“They … knew as adviser to some of these companies inside information about what’s going on in these companies,” he said. “And they go and they use this inside information to trade in the market, and they call that ‘managing risk.’ That’s bullshit. That’s fucking insider trading.… They go, ‘Well, that’s managing our risk.’ What the fuck you mean that’s managing your risk? That is the business model … to use their clients—and their client relationships—to generate information off which they can trade. They’re doing that with countries. They’re doing that all the time. It just seems to me that you’ve got three businesses down there. You’ve got advisory, securities underwriting, and trading. And they have taken the securities underwriting and advisory businesses away from being separate and important units to being information sources for trading. And I don’t understand how that’s legal.”
Eliot Spitzer, the former New York State governor and attorney general, said in an interview that he has heard these charges about Goldman for years. “Front-running is illegal,” he said. “Front-running is a fraud on your client. No question about it.… When you have a client, you don’t give them bad research, you don’t trade in front of them, you don’t subvert their bids. It’s really simple.” But, he noted, neither he nor any other prosecutor has brought such a case against Goldman, in large part because of how difficult it would be to prove in court. “If you had a penny for every person who told you that was what they presume Goldman had done for twenty years, you’d be the richest man in the world,” he said. As attorney general, Spitzer was not shy about prosecuting Wall Street. Indeed, in April 2003, he forged a $1.4 billion settlement with a group of ten Wall Street firms—including Goldman, which paid $110 million—after he showed conclusively that the equity research Wall Street was issuing was being unduly influenced by the firms’ investment bankers looking to win more business.
But whether the evidence would stand up in court, the anecdotes about Goldman’s ruthless behavior abound. One hedge-fund manager recalled the experience his friend, at another hedge fund, had with Goldman during the recent financial crisis when Goldman was the hedge fund’s “prime broker,” responsible for executing and clearing trades as well as general administrative responsibilities related to the fund. “He had them as a prime broker, where they house all the positions,” he remembered. “The people he was trading with at Goldman, they knew exactly what he had and they were basically trying on the trading desk, in conjunction with the prime brokerage business, to squeeze him to make money themselves. Like this sort of front-running the trades that they knew he needed to do to take risk off, because the prime brokers were telling him he had to. They’re actively trying to put the guy out of business, because they thought at this juncture, this fund is worth more to us dead. We can mop up the pieces and sort of pick up a bunch of cheap things from them when they’re a stressed or a distressed seller. It’s worth more to us dead because we can make twenty million bucks more out of this than if it is alive. They had no qualms about making that sort of objective decision. Door 1 or Door 2—which has the highest present value for me? You wouldn’t want to be in the door with the lower dollar sign.”
Then there is the way the firm handles conflicts of interest, which is at the heart of what Senator Levin found so offensive. One of Goldman’s unstated business principles, according to the New York Times, is “to embrace conflicts.” Goldman “argues that [conflicts] are evidence of a healthy tension between the firm and its customers,” according to the paper. “If you are not embracing conflicts, the argument holds, you are not being aggressive enough in generating business.” Other firms are far less aggressive than Goldman in this regard. If, for instance, a firm had agreed to represent a seller of a business, it would not also represent the buyer for obvious reasons, even though many firms will also provide financing to a buyer of a company they are selling. Goldman is more willing to try to figure out a way to do both. Although the instances where Goldman represents both seller and buyer are rare, they do occur and are considered investment banking triumphs because the fee potential is doubled.
The pinnacle of what this was about may have been reached in 2005, when Goldman represented both sides of the $9 billion merger between the New York Stock Exchange—then private and led by John Thain, the former president and COO of Goldman—and Archipelago Holdings, a publicly traded electronic exchange in which Goldman was the second-largest investor. Through the complex merger, the stock exchange could both become a publicly traded company and take the crucial steps needed to keep up with other exchanges that did not have brokers on floors but rather computers in offices far from the floor. The merger was all about the future of Wall Street and who was going to control it. In other words, the very kind of deal in which Goldman would be expected to have a prominent role. What shocked people was that Goldman was on both sides and everyone involved seemed to be fine with that outcome. Goldman ended up making a $100 million windfall from the merger, considering its fee for advising on the deal, the increase in the value of its stake in Archipelago Holdings, and the increase in value of its NYSE seats. “Forgetting about the trading stuff, constantly having conflicts and managing those conflicts by just kind of saying, ‘Guys, we’re above that,’ ” has always amazed him, one private-equity investor said. “Look what they were doing with the deals with the Stock Exchange, they run every side of the deal. And then people would say, ‘You can’t do that,’ [but for Goldman] it was almost like public service, they had to do that, [and then they argued] no one else was as good as they and it would be letting down the mission of furthering tranquility and stability in capital markets if Goldman Sachs didn’t actually manage conflicts.” In short, the private-equity investor was lamenting the fact that Goldman continues to rely on its tired crutch “Trust us, we’re honest.”
Goldman has also been invited to partner with one private-equity firm on a proprietary deal, only to decline the offer and then show up in the auction for the company with another private-equity firm by its side. One bank CEO told the story of how he was bidding on a failed financial institution that the FDIC was selling and that Goldman threatened to bid against his company for the bank if he did not let Goldman into the deal. He described Goldman’s bare-knuckled approach as “anything to make a buck” and as “a sense of ethics that is not compatible with mine.” One former Goldman banker who left the firm and now works at a hedge fund that trades with Goldman continues to marvel at how the firm has changed since it went public. “We trade with Goldman a lot,” he said. “I think that they very clearly went to—across all their businesses—the view that what’s right for Goldman is what matters. As much as they might say the client’s interest comes first here, there, or whatever—maybe that’s still true in investment banking—but it is absolutely not true on the trading side. Like if they could eat your lunch and screw you over, they totally would.”
Another private-equity investor put it more bluntly. “What I’m fundamentally saying is that a lot of their basic business model should be illegal,” he said. Of course, he has experienced the situation where he has asked the firm to represent him on the purchase of the company, only to be told a week later that the firm “has a conflict” and then showed up bidding against his firm for the company. “I think savvy clients now expect that from Goldman,” he said. But he had a larger concern: since Goldman trades on nearly everything these days—from commodities to mortgages to loans—the insider-trading laws, which apply to trading in equities, need to be revised to reflect new categories of trading based on proprietary, nonpublic information that floats around inside Goldman Sachs and then is used to trade. Goldman’s proprietary computer risk-monitoring system—SecDB—allows Goldman to think about risk differently from other firms. Bankers and traders actually approach potential clients and discuss the buying and selling of risk. But sometimes, they take this too far. “They view information gathered from their client businesses as free to them to trade on …,” the private-equity inv
estor said. “It’s as simple as that. If they are in a client situation, working on a deal and they’re learning everything there is to know about that business, they take all that information, pass it up through their organization, and use that information to trade against the client, against other clients, et cetera, et cetera. But it might not be insider trading as written by the Forty Act because they might not be trading in the securities of that company. But that doesn’t make it less outrageous—and it is outrageous! Doesn’t that make it an outrageous business model, where as an adviser to this company, I happen to learn everything there is about the demand for their services ahead of the rest of the market, and then I take that information, I go trade against their competitors, right? If I’m a [widget] company and I’m using Goldman and they’re analyzing my business information for a potential sale of it or an IPO of it or whatever, and they see that like my daily orders are declining before that information is released to the public on a quarterly business, well, they take that information and they go, ‘Holy shit. We need to go short the [widget] industry.’ That is their business model! To use their client—and their client relationships—to generate information on which they can trade.… I don’t understand how that’s legal.”
He has decided he won’t deal with Goldman anymore, as powerful as they remain. He figured that in the long run, Goldman would be very vulnerable as more and more clients resent their trading on their confidential information. “They keep doing this and over twenty years, people will start to figure it out and stop using them as advisers,” he said. “But you have to remember, most companies using them as advisers are really using them for a reason. They’re trying to access capital markets. They’re trying to underwrite securities. I think at most large companies, the managements are temporary and the banking relationships are temporary. As long as they think Goldman can deliver a high-yield deal or if they think they’re best off working with Goldman, they will go with that and worry about the damage later to the extent there is any because they’ll probably be gone. So, in essence, Goldman’s model takes advantage of the short-term nature of client relationships on Wall Street today. That’s something that I don’t think people quite get. People will use Goldman if they think that gives them an ‘in’ with somebody. All these webs of relationships—if you give them plenty of time—might give them an ‘in’ in the short run. In the short run, to get that ‘in,’ they’ll do that. Then by the time somebody is tipped off about the next thing, it will be a new management team.”
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NONE OF THIS comes as a surprise to Sandy Lewis, a former Wall Street merger arbitrageur who had many dealings with Goldman during his years on Wall Street and whose father, Cy Lewis, was the senior partner at Bear Stearns and a close friend of Gus Levy. “My take on the whole firm is that it’s done a masterful job of integrating various parts of the business, which if you study the rules carefully should not be integrated,” he said. “They simply shouldn’t be integrated. They can talk about Chinese walls. That might exist in China. I’m not so sure it exists in any of these firms, including Goldman Sachs.”
A former Goldman partner said that of course Goldman has changed, and will continue to change as long as it is around. One of the firm’s great strengths, he said, is the ability to adapt to changing circumstances with alacrity and still make money. “The firm is not the same now as it was before it went public,” he said. “It’s, in fact, not the same as it was two years ago or even three years ago. It’s constantly changing. The reason for its success is that it has an incredible ability to gauge what’s going on in the outside world and respond to it very, very fast. You combine that with a ferocious competitiveness—the competitiveness is astonishing when you see what these people, how much these people want to win, I’ve never seen anything like it—and that virtually assures that Goldman will continue to be around and continue to excel.”
He said that despite “all the negative publicity”—some of which he thought was deserved, some of which he thought was not—“Goldman is being criticized for being successful. If every investment bank in the United States had done what Goldman had done, there would not have been a financial crisis. That’s what Lloyd Blankfein should have said up in front of the Senate. If I have any criticisms of Lloyd, it’s that Goldman went into the hearing in a defensive mode. What he should have said was, ‘Listen, you’re criticizing us for making all the right decisions. If everyone had done what we did, we wouldn’t be sitting here today. We wouldn’t have had a trillion-dollar meltdown.”
Wondered the former Goldman partner, “Is Lloyd the best person to be dealing with the public, honestly? Probably not. He probably knows that. He’s not a natural public face of Goldman. But is he the right person to be running the firm right now? I think probably, because he understands risk profiles better than anybody else. That’s what matters the most.”
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FOR HIS PART, Blankfein is not immune to the criticism. “In a crisis, you have to deal not only with how you got there, but you have to deal with the legacy of the past,” he said in an interview. “So clearly we have things that we’re going to have to work our way through. There’s the SEC suit, the hearings, the media scrutiny, and you have to at least say there’s certainly a bit of a disconnect between how a lot of people see us and how we see ourselves.” In the wake of the Levin hearing, Blankfein appointed an internal fifteen-member committee, headed by Goldman partners E. Gerald Corrigan, a former president of the New York Federal Reserve Bank, and J. Michael Evans, a vice chairman and a rumored potential successor to Blankfein, to review the firm’s business practices, particularly relating to client relationships, conflicts of interest, and the creation of exotic securities.
The internal committee released its report during the second week of January 2011; its sixty-three pages reveal an extraordinary combination of chutzpah—in that such a document would be produced at all, as clearly no other Wall Street firm would (or has) undertaken such a project—and an Orwellian beehive, where one official-sounding committee after another has been, or will be, formed to make sure that Goldman, despite its DNA, continues to try to adhere to Whitehead’s principles (a complete set of which was featured on the report’s first page). According to the report, there are now—or soon will be—at 200 West Street, Goldman’s new, $2 billion world headquarters near Ground Zero (tax breaks included), something like thirty separate groups and committees—with names such as “Firmwide New Activity Committee” and “Firmwide Suitability Committee”—that Blankfein and Cohn will use to run the firm. “Goldman Sachs relies heavily on committees to coordinate and apply consistent business standards, practices, policies and procedures across the firm,” the report explained. “The firm’s committee governance structure should serve to enhance our reputation, business practices and client service. In this way, committees serve as a vital control function.” Of course, the “Business Standards Committee,” which produced the report, recommended that a new committee be formed—the “Firmwide Client and Business Standards Committee”—that will replace the Business Standards Committee in the future and also have responsibility for “the primacy of client interests and reputational risk.” Gary Cohn will head up the new committee, which will “function as a high-level committee that assesses and makes determinations regarding business practices, reputational risk management and client relationships.”
If it takes its responsibilities seriously, Cohn’s new committee will be plenty busy. One of the few self-critical observations in the report was that, according to an independent survey conducted for Goldman, the firm’s clients have been a bit miffed at the firm lately. “Clients raised concerns about whether the firm has remained true to its traditional values and [b]usiness [p]rinciples given changes to the firm’s size, business mix and perceptions about the role of proprietary trading,” the report explained. “Clients said that, in some circumstances, the firm weighs its interests and short-term incentives too heavily.” This led the Bu
siness Standards Committee to call for a firmwide rededication to Whitehead’s core principles, including a “need to strengthen client relationships which, in turn, will strengthen trust,” to “communicate our core values more clearly,” and also to “communicate more clearly about our roles and responsibilities in particular transactions.” The real question is why Goldman continues to promote a list of principles and behaviors that the firm seems to have abandoned years ago. In the end, is Goldman really all that different from the other firms on Wall Street it believes it is superior to?
Clayton Rose, a former head of investment banking at JPMorgan and now a professor of management practice at Harvard Business School, predicted that regardless of the outcome of the legal process, Goldman will be changed by the current financial crisis. “I think the big challenge for Goldman is internal and it’s cultural,” Rose said. “They have been, for several generations now, so used to having clients deal with them in an unquestioned way, having access to regulators and government officials in a somewhat unquestioned way, and having played the kind of ‘Government Sachs/Goldman Sachs’ revolving door and so forth, that having their business ethics, their business culture, their business model challenged at a very core level—and the kind of compensation that results from that as well—is going to cause a bunch of people there to think about whether they’re going to want to be part of whatever the new iteration of Goldman is going to be.”
That’s what Blankfein should be most worried about, he said. “Will it be a great firm?” he wondered. “Probably. But will it be a different firm? Yes, and as we know from the way the markets and capitalism work, Goldman’s not guaranteed a place in that kind of pantheon of firms in perpetuity. The biggest danger I think they face is within, not without.”
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