What Happened to Goldman Sachs: An Insider's Story of Organizational Drift and Its Unintended Consequences (3 page)
Authors: Steven G. Mandis
Although my study focuses on the Goldman case, this story has much broader implications. The phenomenon of organizational drift is bigger than just Goldman. The drift Goldman has experienced—is experiencing, really—can affect any organization, regardless of its success. As Jack and Suzy Welch wrote in
Fortune
, “‘Values drift’ is pervasive in companies of every ilk, from sea to shining sea. Employees either don’t know their organization’s values, or they know that practicing them is optional. Either way the result is vulnerability to attack from inside and out, and rightly so.”
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And leaders of the organization may not be able to see that it is happening until there is a public blow up/failure or an insider who calls it out. The signs may indicate that the culture is not changing—based on leading market share, returns to shareholders, brand, and attractiveness as an employer—but slowly the organization loses touch with its original principles and values.
Figuring out what happened at Goldman is a fascinating puzzle that takes us into the heart of a dynamic complex organization in a dynamic complex environment. It is a story of intrigue involving an institution that garners highly emotional responses. But it is more than that. It raises questions that are fundamental to organizations themselves. Why and how do organizations drift from the spirit and meaning of the principles and values that made them successful in reaching many of its organizational goals? And what should leaders and managers do about it? It also raises serious questions about future risks to our financial system.
The impressive statistics of Goldman’s many continuing successes, and of clients’ willingness to condone possible conflicts because of its quality of execution, doesn’t mean that the change in the firm’s culture doesn’t pose dangers both for Goldman and for the public in the future. For one thing, if Goldman’s behavior moves continually closer to the legal line of what is right and wrong—a line that is dangerously ambiguous—it is increasingly likely to cross that line, potentially doing damage not only to clients but to the firm, and perhaps to the financial system (some argue the firm has already crossed it). We have seen several financial institutions severely weakened and even destroyed in recent memory due to a drift into unethical, or even illegal, behavior, even though this is often blamed on one or a few rogue individuals rather than on organizational culture. Obviously this would be a terrible outcome for the many stakeholders of Goldman. However, Goldman is hardly an inconsequential or isolated organization in the economy; it is one of the most important and powerful financial institutions in the world. Its fate has serious potential consequences for the whole financial system. This doesn’t go for just Goldman, but for all of the systemically important financial institutions.
I am not arguing or predicting that Goldman’s drift will inevitably lead to organizational failure, or an ensuing disaster for the public (although there are those who believe that this has already happened), I am saying that the organizational drift is increasing that possibility. This is why it’s important to illuminate why and how the organizational drift has come about.
A Little History
In considering how and why Goldman’s interpretation of its business principles has changed, it’s important to consider some key aspects of the firm’s history, and why the principles were written.
According to my interviews with former Goldman co-senior partner John Whitehead, who drafted the principles, there was something special about the Goldman culture in 1979, one that brought it success and kept it on track even in tough times. He thought codifying those values, in terms of behaviors, would help transmit the Goldman culture to future generations of employees. The business principles were intended to keep everyone focused on a proven formula for success while staying grounded in the clear understanding that clients were the reason for Goldman’s very existence and the source of the firm’s revenues.
Whitehead emphasized the fact that he did not invent them; they already existed within the culture, and he simply committed them to paper. He did so because the firm was expanding faster than new people could be assimilated in 1979, and he thought it was important to provide new employees a means to acquire the Goldman ethic from earlier generations of partners who had learned by osmosis. Though by no means the force in the market the firm is today, Goldman had grown and changed a great deal from its early days and its size, complexity, and growth were accelerating.
Goldman Sachs was founded in 1869 in New York. Having made a name for itself by pioneering the use of commercial paper for entrepreneurs, the company was invited to join the NYSE in 1896. (For a summary timeline of selected events in Goldman’s history, see
appendix G
.)
In the early twentieth century, Goldman was a player in establishing the initial public offering market. In 1906, it managed one of the largest IPOs of that time—that of Sears, Roebuck. However, in 1928 it diversified into asset management of closed end trusts for individuals who utilized significant leverage. The trusts failed as a result of the stock market crash in 1929, almost causing Goldman to close down and severely hurting the firm’s reputation for many years afterward. After that, the new senior partner, Sydney Weinberg, focused the firm on providing top quality service to clients. In 1956, Goldman was the lead adviser on the Ford Motors IPO, which at the time was a major coup on Wall Street. To put Goldman’s position on Wall Street in context at the time, in 1948 the US Department of Justice filed an antitrust suit (
U.S. v. Morgan
[Stanley]
et al
.,) against Morgan Stanley and eighteen investment banking firms. Goldman had only 1.4 percent of the underwriting market and was last on the list of defendants. The firm was not even included in a 1950 list of the top seventeen underwriters. However, slowly the firm continued to grow in prestige, power, and market share.
The philosophy behind the firm’s rise was best expressed by Gus Levy, a senior partner (with a trading background) at Goldman from 1969 until his death in 1976, who is attributed with a maxim that expressed Goldman’s approach: “greedy, but long-term greedy.”
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The emphasis was on sound decision-making for long-term success, and this commitment to the future was evidenced by the partners’ reinvestment in the firm of nearly 100 percent of the earnings.
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Perhaps surprisingly, although it’s had many triumphs, over its history Goldman has had a mixed track record.
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It has been involved in several controversies and has come close to bankruptcy once or twice.
Another common misperception among the public is that today Goldman primarily provides investment banking services for large corporations because the firm works on many high-profile M&A deals and IPOs; however, investment banking now typically represents only about 10 to 15 percent of revenue, substantially lower than the figure during the 1980s, when it accounted for half of the revenue. Today, the majority of the revenues comes from trading and investing its own capital. The profits from trading and principal investing are often disproportionately higher than the revenue because the businesses are much more scalable than investment banking.
Even though the firm was growing when Whitehead wrote the principles, its growth in more recent years has been even more accelerated, particularly overseas. In the early 1980s the firm had a few thousand employees, with around fifty to sixty partners (all US citizens), and less than 5 to 10 percent of its revenue came from outside the United States. In 2012, Goldman had around 450 partners (around 43 percent are partners with non-US citizenship) and 32,600 employees.
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Today about 40 percent of Goldman’s revenue comes from outside the United States and it has offices in all major financial centers around the world, with 50 percent of its employees based overseas.
Once regulations were changed in 1970 to allow investment banks to go public on the NYSE, Goldman’s partners debated changing from a private partnership to a public corporation. The decision to go public in an IPO was fraught with contention, in part because the partners were concerned about how the firm’s culture would change. They were concerned that the firm would change to being more “short-term greedy” to meet outside stock market investors’ demands versus being “long-term greedy,” which had generally served the firm so well. The partners had voted to stay a privately held partnership several times in its past, but finally the partners voted to go public, which it did in 1999. Goldman was the last of the major investment banking firms to go public, with the other major holdout, its main competitor Morgan Stanley, having done so in 1986. In their first letter addressing public shareholders in the 1999 annual report, the firm’s top executives wrote, “As we begin the new century, we know that our success will depend on how well we change and manage the firm’s rapid growth. That requires a willingness to abandon old practices and discover new and innovative ways of conducting business. Everything is subject to change—everything but the values we live by and stand for: teamwork, putting clients’ interests first, integrity, entrepreneurship, and excellence.”
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They specifically stated they did not want to adjust the firm’s core values, and they included putting clients’ interests first and integrity, but they knew upholding the original meaning of the principles would be a challenge and certain things had to change.
Although the principles have generally remained the same as in 1979, there was one important addition to them around the time of the IPO—“our goal is to provide superior returns to our shareholders”—which introduced an intrinsic potential conflict or ambiguity between putting the interests of clients first (which was a Goldman self-imposed ethical obligation) and those of outside shareholders (which is a legally defined duty), as well as the potential conflict of doing what was best for the long term versus catering to the generally short-term perspective from outside, public market investors. There’s always a natural tension between business owners who want to make the highest profits possible and clients who want to buy goods and services for as low as possible, to make their profits the highest possible. Being a small private partnership allowed Goldman the flexibility to make its own decisions about what was best in its own interpretation of
long term
in order to help address this tension. Having various outside shareholders all with their own time horizons and objectives, combined with Goldman’s legal duty to put outside shareholders’ (not clients’) priorities first, makes the interpretation and execution of long term much more complicated and difficult.
When questioned about the potential for conflict, Goldman leaders have asserted that the firm has been able to ethically serve both the interests of clients and those of shareholders, and for many years, that assertion for the most part was not loudly challenged. That was largely due to Goldman’s many successes, including leading market position and strong returns to shareholders, and rationalized by the many good works of the firm and its alumni, which served to address concerns about conflicts, even most of the way through the 2008 crisis.
At the beginning of the crisis, Goldman was mostly praised for its risk management. During the credit crisis, Goldman outperformed most of its competitors. Bear Stearns was bought by J.P. Morgan with government assistance. Lehman Brothers famously went bankrupt, and Merrill Lynch was acquired by Bank of America. Morgan Stanley Dean Witter & Co. sold a stake to Mitsubishi UFJ. But the overall economic situation deteriorated very quickly, and Goldman, as well as other banks, accepted government assistance and became a bank holding company. The company got a vote of confidence with a multi-billion-dollar investment from Berkshire Hathaway, led by legendary investor Warren Buffett. But soon after, things changed, and Goldman, along with the other investment banks, was held responsible for the financial crisis. The fact that so many former Goldman executives held positions in the White House, Treasury, the Federal Reserve Bank of New York, and the Troubled Asset Relief Program in charge of the bailouts (including Hank Paulson, the former CEO of Goldman and then secretary of the Treasury) even as the bank took government funds and benefited from government actions, raised concerns about potential conflicts of interest and excessive influence. People started to question if Goldman was really better and smarter, or wasn’t just more connected, or engaged in unethical or illegal practices in order to gain an advantage.
In April 2010, the Securities and Exchange Commission (SEC) charged Goldman with defrauding investors in the sale of a complex mortgage investment. Less than a month later, Blankfein and other Goldman executives attempted to answer scorching questions from Senator Carl Levin (D-Mich.), chair of the Permanent Subcommittee on Investigations, and other senators about the firm’s role in the financial crisis. The executives were grilled for hours in a publicly broadcasted hearing. The senators pulled no punches, calling the firm’s practices unethical, if not illegal. Later, after a Senate panel investigation, Levin called Goldman “a financial snake pit rife with greed, conflicts of interest, and wrongdoing.”
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But lawmakers at the hearings made little headway in getting Goldman to concede much, if anything specific, that the company did wrong.
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In answering questions about whether Goldman made billions of dollars of profits by “betting” on the collapse in subprime mortgage bonds while still marketing subprime mortgage deals to clients, the firm denied the allegations; Goldman argued it was simply acting as a market maker, partnering buyers and sellers of securities. Certain Goldman executives at the time showed little regret for whatever role the firm had played in the crisis or for the way it treated its clients. One Goldman executive said, “Regret to me is something you feel like you did wrong. I don’t have that.”
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There does seem to have been some internal acknowledgment that the culture had changed or at least should change. Shortly after the hearing, in response to public criticism, Goldman established the business standards committee, cochaired by Mike Evans (vice chairman of Goldman) and Gerald Corrigan (chairman of Goldman’s GS Bank USA, and former president of the Federal Reserve Bank of New York), to investigate its internal business practices. Blankfein acknowledged that there were inconsistencies between how Goldman employees viewed the firm and how the broader public perceived its activities. In 2011, the committee released a sixty-three page report, which detailed thirty-nine ways the firm planned to improve its business practices. They ranged from changing the bank’s financial reporting structure to forming new oversight committees to adjusting its methods of training and professional development. But it is unclear in the report whether Goldman specifically acknowledged a need to more ethically adhere to the first principle. The report states, “We believe the recommendations of the Committee will strengthen the firm’s culture in an increasingly complex environment. We must renew our commitment to our Business Principles—and above all, to client service and a constant focus on the reputational consequences of every action we take.”
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The use of the word “strengthen” suggests that the culture had been weakened, but the report is vague on this. According to the
Financial Times
, investors, clients, and regulators remained underwhelmed in the wake of the report by Goldman’s efforts to change.
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A Goldman internal training manual sheds some more light on whether the firm acknowledged its adherence to its first business principle has changed. The
New York Times
submitted a list of questions in May 2010 to Goldman for responses that included “Goldman’s Mortgage Compliance Training Manual from 2007 notes that putting clients first is ‘not always straightforward.’”
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The point that putting clients first is not always straightforward is telling. It indicates a clear change in the meaning of the original first principle.
The notion that Goldman’s culture has changed was given a very public hearing when, on March 14, 2012, former Goldman employee Greg Smith published his resignation letter on the op-ed page of the
New York Times
. In the widely distributed and read piece, Smith criticized the current culture at Goldman, characterizing it as “toxic,” and specifically blamed Blankfein and Goldman president Gary Cohn for losing “hold of the firm’s culture on their watch.”
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Years ago, an academic astutely predicted and described this type of “whistle blowing” as being a result of cultural change and frustration. Edgar Schein, a now-retired professor at the MIT Sloan School of Management, wrote “… it is usually discovered that the assumptions by which the organization was operating had drifted toward what was practical to get the job done, and those practices came to be in varying degrees different from what the official ideology claimed … Often there have been employee complaints identifying such practices because they are out of line with what the organization wants to believe about itself, they are ignored or denied, sometimes leading to the punishment of the employees who brought up the information. When an employee feels strongly enough to blow the whistle, a scandal may result, and practices then may finally be reexamined. Whistle blowing may be to go to the newspapers to expose a practice that is labeled as scandalous or the scandal may result from a tragic event.”
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The publishing of Smith’s letter certainly resulted in a scandal and an examination.
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