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

by Steven G. Mandis

  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.”19 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.”20 But lawmakers at the hearings made little headway in getting Goldman to concede much, if anything specific, that the company did wrong.21

  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.”22

  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.”23 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.24

  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.’”25

  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 w
idely 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.”26

  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.”27 The publishing of Smith’s letter certainly resulted in a scandal and an examination.28

  Goldman and Me

  The question of what happened to Goldman has special resonance for me. I have spent eighteen years involved with the firm in one way or another: twelve years working for Goldman in a variety of capacities, and another six either using its services as a client or working for one of its competitors. I still have many friends and acquaintances who work there.

  In 2010, I was about to start teaching at Columbia University’s Graduate School of Business and shortly would be accepted to the PhD program in sociology at Columbia. The sociology program in particular—which required that I find a research question for my PhD dissertation—provided me with many of the tools I needed to start to answer my question. I decided to pursue a career as a trained academic instead of relying solely on my practical experiences. The combination of the two, I thought, would be more rewarding and powerful for both my students and myself. When I began the study that would become this book, my hypothesis was that the change in Goldman’s culture was rooted in the IPO. I conjectured that what fundamentally changed the culture was the transformation—from a private partnership to a public company. As I learned more, I realized that the truth was more complicated.

  My analysis of the process by which the drift happened is deeply informed by my own experiences. Though some may think this has made me a biased observer, I believe that my inside knowledge and experience in various areas of the firm—from being based in the United States to working outside the United States, from working in investment banking to proprietary trading, from being present pre- and post-IPO—combined with my academic training gives me a unique ability to gather and analyze data about the changes at Goldman. My close involvement with Goldman deeply informs my analysis, so it’s worth reviewing the relationship. A brief overview of my career also reveals how Goldman’s businesses work.

  In 1992, fresh from undergraduate studies at the University of Chicago, I arrived at Goldman to work in the M&A department in the investment banking division. M&A bankers advise the management and boards of companies on the strategy, financing, valuation, and negotiations of buying, selling, and combining various companies or subsidiaries. For the next dozen years, I held a variety of positions of increasing responsibility. My work exposed me to various areas, put me in collaborative situations with Goldman partners and key personnel, and allowed me to observe or take part in events as they unfolded.

  I rotated through several strategically important areas. First I worked in M&A in New York and then M&A in Hong Kong, where I witnessed the explosive international growth firsthand with the opening of the Beijing office. Next, I returned to New York to assist Hank Paulson on special projects; Paulson was then co-head of investment banking, on the management committee, and head of the Chicago office. Also, I worked with the principal investment area (PIA makes investments in or buys control of companies with money collectively from clients, Goldman, and employees). Then I returned to M&A, rising to the head of the hostile raid defense business (defending a company from unsolicited take-overs—one of the cornerstones of Goldman’s M&A brand and reputation) and becoming business unit manager of the M&A department. Finally, I ended up as a proprietary trader and ultimately portfolio manager in the fixed income, commodities, and currencies division (FICC)—similar to an internal hedge fund—managing Goldman’s own money. My rotations to a different geographic region and through different divisions were typical at the time for a certain percentage of selected employees in order to train people and unite the firm.

  Throughout my career at Goldman, I served on firm-wide and divisional committees, dealing with important strategic and business process issues. I also acted as special assistant to several senior Goldman executives and board members, including Hank Paulson, on select projects and initiatives such as improving business processes and cross-department communication protocols. Goldman was constantly trying to improve and setting up committees with people from various geographic regions and departments to create initiatives. I was never a partner at Goldman. I participated in many meetings where I was the only nonpartner in attendance and prepared analysis or presentations for partner meetings, or in response to partner meetings, but I did not participate in “partner-only” meetings.

  As a member of the M&A department, I worked on a team to advise board members and CEOs of leading multinational companies on large, technically complex transactions. For example, I worked on a team that advised AT&T on combining its broadband business with Comcast in a transaction that valued AT&T broadband at $72 billion. I also helped sell a private company to Warren Buffett’s Berkshire Hathaway. As the head of Goldman’s unsolicited take-over and hostile raid defense practice, I worked on a team advising a client involved in a proxy fight with activist investor Carl Icahn.

  When I joined Goldman, partnership election at the firm was considered one of the most prestigious achievements on Wall Street, in part because the process was highly selective and a Goldman partnership was among the most lucrative. The M&A department had a remarkably good track record of its bankers being elected—probably one of the highest percentages of success in the firm at the time. The department was key to the firm’s brand, because representing prestigious blue chip clients is important to Goldman’s public perception of access and influence that makes important decision makers want to speak to Goldman. M&A deals were high profile, especially hostile raid defenses. M&A was also highly profitable and did not require much capital. For all these reasons, a job in the department was highly prized, and the competition was fierce. When the New York M&A department hired me, it was making about a dozen offers per year to US college graduates to work in New York, out of what I was told were hundreds of applicants.

  While in the department, I was asked to be the business unit manager (informally referred to as the “BUM”). I addressed issues of strategy, business processes, organizational policy, business selection, and conflict clearance. For example, I was involved in discussions in deciding whether and how Goldman should participate in hostile raids, and in discussing client conflicts and ways to address them. The job was extremely demanding. After a relatively successful stint, I felt I had built enough goodwill to move internally and do what I was more interested in: being an investor. I hoped to ultimately move into proprietary trading or back to Principal Investment Area (PIA), Goldman’s private equity group.

  Many banking partners tried to dissuade me from moving out of M&A. However, I wanted to become an investor, and a few partners who were close friends and mentors helped me delicately maneuver into proprietary investing. I was warned, “If you lose money, you will most likely get fired, and do not count on coming back to banking at Goldman. But if you make money for the firm, then you will get more money to manage, which will allow you to make
more money for the firm and yourself.”

  Today people ask me whether I saw the writing on the wall—that the shift to proprietary trading was well under way and would continue at Goldman—and whether that’s why I moved. To be honest, I didn’t give it as much thought as I should have. My work in helping manage the M&A department and assisting senior executives on various projects exposed me to other areas of the firm and the firm’s strategy and priorities. When you’re in M&A, you work around the clock. You don’t have time for much reflection or career planning. (This may be, upon reflection, part of the business model and be a contributor to the process of organizational drift.) You’re working so intensely on high-profile deals—those that end up on page 1 of the Wall Street Journal—that you’re swept up in the importance of the firm’s and your work. Your bosses tell you how important you are and how important the M&A department is to the firm. They remind you that the real purpose of your job is to make capital markets more efficient and ultimately provide corporations with more efficient ways to finance. So you rationalize that there’s a noble and ethical reason for what you and the firm are doing. In general, I greatly respected most of the investment banking partners that I knew. And I certainly didn’t have the academic training, distance, or perspective to analyze the various pressures and small changes going on at the firm and their consequences. I do remember simply feeling like I should be able to do what I wanted and what I was interested in at Goldman—an entitlement that I certainly did not feel earlier in my career, and maybe one I picked up from observations or the competitive environment for Goldman-trained talent.

  Paulson, a banker, was running the firm, and several others from banking whom I considered mentors held important positions. So even though it was no secret that revenues from investment banking had declined as a percentage of the total, I didn’t think very much about that, nor did I consider its consequences. One longtime colleague and investment banking partner pulled me aside to tell me that moving into proprietary trading was the smartest thing I could do and that he wished he could take my place. When I asked why, he said, “More money than investment banking partners, faster advancement, shorter hours, better lifestyle, you learn how to manage your own money, and, one day, you can leave and start your own hedge fund and make even more money—and Goldman will support you.” I assured him I was only trying to do what interested me, but I agreed it would be nice to travel less, work only twelve-hour days, and spend more time with my wife and our newborn daughter. When I asked why he didn’t tell me this before, he said, “Then we would have had to find and train someone else.”