Money and Power

by William D. Cohan

  After the DTI report, Maxwell seemed determined to restore his tarnished reputation. In 1974, he bought back Pergamon from Leasco, where it had performed poorly without him. In two years’ time, he had restored Pergamon to profitability and then used it as an acquisition vehicle. In 1981, he bought the money-losing British Printing Corporation and made it profitable by busting unions and slashing staff. In 1984, he bought the Daily Mirror, fulfilling a lifelong ambition to own a newspaper. The paper was losing money, but he made it profitable by again destroying the union and brutal cost cutting. Soon thereafter, he made the bold prediction that his private company would have billions in revenue “and profits to match.” In 1988, for $3.3 billion, he bought Macmillan Inc., a New York book publisher, and Official Airline Guide, using billions of dollars in debt to do so. By the beginning of the 1990s, Maxwell was still short of his goal—his revenue was just shy of $1 billion—but he had divested his printing business as well as Pergamon, his original business, for $446 million.

  As a credit crunch took hold worldwide in the early 1990s, the prices Maxwell had paid for many of his assets—especially Macmillan—looked excessive and the debt burden loomed heavily. “When most of my colleagues looked at Maxwell Communications [in 1991], we felt that the profits were overstated, the debt burden was quite likely to lead to downfall, and we’d become increasingly concerned by the way in which it seemed the share price was rigged,” John Kenny, an analyst at Barclays de Zoete Wedd, told the Times. “I did not see anyone buying the stock, yet on many occasions it was going up.”

  Part of the alleged blame for the apparent manipulation of Maxwell’s stock rested with Goldman, according to the DTI report and various newspaper accounts, and two put options that Maxwell and his son had sold Goldman on 45.65 million Maxwell Communications shares, representing 7 percent of the shares outstanding, a huge and atypical option. An August 14, 1990, option gave Goldman the right to sell 15.65 million Maxwell Communications shares on November 30, 1990, for 185 pence each, or about $3.60 at that day’s exchange rate and 15 pence above the prevailing price of Maxwell’s stock. Goldman bought the put to protect the value of the 16.7 million Maxwell shares it already owned and paid a fee to Maxwell for the right to sell shares to him. The option Maxwell granted Goldman expired two days after the end of period during which Maxwell could not buy his company’s shares.

  During August, September, and October 1990, Goldman accounted for nearly half the trading in Maxwell Communications stock. Goldman exercised the first option the day it was to expire. Maxwell’s stock was trading at 155 pence. Since Goldman could sell the Maxwell stock back to Maxwell at 185 pence, the firm locked in a substantial profit—said to be around $4.5 million—on those Maxwell shares. “We did nothing illegal or wrong,” a Goldman official told the Times in December 1991. According to The Economist, in December 1991, “Goldman insists throughout this buying spree it was acting as a conventional market maker. The firm expected to sell the shares to Maxwell, but had no prior agreement to do so. The proof is in the risk it took. At the end of November 1990, Maxwell rebuffed an offer from [Sheinberg] to sell its entire positions,” then about 30 million shares. Goldman took a loss of “several million dollars” as a result when it had to mark its holding to the prevailing market price of 140 pence.

  On January 4, Maxwell sold Goldman another put option, this time for 30 million Maxwell Communications shares at 152 pence each, two pence above the prevailing price. On February 15, Goldman exercised the option, selling Maxwell the block of stock at three pence above the market price. Goldman made another windfall. In the spring, Goldman started lending Maxwell money—as much as $75 million—secured by 33 million Maxwell Communications shares and then, after it went public in May 1991, 40 million Mirror Group shares, about 10 percent of the company. More than three months late, on August 14, Goldman got around to disclosing to the British authorities that it owned around 7.5 percent of Maxwell Communications, which was a part of its collateral for its loans to Maxwell. Goldman said it “made an honest mistake” in not disclosing the position sooner. “Maxwell’s hunger for cash and willingness to sign away the public companies were the first public signs of his mounting panic,” The Economist observed.

  Indeed, this turned out to be typical Maxwell. He had pledged the stock he owned in his public companies as collateral for loans he had received to finance his acquisition spree and his private companies. He also cadged from his employee pension funds. Some have argued that Maxwell granted the unusually large put options to Goldman at 185 pence as a way to keep the value of the stock high since it was being used as collateral for as much as $4.4 billion in debt. If someone—it turned out to be Maxwell, although no one knew that at the time, except for perhaps Goldman—was willing to pay 185 pence for the stock, it must be worth at least that amount. That is why Kenny, the research analyst, concluded the share price had been manipulated. (The DTI concluded pretty much the same thing, too.)

  Beginning in August 1991, Goldman became increasingly skeptical of the financial health of Maxwell’s empire. On August 2, as Maxwell was contemplating spinning off his businesses in the United States—Macmillan Inc. and Official Airline Guide—and loading them up with some of his debt, Goldman and Merrill Lynch attempted to sell $75 million in Official Airline Guide preferred stock. But the auction failed to find buyers at acceptable rates and signaled that trouble could be afoot. Maxwell denied there were any financial problems at his company and vowed to try to sell the preferred again on September 20. “It will be successful,” he said. On August 12, Maxwell telephoned Sheinberg and told him he would not make a $35 million loan payment to Goldman due that day. “Mr. Sheinberg told us that this was the first time Robert Maxwell had reneged on a deal and that it represented the end of their business relationship,” according to the DTI report. “From that time on Goldman Sachs’ efforts were directed to obtaining repayment of the loans they had made and settlement of the outstanding transactions.”

  When Goldman and Merrill tried again to sell the preferred, it again failed to find buyers. With the knowledge that Maxwell was having trouble getting new financing, in a replay of Penn Central, Goldman started pressing him to repay its $75 million of loans. On October 22, Sheinberg met with Maxwell one last time to try to get him to repay the money owed to Goldman, then three months overdue. If Goldman was not repaid immediately, Goldman would sell the Maxwell Communications shares it held as collateral. “If you do that, you’ll kill me,” Maxwell told Sheinberg. When he did not make the agreed-upon payments, Goldman started selling the Maxwell stock it had as collateral. That day, Goldman sold 9 million shares. In response, Maxwell agreed to make a payment on October 29. When he failed to make that payment, Goldman told him it would sell more collateral. Despite a request by Maxwell’s son, Kevin, not to do so, on October 31, Goldman sold another 2.2 million shares. Goldman continued to sell Maxwell shares for the next five days.

  On November 4, Eugene Fife, a London partner, called Edward George, deputy governor of the Bank of England, and told him there would be a public announcement that Goldman had been selling the Maxwell Communications shares it held as collateral for the loans Goldman had made to Maxwell. According to George’s notes from the conversation, “Gene Fyfe [sic], Chairman of Goldman Sachs, telephoned the Deputy Governor on 4 November to inform him that Goldmans had decided to sell the collateral on two outstanding loans to Robert Maxwell, one for £20 million and one for £30 million. This action had been taken after Goldmans had granted several extensions to the loans. They had now got tired of waiting, particularly given that Maxwell appeared to have sold a number of entities recently, but had not distributed any of the proceeds to Goldmans. The collateral consisted of a block of Mirror Group stock and a block of Maxwell Communications stock. Goldmans intended to sell the Maxwell Communications stock first and to do it as quietly as possible in the hope that there would be no disruption to the market. Maxwell himself was aware of Goldmans’ intentions.”

 
On November 5, at 1:05 p.m., Goldman’s message about the sale of the Maxwell Communications stock hit the newswire. Within hours, Maxwell was dead. At the time of Maxwell’s death, Goldman still owned 24 million shares, which quickly became worthless as Maxwell’s scheme unraveled. At the time of Maxwell’s death, he still owed Goldman $62 million. According to the DTI report, Maxwell denied having manipulated the price of Maxwell Communications stock by entering into the put agreements with Goldman. “The suggestion that I distorted the shares in MCC is untrue,” he said. “I did not support the share price with a view to deceiving or distorting the market and such actions as I have taken have not been designed to preserve my personal wealth at the expense of others.”

  But the relationship between Maxwell and Goldman was fraught with contradictions and disagreements, including about the nature of the relationship itself. For instance, Kevin Maxwell, one of his father’s trusted advisers and executives (who was later accused and acquitted of criminal charges in the matter), told the DTI that during 1990 and 1991, his father and Sheinberg spoke daily whether Maxwell was in “London, New York or on the yacht.” His father was “exceptionally vulnerable to any trader who described a strategy that would lead to an increase in the Maxwell Communications Corporation share price” and that “faced with such a strategy Maxwell would always be a purchaser and Mr. Sheinberg exploited that.” Kevin Maxwell said that Sheinberg told his father that Goldman would “mop up shares in the market, enforce physical delivery by short sellers and so cause the price to rise.” The strategy “would get rid of the bears and, in Mr. Sheinberg’s phrase, ‘reduce the liquidity of the stock in the market,’ thus improving the share price. They agreed on this strategy and, if Robert Maxwell heard there was a bear raid on [Maxwell] shares, he would at once telephone Mr. Sheinberg.”

  Kevin Maxwell recalled “conversations between Robert Maxwell and Mr. Sheinberg when the talk was of driving the share price up to £4, £5 even £10.” Robert Maxwell “believed Mr. Sheinberg when he said he would do this, as he believed Mr. Sheinberg was assisting him as his client,” he told the DTI. When Kevin Maxwell questioned this, his father told him he knew nothing and that “the great Mr. Sheinberg knew everything, as was his belief from the many deals done since 1986.” Kevin Maxwell did not regard this to be a wrongful manipulation of the market but, rather, using a market maker to counteract those who were manipulating the price of Maxwell shares downward. Kevin Maxwell concluded that “[i]t was plain that Mr. Sheinberg must have come to the view at some time that Robert Maxwell was fixated on the share price and as a result moved from someone carrying out a trade to someone who would scheme against his client. Mr. Sheinberg had lied to Robert Maxwell.”

  For his part, Sheinberg told the DTI that “there was never any agreement with Robert Maxwell to cause the price to rise,” that “he always followed his own trading strategy and never described it to” Maxwell, that “it would have been irrational to commit himself to a fixed trading strategy,” that he “may have spoken to Robert Maxwell about the share price going to £4, £5 or even £10, but that was in the context of what might possibly happen if there was a large short position,” and that “he did not speak daily with Robert Maxwell.”

  In other words, there was total disagreement between the two sides. Goldman told the DTI that the firm made approximately £23 million from its dealings with Maxwell. Sheinberg told the DTI that Maxwell was not a “sucker” but rather a “trader’s trader,” and in DTI’s words, “someone who would decide quickly whether or not he wanted to deal and who traded on instinct and impulse.”

  The fallout from Maxwell’s sudden death and the subsequent unraveling of his financial empire cast yet another unwelcome light on Goldman Sachs, leading Friedman to reach the wise decision that 1993 would not be a good time for Goldman to consider an IPO. “I could see the Maxwell thing wasn’t resolved,” Friedman said. “You could see where it was going. But that took a lot of time, a lot of attention. It was very, very painful.” With Maxwell, Goldman had failed to follow, in dramatic fashion, one of the cardinal rules of trading and market making: know your customer. “Of all the reputations smudged by the scandal, that of Goldman Sachs, an American investment bank, was the brightest,” The Economist reported soon after Maxwell’s death.

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  BEFORE LONG, 1994 would bring a whole new set of problems to 85 Broad Street. As 1993 was drawing to a close, the idea of retiring was on Friedman’s mind. Whether he wanted his legacy to be the $2.7 billion in pretax profits or whether he was just exhausted from grappling alone—without his wingman—with the ongoing fallout of Goldman’s numerous scandals and the job of running a hugely complex, global enterprise remains unclear. There is no question that being the sole senior partner of Goldman Sachs was taking its toll on Friedman. Where he once could divide up international travel and flag-waving with Rubin, in 1993 Friedman was on his own. There were also questions raised about both his physical and his mental health. People would often come up to him and tell him he didn’t look well. He knew he felt tired but began to think there was something more to his chronic fatigue. Occasionally, when he would travel, Friedman would experience heart arrhythmia, where his heartbeat would speed up dramatically and uncontrollably. Understandably, this ailment made him very nervous about flying, something that others noticed.

  But Friedman kept forging ahead and, for the longest time, failed to have his ailments checked out medically. He also knew that Sidney Weinberg had died soon after retiring and Gus Levy had died in office, so to speak. “I had no desire to die in the saddle and no desire to get greener and greener in the saddle,” he said. “But, also, hey, there’s a lot of other stuff out there in the world. And I’d like to have time to think about it and explore it. It’d be kind of sad if you were just doing the same thing over and over.”

  Whatever the reason—health, fatigue, exasperation, a feeling of accomplishment, or perhaps some revisionist history—Friedman decided at the beginning of January 1994 that he wanted to retire at the end of the year. “I wanted to do it young enough so that I could do something else with my life,” he said. “I always thought it would be kind of a sad thing if you had nothing but life inside one firm.” He told his wife. He told Robert Rubin, then at the White House, over dinner in Washington. And he told Robert Katz, Goldman’s general counsel, who following tradition had come to Goldman from Sullivan & Cromwell and who had helped Friedman put out the Freeman, Eisenberg, and Maxwell fires. The crucial piece of the strategy—much like Whitehead’s years earlier—was not to tell anyone about the decision, including the other Goldman partners, lest it risk making Friedman a lame-duck executive. Instead, he would drop amorphous hints here and there that he might be starting to think about moving on.

  But from the outset, Friedman’s strategy ran into trouble. He had hoped to designate Henry Paulson, a highly respected investment banker from Chicago, as the firm’s sole next senior partner. Friedman and Paulson were simpatico—as an M&A banker and client banker would be—and Friedman had a deep regard for how highly Paulson’s clients respected him and eagerly sought his counsel. “Hank would be the first guy to tell you that he’s not Mr. Smooth,” Friedman said. “He just happens to be a terrific talent and I noticed early on that here was a young investment banker and the leading CEOs in Chicago were leaning on him.” CEOs would ask to speak with Paulson privately after a meeting and not just rely on him to “deliver the firm” by making sure an M&A team or equity–capital markets team was available. “That’s heavy and he had good judgment,” Friedman said. “And he was smart and it used to irritate the merger guys because after he’d heard their pitch at board meetings a few times he could do it himself just as well.” Starting in 1990, Paulson was one of the three co-heads of investment banking at Goldman, with Willard J. “Mike” Overlock, who had been running the merger department, and Bob Hurst, who had been running the investment banking services group. They were known as the “Three Nots”—“Not Here, Not Smart, an
d Not Nice.” Paulson was “Not Here,” in that he lived in Chicago. He also spent huge amounts of his time building up Goldman’s presence in Asia, especially in China, where early on he befriended the country’s leaders and perceived its potential as a land of business opportunity for clever investment bankers. The “Not Here” name stuck, even though he spent plenty of time in New York, too.

  Just as Friedman was deciding to retire at the end of 1993, coincidentally Paulson told Friedman he was thinking of leaving Goldman. They were having a conversation one weekend, and Paulson was at his modest home in Barrington, Illinois, on a plot of land he had bought from his family’s nearby farm. “Not because I wanted a promotion,” Paulson said, “but I’d had opportunities to do a couple other things. I was questioning whether I might want a different career, as much as I liked Goldman Sachs.” He had been approached about being the dean of a few business schools and about being a senior executive at an industrial company. He also thought about indulging his lifelong passion for conservation, bird-watching, and fishing. He also dreamed of writing novels. “I’d have liked to be another Faulkner, of course,” he said. Knowing Paulson’s potential departure might foil his own plans and be a major loss to the firm, given his moneymaking skills, Friedman invited Paulson and his wife, Wendy, to have dinner with him and his wife, Barbara, in New York. At the dinner, Friedman dropped a few not-so-subtle clues. “I might not be here forever,” Friedman told Paulson. “I’m looking to you for the future.” But Paulson missed the message, especially since Rubin and Friedman had only started running the firm at the end of 1990. “So, you’ve just got to understand from my perspective I thought, well, that just meant he wasn’t going to go out with his boots on like Gus Levy,” he said. In any event, Friedman could not sell the idea of Paulson to Katz, who didn’t think Paulson had enough political support on the Management Committee at that time to be the sole leader of the firm.