“Within hours” of the agreement, the Times reported, Maney and the SEC were bickering about what the two sides had agreed. Maney argued that while Goldman had been charged under the SEC’s antifraud provisions, the firm “was charged only with negligence in failing to inform itself and its customers of the actual state of financial affairs of Penn Central.” The SEC’s counsel countered that “the intent of the complaint was, indeed, to make the charge of fraud” under a part of the securities act known as “Fraudulent Interstate Transactions.” Goldman’s in-house counsel told the paper that Goldman’s “decision to consent to the S.E.C. injunction” was a “matter of business judgment.”
The combination of the SEC’s 1972 investigative report, the SEC’s civil lawsuit against the Penn Central executives and directors, and the SEC’s complaint and consent decree with Goldman conspired to ratchet up the seriousness of the litigation still pending against Goldman from its commercial paper customers. Levy figured out quickly that he needed to put an end to the suits, if he could. John Weinberg’s earlier gambit to settle with creditors at fifty cents on the dollar had failed, and the chances of getting them to agree to a 2.2 percent settlement—the recovery that the two creditors in Mill Factors had agreed to—seemed highly remote. According to the SEC’s 1972 investigation, several of the smaller claimants against Goldman had settled with the firm for twenty cents on the dollar; then it was revealed that in April 1972, Goldman had settled $22 million of claims for $4.5 million—the twenty cents on the dollar—with firms such as American Express (for $1 million), Norton Simon, Inc. (for $600,000), and U.S. Steel (for $466,000). Walt Disney also settled with Goldman. At the time of the settlements, Goldman said the payments were covered by its insurance. George Doty remembered that, at one point, to try to put an end to the litigation, Levy wanted to buy the commercial paper back from his clients—many of whom were also his friends—at one hundred cents on the dollar. “I told him we would not do that,” Doty said. “We couldn’t really. We weren’t going to bail out everybody that bought the paper. They were big adults. They bought. They knew everything we knew and I just as soon as hell was not going to jeopardize the firm to placate some of his best friend clients. So, he yielded.”
But by the middle of 1974, following the signing of the consent decree with the SEC, Goldman still faced the looming lawsuit brought by Fundamental Investors, Welch’s grape cooperative, and the two midwestern clothing stores. Goldman and Levy could not afford to lose that suit, especially since the plaintiffs were seeking 100 percent restitution. In July 1974, Levy decided to take matters into his own hands. He approached John Haire, the head of Fundamental Investors, to see if a settlement could be reached. He still kept that letter from Sullivan & Cromwell in his jacket pocket, after all, and he decided to see if he could prove its value as a harbinger.
With the case headed to a trial on September 5, the Times reported that in a deposition Levy gave on May 3, 1972—in which he was forced to admit Goldman had failed to reveal crucial information to its customers—he insisted that Goldman had “scrupulously observed the law and the highest principles of business and professional ethics.” When the Times reporter called Levy at his office to get a comment about the deposition, Levy said it “stands on its own” and declined to elaborate. Novotny told the Wall Street Journal that the Levy deposition was “old news.”
The next day, Goldman settled with Fundamental Investors for $5.25 million in cash plus some 75 percent of what, if anything, Goldman ended up receiving from Penn Central in the bankruptcy proceedings on its commercial paper claims. While the settlement with Fundamental, for around 26 cents on the dollar, eliminated a major threat to Goldman’s capital, the deal did nothing to dissuade the other plaintiffs in the case—the two clothing stores and Welch’s—to drop the lawsuit and to settle themselves. According to Charles Ellis, Welch’s needed the money back because the co-op “had had a bad harvest” while the two retailers “saw the case as a matter of dishonest dealing and felt morally right in insisting on full recovery.”
On September 9, the Welch’s trial against Goldman began in southern Manhattan before a jury of three men and three women—said to all be “blue-collar” workers. As incredible as it may seem, Goldman allowed an extraordinary amount of dirty laundry to be aired in public, in front of a jury, over a $2.4 million dispute—the difference between the $3 million the plaintiffs sought (full restitution) and the $600,000 (twenty cents on the dollar) that Goldman likely would have offered. On the trial’s first day, Pollack, a young lawyer for the plaintiffs then at his own firm, Pollack & Singer, told the jury, “The central point as the plaintiffs see it is simply this: They knew and they didn’t tell.” Pollack explained to the jury how Goldman had a system of various colored sheets of paper that would be used for memoranda sharing different kinds of information about the companies that it underwrote. For instance, “green sheets” were used to convey information to buyers that became available to Goldman from sources other than a company’s public SEC filings, such as by having conversations with company management. Levy testified the green sheets were to “apprise” investors “of current information.”
Then there were the blue sheets. “The blue sheets are secret memoranda in the files of Goldman Sachs, the credit files of Goldman Sachs recording contacts or conversations between Goldman Sachs and the issuer, in this case recording conversations between Goldman Sachs and Penn Central,” Pollack said. “These blue sheets are profoundly important to this case because, in effect, they are like tracks in the snow. I think having read the blue sheets one would have very little doubt that Goldman Sachs possessed inside information. Having examined the witnesses, you will hear that they did not disclose to their customers the information in these blue sheets.” The green sheets, Pollack said, were what “they told us”; the blue sheets were “what they knew.”
The blue sheets in Goldman’s files recorded everything from the key September 19, 1969, phone conversation between O’Herron, at Penn Central, and Vogel, at Goldman Sachs, where O’Herron told Vogel Penn Central would be “in a very tight cash position” in the first quarter of 1970. The blue sheets also recorded the Goldman partners’ reaction to reading on the “broad tape,” on February 5, 1970, that Penn Central had lost $56 million for 1969. “Mr. Wilson of Goldman Sachs put in a very hurried call to Mr. Levy of Goldman Sachs in St. Louis,” Pollack recounted for the jury, “and Levy said, ‘We’ve got to get them to a meeting in New York. Get Bevan and O’Herron too, to New York for a meeting. I will fly in from St. Louis.’ ” The blue sheets revealed that Wilson told O’Herron that Goldman would go to a “tap issue” basis for selling Penn Central’s commercial paper, meaning it would no longer buy it until it knew it could off-load it immediately. Wilson also asked O’Herron to buy back Goldman’s $10 million of Penn Central commercial paper, which he agreed to do on February 9. “This was right about the time when the sale to Younkers and the others occurred,” Pollack told the jury. “They didn’t tell us they were getting out while we were getting in, that they were bailing out.”
Wilson then told O’Herron, “We’re going to need a story to tell the purchasers.” This set Pollack off. “Why did they need a story?” he asked the jury, rhetorically. “The fact of the matter is they should have told it straight.”
One theme that “runs like a brook” through the entire Penn Central saga, Pollack told the jury, was Goldman’s relentless push to get more and more banking business from the company after it became its exclusive provider of commercial paper. Pollack believed this ambition prevented Goldman from being objective about the company’s financial danger. Goldman did not want to rock the boat. “Goldman Sachs was using commercial paper … as a door opener to other business,” Pollack said. “They wanted to get in with Penn Central. They wanted to be their securities broker. They wanted to be their debentures underwriter. They wanted to do off-shore financing for them.” He pointed out a telegram Levy sent to Bevan that “really tells something a
bout [Goldman’s] mentality” going into the relationship: “Tried to reach you on the telephone today to tell you how happy all of us at Goldman Sachs are that you are going ahead with $100 million of commercial paper and presume that we’ll be the ones to do the job for you. Also hope that in the event of any debenture or convertible debenture financing of the company we will be the manager. Best regards, Gus.”
Pollack was up against the Goliaths at Sullivan & Cromwell. Walter Sachs once described Goldman’s relationship with the law firm as “always” an “intimate” one. Goldman had conducted “an adequate, proper and reasonable” analysis of Penn Central, William Piel Jr. told the jury, to “satisfy itself” and to “maintain its reputation as the leading commercial-paper dealer” in the country. Investors received the information that was “proper to give,” Piel continued.
Piel told the jurors that to blame the Penn Central bankruptcy on Goldman Sachs was very much like “blaming the man who built his house because it got struck by lightning. It is something like that. We’ll say how close it comes to that. We’ll see what kind of disaster it was that hit the whole financial world like a thunder clap, a surprise and a shock—including [to] some of the officers of the railroad—as to what happened. So you must remember it is so easy with 20–20 hindsight to say that somebody who was trying to be aware of the things that might happen should have known that they were going to happen just because in hindsight we see that it did happen. That is the fix that Goldman Sachs is in.”
Toward the end of his opening statement, Piel conceded that Levy and Weinberg knew little about Penn Central’s commercial paper operations—even though Penn Central was Levy’s client—and that this made perfect sense in a business, such as Goldman Sachs, that relied heavily on the confidence its customers put in it. “[W]hen you are running a business that is based on trust and confidence, you don’t need—or you don’t think you need—policemen to watch the policemen and then policemen to watch the policemen who are watching the policemen. What you think is that if you have a man who has the ability and responsibility and the honor to do the job, then you give him the job and trust him to do it.”
Here, curiously, Sullivan & Cromwell and Goldman Sachs made this a case not about Gus Levy and John Weinberg but about Bob Wilson, the partner running the commercial paper department at Goldman. No matter what the jury decided, Piel seemed to be saying, the responsibility for what happened belonged solely to Wilson. “You will probably say to yourselves when he is on the stand he is a pretty young man to have had that responsibility for his firm, and it’s true,” Piel said, “but this is the age of able young men and women”—a curious comment indeed for an establishment attorney to make in 1969. “In a sense this is his case. It’s the Welch Company and the Anthony Company and the Younkers Company against Bob Wilson, because he had the responsibility to his partners to make that decision and to make it on a sound basis.” This maneuver—throwing a junior employee under the bus—would be revisited at Goldman with Fabrice Tourre in the wake of the 2007–2008 housing and mortgage-backed securities scandals.
On September 19, after the plaintiffs had rested their case, Goldman asked the court to throw out the case in its entirety. Goldman argued that the court lacked jurisdiction because the commercial paper was not sold through the use of interstate commerce or the mails, and thus was a state matter, not a federal matter. Goldman also argued that commercial paper was not a security as defined by the 1934 Securities Exchange Act. The judge ultimately rejected Goldman’s argument, and Levy, Whitehead, Bevan, and the sacrificial lamb Wilson were forced to testify to embarrassing effect. Pollock made great sport of reading to the jury their previous depositions, which differed in substantial ways from their testimony in court.
Since Sullivan & Cromwell had made the case about Wilson—no doubt as a way of deflecting responsibility away from Levy and Weinberg—Pollack very cleverly hoisted Wilson on his own petard. He skillfully filleted Wilson—and many of the other Goldman witnesses—by reading to the jury in his closing statement how he had answered a question one way in his deposition and how he answered the same question another way during the trial. For instance, in his trial testimony Wilson said he had regularly been kept apprised of Penn Central’s creditworthiness. But in his deposition, when asked if he were focused on Penn Central’s creditworthiness, he said, “No, there was no need in my mind because of, in our opinion, the tremendous underlying value of the assets in this [company].” When asked if anyone in his department was evaluating Penn Central on a weekly or monthly basis, Wilson responded, “Not that I am aware of.” Which Pollack rightly found to be “a staggering admission for the head of the commercial paper department to make.” Pollack said Wilson had no credibility as a witness.
After a long litany of Goldman’s ongoing omissions and misrepresentations to his clients, Pollack referred to a blue memo written by John Whitehead, the partner in charge of Goldman’s Corporate Finance Department. Whitehead wrote that he feared the commercial paper department “feels itself to be very much under the gun from the rest of the firm to produce instant profits at the maximum level possible for their department. Clearly this is not the proper objective and I think we should tell them so. Their job is to make the maximum possible contribution to the firm’s overall profits, not just their own; to do it in the long run, not just immediately.” Pollack said Whitehead was “perceptive” and saw “what was wrong” in the commercial paper department.
Pollack was brilliant right to the end. He said the case could be summarized simply: “When the company went under, Goldman Sachs, which for nearly two years had maintained an inventory [of Penn Central’s commercial paper], was left with zero in its own position. These plaintiffs were left with $3 million.”
On October 9, the federal jury reached a unanimous verdict against Goldman and ordered the firm to repay the $3 million, plus interest accrued since the filing of the lawsuit more than four years earlier, to the three plaintiffs. The Times called it a “landmark case” and the “first of its kind to go before a jury” and said that the verdict “could lay the groundwork” to resolve another thirty-five similar suits against Goldman, amounting to nearly $30 million. It was the first time a jury had extended securities law to commercial paper, which was a corporate IOU rather than technically a security.
The jury’s verdict was a big blow—“epochal,” Pollack said—to both Goldman’s reputation and its traditional legal strategy of fighting claims against the firm rather than settling for reasonable amounts. The jury awarded the three plaintiffs one hundred cents on the dollar plus another $1 million in interest. Goldman could not afford to have the remaining Penn Central lawsuits against it go that direction. “This was not a minor event,” Pollack said. “If you consider the fact that their total exposure was $82.5 million and they had total capital of $50 million, you can draw your own conclusions about whether this was an emergency for Goldman Sachs. It’s fair to say they were on red alert.”
In March 1975, Goldman settled with Getty Oil for $1.4 million, or seventy cents on the dollar. Some twenty lawsuits against Goldman remained outstanding, totaling around $20 million. According to a statement Novotny released, Goldman had “carefully prepared for any potential outcome of the remaining litigation to insure that these suits will not impair our capital.” In December 1975, a federal judge ruled against Goldman and ordered the firm to pay $500,000, with interest, to Franklin Savings Bank, which had bought Penn Central commercial paper a few months before the bankruptcy. Even when Goldman appeared to win a suit, it ended up losing. For instance, in June 1976, a federal judge in St. Louis ruled in Goldman’s favor against Alton Box Board Company, of Alton, Illinois, which was seeking $625,000. The judge found no “indication that the purchase was induced by any misrepresentation or omission of material fact” by Goldman and that Goldman “was warranted” in representing that Penn Central was “creditworthy” when it continued to sell its commercial paper. But Goldman lost Alton’s appeal and, in
November 1977, agreed to pay Alton $925,000, which was not only the original amount of the note, plus interest, but also Alton’s attorneys’ fees and court costs. In October 1976, a federal judge ruled that Goldman had to repay $600,000, plus interest, to the University Hill Foundation, a fund associated with Los Angeles’s Loyola University. (In the end, Goldman ended up buying back enough of the Penn Central commercial paper to offset a portion of its losses when the company emerged from bankruptcy protection and revived. “The value of the paper subsequently rose when the railroad reorganized, limiting our losses some more,” Whitehead observed.)
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IF ANY OF these ongoing legal judgments against Goldman affected Gus Levy, he did not let on. He ran into Pollack in 1976 at a public event, after not having spoken to him in six years. (They once served together on the board of the Foster Grant Corporation, a manufacturer of sunglasses.) The two men exchanged pleasantries about their health and their families. “He said he felt great,” Pollack said of Levy. Nor did Levy seem fazed by L. Jay Tenenbaum’s unexpected decision to retire from Goldman in November 1975, after more than twenty-two years at the firm. At the time, he was the third or fourth highest paid partner at the firm, with a 3.5 percent share of the profits. But he was burned out. Additionally, he had just remarried—an airline stewardess—and he wanted to make sure his second marriage did not go the way of his first, which it very well might have had he stayed at Goldman Sachs. “L. Jay had had it,” Peter Levy said. “There was a lot of pressure and he just wanted out.” Ever diplomatic, Robert Rubin described Tenenbaum’s departure from Goldman as a long-planned act of selflessness. “He was trying to clear the way for his own eventual retirement, even though he was only forty-four when he hired me.”
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