Money and Power (44 page)

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B
OTH ARTICLES, THOUGH,
focused especially on the question of whether Goldman had sufficient capital to compete in the rapidly changing markets and to provide liquidity to the growing number of partners who were retiring. Would Goldman go public as many firms had, including Morgan Stanley in March 1986 and Bear Stearns in 1985? Unlikely, was
Forbes
’s verdict, pointing out that the firm had $1.2 billion in capital at the end of 1985. “With $1.2 billion and $750 million in excess, we have all we need to serve our clients,” Weinberg said. To the
Times,
he also minimized the possibility that the firm would go public anytime soon. He reiterated that Goldman had all the capital it needed and the partners could plot their “strategies without having to worry about quarterly earnings.”

There was a thread of concern—voiced by anonymous others—that Goldman might need additional capital to compete with Merrill Lynch, which had $2.6 billion of capital, and Salomon Brothers, which had $2.3
billion, as the business became more capital intensive. There was also a sense that a downturn in the business was inevitable and that Goldman would need capital to absorb future losses. “We’re going to have to manage the downside of the cycle,” Rubin told the
Times
. “The 30-year-olds were not on Wall Street during the last downside, even most of the partners weren’t partners then.”

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N
OT SURPRISINGLY GIVEN
Goldman’s ability to muddy the PR waters, Weinberg’s assurance about the firm’s comfortable capital position was an impressive head fake. It turned out that within weeks of the announcement of the GE deal, a partner at
McKinsey & Co., the management consultants, had secretly approached Rohatyn and Lazard about the possibility of taking on a new client,
Sumitomo Bank, Ltd., the giant Japanese financial institution. A few weeks later, on January 10, three executives from Sumitomo plus the McKinsey partners came to Rohatyn’s thirty-second-floor office at One Rockefeller Plaza. The Japanese banker explained their audacious idea of buying a chunk of Goldman Sachs so that Goldman could teach Sumitomo about the investment banking business. They wanted Rohatyn’s help to try to make a deal with Goldman. “
Implicit was always the idea that they wanted a passive window into the investment banking business,” Rohatyn explained. “I told them we had the highest regard for Goldman, that they were one of the best-managed, if not the best-managed, firms in the business.” In February, Rohatyn flew to Tokyo to meet with the Sumitomo executives, where the seriousness of Sumitomo’s intent was conveyed to the Lazard investment banker.

Ironically, while Rohatyn was in Tokyo getting his marching orders, Goldman’s traders were busy losing another $200 million in trades they were having trouble understanding. That was the moment when Rubin and Friedman first broached the idea of an IPO of the firm with the
Management Committee. Not only would having more capital help the firm absorb these outsize trading losses—until they could be stanched—but a group of older Goldman partners were looking to take as much as $150 million of their capital out of the firm and then retire. Then there was Goldman’s evolving business plan, which required more capital to increase Goldman’s principal investments in
proprietary trading, private equity, and real estate. Upon hearing Rubin and Friedman’s pitch, the Management Committee—comprising partners nearing the end of their reigns—could see the wisdom of cashing out with an IPO. The consensus on the committee was that the firm should go public sooner rather
than later. While Weinberg claimed to be largely indifferent to the idea, he endorsed the consensus view and agreed that Rubin and Friedman should present the idea to the annual partnership meeting later that year.

Then in March, Rohatyn called Weinberg out of the blue and broached the idea for the first time of Goldman taking an investment from Sumitomo. Unsure of what to think about such a far-fetched idea—this was well before foreign investment in the United States became commonplace—Weinberg agreed to have the meeting. In an effort to avoid being detected,
Koh Komatsu, the president of Sumitomo, and a colleague took a page from a le Carré novel and flew from Osaka to Seattle and then from Seattle to Washington, and then flew up to New York on the shuttle. Wearing dark glasses to avoid being detected, they arrived at 85 Broad Street to see Weinberg. “
I had to tell him,” Weinberg recalled, “that taking the shuttle from Washington National to LaGuardia was no way to hide. Those planes are full of guys from Wall Street—and reporters!” But what Komatsu proposed that day was as audacious as it was brilliant: for $500 million—not a penny less—Sumitomo would take a 12.5 percent stake in Goldman and agree to have no voting rights and no role in the firm’s governance. Sumitomo’s offer valued Goldman Sachs at $4 billion, a whopping 4.6 times Goldman’s $868 million in equity capital and an equally astronomic 3.3 times Goldman’s total
capital of $1.2 billion, which included another $333 million of subordinated debt. Goldman’s rival, Morgan Stanley, had sold a portion of itself to the public at a valuation below three times book value. There was simply no ignoring an offer this sweet.

Weinberg could barely contain his excitement after Rohatyn and the Sumitomo executives had left his office. He called up his partner
Donald Gant, a Harvard Business School graduate and investment banking coverage officer. “You won’t believe this, not in a million years,” he told Gant. “But I’ve just had the most amazing visit. Don, this may be nothing, but if it does work out, it could be very, very big. Come over to my office right away so I can fill you in. We’ve got work to do!” When Gant arrived, Weinberg told him about Rohatyn’s visit with the two Japanese bankers, wearing dark glasses. “Don, give Felix Rohatyn a call right away to see how serious this guy is about what he said to me,” Weinberg recalled, “that Sumitomo Bank wants to be a partner in Goldman Sachs. See if they’re really serious! Who knows? We may soon be
Goldman Sake!”

Gant, who knew Rohatyn a little from the deal world, spoke with the Lazard banker and reported back to his boss that Rohatyn and Sumitomo were indeed serious. “We can’t just dismiss it,” Gant told Weinberg.
“They have the money and want to be a silent partner. If we negotiate this the right way, Rohatyn says we can write our own ticket.” Weinberg deputized Gant to take the lead in the negotiations. “Knowing the Japanese, it could take a lot of time!” Weinberg said. He knew the Japanese well, having fought them as a marine during World War II and having been in Nagasaki after the bomb had been dropped to help open a prisoner-of-war camp.

Gant and Goldman’s chief financial officer,
Robert A. Friedman, spent the next few months negotiating the deal with Rohatyn and three of his Lazard partners. “
The negotiations were long and difficult,” the
Times
reported, as the two sides had to balance the rules about foreign ownership, what commercial banks were allowed to own of investment banks, and Goldman’s desire to have the Japanese money without giving up anything close to control or influence. Goldman also knew how powerful another $500 million in equity could be—it was close to 60 percent of Goldman’s equity capital, which had been built up over 117 years—especially when it could be leveraged thirty times over. That $500 million could be turned into $15 billion of trading power. In the end, the two sides agreed Sumitomo would pay $500 million to buy a form of debt convertible into 12.5 percent of Goldman’s equity over time. Also, either side could terminate the deal after ten years.

At the end of June, Goldman’s partners overwhelmingly voted to endorse the deal and it was announced publicly in the first week of August. Although the
Federal Reserve still needed to approve the investment, it was big news.

At first, the Federal Reserve did not like the deal, which resulted in a lot of “
soul searching,” according to the
Times
. “At issue to many Fed officials is whether a foreign banking institution’s purchase of a 12.5% nonvoting ownership stake in an American securities firm sets a bad precedent and is, in fact, legal considering the separation of banking and underwriting set forth in the Glass-Steagall Act of 1933,” the
Times
reported. “Fed officials seem to worry that control is a subtle influence and that, despite the nonvoting agreement, Sumitomo might end up exerting some influence over Goldman’s activities and decisions.” The Fed decided to hold a public hearing on October 10. “We want people to discuss not only the specific terms of the Sumitomo-Goldman deal but the broader issues,” a Fed official explained. “Is this the end of Glass-Steagall, or is this indeed just a passive investment?”

At a rare public hearing at the Fed, which was attended by more than two hundred people,
Michael Bradfield, the general counsel, seemed particularly focused on whether the investment would
“lead to
Sumitomo influencing the management decisions of Goldman Sachs” and be a violation both of Glass-Steagall and the Bank Holding Company Act of 1956, which limits to 25 percent the nonvoting stock ownership from another entity. While the worry about
Japanese control of an American financial institution seems quaint after that country’s epic economic collapse in the 1990s, the concerns about the breaching of Glass-Steagall were prescient—and ironic, considering Robert Rubin’s role in repealing the law when he was Clinton’s treasury secretary, after which he took a very high-paying job at
Citigroup, a chief beneficiary of the law’s repeal.

Scott Pardee, a vice chairman of
Yamaichi International who had worked at the
Federal Reserve Bank of New York for nineteen years, testified that the distinction the Glass-Steagall Act made between commercial banking and investment banking was an important one and worth preserving. “
I may be old-fashioned,” he said, “but I believe that there are distinctions that can be made between the two kinds of business. I think those distinctions are major. A commercial bank accepts deposits and has a responsibility for the safekeeping of depositors’ money. For a bank to use depositors’ money to engage in high-risk business raises the stakes for everyone, including the depositors, the bank’s competitors, who may feel obliged to follow suit, and the central banks, which must stand ready to perform their lender of last resort function, should the bank fail to maintain adequate capital and sufficient discipline in risk management.” While he said he did not think the deal under consideration violated the intent of Glass-Steagall, he added, wisely, his concern that “as the globalization continues … you will require more resources and active involvement” from the Federal Reserve.

On November 19, the Fed approved the deal after both Goldman and Sumitomo agreed to make subtle changes to it, including capping the Japanese investment, requiring that Sumitomo raise more capital—highly unusual since Sumitomo, as a Japanese bank, did not fall under the Fed’s jurisdiction (despite the fact that Sumitomo owned a small bank in California)—and that Goldman and Sumitomo not move forward with their planned business joint ventures in London and Tokyo. It marked the first time a large foreign bank holding company had taken a significant stake in an American securities firm. “In our view, with these changes the investment is truly passive,” Bradfield said. In a statement, the Fed said, “The board was concerned that this combination of significant equity investment and maintenance of extensive business relationships would give the investor both the economic incentive and means to exercise a controlling influence over the management policies” of Goldman. Weinberg seemed happy to make the changes. “This was a passive
investment from the first word,” he said, “and there was never a desire on Sumitomo’s part to get control.”

The Fed’s approval cleared the way for Goldman to get Sumitomo’s money by December 1. “This will give us additional capital to provide clients with a broad range of investment,” Weinberg said. But the bigger question floating around the halls of 85 Broad Street was whether the Sumitomo capital was enough. Should Goldman still go public as Rubin and Friedman had proposed earlier in the year?

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T
HIS WAS THE
question confronting the 104 Goldman partners who had gathered Saturday morning, December 6, in the firm’s second-floor meeting room. It had been a surreal few days before the meeting. Not only had Goldman received the Sumitomo millions on December 1—and now had a large Japanese bank as an investor—but that same day, thirty-seven new partners had been named. The nine-member
Management Committee had already endorsed the idea of an IPO and in the days leading up to the partners’ meeting had been canvassing the rest of the partnership for their support. Fairly uniquely on Wall Street, each partner’s vote counted as one, regardless of how many shares he—or she—owned. (The firm’s first woman partner, Jeanette W. Loeb, had been selected on December 1.) That meant that the thirty-seven new partners would have just as much say as the Management Committee—but a totally different agenda. As new partners, they had not had the chance to build up their wealth in the firm, and many of them believed it was too soon to go public.

The nine members of the Management Committee sat on the stage at the front of the room facing the ninety-five other partners in the audience. Many members of the committee spoke up in support of the IPO, but everyone paid particular interest when Friedman and Rubin got up together to speak in favor. Weinberg had positioned them, after all, to lead the firm after he retired. They made the case that with even more capital, Goldman could soon be a rival to Salomon Brothers in trading and could also become a leader in
proprietary trading (for its own account) as well as in private equity and other forms of principal investing. Then they touched on the issue of partner liability. As a partnership, each of them individually was responsible for absorbing the losses the firm incurred in an amount equal to his entire net worth. This was no small worry, given the recent trading losses and such existential threats as the lawsuits that had hit the firm in the wake of the Penn Central bankruptcy. Who knew what might be lurking out there that could zap Goldman again? Rubin and Friedman argued that the time had come for
the IPO for many reasons, with the hope being that if the partners agreed it could be done before the next financial crisis, which Rubin for one suspected was imminent.