At the end of June, Goldman’s partners overwhelmingly voted to endorse the deal and it was announced publicly in the first week of August. Although the Federal Reserve still needed to approve the investment, it was big news.
At first, the Federal Reserve did not like the deal, which resulted in a lot of “soul searching,” according to the Times. “At issue to many Fed officials is whether a foreign banking institution’s purchase of a 12.5% nonvoting ownership stake in an American securities firm sets a bad precedent and is, in fact, legal considering the separation of banking and underwriting set forth in the Glass-Steagall Act of 1933,” the Times reported. “Fed officials seem to worry that control is a subtle influence and that, despite the nonvoting agreement, Sumitomo might end up exerting some influence over Goldman’s activities and decisions.” The Fed decided to hold a public hearing on October 10. “We want people to discuss not only the specific terms of the Sumitomo-Goldman deal but the broader issues,” a Fed official explained. “Is this the end of Glass-Steagall, or is this indeed just a passive investment?”
At a rare public hearing at the Fed, which was attended by more than two hundred people, Michael Bradfield, the general counsel, seemed particularly focused on whether the investment would “lead to Sumitomo influencing the management decisions of Goldman Sachs” and be a violation both of Glass-Steagall and the Bank Holding Company Act of 1956, which limits to 25 percent the nonvoting stock ownership from another entity. While the worry about Japanese control of an American financial institution seems quaint after that country’s epic economic collapse in the 1990s, the concerns about the breaching of Glass-Steagall were prescient—and ironic, considering Robert Rubin’s role in repealing the law when he was Clinton’s treasury secretary, after which he took a very high-paying job at Citigroup, a chief beneficiary of the law’s repeal.
Scott Pardee, a vice chairman of Yamaichi International who had worked at the Federal Reserve Bank of New York for nineteen years, testified that the distinction the Glass-Steagall Act made between commercial banking and investment banking was an important one and worth preserving. “I may be old-fashioned,” he said, “but I believe that there are distinctions that can be made between the two kinds of business. I think those distinctions are major. A commercial bank accepts deposits and has a responsibility for the safekeeping of depositors’ money. For a bank to use depositors’ money to engage in high-risk business raises the stakes for everyone, including the depositors, the bank’s competitors, who may feel obliged to follow suit, and the central banks, which must stand ready to perform their lender of last resort function, should the bank fail to maintain adequate capital and sufficient discipline in risk management.” While he said he did not think the deal under consideration violated the intent of Glass-Steagall, he added, wisely, his concern that “as the globalization continues … you will require more resources and active involvement” from the Federal Reserve.
On November 19, the Fed approved the deal after both Goldman and Sumitomo agreed to make subtle changes to it, including capping the Japanese investment, requiring that Sumitomo raise more capital—highly unusual since Sumitomo, as a Japanese bank, did not fall under the Fed’s jurisdiction (despite the fact that Sumitomo owned a small bank in California)—and that Goldman and Sumitomo not move forward with their planned business joint ventures in London and Tokyo. It marked the first time a large foreign bank holding company had taken a significant stake in an American securities firm. “In our view, with these changes the investment is truly passive,” Bradfield said. In a statement, the Fed said, “The board was concerned that this combination of significant equity investment and maintenance of extensive business relationships would give the investor both the economic incentive and means to exercise a controlling influence over the management policies” of Goldman. Weinberg seemed happy to make the changes. “This was a passive investment from the first word,” he said, “and there was never a desire on Sumitomo’s part to get control.”
The Fed’s approval cleared the way for Goldman to get Sumitomo’s money by December 1. “This will give us additional capital to provide clients with a broad range of investment,” Weinberg said. But the bigger question floating around the halls of 85 Broad Street was whether the Sumitomo capital was enough. Should Goldman still go public as Rubin and Friedman had proposed earlier in the year?
——
THIS WAS THE question confronting the 104 Goldman partners who had gathered Saturday morning, December 6, in the firm’s second-floor meeting room. It had been a surreal few days before the meeting. Not only had Goldman received the Sumitomo millions on December 1—and now had a large Japanese bank as an investor—but that same day, thirty-seven new partners had been named. The nine-member Management Committee had already endorsed the idea of an IPO and in the days leading up to the partners’ meeting had been canvassing the rest of the partnership for their support. Fairly uniquely on Wall Street, each partner’s vote counted as one, regardless of how many shares he—or she—owned. (The firm’s first woman partner, Jeanette W. Loeb, had been selected on December 1.) That meant that the thirty-seven new partners would have just as much say as the Management Committee—but a totally different agenda. As new partners, they had not had the chance to build up their wealth in the firm, and many of them believed it was too soon to go public.
The nine members of the Management Committee sat on the stage at the front of the room facing the ninety-five other partners in the audience. Many members of the committee spoke up in support of the IPO, but everyone paid particular interest when Friedman and Rubin got up together to speak in favor. Weinberg had positioned them, after all, to lead the firm after he retired. They made the case that with even more capital, Goldman could soon be a rival to Salomon Brothers in trading and could also become a leader in proprietary trading (for its own account) as well as in private equity and other forms of principal investing. Then they touched on the issue of partner liability. As a partnership, each of them individually was responsible for absorbing the losses the firm incurred in an amount equal to his entire net worth. This was no small worry, given the recent trading losses and such existential threats as the lawsuits that had hit the firm in the wake of the Penn Central bankruptcy. Who knew what might be lurking out there that could zap Goldman again? Rubin and Friedman argued that the time had come for the IPO for many reasons, with the hope being that if the partners agreed it could be done before the next financial crisis, which Rubin for one suspected was imminent.
Oddly, though, their presentation landed with a thud. “The presentation made to the partners that Saturday has been described as, at best, uninspiring and weak,” according to Endlich. “Others have called it haphazard and half-baked, emphasizing that its quality was far below that of presentations the firm routinely gave its clients. Most agree that it was an amateurish effort; what was presented was little more than a concept.” Partners were given a document that outlined the new structure whereby they would become “managing directors” whose stock would be worth around three times more than what they paid for it originally. Furthermore, many of the numbers didn’t add up, and the investment bankers in the audience were busy trying to reconcile them. Emotions ran high. Chaos reigned. “By afternoon, an impassioned debate had erupted …,” Endlich continued. “Partners screamed and cried … it was a cathartic experience.”
Soon enough, it was clear that the new partners had little interest in going public since they had not yet had a chance to build up enough value in their Goldman stock to benefit sufficiently from an IPO, while the investment banking and M&A partners were indifferent to the idea because their businesses required very little capital to operate and were already world leading and extremely profitable. Many wondered who really owned the firm—the present generation lucky enough to be around to cash out when the firm went public, or the future generations for whom the present generation was just a steward? And why should the current partners get filthy rich as a result of the work d
one by the thousands of people who came before them in the previous 117 years? Eleven years later, Weinberg reflected back on the 1986 partners’ meeting: “I always felt there was a terrific risk, and still do, that when you start going that way you are going to have one group of partners who are going to take what has been worked on for 127 years and get that two-for-one or three-for-one. Any of us who are partners at the time when you do that don’t deserve it. We let people in at book value, they should go out at book value.”
The partners’ meeting lasted through the day and ended inconclusively. That night, the partners reassembled for a black tie party at Sotheby’s. “Each partner was engaged in a balancing act,” Endlich recounted, “an internal struggle to weigh the different factors that would affect his vote. Personally most partners wished the firm to remain a partnership; yet a judgment needed to be made as to whether the firm required a larger and more stable capital base in the near future. And then there was raw self-interest, a very personal calculation of the optimal way to enhance one’s wealth.” Regardless, the final decision would be made the next day through a vote of the partners.
But when the partners reconvened at 85 Broad that Sunday morning, it was clear that both of Sidney Weinberg’s sons—John, the senior partner, and his brother, Jimmy—were against the idea. John Weinberg had not said much of anything on Saturday—which spoke volumes—but when Jimmy Weinberg got up to speak, his words carried immense weight, if only because of the partners’ respect for the Weinberg name. According to Endlich, “Jimmy told the group the proposal made no sense. Goldman Sachs had a heritage, and he was on the side of preserving it. He reminded the partners of their stewardship, of their responsibility to the next generation. He would feel uncomfortable reading about the partners in the newspapers, of having details of their financial situation made available for public consumption. People stared in amazement.” And that was that. There was no vote. Jimmy Weinberg “had a real aversion, if not allergic reaction, to anything public,” Peter Weinberg explained about his father. “He’s really, really focused on that.” Goldman would not be going public, at least in 1987. “Guys cried …,” one unnamed partner told Institutional Investor nine years later. “[John Weinberg] didn’t want to ram it through.” The time was not right. “We were not psychologically ready to be a public company, with all that entailed,” Boisi recalled. “I found it ironical, being an adviser to corporate clients on equity offerings, our own blindness to what the impact was going to be on our own culture.” The next day—Monday—John Weinberg circulated a memo throughout the firm, under his signature: “The partnership will continue to review all appropriate financing structures and alternatives which will continue to allow us to be a leader in the global investment banking arena.”
CHAPTER 11
BUSTED
Two months later, the question of a public offering for Goldman Sachs anytime soon was moot. On the morning of February 12, around eleven thirty, Thomas Doonan, a United States Marshal and an investigator in the U.S. Attorney’s Office for the Southern District of New York, entered the Goldman building at 85 Broad Street in search of a senior partner, Robert Freeman. Freeman, then forty-four years old, was the head of Goldman’s hugely important risk arbitrage department on the twenty-ninth floor, having taken over the day-to-day management from Rubin, his friend, boss, and mentor. On that cold February day, Freeman’s assistant told her boss that Doonan was waiting for him in his small office, just off the trading floor. When Freeman walked in, Doonan closed the door and pulled down the shades. Doonan, who at first mispronounced Freeman’s name, told him he was under arrest for insider trading and a breach of federal securities laws. “I don’t know why I did this,” Freeman recalled many years later. “Maybe it’s my tenacious half, I don’t know. I said, ‘Well, the least you can do is get the name right.’ And the guy came right up to me, put his nose up to me, and then he backed off.” They calmed down and took seats.
In shock and disbelief after hearing Doonan’s words, Freeman opened the door to his office slightly and asked his secretary, Bernadette Smith, to call Lawrence Pedowitz, a lawyer at Wachtell, Lipton, Rosen & Katz whom Goldman had hired the previous November when Freeman’s name first surfaced as someone the government was tracking as a result of the arrests—also for insider trading—of the arbitrageur Ivan Boesky and two Drexel Burnham Lambert executives, Dennis Levine and Martin Siegel. Two months earlier, in September, David S. Brown, a vice president in Goldman’s investment banking group, pleaded guilty to two counts of insider trading for selling tips—for thirty thousand dollars—about two pending mergers to Ira Sokolow, a Shearson Lehman Brothers banker, who passed the tips on to Levine, who made $1.8 million from them.
Now, just as the firm was recovering from the Brown embarrassment, one of its most senior partners was under arrest, also on insider-trading charges. “Bob, you gotta be kidding,” Pedowitz said to him. Pedowitz, who had been a criminal prosecutor in the United States Attorney’s Office for the Southern District of New York before joining Wachtell, asked Freeman to put Doonan on the phone. “Look, Bob Freeman’s a very good guy,” Pedowitz told Doonan. “Please don’t handcuff him in the office.”
Doonan obliged, and a humiliated—but uncuffed—Freeman was led across the trading floor, in front of all his Goldman colleagues, to the elevators and then was taken down to Broad Street. Once outside, he was handcuffed, put in a van, and taken to the federal courthouse in Foley Square to be arraigned. Doonan also took with him a bunch of deal files from the firm. When Freeman got out of the van, Goldman’s head of security, Jim Flick—a neighbor of Freeman’s from Rye, New York—threw a raincoat over Freeman’s wrists, and the assembled press snapped pictures of the Goldman partner heading into the courthouse. He was photographed and fingerprinted. His passport—which had to be retrieved from his home—was confiscated. So frazzled was Freeman that when asked his Social Security number, he could not remember it. “Something was happening to me and I was sort of outside of myself observing,” he said. His bail was set at $250,000—he thinks Goldman whisked the money out of his Goldman account—and he was released to a life that would never be the same. “Wall Street went into shock,” Fortune reported, capturing well the sentiment at the time. “Goldman Sachs has long been perhaps the most respected of the big investment banking houses. If anyone seemed beyond suspicion, it was Goldman, and Freeman was well known on the Street as one of its most highly prized partners. For them to be caught up in this sleazy affair seemed almost beyond belief.”
Also arrested that morning a few blocks away from Goldman was Richard B. Wigton, fifty-two, a vice president at Kidder, Peabody and a senior arbitrageur who had worked with Martin Siegel at Kidder before Siegel went to Drexel. The previous evening, another Kidder vice president, Timothy L. Tabor, thirty-three, was arrested at his East Side apartment and then jailed overnight at the Metropolitan Correctional Center. Like Freeman, Wigton and Tabor were charged with insider trading that had produced million of dollars of illegal profits, according to federal prosecutors, led by Rudolph W. Giuliani, the U.S. Attorney for the Southern District of New York. Freeman alone was charged with having profited personally from the insider trading since he—allegedly—had done some of it in his personal Goldman account, which Goldman had allowed, in a long-standing departure from an early rule against partners even taking out loans.
Even though he knew his name had been mentioned in the paper three months before and suspected, as he said, that “one day I might hear from the government,” in the hours after his arrest, “I was totally shocked,” he said. “It wasn’t one hundred percent a surprise that some day, I was going to hear something from the government. But, usually, these things, there’s an investigation and they subpoenaed documents, none of that.”
When he got the call from Freeman, Pedowitz thought it was a joke. “I thought he was pulling my leg,” Pedowitz said. “But he made it clear he was not pulling my leg.” After spending three months reviewing the trading reco
rds and interviewing Goldman traders and bankers, he was convinced Freeman should not have been mentioned in the same breath as Siegel, Boesky, Levine, and the rest of the motley crew of insider traders. At worst, he thought it might be possible the SEC might bring a civil action against Freeman or Goldman. “The very first insight we had that there was going to be a case as opposed to just the rumor mill generated by the article, was Bob’s arrest,” he said. “I was totally shocked. I thought it would likely be an SEC case. I had no idea that the U.S. Attorney’s Office was involved or that he would be arrested.” Pedowitz was aware of Boesky’s allegations and had studied Goldman’s trading records for the Boesky deals. He knew there was big money involved. “Goldman was super sensitive,” he said, “not only to the fact that Boesky might touch them, but also that reputationally, this could affect their investment banking business, which in those days was a huge portion of their revenue too. They really wanted to understand this. The anxiety about Bob was not huge because people basically believed he had done his business appropriately with a huge amount of research.”
Money and Power Page 35
