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

by Steven G. Mandis

  I became a proprietary trader and then a portfolio manager in Goldman’s FICC Special Situations Investing Group (SSG). We built it into one of the largest, most successful dedicated proprietary trading areas at Goldman and on Wall Street. Created during the late 1990s, SSG initially primarily invested Goldman’s money in the debt and equity of financially stressed companies and made loans to high-risk borrowers (although we expanded the mandate over time). SSG was separated from the rest of the firm, meaning we sat on a floor separate from the trading desks that dealt with clients. We were called on as a client by salespeople at Goldman and the rest of Wall Street as if we were a distinct hedge fund. We did not deal with clients.

  Even separated as we were, we had the potential for at least the perception of conflicts of interest with clients. For example, we could own the stock or debt of a company when, unknown to us, the company would hire Goldman’s M&A department to review strategic alternatives or execute a capital market transaction such as an equity or debt offering. In that case we could be “frozen,” meaning we were restricted from buying any more related securities or selling the position, something that would place us at a potential disadvantage because we could not react to new information. If we wanted to buy the securities of a company, and unbeknownst to us Goldman’s bankers were advising the company on a transaction, we could be blocked from the purchase.

  The biggest advantage I believed we had over our competitors—primarily hedge funds—was that we had a great recruiting and training machine in Goldman; we could pick the very best people in the company. Most had heard that we were extremely entrepreneurial, that we gave our people a lot of responsibility and ability to make a larger impact, that we were extremely profitable, and that we paid very well. Those from SSG also had an excellent track record of eventually leaving to set up or join existing hedge funds. We also had infrastructure—technology, risk management systems, and processes—that was unmatched by Wall Street banks, because Goldman invested heavily in it, recognizing the strategic importance of the competitive advantage it gave us.

  We were trained to run investing businesses (for example, evaluating and managing people and risk or setting goals and measureable metrics). We had access to almost any corporate management team or government official through the cachet of the Goldman name and its powerful network. We also had a low cost of capital, because Goldman borrowed money at very low rates from debt investors, money that we then invested and generated a return a good deal higher than the cost of borrowing. We had one client—Goldman—and this was good, because it meant we did not have to approach lots of clients to raise funds. However, it was also a bad thing, because all the capital came from one investor. If Goldman (or the regulators, as later happened with the Volcker Rule) decided it should no longer be in the business, you were out of a job, although it was likely many others would want to hire you.

  When I started in proprietary trading in FICC, I immediately noticed one big difference from the banking side. Although my new bosses were smart, sophisticated, and supportive, and as demanding as my investment banking bosses, there was an intense focus on measuring relatively short-term results because they were measurable. Our performance as investors was marked to market every day, meaning that the value of the trades we made was calculated every day, so there was total transparency about how much money we’d made or lost for the firm each and every day. This isn’t done in investment banking, although each year new performance metrics were being added by the time I left for FICC. Typically in banking, relationships take a long time to develop and pay off. A bad day in banking may mean that, after years of meetings and presentations performed for free, a client didn’t select you to execute a transaction. You could offer excuses: “The other bank offered to loan them money,” “They were willing to do it much cheaper,” and so on. It was never that you got outhustled or that the other firm had better people, ideas, coordination, relationships, or expertise, something that would negatively reflect on you or the firm (or both). In proprietary trading, there were no excuses for bad days of losses. We were expected to make money whether the markets went up or down. There was another thing I learned quickly. One could be right as a trader, but have the timing wrong in the short term and be fired with losses that then quickly turned around into the projected profits. In addition, relative to banking, in judging performance the emphasis seemed to tilt toward how much money one made the firm versus more subjective and less immediately profitable contributions. The fear of this transparency and the potential for failure kept many bankers from moving to trading.

  I later discovered that Goldman’s proprietary trading areas actually maintained a longer-term perspective than did most trading desks and hedge funds, where a daily, weekly, or (at most) monthly focus was generally the norm. Our bosses reviewed information about our investments daily, but they tended to have a bias toward evaluating performance on a quarterly and even yearly basis (but much shorter than evaluating a client relationship in banking, which could take years). We were held accountable and were compared on risk-based performance against hedge fund peers, as well as other Goldman desks. If we found good opportunities, we got access to capital and invested it. Theoretically, when we didn’t see attractive opportunities, we were to sell our positions and return the money to Goldman, with the understanding that we had access to it when we felt there were attractive opportunities.

  However, I learned there was a perverse incentive to keep as much money as possible and invest it to make the firm as much money as possible—and yourself as much money as possible—even if the risk and reward might not be as favorable as other groups’ opportunities. There was a feeling that we were “paid to take risks,” and the larger the risks you took, or were able to take, the more important you were to the organization. We did have a critical advantage over most banks—we knew that many of our bosses and those at the very top of the firm understood, and were not afraid of, risk. Many had managed risk and knew how to evaluate it. They also would sometimes leave us voicemails or discuss in meetings their feelings or perspectives on the current environment and risks.

  In my conversations with former competitors, I later learned that Goldman’s approach to managing proprietary traders was substantially different from theirs. For example, if we lost a meaningful amount of money in an investment while I was at SSG, we would sit down with our bosses (and sometimes other traders not in our area) to rationally discuss and debate alternatives, such as exiting all or some of the position, buying more (“doubling down”), hedging the downside, or reversing our position and making an opposite bet. I learned that traders from other firms generally did not sit down with others to discuss alternatives. Rather, most often they were simply told to sell and realize the loss of money-losing investments (“cut your losses”), because their bosses or their bosses’ bosses didn’t understand the risks. Competitors’ traders told me they couldn’t comprehend the idea of our getting together with someone as senior as the president of the firm, and especially traders outside our area, to discuss and debate the attractiveness of an investment. For this reason, traders at other firms did not get as many great learning opportunities or would make poor decisions.

  When I left in 2004, the firm was very successful in reaching certain organizational goals. It had the best shareholder returns and continued to recruit the best and brightest people in the industry. It had access to almost any important decision maker in the world. The culture and working environment were such that a motivated, creative person felt as if he or she could accomplish just about anything; all one had to do was convince people of the merits of the idea. But the firm felt different: it was much larger, it was more global, and it was involved in many more businesses. One could certainly start to feel the greater emphasis on trading and principal investing. The bureaucracy had grown, and as SSG grew and diversified we were increasingly encountering turf wars with other areas. I knew fewer people, especially senior partners, many of whom had retired by 200
4, so I also felt a weaker social tie to the firm.

  At the same time, there was great demand from outside investors (including Goldman Sachs Asset Management) to give money to Goldman proprietary traders to start their own firms and invest. Also the firm’s prime brokerage business and alumni network had a great track record for helping former proprietary traders start their own firms. I felt I had a good track record and reputation, and enough support from Goldman and many of its employees and alums who were friends, to start my own investment business.

  With my savings from bonuses, and with my 1999 IPO stock grant and other shares fully vested on the fifth anniversary of the IPO, I left Goldman in 2004 to cofound a global alternative asset management company with an existing hedge fund that already had approximately twenty people and $2 billion in assets under management. Shortly after, several Goldman investment professionals joined me. Less than four years later, I had helped expand the firm to 120 people and $12 billion in assets under management.28 I was the chief investment officer and helped manage and oversee over $5 billion, about half of the firm’s assets, through multiple vehicles focused on the United States and Europe. Also, I helped start several other funds while also serving on all of the firm’s major investment committees. In my position, I saw firsthand the competitive, organizational, technological, and regulatory pressures facing an organization (also a private partnership) as well as the organizational challenges of growth. I maintained a close relationship with Goldman, becoming a trading and prime brokerage client and coinvested with Goldman. My partners and I also hired Goldman to represent us in selling our asset management firm. In early 2008, we announced a transaction valuing the firm at $974 million.29 So I also experienced what it meant to be a trading and banking client of Goldman’s and am able to compare the experience versus other firms.

  I have also worked for one of Goldman’s competitors at a very senior level, as an executive at Citigroup from 2010 to 2012 in various roles, including chief of staff to the president and COO, vice chairman and chief of staff to the CEO of the institutional clients group (ICG), and member of the executive, management, and risk management committees of that group.30 When I joined Citi, it was under political and public scrutiny for taking government funds, and the government still owned Citi shares. It was a complex business with many organizational challenges; it was an intense experience, with me starting work at 5:30 a.m. almost every day to be prepared to meet with my boss at 6 a.m. My experience at Citigroup was critical in my development of a new perspective on Goldman and the industry. Citigroup has approximately 265,000 people in more than 100 countries. In addition to being much larger (in total assets and number of employees) than Goldman, Citigroup is much more complex, because it participates in many more businesses (such as consumer and retail banking and treasury services) and locally in many more countries. In addition, unlike Goldman, Citigroup was created through a series of mergers and acquisitions. At Citi, I had the chance to compare the practices and approaches of a Goldman competitor that had a big balance sheet (supported by customer deposits to lend money to clients) and that had grown quickly through acquisitions—two things Goldman did not really do.

  Before working at Citigroup and during the financial crisis, I advised McKinsey & Company on strategic, business process, risk, and organizational issues facing financial institutions and related regulatory authorities worldwide. McKinsey is one of the most prestigious and trusted management-consulting firms in the world, with some fifteen thousand people globally. There are many differences between the firms, but as with Goldman (before Goldman became a public corporation), McKinsey is a private partnership that has a revered partnership election process. Goldman and McKinsey compete for the best and brightest graduates every year, and there are elements of the McKinsey culture that are similar in many ways to Goldman’s, especially to the Goldman I knew when I started. When attending McKinsey training programs, I could have closed my eyes and replaced the word McKinsey with Goldman, and it would have been like my 1992 Goldman training program all over again. McKinsey has an intense focus on recruiting, training, socialization of new members, and teamwork. It also has long-standing, revered, written business principles. Lastly, it has an incredible global network.

  The people at McKinsey are incredibly thoughtful and hard working and have very high standards of integrity, and I learned a great deal about how they built and grew the business globally and added new practices while trying to preserve a distinct culture. McKinsey provided me the context of a large, global, growing advisory firm. McKinsey emphasized “client impact” over “commercial effectiveness” in evaluating its partners. With McKinsey, I also gained exposure to many other financial institutions, along with their senior management teams, their processes, and their cultures, and this exposure also helped put my experiences at Goldman—and the reaction of its management teams to various pressures—into context. Lastly, I had hired and worked with McKinsey as a client, and am able to compare that experience as a client versus being a client of other firms, including Goldman.

  Subtle Changes Made Obvious

  To give you a better sense of the shift I noticed and the organizational drift I’m talking about, I want to offer a set of comparative stories—“before” and “after” snapshots—to illuminate the differences. They illustrate the shift in the client-adviser relationship as well as in Goldman’s practice of putting the clients’ interests first.

  This post-1979 historic commitment to always putting clients’ interests first and signifying more then a legal standard is demonstrated by a 1987 event. Goldman stood to lose $100 million, a meaningful hit to the partners’ personal equity at the time, on the underwriting of the sale of 32 percent of British Petroleum, owned by the British government. The global stock market crash in October had left other investment banks that had committed to the deal trying to analyze their legal liability and their legal rights to nullify their commitment, but Goldman stood firm in honoring its commitment despite the cost and despite Goldman’s legal claims. Senior partner John L. Weinberg explained to the syndicate, “Gentlemen, Goldman Sachs is going to do it. Because if we don’t do it, those of you who decide not to do it, I just want to tell you, you won’t be underwriting a goat house. Not even an outhouse.”30

  The decision was not a simple matter of altruism. The principle of standing by its commitment had long-term economic benefits for Goldman. Weinberg was able to see beyond a short-term loss, even a large one, and to consider Goldman’s longer-term ambition to increase its share of the privatization business in Europe. That could be achieved only by living up to its commitments to clients, even beyond the legal commitment. His decision was consistent with the standard of the original meaning of the first principle: “Our clients’ interests always come first.” In addition, it illustrates the nuance between “long-term greedy” and “short-term greedy.”

  More than twenty years later, this standard of commitment to clients beyond legal responsibility has largely been lost. Goldman policy adviser and former SEC chairman Arthur Levitt has challenged the “clients first” principle because “it doesn’t recognize the reality of the trading business.”31 He points out that Goldman’s sales and trading revenues outstrip those of the advisory businesses, financing, and money management, and there are no clients in sales and trading—only buyers and sellers. There should be transparency, Levitt suggests, but no expectation of a “fellowship of buyers and sellers that will march into the sunset” together. Goldman should stop using “clients first” in promoting itself, Levitt argues, because of the conflicts inherent in trading—the natural and ever-present tension between buyers and sellers.

  This argument hit home for me when I compared one of my first experiences as an analyst at Goldman with my later experience as a Goldman client. When I was a first-year financial analyst in 1992, I was assigned to work with Paulson and a team of investment bankers to advise the Chicago-based consumer goods company Sara Lee Corporation. The project was
to review Sara Lee’s financial and strategic alternatives related to a particular management decision. Paulson was demanding, and he instructed us to leave no stone unturned.

  We worked 100-hour weeks, fueled by Froot Loops and Coca-Cola for breakfast and McDonald’s hamburgers and fries for lunch and dinner. We performed all sorts of financial analysis, trying to make sure we thought of every possible alternative and issue. We also collected ideas from all the experts Goldman had. In the end, we had a presentation book 50 to 70 pages long for the client, plus another 100-page backup book. We made sure that every i was dotted and t was crossed, every number corresponded to another number, every financial calculation was accurate, and every number that needed a footnote had one. Perfection and excellence were expected—not only by Paulson but also by everyone else at the firm—no matter the personal sacrifice.

  At Sara Lee’s offices, all five of us from Goldman, including Paulson, waited anxiously to go into the meeting. When we were ushered into the boardroom, we took seats across the table from Sara Lee’s CEO, John H. Bryan, who would one day join the board of Goldman. After saying our hellos, we started putting our material out on the table. However, Paulson sat down next to Bryan, across the table from the rest of the Goldman team. After Paulson made some introductory remarks, speaking to Bryan as if no one else was in the room, we started presenting our analysis, the pros and cons of the alternatives, and our recommendations. (I had no speaking role; I was at the meeting in case someone asked any questions about the numbers. This was customary at Goldman—to watch and learn.)