Money and Power

by William D. Cohan

  Goldman’s behavior left some executives at SocGen stunned. “It was extraordinary to me that armed with all of this inside information that they actually had the chutzpah to come out and make a competing bid at the same time that they had access to all this information about our strategy,” explained one insider. “And they did it in the usual way, by saying that they had a separate team and ‘Chinese walls’ and all sorts of things. I was so livid about that I pushed hard for a lawsuit against them based on the conflict. It seemed to me, and others, that we had the better of that argument. But even if we didn’t, the fact was throwing that kind of dirt in their face where it belonged was something that I wanted to do because I knew that we had a good chance of getting a preliminary injunction. But even if we didn’t get that far, we would do a lot of damage to just slow them down and to be able to take discovery of how they were using this information and how the Chinese walls were working, because it was just so outrageous to me. It was about as outrageous as anything I’ve seen, frankly, in the business.”

  While the idea of bringing a lawsuit against Goldman was raised—Sullivan & Cromwell obviously recused itself since Goldman was a major client—in the end Bouton, the SocGen chairman, decided not to sue Goldman. “Goldman has always been aggressive about its own interest when it comes to a big fee particularly, and against its client’s interest in situations like that,” said the insider. “And that was the clearest one that I’m aware of. And pretty high stakes, obviously pretty visible and you can imagine how much fun it would have been to file an action in New York federal court and watch what happened next. Because in a battle like that, any commencement of a litigation would have put a chill through their whole operation internally. It would have given us the right to take discovery on whether the Chinese wall was a legally sufficient defense.”

  Even other financiers who partnered with Goldman to buy companies were often left dazed by the firm’s behavior. “They’re kind of hugely mediocre,” said one private-equity executive who has partnered with Goldman on deals. “They do things exactly the way most firms do—they say one thing and they do another. They talk about hard work, discipline, and commitment and then they always do what’s in their own financial interest to do. Like a law firm or bank that pitches a business, gets the business, and then does the bait and switch. It’s not in their DNA—we’re only talking their private-equity investments—it’s not in their DNA to be engaged. Their financial engineers are crude. They’re quick. They’re slam-bam-thank-you-ma’am, but they like to present it as a committed relationship. It’s only—and all—about the money and maintaining the veneer.”

  Goldman’s behavior was not unusual, he said. Indeed, it was quite common and he liked that the firm had a relentless desire to win. What made it unusual was that the Goldman team liked to act as though it had higher standards of ethics and behavior. He marveled at how Team Goldman continued to believe passionately in the myths created about the firm. “They have been inculcated to portray themselves as differentiated for a long time,” he said. “It’s partially because they haven’t torn down their icons. They’ve been very clever about that. You talk about John Weinberg. John Weinberg has not been torn down. Even with the kinds of bruises he’s been taking, Rubin, by and large, has not been torn down, certainly not by the firm. Sidney Weinberg is still the great Sidney Weinberg! Gus Levy is still the great Gus Levy! They have what the Yankees have, which is the monument park in center field and they celebrate it and they’re, to some degree, hated for it but they still get to put on the pinstripes and intimidate other people just by showing up.”

  A former banker himself, he could not get over how well the Goldman professionals stay on message. “They’re a little bit more comfortable lying to your face than other firms,” he continued. “Goldman will tell the story and actually never blink at you. Everyone else is going, ‘We always put our clients first,’ and it’s a little bit like one of those TV things where you look behind you and go, ‘Bullshit, we do.’ Goldman actually will say—hand-over-heart, guys—‘This is what we’re about. This is our culture. It’s about client service. Our culture is about always doing what’s right in the long-term interest.’ And other firms will kind of go, ‘Okay, now that I’ve given my stupid speech, let me tell you the truth.’ Goldman, there’s again, that discipline.”

  ——

  SOMETIMES THIS SO-CALLED “discipline” shows up when Goldman is asked to advise a big, publicly traded company on an assignment and then takes its sweet time about going through the internal “conflicts” check before deciding to take it, or not. Most firms would respond in a time-sensitive situation in twenty-four hours, max, but Goldman has been known to take as long as a week, while it decided where its highest expected value might be. Should it work for the company that asked first? Or, using the knowledge it gained from the conversation, should Goldman find another party to work for that might pay a higher fee or have a higher likelihood of succeeding in the situation. Often, clients enable Goldman to string them along in this way, in part because of the respect many of them have for the firm. “The clients give them more rope than most of us would have any instinct to ask for,” explained one gray-haired competitor.

  As far as the public was concerned, no deal crystallized the evolution of Goldman’s approach to conflicts—and its perceived ability to “manage” them—than the high-profile, $3.2 billion April 2005 merger between the New York Stock Exchange and Archipelago Holdings, the company that owned the Archipelago Exchange, the first “totally open” fully electronic equity-trading exchange. For students of Wall Street conflicts, the merger had everything: Goldman advised both the NYSE, code-named “Navy,” and Archipelago, code-named “Army,” on the deal, the rare and proverbial Holy Grail of M&A assignments. John Thain, the NYSE’s CEO, had, of course, spent his whole prior career at Goldman, rising to the position of president and second-in-command to Paulson. He did not recuse himself during the deal even though he owned hundreds of millions of dollars’ worth of Goldman stock. For its trouble, Goldman was paid a $3.5 million fee by Archipelago. The NYSE also paid Goldman $3.5 million. Goldman also owned—in various pockets around the firm—7.3 million shares of Archipelago, or 15.5 percent of the company, and was the second-largest shareholder after General Atlantic, another private-equity firm, which owned 22 percent of Archipelago. Goldman was one of the lead underwriters of the Archipelago 2004 IPO. On the day the NYSE-Archipelago merger closed, in March 2006, Goldman’s stock in the combined, publicly traded NYSE was worth close to $500 million. Goldman also owned 21 seats on the NYSE—out of a total 1,366 seats—worth around $4 million each. Goldman ended up with a 5.7 percent stake in the combined company.

  The deal caused a firestorm of criticism about the many hats Goldman wore during the merger. “Wall Street has been buzzing with criticism of Goldman Sachs’s role in the transaction,” the Wall Street Journal reported. “Some wonder whether Goldman Sachs deprived NYSE seat owners—and Archipelago shareholders—of the best possible deal, while making a deal that benefits the firm. Former NYSE director Kenneth Langone, who is trying to mount a possible bid for the NYSE, has pointed to what he describes as Goldman Sachs’s ‘unseemly’ role in arguing that the deal undervalues the Big Board.” But Goldman, as usual, would have none of the criticism. “Managing conflicts effectively is fundamental to the business of investment banking,” said Goldman spokesman Lucas van Praag.

  The criticism forced Archipelago to take the unusual step of releasing Goldman’s April 15, 2005, engagement letter, which showed that not only did both sides acknowledge Goldman’s many conflicts but also deliberately limited Goldman’s role to setting up meetings and doing some financial analyses. “We will assist the company”—Archipelago—“and the New York Stock Exchange in connection with a potential transaction which assistance may include facilitating discussions between the company and the New York Stock Exchange with respect to a transaction,” according to the fee letter. “As part of our services,
we will perform certain valuation analyses, including with respect to any pro forma combined company resulting from a transaction. Notwithstanding the foregoing, we will not (i) negotiate on your behalf the financial aspects of a transaction with the New York Stock Exchange or (ii) render a fairness opinion in connection with a transaction.” Anticipating the negative reaction to Goldman’s dual roles, the two sides had agreed to hire both Lazard and Citigroup to provide fairness opinions about the deal.

  The engagement letter also explicitly prevented either side from suing Goldman about the conflicts. Archipelago “understands and acknowledges that we are rendering services simultaneously to the company and to the New York Stock Exchange in connection with a transaction,” Goldman’s letter said. “The company understands and acknowledges that potential conflicts of interest, or a perception thereof, may arise as a result of our rendering services to both the company and to the New York Stock Exchange.”

  Looking back, Thain defended his decision to have Goldman serve on both sides of the deal. “We needed someone to help us put the deal together,” he said. “We didn’t need two people to help us put the deal together because having two firms kind of vying for who’s a better negotiator didn’t really make sense. We did bring in a third party at another firm”—Lazard—“to bless it. But I think it was mostly just sour grapes on the part of other people, and in terms of getting the deal done in an expeditious way, it made a lot of sense. Now was it worth making everybody mad? Probably not, but from the point of view of getting the deal done it made a lot of sense.” He praised Goldman’s bankers for having expertise in the “space” and for knowing the people on both sides of the deal.

  Thain also defended the deal as the best way for the NYSE to survive. “We kept it from becoming irrelevant,” he said. “We modernized its business model. We diversified its product. When I got there it was private, not for profit, only traded New York Stock Exchange listed stocks, and was losing market share rapidly. We changed its governance structure. We changed its corporate structure. We diversified it product-wise, and in the end we globalized it, so it traded New York listed stocks, over-the-counter NASDAQ stocks, options, futures, and derivatives, and bonds. We moved from only New York stocks to pretty much the full range. When I started you could’ve bought a seat on the exchange for a million dollars. There were one thousand three hundred and sixty-six seats. That means the whole market value of the New York Stock Exchange was one point four billion dollars. When I left, the market value of the combined company after the Euronext deal was about twenty billion dollars.”

  For his part, Paulson defended the legality of the assignment, given the various disclosures that occurred about the firm’s conflicts. But he did question the wisdom of the assignment from a public-relations perspective. “The New York Stock Exchange isn’t just another company,” he said. “Okay? It’s a national treasure. It’s not just another company and what happened was when the editors from the press found out it was a public-relations problem.” He remembered telling the Goldman board, “There’s not an ethical breach. This is legal. It’s ethical. The deal probably wouldn’t have gotten done but for this confidential [arrangement] where you needed people that really understood it and both sides very much wanted Goldman Sachs and Goldman Sachs was a partial owner of Archipelago and that didn’t bother the New York Stock Exchange or their board, or John Reed or John Thain.”

  A few weeks after this conversation about the NYSE/Archipelago merger, Paulson called back. He had given the situation more thought and felt uncomfortable enough about the role Goldman had played to want to clarify his thinking about it. He remembered that Peter Kraus, the Goldman banker on the deal, had come to see him to both warn him that the firm could catch some flak for its dual roles and to take a “victory lap” for what would normally be considered a marquee transaction. He started processing what Kraus had told him: that Goldman would be a big owner of the combined company and that Thain had been a former Goldman president and that his key lieutenant, Duncan Niederauer, had also been a Goldman partner. (Niederauer is now the CEO of the NYSE.) “I questioned whether we should represent both sides because I thought we will take some bad publicity and some flak,” Paulson said he told Kraus. “There’s nothing unethical or wrong about it but I think some flak’s coming. I’m making a decision right now we’re not going to represent both sides. Just for that reason and the New York Stock Exchange and John Thain is more sophisticated so we’ll represent Archipelago and you call John Thain and tell him that.”

  Kraus called Thain as instructed but Thain was not happy. “Peter showed up [in his office] and said John was angry, John was very insistent,” Paulson recalled. Kraus had brought a group of bankers with him to Paulson’s office to discuss the pros and cons of representing both sides. They collectively decided to move forward representing both sides. “Over history there’d been plenty of mergers of equals or mergers that had been done that way,” Paulson said, correctly. “They’re not the most common but they have been done that way.”

  He continued, “This wasn’t that we did something wrong, something unethical. This was Goldman Sachs getting a deal done, after which everyone said, ‘Boy, this is a superb deal. This makes great sense. It’s brilliant.’ This was Goldman Sachs understanding the market, understanding how you would put these two companies together, how you would manage the technology integration and those kinds of questions. Again this was not Goldman Sachs trying to push itself on clients to haul in fees. This was Goldman Sachs acceding to the wishes of the clients and to the boards. This was really a conflict that was seen by the press and by other bankers and by the public because it was just a bridge too far to explain it. And what I missed was, as I said, this was the New York Stock Exchange and every single major investment banker said, you know, ‘I’ve got a vested interest in this. I care about this.’ This is a public institution in many ways and it just came across as arrogant and as fairly simple for overreaching. But it wasn’t any conflict where we were screwing a client or doing something that was against the client’s interest. This was Goldman Sachs coming up with an idea, executing a brilliant transaction, and doing it ethically but missing the forest for the trees and appearing arrogant and looking like we were trying to be all things to all people.”

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  IN APRIL 2006, the august Economist put Goldman Sachs on its cover, in an effort to describe the firm’s “magical hold at the summit of its industry.” Goldman, of course, had long been the envy of every other firm on Wall Street, not only because of all the money it made year after year for its partners (and everyone else who worked there) but also because regardless of what questionable things the firm did—and there were plenty—its reputation for excellence and professionalism never seemed to suffer. Other firms could become embroiled in scandals, and clients would flee like cockroaches when the lights go on. But at Goldman Sachs, the firm seemed to have a permanent Teflon veneer. If no one ever got fired for hiring IBM—as the old corporate adage went—the very same comment could be said of Goldman, and often was. This simple fact created much jealousy of Goldman from the rest of Wall Street. A common refrain—among bankers anyway—was that for all their vaunted reputations, when it came to the nitty-gritty of an M&A deal, the Goldman guys were just not that good. Where was the special insight or kernel of advice that set them apart from all the other French-cuff and Hermès-tie-wearing bankers?

  But there were—are—important cultural differences behind Goldman’s extraordinary ongoing success that set the firm apart from its peers. The Economist’s April 2006 cover story about Goldman tried to capture some of these unique aspects of the firm’s culture. “The secret of Goldman’s success is the stuff of constant speculation, above all among the investment bank’s competitors, none of which has come close to matching its sustained record of superior performance,” the magazine observed. “Back before Goldman went public in 1999, the firm was looked upon with a certain awe—a secretive, private partnership, the
last truly large such entity in American finance, that consistently minted money without having to disclose anything. In 2006, despite public filings that are so large they can be more easily measured in weight than in pages, Goldman Sachs remains just what it was in 1999, only more so: it is a hugely profitable enterprise—return on equity during the first quarter of this year approached 40%, notwithstanding a compensation scheme for employees that would make the old partners jealous—and it remains something of an enigma. Over time, that enigmatic quality has only increased, defying predictions that the greater transparency supposed to accompany going public would reveal to the world Goldman’s secret formula. In part, this is deliberate. Its primary source of profit has shifted from banking to trading, and the firm is intentionally quite vague about how, and precisely where, those trades are made or, equally relevant, from whom the profits are coming. One line in its accounts, ‘fixed income, currency and commodities’ (referred to as FICC) accounts for a huge chunk of revenues and this is because … well, no one outside Goldman knows exactly why.”

  The magazine touched on Goldman’s Svengali-like ability to massage its public image. “Whether Goldman was, in fact, really different in its approach to vice, or virtue, than any other Wall Street firm is the cause of some debate, but beginning in the 1960s the bank graduated from the second-tier to pre-eminence at least in part because it was perceived by its clients as the one to trust,” the article continued. “Symbolically, for years it advised on few hostile takeover bids. This role has, theoretically at least, become increasingly tenuous as Goldman has moved from being mostly an agent (as an underwriter) to a principal, as a trader and direct investor. Inevitably, in setting a price either for a security or a company that it might buy or sell, Goldman is no longer looking after only its client’s interest. Indeed it has become harder to distinguish between who is a Goldman client and who is a Goldman competitor.” After citing a few examples of where Goldman’s conflicts have gotten it into a public-relations fix, the magazine concluded, “Mostly, though, Goldman’s formidable reputation works in its favour.”