But among those precepts that followed were some that sounded great on paper but were too easily violated, as was apparent at Goldman in the Trading Corporation and Penn Central scandals (and on others to come, in short order). “Our assets are our people, capital and reputation,” Whitehead continued. “If any of these is ever diminished, the last is the most difficult to restore. We are dedicated to complying fully with the letter and spirit of the laws, rules, and ethical principles that govern us. Our continued success depends upon unswerving adherence to this standard.” As a corollary to the importance Whitehead placed on ethical behavior at the firm, he added, “Integrity and honesty are at the heart of our business. We expect our people to maintain high ethical standards in everything they do, both in their work for the firm and in their personal lives.”
Whitehead’s remaining goals for the Goldman troops involved the expected exhortations on the importance of profitability, professionalism, creativity, and innovation. He also acknowledged how important recruiting had become to the firm. “Although our activities are measured in the billions of dollars, we select our people one by one,” he wrote. “In a service business, we know that without the best people, we cannot be the best firm.” He later elaborated on what he meant. His definition of “the best” was a combination of “brains, leadership potential and ambition in roughly equal parts.” Brains, he allowed, could be determined easily enough from test scores and grades. Leadership was apparent from extracurricular activities and summer jobs. He always looked for “take-charge people,” those with “energy and initiative, which are so critical to leadership.” Ambition was essential. “We depended on people who were absolutely driven to succeed at everything they did.” Whitehead also wanted to make sure the people Goldman recruited had the “opportunity to move ahead more rapidly than is possible at most other places. We have yet to find limits to the responsibility that our best people are able to assume.” (This was one of the commandments that the lawyers seemed to get hold of, by adding that “[a]dvancement depends solely on ability, performance and contribution to the firm’s success, without regard to race, color, religion, sex, age, national origin, disability, sexual orientation, or any impermissible criterion or circumstances,” albeit too late for James Cofield.)
When Whitehead finished his list, he shared it with Goldman’s Management Committee, which tweaked it and then approved its distribution to everyone at the firm. A copy was also sent to each employee’s home “in hopes that the family would see it, too, and be proud of the firm where Dad (or in a few cases, Mom) worked, and spent so much of his time.” Whitehead explained that “travel was pretty extensive in those days, especially for new businessmen” and he shared the principles with wives and children “to impress the families” that Dad “worked for a high-grade firm that did have high standards” and helped to “assuage our employees’ feelings of guilt toward their families for their absenteeism by saying ‘Look at the character of our firm.’ ” To Whitehead, the principles were “a big hit” and “respected throughout the firm.” Indeed, managers were expected to meet with their groups—“including secretaries,” he said—at least once a quarter for “at least an hour” to discuss the business principles and how they applied to the transactions the department was doing. “[T]he department heads were required to send in minutes of their meeting and what was raised and what questions came up about ethics,” Whitehead said. “[The] management committee would look at that and contemplate whether or not there was a need to make some formal change in policies.” These meetings continue at Goldman Sachs today.
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WHITEHEAD’S OTHER PET project at Goldman was forcing the firm to expand internationally. He criticized both Levy and Sidney Weinberg for being painfully parochial. “Sidney Weinberg’s contacts were all American and, later on, so were Gus Levy’s,” Whitehead explained. “I don’t think Sidney ever left the United States, even for vacations.” As for Levy, he observed, “When Gus had to fly to London one time for a business meeting, he flew back the next day. There was nothing more for him to do there.”
During the more than forty years these two men ran Goldman there were a few stabs at being part of the international community. There was Goldman’s long-standing “correspondence” relationship with Kleinwort Benson in London. But that was more of a relationship based on mutual favors. “If a client needed something done in London,” Whitehead explained, “we always recommended Kleinwort.” In return, Goldman expected Kleinwort to direct its U.K. clients to Goldman if they wanted to do something in the United States.
But Goldman’s competitors were more aggressively establishing themselves in Europe. In the early 1960s, Morgan Stanley had opened an office in London. First Boston had an office in Europe. Merrill Lynch had several brokerage offices across Europe, and Salomon Brothers “was doing a brisk business in bonds overseas,” Whitehead observed. Goldman had barely done anything. In 1967, General Electric’s chairman called Sidney Weinberg and informed him that the company had hired Morgan Stanley to underwrite a bond issue for it in Europe. “[T]hat was a dark day for the firm,” Whitehead allowed. “We had to get into Europe or else.”
The next year, Henry Fowler, the outgoing treasury secretary, joined Goldman as a partner and as chairman of the firm’s new International Advisory Committee. “I thought it would give our international efforts a great boost to have a former treasury secretary such as Joe”—as everyone called Fowler—“with us …,” Whitehead explained. “With his political and financial contacts around the world, Joe proved a tremendous asset.” Fowler worked closely with Michael Coles, a British citizen and Harvard Business School graduate who Whitehead asked to move to London in early 1970 to open Goldman’s first European office.
A few years later, Whitehead flew to Washington to try to persuade another former senior government official—Secretary of State Henry Kissinger—to join Goldman as a partner. At first, Kissinger demurred. But the Two Johns persisted and met with him “at least a dozen times to try and win him over,” figuring he would be even a more valuable door-opener than Fowler. In the end, Kissinger opened his own consulting firm—Kissinger Associates—but agreed to consult with Goldman two days a month and become head of the International Advisory Committee. Kissinger provided Goldman with “tremendous advice about the political side of world affairs” and his judgment was “invariably sound.” The relationship lasted eight years. The relationships with Fowler and Kissinger were further evidence of a key Goldman strategy of forging relationships with powerful government officials, one that would become increasingly crucial to the firm.
Slowly but surely, Goldman built up its London operations, staffing it with one ambitious man after another willing to call on British companies that for generations had never done any business with an American investment bank, let alone a Jewish firm like Goldman. (Even for long-established European firms such as Lazard Brothers—which was one of seventeen banks favored by the British government—doing business in London often proved difficult because of how recognizably “Jewish” it was.) Whitehead’s tactic for making progress was very much the same one he pioneered in expanding Goldman’s business in the United States: a concerted, organized calling effort by Goldman’s best and brightest. But the process of winning new business in Europe was even more difficult than it proved to be at home, and many of Goldman’s partners grumbled about the ongoing losses in London. But Whitehead rebuffed these concerns. Goldman had to make the investment in Europe “or the consequences for the firm would be dire.” That’s when he lighted on the idea of changing the way the losses in London were accounted for. Instead of treating London as a stand-alone business, he decided to net its investment banking losses against the overall investment banking profits. He made a similar calculation for the other business lines in London. All the expenses in London should be netted off against the gains in the United States, he reasoned, since “[w]hen you’re starting a new activity in a new place you have to add people before
you can expect revenues.” He had learned that very lesson when he started the New Business Group, “which had taken a long time to produce a substantial return on our investment.” Like magic, the attitudes toward the London office “swung around 180 degrees” since “every division head now felt some responsibility for what happened in London, and the results began to show it.”
Notwithstanding the accounting change, Goldman’s slog in Europe continued to be a tough one. The firm was competing not only against other upstart American firms but also against an entrenched establishment of British merchant banks, where corporate executives “were reluctant to change bankers for fear of offending some old classmate from Harrow or Eton who now worked at Morgan Grenfell or Schroders.” But, according to Whitehead, the “different style” of Goldman’s new-business bankers “began to catch on” in London because “[t]hey were younger, seemed brighter, were better informed, had new ideas,” and “sometimes were a little brash but didn’t waste time talking about their golf game.” Word slowly got around that Goldman’s bankers were worth talking to.
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WHATEVER GOLDMAN WAS doing in the years after Levy’s untimely death seemed to be working. After its record $50 million pretax earnings in 1977, the firm made $60 million pretax in 1978, a 20 percent increase. When asked about the increased earnings, Whitehead declined to comment, but the firm did allow—in what the Wall Street Journal described as an “understatement that has become something of an annual tradition”—that “[d]uring the past five years, the firm’s net income before income taxes has averaged well over $25 million annually,” putting Goldman in the same league—in terms of profitability—with the much larger retail-oriented firms Merrill Lynch and E. F. Hutton. In 1978, Goldman handled nearly 15 percent of the block trades—of ten thousand shares or more—on the New York Stock Exchange, indicating that Levy’s competitive spirit lived on. It managed, or comanaged, eighty-seven corporate underwritings, totaling $7.6 billion. Goldman also managed $2.6 billion private-placement financings—those sold to specific institutional investors, not to the public—and raised some $16 billion for state and local governments.
In October 1980, such was Goldman’s increasing prominence on Wall Street that the firm announced it was building a new twenty-nine-story, $100 million headquarters building at 85 Broad Street, down the street from the New York Stock Exchange. Skidmore, Owings & Merrill was the building’s architect (although the nondescript brownish precast concrete façade was not one of the firm’s proudest achievements). It was to be the first major office building built by a Wall Street firm in Manhattan in more than a decade. New York City gave Goldman ten years of tax abatements on the building, starting at a 50 percent annual abatement and decreasing by five percentage points each year thereafter. The Goldman partners had decided to build 85 Broad Street instead of one of the alternatives, which was to take a bunch of top floors in one of the World Trade Center towers.
But what made the new building controversial—at least from the Goldman partners’ perspective—was that the firm decided it would own the building and the land itself, rather than just rent the space it needed, meaning the equity for it would come from the Goldman partners individually. In typical Goldman fashion, the Two Johns presented a united front about the decision to build and own a new headquarters building, but the reality was not so clear-cut. “There was a lot of debate about whether to build Eighty-five Broad Street,” Bob Rubin recalled. The idea of sinking so much of their own net worth into a building in lower Manhattan did not sit well with many of the Goldman partners. But once the generals made the decision to proceed, the troops got in line. In the end, Goldman made the building work. “When we all first moved in there, there were cigarettes at every table, in a silver holder,” former partner Richard Witten recalled. “The chef was famous for his chocolate chip cookies, and they were served at every meal.” According to the New York Observer, “A partner running a meeting got a button that looked like a garage door opener. It summoned the uniformed waiter.”
CHAPTER 9
A FORMULA THAT WORKS
There was much less internal debate at Goldman, Rubin stated, not entirely accurately, about another momentous decision: to buy, in October 1981, J. Aron & Company, the nation’s largest supplier of green coffee beans and a major trader of precious metals and commodities with more than $1 billion in revenues in 1980. Not only was the acquisition of J. Aron the largest in Goldman’s history, but it was also the only major acquisition the firm had ever made, aside from buying one or two small, regional commercial paper providers at the time of the Great Depression. Nearly alone on Wall Street, Goldman had—to that point—shunned major acquisitions as a way to grow its business for fear of diluting its insular corporate culture and because of the inherent difficulties of integrating mergers under any circumstances.
The idea for the acquisition of J. Aron evolved as Goldman’s arbitrage business became more and more sophisticated—and profitable—over time. As part of his job, Rubin was always on the lookout for arbitrage opportunities, and not necessarily those involving two merging companies. Sometimes two securities trading independently but linked through a derivative presented an arbitrage opportunity. After reading up on one such opportunity involving the warrants and equity of Phillips Petroleum, Rubin—then not a partner—wrote a long memo suggesting that the firm buy Phillips’s common stock and sell its warrants (the right, but not the obligation, to buy Phillips’s common stock). Rubin gave the memo to Tenenbaum, who passed it along to Levy. He called Rubin into his office. “Ahh, I don’t want to do all that,” Levy told Rubin. “Let’s just go short the warrants.”
“Gus,” Rubin replied, “you know we have to be hedged.”
But Levy had decided and couldn’t care less if Rubin thought the firm should be hedged. “Gus responded with a five-word sentence conveying that he didn’t care about hedging, didn’t care about my memo, and didn’t care about explaining the matter,” Rubin explained, “because if I didn’t know this stuff, I shouldn’t be at the firm in the first place.”
“I don’t have time for on-the-job training,” Levy told Rubin.
Rubin asked Tenenbaum what he should do since he suspected that constructing the trade the way Levy demanded would expose the firm to unnecessary risk. L. Jay told him that he should short the Phillips warrants, as Levy had said. Rubin did as told, and the firm made money. “[F]ortunately the stock didn’t run up while we were holding the position,” Rubin said.
Rubin’s experience trading the Phillips warrants led him to explore whether money could be made exploiting the illiquidity that then existed in the over-the-counter trading of options, which were the right, but not the obligation, to buy specific amounts of stock in a company at a specific price by a specific time. In other words, buying and selling options was—and is—a form of legalized gambling. That was especially so in the 1960s and early 1970s before options began to be traded on an exchange—which began in 1973, with the creation of the Chicago Board Options Exchange, or CBOE—and were traded among less-than-reputable securities dealers. “Prices were not transparent, to say the least,” Rubin explained, but he believed his arbitrage desk could make money trading them. Over time, Rubin came to the conclusion that Goldman could supplant the unsavory options dealers by trading options directly with its clients, other Wall Street firms and investors. There was money to be made.
But Rubin’s proposal met with some initial resistance from his partners, who were well aware of Sidney Weinberg’s dictum against trading options, a carryover from Weinberg’s belief that options trading had been one of the causes of the problems Goldman had with the Goldman Sachs Trading Corporation. By the time Rubin proposed the idea to Levy, though, Weinberg was dead. “If you want to get involved with options, go ahead,” Levy told him and then got the Management Committee to approve it. The creation of the CBOE allowed option trading to flourish by creating standardized terms for listed options and a clearing system—whereby there
was a method to make sure one party to a trade did not welch on it—for secondary trading. Rubin remembered how Joe Sullivan, the founder of the CBOE, came to see him sometime in 1972 and explained how it was going to work. Rubin introduced Sullivan to Levy, “who listened to him and said, with a twinkle in his eye, that this was ‘just a new way to lose money,’ and then offered his support.” Rubin went on the CBOE’s founding board of directors. He remembered that before the first trade on the CBOE—on the morning of April 26, 1973—Sullivan called him with a concern that no one would show up to trade the options. Rubin had also hoped that Goldman could do the first trade. In the end, on that first day, 911 options contracts traded for sixteen underlying stocks. “[O]ptions trading turned into a genuinely liquid market and led to the creation of large markets in listed futures on stock indices and debt,” Rubin explained.
Based on Goldman’s success trading options, around 1978 Rubin pushed the firm to start trading commodities. “We’re in the arbitrage business,” he told George Doty. “We’re in the options business. It’s not that different than commodities. So why don’t we go in the commodities business?” Doty agreed with Rubin. The firm decided to get into the commodities business “in a small way” by hiring Dan Amstutz, a grain trader at Cargill, to start trading agricultural commodities as part of Rubin’s arbitrage department.
J. Aron had been a banking client of Goldman’s for many years, and Goldman was J. Aron’s futures broker. The company had been founded in New Orleans in 1898 by Jacob Aron as an importer of green coffee beans. In 1915, J. Aron opened an office in New York City at 91 Wall Street. The firm was conservatively run. Its principal business evolved into buying and selling commodities in different geographic markets—for instance, buying sugar or rubber in New York and selling in London—and capturing the price differential as profit. “Our plan of operation calls for being long or short up to a maximum of twenty seconds,” Jack Aron, the company’s chairman and Jacob’s son, once said. Jack Aron had known Gus Levy for many years, and both were active in the Jewish community and in their support of Mount Sinai Hospital.
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