What Happened to Goldman Sachs: An Insider's Story of Organizational Drift and Its Unintended Consequences (21 page)

Is Goldman Likely to Recognize the Change?

The perception of Goldman changed virtually overnight in 2008. I analyzed 345 selected articles in the
New York Times
from 1980 to 2012 and categorized them as positive or negative based on tone. From 1980 to 2007, no matter how I cut the data by time period, the number of positive articles was always higher than the number of negative articles (the total was 288 positive articles to 118 negative, for a ratio of 2.4 times as many positive). Using the same criteria, from 2008 to 2012 there were 103 negative articles to 57 positive articles, for a ratio of 0.6 times as many. I divided the articles into topic categories, and the two most common negative article topics were Goldman’s conflicts with clients and its connections to the government.
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When Goldman announced it would review its business practices, Blankfein explained that there was “a disconnect between how we as a firm view ourselves and how the broader public perceives our role and activities in the market.”
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Goldman was concerned not only about public perception but also about client perception. The firm’s business standards committee commissioned an independent study conducted by a prestigious consulting company to interview two hundred clients to explore their concerns about whether the firm still lived up to its core values and business principles after the rapid growth and shift in Goldman’s business mix toward proprietary trading.

Management had been enthusiastic about the proprietary trading business since the early 1990s but approached it carefully, with top talent and “attentive management,” and, financially, it was an “unqualified success.”
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Still, the study revealed that clients believed Goldman was placing too much emphasis on its own interests and not enough on those of its clients. The report stated, “Clients raised concerns about whether the firm has remained true to its traditional values and business principles given changes to the firm’s size, business mix and perception about the role of proprietary trading. Clients said that, in some circumstances, the firm weighs its interests and short-term incentives too heavily.”
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Clearly, Goldman knows that it has a serious public relations problem. The business standards report expresses Goldman’s recommitment to the core values that once made the firm the most respected of Wall Street institutions. However, some clients I interviewed said that Goldman’s response has been more to increase its investment in public relations and public service, and to reassure clients and the public that Goldman has not lost its customer focus, and less to make substantive changes such as spinning-off or closing businesses, as the firm had done with the Water Street Fund when clients complained. The clients are not surprised because Goldman is in a much more powerful position than it was then.

The lead in the
Wall Street Journal
’s sneak peek at highlights of the business standards committee’s report attributes a defensive motive to Goldman’s imminent release of the report: “Goldman Sachs seeking to beat back criticism that it abused its muscle and trading savvy to put its own interests ahead of clients, agreed to release details on how and where the Wall Street giant makes its money.”
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The report was released “to great fanfare” but was not received by the outside world with much enthusiasm.
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Its primary purpose seemed to be “a more aggressive defense of Goldman’s image, not a deep restructuring of its business model.”
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Or it sought “to reassure Goldman’s clients, to placate regulators, and to direct employee activity.”
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More bluntly, the report was described as “an exercise in misdirection.”
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The starting point for evaluating the report must be the assumption that Goldman is not very likely to shift away from trading, because “at least as Goldman has pursued it … [trading] can make money in good markets and bad” and because it cannot return to its earlier self: “smaller and a partnership that defined itself as an adviser or intermediary.”
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The media’s treatment of the report implied that it avoided the real issues, including Goldman’s “size, complexity and the role of shareholders and employees.”
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What some found most notable was that the report did not include “mention of any issues that are of first order importance regarding how Goldman (and other banks of its size and with its leverage) can have big negative effects on the overall economy, [even though] one of Goldman’s business principles is ‘we consider our size an asset that we try hard to preserve.’”
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Consequently, another critic claimed that the report read “more like a consultant’s brief—banal, crowd-pleasing, and recommending organizational changes. It will, for this reason, be little read and less heeded.”
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In May 2013, Goldman released a thirty-page report on its business standards that followed up on its January 2011 report. Goldman stated that by February 2013, all thirty-nine recommendations had been fully implemented. The report’s opening line is “Our clients’ interests always come first.” The report’s standards address relationships with clients and conflicts of interests, with an emphasis on client understanding, transparency, and disclosure. The media reaction was that “ambitions like these are frequently aspired to in public policy statements, but are difficult to effectively implement … in the profit-led and bonus-driven culture of Wall Street that led up to the financial crisis. Such a culture is most prevalent among traders and front-office staff, but it can also influence compliance and control functions.”
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Hiring Lawyers

On August 22, 2011, shares of Goldman tumbled nearly 5 percent, knocking $2.7 billion off the firm’s market value, after a report that Blankfein had hired a prominent criminal defense lawyer. Goldman portrayed it as routine, given the several government investigations faced by the firm. But the sharp reaction in the stock price showed the fragile nerves of investors, who were worried that potential legal liability could damage the firm and its earning power.
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Goldman executives were expected to be interviewed by the Justice Department. The agency was conducting an inquiry that resulted from a 650-page report produced earlier in 2011 by the Senate Permanent Subcommittee on Investigations. That report said that Goldman generally had misled clients about its practices related to mortgage-linked securities.

Some partners told me that Blankfein’s action was interpreted and processed by Goldman employees. However, some of the partners also saw it as a reflection of a change in culture and the environment. They said that now if an employee is unhappy with a bonus or feels he or she was unfairly passed over for a promotion, he or she will consider consulting a lawyer or speak to human resources (or both). They said partners privately complain about such behavior as a change in culture and rationalize it as a “sign of the times.” They said employees were following the lead of the executives, who had resorted to legalese defensive language in the hearings by executives. In any case, some conceded Blankfein’s actions had the unintended consequence of supporting behavior that would not have occurred otherwise.

Identity and Identification

The most recent glaring criticism of Goldman’s reputation came from Greg Smith, an employee who had worked at Goldman for twelve years. Smith delivered his resignation in an op-ed piece published in March 2012 in the
New York Times:
“Why I Am Leaving Goldman Sachs.”

In the op-ed, Smith attributed his resignation to the drastic changes in Goldman’s culture in the past decade or so: “The firm has veered so far from the place I joined right out of college that I can no longer in good conscience say that I identify with what it stands for.”
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He pointed out specific symptoms of the current “toxic and destructive” environment, such as referring to clients as “Muppets.”

More significantly, Smith pointed out the lack of focus on clients, which had been crowded out by a “how much did we make off the client?” attitude. Smith saw Goldman’s cultural ills as the result of leadership style—specifically charging that Blankfein and Cohn had “lost hold of the firm’s culture on their watch” because of a sea change in the way the firm thought about leadership. Smith claimed that there were now three quick ways to become a leader at Goldman: persuading clients to invest in the things Goldman wanted to get rid of because they were not sufficiently profitable; hunting elephants—that is, getting clients to buy things that may be wrong for them but have the highest profit potential for Goldman; and finding yourself “sitting in a seat where your job is to trade any illiquid, opaque product with a three-letter acronym.”

Goldman’s formal internal response to Smith’s op-ed piece, issued over the signatures of Blankfein and Cohn, characterized Smith as “disgruntled” and expressed disappointment that an individual opinion spoke louder than the “regular, detailed and intensive feedback” from the 89 percent of employees who believed Goldman served its clients well.
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Citing both internal and external surveys, Blankfein and Cohn maintained that Smith’s assertions did not “reflect [Goldman’s] values … culture and how the vast majority of people at Goldman Sachs think about the firm and the work it does on behalf of our clients.”
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Though Goldman aggressively dismissed both Smith and his accusations, some current and former employees say that there is “a sizable, yet silent contingent within the investment bank, a group of people who are increasingly frustrated with what they see as a shift in recent years to a profit-above-all mentality.”
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Therefore the normalization process doesn’t impact everyone in the same way and at the same time. While many partners I interviewed thought that the culture had not changed, there were a few that would admit it and could see it. Two partners I interviewed admitted that they may be in the minority in seeing or admitting the culture has changed. I asked why they did not leave. They explained that they heard the culture is much worse at other firms. Also, they know of others leaving and being bored, unimpressed, and disappointed with their new employers. They said there are many things they like about Goldman, such as individual friends/relationships, the intelligence and drive of the people, the social status (which they said had taken a hit, but they believed most people still think it is the best and most prestigious firm with the best people), the network internally and externally one builds at the firm, and the good work that the firm and its people do. They talked about how much good the firm and its employees do that gets no real press. They said the firm is better run operationally today than it ever has been, but admitted that its operational efficiency does not mean the culture has not changed.

Goldman performed an exhaustive investigation of Smith’s allegations, including combing through e-mails looking for the word “Muppet,” and claimed it found nothing material. However, it was unclear to a partner I interviewed if the goal was to prove Smith wrong, to identify badly behaving people and punish them, to show that Goldman is taking the charges seriously, to frighten staff into being more discreet in what they write in corporate e-mails—or all of the above.

Goldman aggressively went after Smith personally. But one partner I interviewed explained with reflection that in the end it didn’t matter whether Smith was disgruntled or not, too junior or not, in enough strategically important areas of the firm or not, motivated by money or not, and it didn’t even matter whether he got the reasons right; at a high level, his letter was making a basic claim: that the culture of Goldman had changed from when he started, and for the worse. That statement could not easily be dismissed, because after the hearings, the fines, the negative articles, and the investigations, and the executives’ responses to them, many people were taking a minute out of their busy lives and daily routines and looking around and starting to wonder whether the culture itself had indeed changed. But for whatever reason, most people went back to their jobs, and maybe the silent group would slowly leave not just Goldman, but the industry.

Another partner compared what Smith had done to an employee who had been elected partner in 1994 and whose name had been listed publicly as being elected. But then he turned down partnership and left the firm to join a private equity firm with a reputation of values in its industry. The partner explained it was hard for the firm to dismiss him, considering he was elected a partner just weeks prior, but as if it were standard operating organizational response, rationalization rumors of why he didn’t accept were whispered. But when the event happened, whether or not intentional, it sent a signal questioning what was going on at the firm in 1994 that someone would turn down what so many were looking to become, and maybe people thought about what it meant and then went back to their daily routine. I remember it was only discussed very privately because it was a very sensitive topic. Maybe it was a data point for those already wondering about the firm, and then they just quietly left. Maybe, the people who stayed processed it and it impacted their future behavior. Based on my interviews and my own personal experience, upon reflection it had some impact, but what or how much is unclear.

Why Do Clients Stay?

Despite public outcry and even disappointment among clients, Goldman doesn’t lack for business. Its brand is still highly rated, and Goldman offers a unique value proposition to clients for several reasons, primarily related to access, information, risk management, and people.
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Goldman has the best network of connections globally and attracts the best and brightest people. For the Vault Banking Survey in 2012, some thirty-five hundred investment banking professionals were interviewed. For the thirteenth straight year, banking professionals named Goldman the most prestigious bank to work for in North America. Professionals also ranked Goldman first in Europe.

Goldman is in the center of a large information flow that it gathers from clients. Goldman uses its risk management capabilities and its culture of teamwork to gain insights and then packages the insights and information, makes timely introductions, and executes smart trades. According to client interviews, the firm will continue to excel and dominate, because, relative to its competitors, it generally provides better advice, information, access, and liquidity. However, there are signs that Goldman’s culture continues to drift, and therefore Goldman runs the risk of becoming less ethically distinguishable than its competitors in the long term (if it isn’t already). Many competitors and clients believe that ethically Goldman is already where the rest of Wall Street is—but smarter about it. However, they generally agreed that its ability to execute and take advantage of the information and network and use it for itself and its clients is unparalleled. And so until there is a system failure of such massive proportions from unintended consequences or significant regulatory changes, it is difficult to imagine that Goldman will not continue its leadership position.

Why do people continue to do business with Goldman? The simplest answer is that they need to, although that does not necessarily mean they are always happy about it. Some profess to a love-hate relationship.
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For example, a senior executive at a large European industrial company claims not to be very concerned about Goldman’s image problems: “We hated Goldman as a matter of policy. You kept your hands in your pockets when you dealt with them … They are indeed very aggressive and you better not turn your back on them … They are also highly competent. It is like everywhere else: high risk equals high return. If you deal with Goldman you always have to keep that in mind and then you can’t complain if the more intelligent guys are sitting on the other side of the table.”
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Referencing Taibbi’s
Rolling Stone
article, a client I interviewed said Goldman is everywhere; it is the most powerful investment bank. When I rhetorically asked if it is “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money,” he said not exactly, but then he explained that Goldman is everywhere, knows everyone, and is wherever there is a market in which to make money.
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And to make money as an investor, he needs to deal with them and get along with them.

Moving into the credit crisis, with trading and principal investing contributing 68 percent of the company’s 2007 revenue, compared with 9 percent from advisory fees, some clients questioned whether they could count on Goldman to provide unbiased advice:

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We always need to worry a little about Goldman because we need them more than they need us, and the firm is run by traders,” Todd Baker, then-executive vice president for corporate strategy and development at Washington Mutual Inc., wrote in an October 2007 e-mail to Kerry Killinger, CEO at the time. Killinger, in considering whether to hire Goldman Sachs for advice on transferring credit risk off of WaMu’s balance sheet, wrote back, “I don’t trust Goldy on this
…”

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There was an underlying suspicion that Goldman did play in the gray areas [of the law], and I’ve spoken to a number of clients who finally did leave Goldman or refuse to do business with Goldman because of that concern,” [Charles Peabody, an analyst at Portales Partners LLC in New York] said, declining to name any
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It may be that
Guardian
financial editor Nils Pratley is right when he says that “the clients (or most of them) know they are at risk of being treated as Muppets” and even profess to hate Goldman, but choose to continue doing business with the firm because as an investment bank it enjoys “an extraordinarily privileged position in being trading houses, market-makers and advisers to companies[, making] them both impossible to avoid and riddled with conflicts of interest.”
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Dealing with Goldman simply makes good business sense, but it carries a sense of caveat emptor these days.

Joe Nocera, a
New York Times
columnist, agrees: “The [client] calculus at Goldman has always been, ‘There’s no one smarter out there. I actually can get the best advice from Goldman Sachs and they will often bring me the best deals, but I also know that I can’t trust them, that ultimately, their motives aren’t necessarily aligned with my motives.’”
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Perhaps this lack of trust is less important in trading, where competition is based more on price and liquidity, but it should be of concern in investment banking, where clients must be able to trust that Goldman will not use the client’s information against the client’s best interests.

But the Goldman response to Smith’s letter hangs over its client relationships. One client, the very large Dutch investment adviser APG, said it took Goldman more than a day to contact APG with reassurances about Smith’s allegations: “We would have expected that a company that faces such a big media backlash over something so core to their business such as client trust would have instantly reached out to those clients to say something.”
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The client’s real objection was having to explain to its own clients why it was doing business with Goldman, and having to explain about Goldman’s culture.
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Ultimately, however, another client said, “For us it’s about what these banks bring to the table. I think Goldman has the intellectual capital; they’ve got the know-how to do these transactions. There are other banks out there, but Goldman is still the preeminent investment bank and they give solid advice.”
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As a client, I had a chance to see how different Goldman’s value-added proposition was. I had a potential investment idea, but it required the coordination and collaboration of several parts of a bank to execute the transaction. I took the idea to several banks, but I never got past the first meeting with any of them. The groups within the same bank couldn’t agree on who would get what credit or revenues, something that would impact their bonuses (they never said this out loud, and I am reading between the lines of politically correct bankerspeak). So instead of executing a trade for a client, the banks did nothing.

I had a meeting with Goldman, and the partners understood that overall the firm would make money, even though each area might not be happy with its individual credit or revenues. The partners saw an overall opportunity, spoke among themselves, came to an agreement, and agreed to do the transaction (my personal relationship with them probably also helped). This teamwork in execution is a tremendous advantage for Goldman and shows that a residual social network and partnership culture still exists.

As the deal progressed, Goldman better understood what I was doing and thought it was a great investment idea. Later, Goldman said it wanted to coinvest in the deal. This is an example of the powerful strategy Goldman claims of combining advisory work with coinvesting. Goldman, to its credit, was the only bank smart enough to figure out how to get the deal done and recognize it was a good deal. Goldman’s coinvestment helped execute the deal for us at attractive terms.

I was very happy with Goldman’s advice and execution. However, a few months later I heard a rumor from a competitor that Goldman had done a similar deal with another client—much larger than we were—implying that Goldman took information about the deal and showed it to another client. I do not know whether this is true. So even though I had good feelings about Goldman getting the deal done for me, recognizing I never would have gotten it done without Goldman’s approach and ability to execute, I was slightly annoyed that, allegedly, Goldman used information to benefit itself with a larger client.

When I heard the rumor (again, only a rumor), it kept me on my guard. I didn’t say anything. I didn’t want to upset Goldman, because it is a very important player in the marketplace. I kept doing business with Goldman (and later I was involved in hiring Goldman to sell my firm). In my opinion, its people were responsive, well prepared, thoughtful, and connected. However, I did not feel as if all the people at Goldman could be trusted completely all the time. This should not be a shocking revelation in hindsight, but it was for someone who started at Goldman in the early 1990s. And the point I am making is the change.

What makes Goldman a tough competitor is its depth of talent and its systematic approach to providing high-quality client service (including getting senior partners to connect with clients). As an outsider, one can appreciate that, relatively speaking, Goldman is stacked with talent. The bench is deep, and the quality of the talent is relatively consistent. The firm’s expertise is phenomenal, again benefiting by pulling information from various people, geographies, and areas.

In my interviews with clients, many said the quality of talent on Wall Street had declined overall, Goldman included, perhaps because many clients themselves have become specialized in their knowledge and technology has commoditized information and the business in many ways. There is also strong competition for the best talent. Many talented individuals interested in finance go to private equity firms and hedge funds, which offer attractive opportunities.
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Many smart people are going into technology or other fields. But clients felt that Goldman would probably be considered the best alternative generally, not necessarily in every area of specialization, if one is interested in banking or wants training and credentials.

Clients I interviewed said that other firms have equal (if not better) talent in selected people or specialties, but it is not nearly as broad, consistent, and deep, nor as coordinated, as it is at Goldman. A Goldman banker or employee will speak to multiple people to get their views and then present a firm view. At many other banks, clients explained they typically get the talent of only one person of high quality that they trust. They elaborated that one individual has a tough task competing against Goldman even if the one person is more trustworthy. The organizational elements that support coordination set Goldman apart, and this is one reason clients still use the firm. This differentiator has been and will be challenging to maintain. Some partners I interviewed said that the volume of deals, geographic dispersion, information overload, technology changes, new regulations, and client expectations have changed the dynamics of collaboration and that they are more rushed and have less time to help others than they had in the early 1990s, for example. However, they pointed out that their peers have the same challenges and were confident that Goldman has the ability to adapt.

Many clients pointed out that not just at Goldman but at its peers, even if they trust their one key adviser, they are always skeptical of the organizational pressures. Their adviser may have the client’s best interests at heart, but at the same time the adviser has internal pressures to sell products or do things in order to get paid or keep his job or get promoted. Therefore, the quality of execution, the ability to provide liquidity or find a buyer that no one else thought of or find a creative solution often trumps trust on deciding which firm to hire because clients are skeptical anyway.

Goldman still attracts a staggering amount of business. If clients were sick of alleged abuses, they would go to another competitor. Every time clients choose to do business with Goldman, essentially they are subconsciously performing a cost–benefit analysis, and they are making the unpopular (even if financially prudent) decision of giving their business to Goldman. Even though Goldman’s market shares seem to be fine after the crisis, I did find one interesting fact, that the premium fees that it charged clients above its competitors dissipated in at least one key area.
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Perhaps this is a coincidence or there are not enough data points, but it is interesting to see if changes in Goldman’s fees in the future will be a barometer of what clients think beyond just market share.