Money and Power

by William D. Cohan

  Naturally, Goldman found Representative Oxley’s report to be outrageous. Lucas van Praag, Goldman’s spokesman, said that Goldman had simply made IPO stock available to its high-net-worth clients—of which there were seventeen thousand with investable funds of more than $25 million—and the CEOs Oxley singled out just happened to be among them. In addition, the information he was basing his claim on had been given to Congress by Goldman. “Their conclusion is not based on anything in fact,” he said. “We provided the information they asked for and they never asked us a single question about anything we gave them.” Asked about Ford, in particular, van Praag said, “We chose to give [Goldman] shares to people who we thought would be useful to our business and would be long-term holders. Bill Ford was one of them. He bought a lot of shares and still owns every one of them.” But Goldman’s logic—giving valuable IPO shares to people “useful to our business”—was hardly exculpatory.

  When Paulson heard about Oxley’s report and his interpretation of the information Goldman had shared, he was apoplectic. He said he was “absolutely stunned” and “furious.” He called Oxley four times in the next two days, and when they finally connected, Paulson told him that while the information he relied on for his conclusions was accurate, his interpretation of those facts was “meaningless and insulting.” When Eliot Spitzer, then New York State’s attorney general, heard about the spinning scandal, he wanted to put an end to it immediately (although his fellow Wall Street regulators Mary Schapiro and Robert Glauber were not supportive of him). “If an investment bank wants to curry favor with a company, and give that company a discount on a fee to get it to do business, great, wonderful,” he said in an interview. “If an investment bank wants to give the company a hot stock allocation and it goes into the corporate treasury, that’s great. That’s a business transaction. But if the investment bank gives it to the CEO, that’s—not to mince words—that’s bribery, because it’s a corporate asset, not the individual’s asset. It’s no different than a contractor giving somebody money under the table to get the bid. So the ban was premised on the notion that the CEOs had a fiduciary duty to the company and that when they took those shares into their own personal account, they’re violating their obligation to the company.”

  Then, in November 2002, came word that the SEC had sent Goldman a Wells notice of its intention to bring civil charges for a practice known as “laddering,” whereby Goldman was supposedly allocating the shares of hot IPOs to investors that it knew would buy more of the stock in the aftermarket at higher prices, thus ensuring the (then) much-coveted first-day trading “pop,” or rapid increase in the stock’s price. The investors’ reward was to get greater and greater allocations of other hot IPOs in the future that would also likely accelerate in price. The investor would also get the reward of buying the IPO low and selling it high. Spitzer might have referred to this practice as “bribery” as well. Goldman was outraged by the SEC’s investigation. “We categorically deny any allegations of wrongdoing and believe there is no basis for the SEC to take such a position,” Goldman said in a statement.

  Goldman’s view that the SEC’s charge was fiction was severely challenged by Nicholas Maier, who worked for Jim Cramer at the hedge fund he set up after leaving Goldman. Maier joined Cramer’s hedge fund in January 1994 and, for the next five years, his job, in part, was to make sure Cramer’s hedge fund got serious allocations of the hot IPOs, many of which came from Goldman. To do that, he claimed in a May 2005 deposition in Brattleboro, Vermont, he would do everything he could to convince brokers at Goldman and other Wall Street firms that Cramer was a long-term investor and wouldn’t flip the stock for a quick profit. But that was a fiction. “Our company was very, very rarely in for the long haul,” Maier testified. “And with IPOs, I would say the average turnover was within a few hours of the opening. I mean, there were occasions where we held on to it. But overall it was, as my boss [Jim Cramer] said, you know, ‘If someone comes up and gives you twenty bucks, put it in your pocket and walk away.’ ”

  Then he explained how laddering worked at Goldman and how he and Cramer would play along to get the IPO allocations that they coveted—and the free profits that came with them. During the process of allocating the stock of a hot Internet company, the demand from institutional investors, including hedge funds, would be so strong that Goldman would create a checklist of behavior that would be required for a fund to get an allocation. These would include attending the “road show,” where the company would present its story to investors; calling the research analyst at the Wall Street firm that was covering the company “and act[ing] as if he really loved the stock”; putting in an order for 10 percent of the stock, knowing that such an amount would never be granted; and paying millions in trading commissions to the Wall Street firm in a given year, which he testified was the “most important” factor “and why the little guy can never expect to get in on hot IPOs.” And then came the whole process known as the “aftermarket order.”

  Maier explained how in order for Cramer to get the IPO allocation, Goldman would demand that Cramer buy stock in the aftermarket at set prices. “If you really are very interested and deserve your five thousand shares in the IPO price[d] at twenty dollars,” he testified his broker at Goldman told him, “you should promise to buy fifty thousand more shares wherever the thing opens, be it fifty dollars or five hundred dollars. Take a typical ‘hot’ deal. I get five thousand shares of an IPO price[d] at twenty dollars that we think is going to open at fifty. I want it so much that I agree to buy another fifty thousand at any price. I therefore wholeheartedly agree with the investment bank that the IPO is a legitimate and valuable company. Nearly all of the major investment banks made us commit to aftermarket orders, and they kept score. The investment bankers went to their brokerage house’s trading desk to make sure that if Cramer and Company committed to buying in the aftermarket, Cramer and Company bought in the aftermarket. This was their way of making sure hot deals stayed hot. If we didn’t buy in the aftermarket, we wouldn’t get any shares in the next IPO.”

  In a July 2002 article in the Washington Times, Maier was quoted as saying about Goldman and laddering: “Goldman from what I witnessed, they were the worst perpetrator. They totally fueled the [market] bubble. And it’s specifically that kind of behavior that has caused the market crash. They built these stocks upon an illegal foundation[, then] manipulated [the stock] up, and ultimately, it really was the small person who ended up buying in” and losing money. He added, “Goldman created the convincing appearance of a winner, and the trick worked so well that they seduced further interest from other speculators hoping to participate in the gold rush. The general public had no idea that these stocks were actually brought into the world at unnaturally high levels through illegal manipulation.”

  In his Brattleboro deposition, Maier made clear that Cramer told him how to deal with Goldman on these matters. “They are going to tell you what to do, and you are going to do it,” he said Cramer told him when he started on the job. “And all I care about is that. If there is a deal that opens up, I want to be there. You play the game they tell you to play so that we can make as much money as possible.” He acknowledged that since these Internet companies by and large had no earnings and barely any revenue, doing a fundamental analysis of their value was not only not possible, it was beside the point. “It was too much of an intangible,” he said. “We chose what was not an intangible, which was that, by playing this game and having somebody walk up to me, like Goldman Sachs, and put half a million bucks in my pocket for a couple of lunches, a couple of phone calls, and a little playing around in the trading, that was tangible. That was, you know, easy money, and we would take it.” He recalled this happening in at least two Goldman underwritten hot IPOs, for Amazon and for Exodus Communications.

  Much the same version of Maier’s assertions in his Brattleboro deposition were contained in his March 2002 book, Trading with the Enemy, about his time on Wall Street working for Cramer
. Cramer was not pleased by Maier’s account of what occurred at his hedge fund and threatened to sue Maier for libel but never did.

  In January 2005, Goldman paid $40 million to settle a civil suit with the SEC related to its penchant for laddering investors in the hot IPOs it underwrote. One of the many examples the SEC cited in its complaint involved Goldman’s handling of investors in the IPO of WebEx, an Internet video-conferencing company that Goldman took public in July 2000. On July 27, the institutional sales rep for an investor told the Goldman “deal captain” about his client’s willingness to buy WebEx shares in the aftermarket: “They’ll take the full amount and will hold it for at least 30 days unless you say longer BUT this is a relatively new relationship with a lot of business to do and I’d like to avoid hurting them too much if this one is in serious trouble.” The deal captain responded, “We’re looking for something longer term. No lack of demand. Want to wait for the next one?” The salesman responded, “They’ll hold it for at least 90 days and they’ll buy 3 for 1 up to $17” in the aftermarket. The next day, when WebEx started trading, the deal captain wrote to the salesman about when it would be good for his client to buy in the aftermarket: “first trade would be great.” The salesman replied that his client had complied: “Just sent it in—they got 10 so they’re buying 30 with a 17 top. These guys ALWAYS do what they say—if they got 100 they would be buying 300.”

  But the spinning and laddering, while seemingly illegal and unethical, were a mere sideshow to the massive deception that Goldman—and nearly every other major underwriter of Internet stocks during the 1990s—participated in by rewarding with big bonuses their supposedly independent research analysts for writing favorable reports about the stocks of the Internet companies the Wall Street firms were taking public. Even though many research analysts did not believe what they were writing about these stocks, the pressure on them from their own firms’ investment bankers to write favorably was intense because the fees that the bankers could reap by underwriting and trading the hot IPOs were irresistible. Big fees meant big bonuses in an era where bankers were rewarded with huge bonuses based on how much revenue they generated rather than how much profit the firm overall generated.

  Spitzer and the SEC led the charge against Wall Street in the Internet research scandal and successfully got the firms to collectively cough up fines totaling $1.4 billion. Goldman was far from the most egregious violator of the compact that allegedly existed between underwriters and investors—that title belonged to Salomon Brothers, which forked over $400 million—but Spitzer got Goldman to pay $110 million. Even from the evidence in a smattering of e-mails, it was clear that Goldman was helping to rig the game just like everyone else. “Certain research analysts at Goldman Sachs were subjected to investment banking influences and conflicts of interest between supporting the investment banking business at Goldman Sachs and publishing objective research,” the SEC wrote in its complaint against the firm. “The firm had knowledge of these investment banking influences and conflicts of interest yet failed to establish and maintain adequate policies, systems, and procedures that were reasonably designed to detect and prevent those influences and manage the conflicts.”

  The documents and e-mails the SEC and Spitzer provided in the settlement documents make clear that a number of Goldman’s research analysts felt pressured by bankers to write favorably about their clients in order to help the bankers generate revenue from them. One analyst, asked what his three most important goals were for 2000, wrote: “1. Get more investment banking revenue. 2. Get more investment banking revenue. 3. Get more investment banking revenue.” In another analyst’s year-end review, some of his colleagues criticized his close ties to the bankers. “He has been in the incredibly awkward position of having the investment bankers have a stronghold over his written work—STOR [StorageNetworks], LDCL [Loudcloud] to name a few embarrassments,” observed one colleague. Another one added, “One gets the sense that he’s been held captive to the agenda of others within the Firm and that, were he allowed to exercise an independent investment thesis, he would have had a decidedly different take of this group’s prospects.”

  Not surprisingly in this environment, bankers would bring research analysts along on IPO new business presentations, with the promise that the analyst would cover the company—favorably—after the IPO, which of course Goldman should lead. In an April 2000 e-mail, a Goldman investment banker wrote to the Goldman research analyst covering Loudcloud: “For next Wednesday’s meeting, we have a challenge before us. We have been guided today by Loudcloud that we must show total focus and commitment from a RESEARCH perspective. [Loudcloud representative] strongly suggested that you guys come prepared to SELL.… HERE IS THE SUGGESTION: CAN YOU GUYS PREPARE A BRIEF (3–4 PG) RESEARCH REPORT ON LOUDCLOUD FOR THE MEETING. This is effectively our pitch.… This way we can say we are so excited about the story that we have already begun writing the report.” (The emphasis was in the original e-mail.) In response, the analyst wrote: “I want to make this thing the best. WE WILL WIN THIS MANDATE.”

  As the Internet bubble was reaching its zenith, Goldman displayed an increasing inability to deal effectively with its conflicts of interest, erring time and time again in favor of potential investment banking revenue at the expense of institutional and retail investors who might well have preferred to know the truth. In January 2001, the management of WebEx, the videoconferencing company that Goldman had taken public six months earlier, tried to use its muscle—effectively, it turned out—to influence a research report that the Goldman analysts covering the firm were working on. “As discussed,” he wrote, “I want NO mention of any funding issues in this written report. I told you if people called and asked you why your plan shows a need for modest funding, you can verbally tell them that management believes they have adequate funding and it is probably because management has a less conservative plan than you do.”

  The Goldman analyst responded, “The webx [sic] funding issues is a key area of investor concern, as such will remove any mention from the top section of the note, but will address it in a manner this [sic] is consistent with your recommendation for verbal responses to client inquiries in a later section. To exclude it completely detracts from the intention of the note, which is to address key investor concerns upfront and then give them a reason to buy the stock.” He attached a copy of the revised report to his e-mail. The WebEx executive replied: “Thank you. This is much better. The other note said the company has a funding problem, but we think it isn’t very big. This says that the company believes it has enough funds, but there could be a problem; and if there is it will be minor. Thanks again for the change.” Goldman issued the revised report on January 22, 2001.

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  TOWARD THE END of January 2003, Paulson was speaking to investors about the firm at a Salomon Smith Barney conference and did himself no favors. Goldman had been reducing staff during this period, so nerves were understandably raw around the firm. During the question-and-answer period, a question arose along the lines of, “Hank, you’ve been cutting, and you’ve been cutting, and you’ve been cutting staff in this terrible environment. At a certain point, you have to start cutting muscle. Have you hit that point yet?” In his answer, Paulson implied that between 80 and 85 percent of Goldman Sachs’s employees were irrelevant to the company’s success—a message that flew in the face of the company’s professed antisuperstar ethos. “I don’t want to sound heartless,” he said, “but in almost every one of our businesses, there are 15–20 percent of the people who really add 80 percent of the value. I think we can cut a fair amount and not get into muscle and still be very well-positioned for the upturn.” Understandably, Paulson’s comments did not go over well at the firm. “News of that comment spread through the firm like wildfire,” remembered David Schwartz. “It was afternoon London time, but before I went home, I knew about it. I think in New York, there were buttons that were made up the next morning: ‘Are you one of the 80 percent or the 20 percent?’
It was instantaneous flow of information around the whole fucking firm. I gather that Paulson’s phone did not stop ringing that afternoon.”

  Paulson quickly realized he had to put out the fire he started. In a voice mail message to the firm’s twenty thousand employees, Paulson acknowledged that his remarks were “insensitive” and “glib.” He apologized. “The eighty-twenty rule is totally at odds with the way I think about the people here,” he said, adding he would also apologize in person at a series of upcoming town hall meetings. According to one report, “He reaffirmed the importance of teamwork over individual glory and acknowledged that he was embarrassed by his choice of words.” Schwartz recalled that “it wasn’t more than forty-eight hours and Paulson apologized to the entire firm for his comments. He said they were ‘ill-considered’ and they did not reflect what he really believes. He apologized to everyone and asked for forgiveness. It was abject apology. There was no ducking or diving.” Schwartz thought the incident, while appalling, revealed Goldman at its best. “The ability to process the information almost instantaneously through the whole organization and to come up with the right solution to the problem equally instantaneously in a way that, I think, very few other CEOs would have done was very impressive,” he said. “Other CEOs would say, ‘It’s really true. People should just get over it.’ Not Hank. Hank is a stand-up guy.”