What Happened to Goldman Sachs: An Insider's Story of Organizational Drift and Its Unintended Consequences (30 page)

1994:
Lehman Brothers goes public (C). Goldman suffers large losses in the bond market as interest rates rise (C, O). Goldman settles suits brought by a number of pension funds related to its involvement with media mogul Robert Maxwell after it was alleged that Maxwell stole money from Maxwell company pension plans by hiring Goldman to broker a trade between various Maxwell-controlled entities. Goldman pays out $253 million in settlements, allocated to the people who were general partners in Goldman between 1989 and 1991. A significant number of partners leave the firm (many times more than normal) to protect their capital, taking their capital with them (C, O). Steve Friedman, senior partner for only four years, retires (O). Many of the partners who stay at the firm have some resentment toward those who left, and they question the culture. Goldman names 58 new general partners (one and a half times as many as usual), the firm’s largest partner class ever (O, C). The unprecedented amount of change at the partnership level impacts the partnership network. One M&A banker who is elected partner turns down the opportunity, something exceptional in the history of the firm (O). In a power struggle after Steve Friedman’s announced retirement, Jon Corzine (from trading) becomes sole senior partner, never having rotated through other areas such as investment banking (O). Hank Paulson is named COO (O), never having co-headed a division with Corzine (O). Some partners are convinced, in part, to stay because of the possibility of an IPO (O). The partners who stay form a unique bond, supporting each other through tough times, determined to make Goldman a success, but they also see firsthand the risks of a private partnership. Goldman starts implementing risk management systems (T). Corzine and Paulson immediately reduce employee head count and costs by slashing pay and bonuses. Some people still remember the large layoffs in the late 1980s, affecting how employees think about the firm as a place to work, and it was now happening so soon again (O, C). Despite issues, the firm is still ranked first in US and foreign common stock offerings, IPOs, worldwide completed mergers and acquisitions, investment-grade debt, and US equity research. J.P. Morgan pioneers the concept of the modern credit default swap, which will play a major role in the credit crisis. Eric Mindich, who ran the equities arbitrage department that invested the firm’s own capital, becomes, at age twenty-seven, the youngest partner in the firm’s history, signaling the importance of proprietary trading (O, C). Restrictions are put on the withdrawal of partners’ capital (O). Goldman opens a Beijing office (O).

1995:
Corzine replaces the twelve-member management committee with a six-member executive committee (O). Goldman opens offices in Shanghai and Mexico City and creates joint ventures in India and Indonesia (O, C). Treasury provides aid to Mexico during the peso crisis, an action that helps save Lehman Brothers, which had made a big, mistaken bet without hedging. Global Alpha, one of the earliest “quant vehicles” was founded in GSAM and would spawn a new wave of quant funds (C, T).

1996:
Goldman is back on track and profits are restored to 1993 levels. Corzine and Paulson push for business diversification, increasing international, investing, and asset management business. There are media rumors of a Goldman IPO. There is a push for a partnership vote on an IPO, but it is withdrawn in the face of overwhelming opposition. An independent compensation firm concludes that the top five to ten partners would increase their compensation if Goldman were a public company but that most would be worse off. Also discussed were issues such as impact to culture, moral obligations to earlier and future generations, and the attractiveness of the business model. The most commonly stated reason for the opposition is the potential unknown impact on Goldman’s culture in losing the partnership structure. A new class of “junior partners” is created (called “partnership extension”) in an effort to prevent further defections and retirements. Partners as well as nonpartners are now referred to as “managing directors,” although internally, partners are known as “partner managing directors” (PMDs) and nonpartner managing directors are referred to as “MD-lites.” To the outside world, it is difficult to distinguish who is a partner and who is not. The title of managing director (versus partner) is the same at competitors like Morgan Stanley (C, O). Goldman also adopts a limited liability structure, limiting personal risk (R). Goldman helps take Yahoo! public, triggering the internet IPO boom. Goldman experiments with e-mail (C).

1997:
Paulson says Goldman’s policy of not advising on hostile takeovers is no longer in the firm’s interest, but Corzine resists any change that might damage Goldman’s image. They compromise on an experiment with a test case outside the United States, and Goldman advises Krupp in a successful hostile take-over of Thyssen (O, C). J.P. Morgan develops a proprietary product that helps banks clean up their balance sheets using credit default swaps—the first synthetic collateralized debt obligations (CDOs) (T, C). Morgan Stanley merges with Dean Witter Reynolds, the financial services business of Sears that serves retail clients (C). The acquisition extends Morgan Stanley’s ability to sell stock offerings and makes Morgan Stanley larger. Travelers Group, run by Sandy Weill, purchases Salomon Brothers, a major bond dealer and investment bank, for $9 billion (C). Bankers Trust purchases Alex Brown for $2.1 billion (C). The Asian debt crisis presents a large opportunity for Goldman to invest its own capital in the region (O, C). Goldman’s GSAM acquires Commodities Corporation (CC) for an undisclosed amount, estimated to be more than $100 million (C). At the time of its acquisition, CC had approximately $2 billion in assets under management, primarily as a fund of hedge funds: a fund investing in a variety of hedge funds to diversify risk. It was part of GSAM’s continued push into higher-margin, more-sophisticated products for its clients. The firm merges J. Aron with fixed income to create the division known as FICC, to be run by Blankfein (O, C).

1998:
Long-Term Capital Management (LTCM), a hedge fund, is about to fail. Wall Street fears that LTCM is so big that its failure would cause a chain reaction in numerous markets, causing significant losses throughout the financial system. Goldman, AIG, and Berkshire Hathaway offer to buy out the fund’s partners for $250 million, to inject $3.75 billion, and to operate LTCM within Goldman’s own trading division. Many of the partners worry about the risk they would assume (O). A deal is not worked out, and the Federal Reserve Bank of New York organizes a bailout (R). The Goldman executive committee discovers that Corzine has been holding talks with the CEO of Mellon Bank about merging the firms. In what some describe as a coup d’etat, Corzine is told to focus on and leave after an IPO of the firm (O). After being made co-CEO, Paulson supports the IPO (some believe it was a quid pro quo). After significant debate and letters from both John Weinberg and John Whitehead advising against it, Goldman decides to go public (C, O, R). Thain and Thornton are allegedly promised to become co-CEOs in two years for supporting paulson. The IPO, originally planned for September, is postponed because of instability in the global markets. The Russian financial crisis begins. Deutsche Bank agrees to purchase Bankers Trust for $10.1 billion (C), signaling that foreign competition is coming to the United States. Citicorp and Travelers Group merge, creating a $140 billion firm with assets of almost $700 billion (C). The deal enables Travelers to market mutual funds and insurance to Citicorp’s retail customers while giving the banking divisions access to an expanded client base of investors and insurance buyers. The remaining provisions of the Glass–Steagall Act—enacted following the Great Depression—forbid banks to merge with insurance underwriters, and this means that Citigroup has two to five years to divest any prohibited assets. However, Weill states at the time of the merger that he believes that the legislation will change over time. (On CNBC’s “Squawk Box” in July 2012, Weill calls for a return of the Glass–Steagall Act.) Under pressure from competitors taking companies public that have no revenues or profits, Goldman starts to take companies like eToys and NetZero public, which have limited operating history and little to no profits (O, C).

1999:
In January, Jon Corzine leaves Goldman to run for US Senate from New Jersey, leaving Paulson as sole chairman and CEO (O). Goldman advises on its first hostile deal in North America (O). Goldman adds a new business principle—most significantly, a commitment to provide superior returns to shareholders (C, O). In May, Goldman goes public and changes its name to The Goldman Sachs Group, Inc. The firm is valued at $33 billion at the time of the IPO. The IPO is one of the largest events in the firm’s history. The decision to go public was debated for decades. In the end, Goldman offers only a small portion of the company to the public, with some 48 percent still held by the partners, 22 percent of the company held by nonpartner employees, and 18 percent held by retired Goldman partners and two longtime investors: Bank Ltd. and Hawaii’s Kamehameha Activities Association (the investing arm of Kamehameha Schools). This leaves approximately 12 percent of Goldman held by the public. In November, portions of the Glass–Steagall Act of 1933 (prohibiting a bank holding company from owning other financial companies) are repealed, opening the door to financial services conglomerates offering a mix of commercial banking, investment banking, insurance underwriting, and brokerage (R). Even with Goldman’s success, it is still valued less than many internet or dot-com companies. Some of the best and brightest are now more interested in working at a technology company than at Goldman (C). Other firms, such as Donaldson, Lufkin & Jenrette, start to offer significantly higher compensation than Goldman, especially at the entry-level positions (C). Goldman acquires Hull Trading Company, a leading technology-driven algorithmic trading firm and electronic market maker, for $531 million (C, T). Technology-driven trading is starting to dominate (T). In November, Goldman establishes the Pine Street Leadership Development Initiative, in part, to help socialize larger numbers of managers (O). The Euro becomes an accounting currency and was scheduled to enter circulation in 2002, helping to accelerate pan-European banking consolidation.

2000:
The Commodity Futures Modernization Act determines that credit default swaps are neither futures nor securities and therefore are not subject to regulation by the Securities and Exchange Commission or the Commodities Futures Trading Commission (CFTC) (R, T). The CFTC changes a rule called Regulation 1.25 to permit futures brokers to take money from their customers’ accounts and invest it in an expanded number of approved securities (some people think this contributed to the issues related to MF Global) (R). The NASDAQ Composite, reflecting the dot-com bubble, hits an all-time high. Credit Suisse acquires Donaldson, Lufkin & Jenrette for $11.5 billion (C). Goldman purchases Spear, Leeds & Kellogg, one of the largest specialist firms on the New York Stock Exchange, for $6.3 billion, strengthening Goldman’s ability to market directly to the growing ranks of retail investors and to gain market information (C, T). Selected Spear, Leeds & Kellogg partners became Goldman PMDs.

2001:
Goldman disbands its M&A department and places its M&A bankers in groups focused on specific industries (C, O, T). Goldman is the top global M&A adviser and underwriter of all IPOs and common stock offerings. The September 11 terrorist attacks have significant economic impacts. The Fed reduced the federal funds rate to 1 percent from 2001 to 2002, leading to a surge in home sales and refinancing. Goldman issues a report on the emerging BRIC (Brazil, Russia, India, and China) economies.

2002:
In a faltering economy, with the high degree of consolidation of banks after the repeal of the Glass–Steagall Act, there is media speculation that Goldman could be forced into a merger to remain viable against large competing banks having assets double or triple those of Goldman. Paulson announces Goldman’s strategy for becoming the leading global investment bank, securities, and investment management firm (C). Goldman gives special stock offerings to executives in twenty-one companies that it took public, including Yahoo! cofounder Jerry Yang, Tyco’s Dennis Kozlowski, and Enron’s Ken Lay, to win new investment banking business. Goldman pays $110 million to settle an investigation by New York state regulators into manipulations (C, R). The Sarbanes–Oxley Act is signed into law, setting specific reporting and auditing requirements intended to protect investors. It specifically establishes tight accountability standards for the boards of US public companies, management companies, and public accounting firms (R). IPO volume goes down, creating pressure for banks to find other ways to meet earnings growth and return on equity targets. Various investment banks offer complex financial products with which European governments can push part of their liabilities into the future (C). Greece’s debt managers agree to a transaction with Goldman. The structure disguises the debt so that it does not show up in the Greek debt statistics for the euro convergence criteria.

2003:
In January 2003, Paulson is criticized for saying that about 15 percent to 20 percent of Goldman employees add 80 percent of the value and that even significant staff cuts would leave the firm well positioned for the upturn (O). He later issues an apology to all of the company’s employees via voicemail. The SEC charges Goldman with conflicts of interest among its research analysts, charges that the firm eventually settles for $110 million. Goldman pays $9 million in sanctions to settle a separate SEC case involving allegations that it failed to maintain policies to prevent the firm from misusing material, nonpublic information obtained from outside consultants about US Treasury thirty-year bonds.

A former Goldman economist pleads guilty to insider trading. In October, in a move to eliminate a potential source of criticism and conflicts of interest, Goldman tells its MDs that they may no longer serve on the boards of public companies.

2004:
The alternatives (hedge fund and private equity) boom begins after investors see that alternatives performed well during the bear market and dot-com bust (C). Goldman proprietary traders begin leaving and forming their own firms. The proliferation of hedge funds and private equity firms makes it difficult to recruit and retain the best and brightest. This trend is aggravated by the end of the five-year vesting period for those given restricted stock in the IPO. Now employees can sell all their IPO stock. The stock vested in years 3, 4, and 5 after the IPO, 33 percent each year. At the request of Goldman and other major Wall Street firms, the SEC agrees to release them from the net capital rule, which required that investment firms hold a certain amount of capital to limit their leverage and provide a cushion of liquid assets to ensure payment of the firm’s obligations to its clients (R). The SEC establishes a risk management office to monitor the industry for signs of potential problems, but it is soon dismantled (R). Goldman settles with the SEC for $10 million over charges it improperly promoted a stock sale involving PetroChina (R).