Money and Power (39 page)

T
here was much less internal debate at Goldman, Rubin stated, not entirely accurately, about another momentous decision: to buy, in October 1981,
J. Aron & Company, the nation’s largest supplier of green coffee beans and a major trader of precious metals and commodities with more than $1 billion in revenues in 1980. Not only was the acquisition of J. Aron the largest in Goldman’s history, but it was also the only major acquisition the firm had ever made, aside from buying one or two small, regional commercial paper providers at the time of the
Great Depression. Nearly alone on Wall Street, Goldman had—to that point—shunned major acquisitions as a way to grow its business for fear of diluting its insular corporate culture and because of the inherent difficulties of integrating
mergers under any circumstances.

The idea for the acquisition of J. Aron evolved as Goldman’s arbitrage business became more and more sophisticated—and profitable—over time. As part of his job, Rubin was always on the lookout for arbitrage opportunities, and not necessarily those involving two merging companies. Sometimes two securities trading independently but linked through a derivative presented an arbitrage opportunity. After reading up on one such opportunity involving the warrants and equity
of
Phillips Petroleum, Rubin—then not a partner—wrote a long memo suggesting that the firm buy Phillips’s common stock and sell its warrants (the right, but not the obligation, to buy Phillips’s common stock). Rubin gave the memo to Tenenbaum, who passed it along to Levy. He called Rubin into his office. “
Ahh, I don’t want to do all that,” Levy told Rubin. “Let’s just go short the warrants.”

“Gus,” Rubin replied, “you know we have to be hedged.”

But Levy had decided and couldn’t care less if Rubin thought the firm should be hedged. “Gus responded with a five-word sentence conveying that he
didn’t care about hedging, didn’t care about my memo, and didn’t care about explaining the matter,” Rubin explained, “because if I didn’t know this stuff, I shouldn’t be at the firm in the first place.”

“I don’t have time for on-the-job training,” Levy told Rubin.

Rubin asked Tenenbaum what he should do since he suspected that constructing the trade the way Levy demanded would expose the firm to unnecessary risk. L. Jay told him that he should short the Phillips warrants, as Levy had said. Rubin did as told, and the firm made money. “[F]ortunately the stock didn’t run up while we were holding the position,” Rubin said.

Rubin’s experience trading the Phillips warrants led him to explore whether money could be made exploiting the illiquidity that then existed in the over-the-counter trading of options, which were the right, but not the obligation, to buy specific amounts of stock in a company at a specific price by a specific time. In other words, buying and selling options was—and is—a form of legalized gambling. That was especially so in the 1960s and early 1970s before options began to be traded on an exchange—which began in 1973, with the creation of the Chicago Board Options Exchange, or CBOE—and were traded among less-than-reputable securities dealers. “
Prices were not transparent, to say the least,” Rubin explained, but he believed his arbitrage desk could make money trading them. Over time, Rubin came to the conclusion that Goldman could supplant the unsavory options dealers by trading options directly with its clients, other Wall Street firms and investors. There was money to be made.

But Rubin’s proposal met with some initial resistance from his partners, who were well aware of Sidney Weinberg’s dictum against trading options, a carryover from Weinberg’s belief that options trading had been one of the causes of the problems Goldman had with the
Goldman Sachs Trading Corporation. By the time Rubin proposed the idea to Levy, though, Weinberg was dead. “If you want to get involved with options, go ahead,” Levy told him and then got the Management Committee to approve it. The creation of the CBOE allowed option trading to flourish by creating standardized terms for listed options and a clearing system—whereby there was a method to make sure one party to a trade did not welch on it—for secondary trading. Rubin remembered how
Joe Sullivan, the founder of the CBOE, came to see him sometime in 1972 and explained how it was going to work. Rubin introduced Sullivan to Levy, “who listened to him and said, with a twinkle in his eye, that this was ‘just a new way to lose money,’ and then offered his support.” Rubin went on the CBOE’s founding board of directors. He remembered that before the first trade on the CBOE—on the morning of April 26, 1973—Sullivan
called him with a concern that no one would show up to trade the options. Rubin had also hoped that Goldman could do the first trade. In the end, on that first day, 911 options contracts traded for sixteen underlying stocks. “
[O]ptions trading turned into a genuinely liquid market and led to the creation of large markets in listed futures on stock indices and debt,” Rubin explained.

Based on Goldman’s success trading options, around 1978 Rubin pushed the firm to start trading commodities. “We’re in the arbitrage business,” he told George Doty. “We’re in the options business. It’s not that different than commodities. So why don’t we go in the commodities business?” Doty agreed with Rubin. The firm decided to get into the commodities business “in a small way” by hiring
Dan Amstutz, a grain trader at
Cargill, to start trading agricultural commodities as part of Rubin’s arbitrage department.

J. Aron had been a banking client of Goldman’s for many years, and Goldman was J. Aron’s futures broker. The company had been founded in New Orleans in 1898 by
Jacob Aron as an importer of green coffee beans. In 1915, J. Aron opened an office in New York City at 91 Wall Street. The firm was conservatively run. Its principal business evolved into buying and selling commodities in different geographic markets—for instance, buying sugar or rubber in New York and selling in London—and capturing the price differential as profit. “Our plan of operation calls for being long or short up to a maximum of twenty seconds,” Jack Aron, the company’s chairman and Jacob’s son, once said. Jack Aron had known Gus Levy for many years, and both were active in the Jewish community and in their support of
Mount Sinai Hospital.

Occasionally, Aron would talk to Levy about the sale of the family’s business. Whitehead was also part of the discussions. In 1979, with Aron looking to retire and take his money out—his sons were not interested in the business—Goldman came close to buying J. Aron. But the deal fell apart over how to handle the tax liability related to a major trading gain J. Aron had embedded in its balance sheet. Soon thereafter, Jack Aron decided to sell his stake in J. Aron to the other partners in the business, led by the shrewd
Herbert Coyne, his brother Marty, and twelve other shareholders.

For his part, George Doty got to know J. Aron through work he was doing with the firm to help create tax-deferral schemes for Goldman’s partners. As a result, he became an increasingly supportive proponent of seeing if Goldman could buy the business. In 1981, that chance came again when Coyne asked Goldman to help it find a buyer for J. Aron, as consolidation was rampant in the
commodities trading business. J. Aron
received a bid from Engelhard Minerals and Chemicals Corporation, a publicly traded company, but J. Aron did not want to be part of a public company for fear that competitors would learn just how obscenely profitable it had become. “
Aron’s philosophy was ‘Never tell anybody how much money you make, just smile on the way to the bank,’ ” explained one former Aron partner. Coyne and his partners rejected the Engelhard offer.

That’s when Whitehead, Doty, and Rubin got the idea that maybe Goldman should buy Aron. After all, Goldman was still private—thus eliminating the largest obstacle for a sale from the Aron perspective—and the business had been incredibly profitable, with return on equity in the range of 70 percent annually, well in excess of Goldman’s business, in large part because J. Aron made more money than Goldman did on a per-employee basis. “These people seem to have the same culture we do, and it’s a business we can understand,” Rubin told Doty. “Maybe we should try to buy them.” By then, Rubin had been appointed to Goldman’s
Management Committee after Young had retired. Whitehead and Weinberg were also on board for making the acquisition.

But not everyone thought buying J. Aron was a good idea. Whitehead had asked
Steve Friedman to analyze the deal and make a recommendation. He did not see the fit between J. Aron and Goldman Sachs. “
I looked at it and I basically thought, ‘Culturally—I’m a merger guy, I know how difficult it is to make cultures work—I don’t see this working culturally at the senior levels,’ ” Friedman said. “And we’re paying a heck of a price, in terms of goodwill.” Friedman had no problem with Goldman being in the commodities trading business but preferred the approach of finding the right people and building the business the Goldman way. Friedman thought that approach would be less costly—financially and culturally. Friedman wrote a memo to Whitehead arguing that Goldman should pass on the J. Aron deal and build a commodities trading group itself. “
Whitehead was somewhat annoyed with me because he asked me to get involved and then I disagreed with his judgment,” Friedman said.

Despite some internal opposition from other partners, at the end of October 1981, Goldman announced it was buying J. Aron, which had some $1 billion in annual revenue and $60 million in profits. In an interview with the
Times,
Whitehead declined to state the price Goldman paid, but the newspaper pegged it at “
slightly more than $100 million,” or nearly half Goldman’s $239 million of capital (other estimates ranged from $120 to $135 million to as much as $180 million). One seat on Goldman’s Management Committee went to a J. Aron partner, and six J. Aron partners became partners of Goldman, 10 percent of the partnership
ranks—not one of which had been vetted in the traditional, rigorous
Goldman way. “
While we prefer not to discuss the price involved,” Whitehead said, “we can say that the five top officers of J. Aron will become partners in our house”—it ended up being six partners—“and that J. Aron will continue to operate with its present staff” of around four hundred people “and company name, which is too well known around the world to change.”

Goldman’s acquisition was as much a reaction to what its competitors were doing as anything else. By 1981,
Salomon Brothers had been acquired by Phibro Corporation (with the whole business later being renamed
Salomon Brothers, Inc.), and Donaldson, Lufkin & Jenrette, or DLJ as it was known, the midsize but plenty savvy investment bank, had bought
ACLI International, another large
commodities trading business. At the same time as some Wall Street firms were getting into the commodity trading business in a big way, others were selling themselves outright: by then,
American Express had bought
Shearson Loeb Rhoades,
Prudential Insurance had bought
Bache Halsey Stuart Shields, and Sears, Roebuck, the longtime Goldman client, had bought Dean Witter.

Whitehead’s vision for J. Aron was that it could vastly increase Goldman’s reach into trading commodities and gold and would allow the firm to provide its clients with the opportunity to trade stocks and bonds in any currency anywhere around the world. Before J. Aron, he said, Goldman’s clients would have to go to a commercial bank if they wanted to trade in, say, Swiss francs. He wanted to change that dynamic. “
I saw huge moneymaking opportunities,” he said, “for instance, if we could have bought the entire coffee crop of Brazil, in one transaction with the Brazilian government, at a fixed price, and then sell it simultaneously to the coffee makers in the United States.” He said with J. Aron, Goldman could assume the responsibility for storing the coffee in Brazil, for putting it on ships, for bringing the ships to New York, for insuring it, and then for selling the coffee at the same time to the coffee companies. “We could have supplied them with all their coffee,” he said, “ready to be ground, in a warehouse in New York for X dollars. I saw that as a big arbitrage opportunity. The efforts to do something like that in the first couple of years were unsuccessful by the Aron people. They weren’t used to taking any positions at all, not a single dollar of risk. I saw this as a riskless transaction. We would get the insurance in advance, we would get the warehouse rented in advance, we would think of all the things that might happen and hedge ourselves against those and take them into consideration and still provide coffee beans in New York at a lower price than all the big coffee companies could buy them if they went on their
own. And so eventually it worked, but it only worked after Goldman people had taken over the management of J. Aron, which they basically did within five years after we had acquired it. There were hardly any J. Aron people left.”

——

B
UT MUCH AS
some of the partners, especially
Steve Friedman, had feared, J. Aron was a near disaster for Goldman from the start. The six J. Aron partners and their four hundred colleagues seemed like a poor fit at the buttoned-down Goldman—“
[I]t was something of a shock to find a division full of people who would not have made the first cut,” Lisa Endlich wrote—and many of the younger, ambitious Goldman bankers and traders were offended that six coveted partnership spots had been ceded to the J. Aron crew, making their path to the top even more difficult than it already seemed to be. Such was the growing level of antipathy between the two groups that in the 1983 Goldman “annual review” photograph, the former J. Aron employees—including
Lloyd Blankfein—wore red suspenders in order to mock the straitlaced Goldman bankers. “J. Aron was a graft on the body which never took,” according to one former Goldman partner.

But what led to near-open revolt at Goldman was the simple fact that the J. Aron business stopped performing financially. “
It was less than six months after that that all of a sudden, instead of being this very profitable thing, they started not making money,” Rubin explained. Part of J. Aron’s competitive advantages were lost when its competitors became better capitalized after being bought by DLJ and Salomon, and part was lost when those who left J. Aron after the Goldman acquisition took their intellectual capital to other firms that could then compete more effectively against J. Aron. Whatever the reasons, J. Aron quickly became a major problem for Goldman. In 1982, J. Aron’s profits were half of what they were the year before, and by 1983, the profits were gone. “
You had the combination of people not really blending well together,” one former partner of both firms said. “There was defensiveness on the part of the Aron people. If you were making $50 million it would not have mattered but we weren’t making any money, we were just sort of surviving.” He recalled speaking with one of the senior Goldman partners. Echoing Walter Sachs, “He said, ‘Anybody can be your partner when things are going well. Now you’ll find out who your good partners are and who are not.’ I have never forgotten that and I still think about it today. He was right.”