only Mill’s largest single creditor (owed a total of $8.4 million) but also its landlord (owed nearly $100,000 in annual rent payments). Over the years, Goldman had placed some $7 million of the company’s commercial paper with about fifty different investors. Most of that paper was then in default, meaning that Mill had stopped paying the interest on the IOUs in order to preserve cash. It turned out that of Mill’s loan portfolio of $45 million, $35 million was suspect and unlikely to be paid back to Mill. This disaster, in turn, made it virtually impossible for Mill to make good on its own short- and long-term debt of more than $80 million. “There is no gainsaying the fact that there was mismanagement here,” according to the company’s special outside counsel, Charles Seligson. “You don’t get a portfolio of $35 million in doubtful accounts out of a portfolio of $45 million unless somebody poorly managed the extension of credit.”
Some of Mill Factors’s creditors thought Goldman should have known about the company’s problems before selling its commercial paper. Among them were Worcester County National Bank, in Worcester, Massachusetts, which bought $1.3 million in Mill’s commercial paper on behalf of a number of charitable accounts it administered, and Alexander & Baldwin, a Hawaii-based diversified mini-conglomerate, which bought $1 million in Mill’s commercial paper from Goldman. The Worcester bank’s antipathy toward Goldman was such that it was the lone creditor holdout on a plan—which required unanimity from the creditors—to keep Mill out of bankruptcy and effect a sale of the company to another finance company. “Our position is that Goldman was negligent in recommending this paper to us and should make good the loss,” John Hunt, a senior vice president of the bank, told the Times. Goldman refused to cover the losses—estimated at 60 percent of the original investment—for fear that a precedent would be set that it would have to follow in other bankruptcies where the commercial paper creditors suffered losses. In the end, while others in the case kicked in large sums to settle lawsuits—for instance, Mill’s accounting firm, Lybrand, Ross Brothers & Montgomery, paid nearly $5 million—Goldman paid only $50,000 but denied “all liability” and agreed to settle the cases only “to avoid the time and expense” of protracted litigation.
Goldman was right to be worried about setting a precedent. The Mill` Factors crash was merely an amuse-bouche for the collapse of the Penn Central Transportation Company, the nation’s largest railroad, in June 1970. The Penn Central bankruptcy was then the largest in American corporate history, and Goldman’s commercial paper business was at the center of the company’s financial difficulties. Once again, Goldman Sachs was facing an existential threat. “Everyone hunkered down,” Doty said. “We had a couple of difficult years.”
CHAPTER 7
CAVEAT EMPTOR
Penn Central was formed, in February 1968, by the merger of the Pennsylvania and New York Central railroads to become the nation’s largest railroad and one of its largest companies. Together, the two companies had some $1.2 billion in debt outstanding, spread out among more than fifty different bonds. After the merger, the company’s executives sought to refinance and consolidate that debt. On July 29, 1968, the Interstate Commerce Commission, Penn Central’s regulator, approved the company’s request to issue commercial paper for the first time. On August 6, Goldman sold $35 million of Penn Central’s commercial paper and expected to sell another $65 million by the end of the year. The offering was “very well received,” Goldman said.
Fewer than two years later, Penn Central had filed for bankruptcy protection—allowing it to reorgan
ize as a going concern, as opposed to being liquidated—in part because the company could not repay the minimum of $75 million in commercial paper outstanding it had to refinance by the end of June 1970. Penn Central had been negotiating with the U.S. government to provide it with loan guarantees, but those discussions did not come to fruition. The company operated 20,530 miles of track in sixteen states and two Canadian provinces and provided 35 percent of all railroad passenger service in the United States. The company also had substantial real-estate holdings, including Grand Central Terminal in New York, plus much of the land on Park Avenue between Grand Central and the Waldorf-Astoria hotel. Nevertheless, Penn Central ended up defaulting on $87 million of its short-term commercial paper. Sensing legal trouble, Levy dispatched John Weinberg, Sidney’s son, to try to negotiate a deal with various holders of the Penn Central commercial paper whereby Goldman would buy back their paper at fifty cents on the dollar. Weinberg was not successful, and Goldman was soon facing serious problems.
Levy, meanwhile, was branching further out into public service, albeit in a behind-the-scenes role. In May 1970, New York governor Nelson Rockefeller appointed him to serve on the board of the powerful Port of New York Authority, which was responsible for overseeing the bridges, tunnels, and airports taking people into and out of the city. Soon enough, Levy was involved in getting his Wall Street buddies to pressure Rockefeller’s successor, Governor Malcolm Wilson, to change his mind about raiding the authority’s coffers to support mass transit, a move that really upset Lewis Kaden, then the counsel to Brendan Byrne, the governor of New Jersey, who wanted to use the money. “Levy is where the money is,” Kaden told New York magazine.
Bob Rubin, meanwhile, who was still working for Tenenbaum in Goldman’s arbitrage department, flirted with leaving the firm. Sandy Lewis, who ran White, Weld’s arbitrage department, said Rubin called him about the possibility of getting a job working for Lewis there. Rubin had only been at Goldman for just over three years when he approached Lewis, at White, Weld, but clearly he was antsy.
According to Lewis, Rubin approached him in 1969. “Bob Rubin wanted to get out,” Lewis said. He had grown disenchanted with Goldman and what he thought it took to succeed there. “It’s a dishonest mess that’s making honest people dishonest,” Lewis said Rubin told him. He said Rubin complained about “making the calls” as well as the erratic behavior he witnessed day in, day out. “People were throwing books and chairs around,” Lewis said Rubin told him. “There were lots of temper tantrums. But what’s going on was to cover the kind of things they had to do that made them ashamed of themselves.” (Sandy Lewis was convicted of federal charges of stock manipulation in 1989, pardoned by President Clinton in 2001, and had his lifetime trading ban overturned by the Securities and Exchange Commission in 2006.)
In his book, Rubin had a different version of his pursuit of the White, Weld offer. He wrote that a friend of his from law school, Eli Jacobs, worked at the firm and when “the fellow who ran its arbitrage department left”—Sandy Lewis, who was fired in December 1969—Jacobs called him to see if he would be interested. Paul Hallingby, the senior partner of White, Weld, offered to make Rubin a partner, at age thirty-two. Rubin was prepared to accept the White, Weld partnership. “I liked what I saw there,” he said. He also assumed he would never become a partner at Goldman, and White, Weld was a good alternative, he thought, and in any event a certainty. “I never in a million years thought they’d offer me a partnership,” Rubin said. Rubin went to Tenenbaum to tell him he was leaving Goldman for White, Weld. Tenenbaum went to see Levy, who, Rubin later wrote, “wasn’t happy about having to deal with this problem.” Tenenbaum said to Levy, “Gus, Hallingby offered Rubin a partnership. I think he’s really valuable to us. He’s a terrific kid. You know it and what he’s like.” Levy told Tenenbaum, “Okay. Tell him to keep his nose clean. At the end of the year, we’ll put him up for partnership.” What appealed to Tenenbaum and Levy about Rubin was, among other things, Tenenbaum recalled, “his pedigree of law. He’d been summa cum laude, and law degree, and the whole thing. He just was a bright kid, and careful.” Tenenbaum said he did not mention it to Levy, but he was also impressed by Rubin’s wife, Judy, who would eventually be named the New York City commissioner of protocol.
Based on Tenenbaum’s representation about a Goldman partnership, Rubin told Hallingby he was staying at Goldman. True to Levy’s word, he did put Rubin up for partner at the end of 1970. On December 30, Rubin became one of nine men to be named new general partners of the firm, along with H. Corbin Day, Eugene Mercy Jr., and Eric Sheinberg. “I was, to say the least, surprised,” Rubin said, without explaining how he reconciled being surprised with what Levy had told him the year before. It was not lost on him, though, that he became a partner at Goldman in the middle of the Penn Central fiasco. “I thought to myself, ‘This isn’t very good, because there isn’t going to be a firm’ ” of which to be a partner.
Rubin was onto something. By November, four investors in the Penn Central commercial paper sued the firm in federal court in Manhattan for more than $23 million, nearly half of the firm’s capital. “The basic issue is this,” the Times reported, “to what extent are commercial paper dealers, who have placed about $13 billion of the total [commercial] paper outstanding [of about $34 billion], responsible when one of the companies whose notes they are handling get into financial trouble.” For Goldman, in 1970, this was not just a theoretical question but rather went to the heart of whether it would remain solvent. At that time, the firm had around $50 million in capital—all of it from its partners. Needless to say, if the holders of the full $87 million of the Penn Central commercial paper Goldman placed came after the firm, the effect could be devastating, especially since the Mill Factors case still loomed.
The plaintiffs in the lawsuit against Goldman were Fundamental Investors, a $1 billion mutual fund that held $20 million of Penn Central’s commercial paper bought in a ten-day period near the end of 1969; C. R. Anthony, an Oklahoma City retailer with $1.5 million of the paper; Welch Foods, Inc., of Westfield, New York, the maker of Welch’s grape juice, with a $1 million investment; and Younkers Inc., a Des Moines–based retailer, which bought $500,000 of the Penn Central notes. In their fifteen-page complaint, the creditors charged Goldman with “fraud, deception, concealment, suppression and false pretense” in the sale of the commercial paper to them. They claimed Goldman had “made promises and representations as to the future [of the company] which were beyond reasonable expectations and unwarranted by existing circumstances,” had made “representations and statements which were false,” that Goldman had represented that Penn Central was “prime quality,” and that Goldman had made “an adequate investigation of, and kept under continuous current review, the financial condition of Penn Central.” The plaintiffs also claimed that Goldman had agreed to buy back the commercial paper. “For the commercial paper holders this was an extremely big event,” explained Daniel Pollack, the plaintiffs’ attorney, about the Penn Central default. “For example, for the farmers at Welch’s this was all their money. One bad harvest and the potential loss of cash equivalents was a potential catastrophic event for them.”
Penn Central had been Gus Levy’s client, but in the grand Wall Street tradition of success having many fathers and failure being an orphan, the firm’s defense in the media was left to Robert G. Wilson, the partner in charge of Goldman’s commercial paper business. “[T]here is absolutely no merit to the claims which have been made against Goldman Sachs,” he told the Times. “We regret that anyone is facing a potential financial loss as a result of the unforeseen circumstances, but the action against Goldman Sachs has no basis in fact. We intend to resist it vigorously.” He added that during the time that Goldman was selling Penn Central’s commercial paper, “we were confident that the transportation company was credit worthy” and “had access to credit at least sufficient to cover its current obligations and repay commercial as it became due.” He said that even in late May
1970—a few weeks before the company’s bankruptcy filing—Wilson had “every expectation” that Penn Central would be able to get a government-guaranteed loan, which did not happen, despite the company’s final appeals to Congress and to President Nixon.
A day after the Fundamental Investors suit, a subsidiary of American Express sued Goldman, too, for $2 million, as a result of sales of the Penn Central commercial paper, even though Goldman was also American Express’s commercial paper dealer (American Express’s claim was later increased to $4 million). Then, in February 1971, the Walt Disney Company sued Goldman for $1.5 million as a result of the collapse of Penn Central after Disney had bought $1.5 million of the commercial paper. A month later, the Mallinckrodt Chemical Works sued Goldman, among others, on account of its loss in the Penn Central commercial paper. In the end, some forty lawsuits were filed against Goldman.
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THIS WAS YET another precarious time on Wall Street. The crux of the problem, which Wall Street historians have dubbed the “back-office crisis,” was that during 1967 trading volumes on the major stock exchanges exploded, and the private, poorly capitalized Wall Street partnerships were ill equipped to handle the extensive paperwork involved with settling trades occasioned by the “sudden and unexpected upsurge” in volume. Many firms were slow to add the back-office personnel required to handle the new flow. Unfortunately, when the personnel were eventually hired—in a rush, of course—performance suffered. Some firms were drowning in a sea of unprocessed, and inaccurately accounted for, paper. But by the end of 1969, “the worst of the paperwork problems had been surmounted,” according to Lee Arning, then a New York Stock Exchange executive.
The crisis, though, had just begun, for at the very moment that many brokerages had increased their personnel costs to scale the mountain of paper, the volume of business fell off a cliff. There was a feeling that 1970 was capitalism’s most acute test since 1929. These were not Goldman’s problems, though. The firm had virtually no retail customers and did not have the back-office problems experienced by retail brokers. Indeed, in 1970, the firm’s profits “topped $20 million,” Levy told the Wall Street Journal, the third highest in its 101-year history. The “gratifying” results came from Goldman’s role in underwriting sixty-four debt and equity offerings, raising more than $3.5 billion, and an 80 percent increase in the volume of the firm’s block trades. Goldman’s capital increased to $49 million, from $46 million, and its leverage ratio—aggregate indebtedness to net capital—was 6.5, well within the 20:1 stock exchange regulations. But, thanks to the Penn Central bankruptcy, Goldman’s problems were every bit as acute as those of its Wall Street brethren. Not that most people had any idea. For instance, in July 1971, despite the ongoing existential threat, Goldman appeared to get the full cooperation of John H. Allan, a Wall Street reporter at the New York Times, for a lengthy feature about the firm that discussed everything but Goldman’s precarious legal and financial prospects. Goldman, Allan reported, was doing just fine.
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