-Caveat Lector- from: http://msnhomepages.talkcity.com/ReportersAlley/thecatbirdseat/GoldmanSachs.ht m ---- FOR WALL STREET the early 1970s were wretched times. In January 1973 the Dow had stood at 1,051 and by December 1974 it had almost halved to 578 and would not rise above 1,000 again until 1980. For Goldman Sachs, which would struggle with low earnings and a spate of lawsuits, this would be a particularly difficult time. The low point in Levy's management of the firm came in February 1979, after the Penn Central Railroad reported dismal earnings. An official of the National Credit Office (the agency that rated commercial paper) telephoned Goldman Sachs, Penn Central's commercial paper issuer, to discuss the railroad's creditworthiness. The firm reassured the official of its generally positive view of the situation, and the paper's "prime" rating was left in place. . . . Goldman Sachs continued to sell Penn Central paper, but took steps that minimized its own exposure to the securities. While still recommending the commercial paper to customers, the firm feared that there would be little customer demand and insisted that henceforth it would provide customers with Penn Central paper from a "tap" -- that is, the railroad would issue a specified amount whenever Goldman Sachs brought them an interested buyer. In this way, Goldman Sachs would have no more than $8 million in inventory. . . . When Penn Central plunged into bankruptcy, panic engulfed the commercial paper market. Investors concerned about the solvency of other issues by Goldman Sachs--the firm had about 300 issuers at the time--rushed to redeem their securities. Corporations all over America had to borrow from banks to repay these short-term debts, and the Federal Reserve was forced to act to ensure continued liquidity. ... Goldman Sachs has assumed, incorrectly, that the Federal Reserve would rescue the railroad by providing it with the needed liquidity. . . . Levy testified later that at no time was he concerned about the solvency of the railroad. Regardless, Goldman Sachs was censured by the Securities and Exchange Commission for its actions and required to give customers more detailed information about issuers in the future. Despite the fact that Goldman Sachs had access to a great deal of adverse financial information about Penn Central, the SEC said that it "did not communicate this information to its commercial paper customers, nor did it undertake a thorough investigation of the company. . ." For Goldman Sachs the episode was nothing short of a disaster. The firm's good name, nurtured for so many decades by Sidney Weinberg, was once again tarnished, its credibility damaged, its finances precarious. . . Clients lined up to sue the firm, with Goldman Sachs named in at least forty-five lawsuits. The railroad had defaulted on $87 million worth of commercial paper at the time of the bankruptcy, and the firm faced potential lawsuits for an amount greater than the partners' capital, which stood at only $53 million at the time. It was a frightening time for the forty-five partners, because their personal liability was unlimited. Although the firm did not admit liability, it eventually settled with many clients, buying their paper back for between twenty and twenty-five cents on the dollar and granting them some participation in any recovery of funds that might be made from Penn Central. In October 1974, Welch's Foods and two other plaintiffs sued the firm, and the case went to trial. A federal jury found Goldman Sachs guilty of defrauding its customers by selling them Penn Central commercial paper in 1969 and 1970, when the railroad was going broke. The firm was forced to buy back the commercial paper from the plaintiffs at its face value plus interest. . . . * * * In October 1976, Levy suffered a stroke and collapsed while chairing a board meeting . . . Leaderless, the firm was left in turmoil. . . . * * * The author writes that the two leading contenders for Levy's leadership seat were John Whitehead and Sidney Weinberg's son, John L. Weinberg, and that eventually they were elected to co-chair the firm. Sidney, according to the author, had given his son advice about the business, and relates a story about him sending John to see Floyd Odlum, the man to whom he had sold the Goldman Sachs Trading Corporation: While the other meetings John attended may have produced some sound advice, Odlum's words still ring in John's ears some fifty years later . . . Odlum offered the younger Weinberg these prophetic words of advice: "I am going to do something for you. I will give you this book, but you have to promise me that for the whole rest of your career, you will keep a copy of this book and refer to it. . . ." The book was Popular Delusions and the Madness of Crowds by Charles McKay, originally published in 1841. "Watch for the excesses," Odlum warned. "No one is going to tell you what they are or when they will arise; each time they will look different." Excesses will be taken care of by the marketplace, he told the younger man, but as each generation forgets the lessons of the last, the same mistakes are made again. He cautioned that success would come only to those who could recognize and correctly value risk. Weinberg took the book and the elder man's advice to heart. To this day he keeps a copy of the book in each of his offices . . . Odlum's words of advice ultimately saved Goldman Sachs from hundreds of millions of dollars in losses in business the firm walked away from. Goldman Sachs's success in the 1980s can be attributed not only to what it did but perhaps, more important, what it did not do. Goldman Sachs steered clear of making hazardous bridge loans (short-term loans made by investment banks until public funding becomes available) and involved itself in few failed leveraged buyouts. . . . * * * By the 1970s, Levy's legacy had passed to consummate trader Robert Rubin . . . The 1980s would mirror the 1920s with an eerie deja vu. The market rally, the ensuing crash, the financial scandals, the merciless government investigations -- all had been witnessed sixty years earlier. . . . The takeover wave would bring new and unimagined opportunities, as hostile tenders and "greenmail" provided price aberrations of the kind that arbitrageurs thrive upon. Working with a $1 billion portfolio of securities, Rubin and his half dozen assistants immersed themselves in the takeover mania of the 1980s. Robert Freeman was Rubin's number one assistant, soon becoming a partner in the division. * * * For years the "Chinese Wall" -- the veil of secrecy intended to keep confidential information from traveling from one department to another -- between banking and arbitrage was paper thin. Bankers all over Wall Street hopped the divide with frightening regularity, consulting with traders about the market's perception of a deal . . . The risk arbitrage department at Goldman Sachs acted as in-house consultant to the firm's merger specialists in a way that was entirely legal. Arbitrageurs provided expert advice in evaluating the complexities of a deal and calculating the potential market reaction... Consultations between the two departments would continue until 1986, when the trading environment on Wall Street and what was considered acceptable practice changed radically... On May 12, 1986, Dennis Levine, an investment banker at Drexel Burnham Lambert , was arrested and charged with making $12 million on insider trading. . . . the stories remained on the front pages of newspapers of the nation until the end of the decade. By then, dozens of individuals had been arrested, their firms humiliated, as billionaires traded in their mansions for jail cells. * * * The SEC investigations that began in 1986 changed the entire climate on Wall Street. Previously accepted and legal practices came under scrutiny as firms tightened their internal controls in response to a more thorough and aggressive SEC. Many of the accepted practices at Goldman Sachs and other firms that allowed arbitrageurs unimpeded access to information -- talking with the bankers working on a particular deal, for example -- would be closely scrutinized and after 1986 changed dramatically. . . . No one dreamed of the damage a minor figure at a second-rate firm could do to Goldman Sachs. . . . Information provided by Levine resulted in the arrest of a group of relatively junior bankers from Shearson Lehman, Lazard Freres, and Goldman Sachs. These young men had made relatively little or nothing from their illegal activities but would pay a huge price. The Goldman Sachs banker, who pleaded guilty, was very junior and left the firm immediately. Then, in a desperate plea bargain agreement, Levine offered up Ivan Boesky, the best-known arbitrageur of the day. Boesky had preached greed, financial success, and self-interest as acceptable, even morally laudable goals. . . * * * On November 14, 1986, Boesky was arrested, pled guilty to charges of insider trading, and paid the then unheard-of fine of $100 million. He, in turn, implicated Martin Siegal, a well-respected and successful banker and merger expert who recently had moved from solid Kidder Peabody to more daring Drexel. Siegal had accepted suitcases of cash in exchange for tipping Boesky about upcoming takeovers. Seigel then pointed his finger directly at Robert Freeman, chief of risk arbitrage, head of international equities, and trusted partner of Goldman Sachs. On the snowy morning of February 12, 1987, special deputy U.S. Marshall Thomas Doonan and two postal inspectors, all armed, walked onto the 29th floor trading room of Goldman Sachs. They quickly located Freeman and asked him to step into his glass-fronted office. There they lowered the blinds and told the shocked Freeman that he was under arrest. . . Goldman Sachs and much of the financial world was in shock. This was a partner of the firm with the cleanest reputation on Wall Street. . . . Freeman was a high-ranking partner who had worked with both Rubin and Friedman, and Goldman Sachs would not distance itself from him. Many within the firm have suggested that it was ... the culture of the firm, its commitments to sticking by those in trouble, that caused the firm to pursue Freeman's defense so doggedly. A more cynical explanation is that in a private partnership, where liability is unlimited, there is a strong incentive to diminish the guilt of any member of the team. . . . * * * For two years the firm's top management was consumed with Freeman's defense. . . . On April 9, 1987, Freeman was indicted on federal charges of conspiracy to violate securities laws. On Feb 12, 1988 ... James Stewart and Daniel Hertzberg, both Pulitzer Prize-winning editors and writers for the Wall Street Journal, wrote an article that would change the course of events. Based on their own investigation, the story alleged a detailed catalogue of misdeeds by Freeman in his relationship with Siegel, all but one of which Freeman would staunchly deny. . . It was the final allegation -- the one concerning the now famous "bunny" comment -- that would be Freeman's undoing. . . . In October 1985, the leveraged buyout firm of Kohlberg, Kravis, Roberts and Co. (KKR) had offered almost $5 billion, at $45 a share, for Beatrice Corporation, in what was the largest leveraged buyout to date. . . . Martin Siegel was one of KKR's investment bankers. . . . The bid was raised to $47 on Oct 29, and Freeman purchased shares of Beatrice for both the firm's arbitrage account ($66 million) and his personal account ($1.5 million) after details of the increased offer were made public. On Nov 14, Beatrice and KKR announced an agreement on a price of $50 per share, $43 in cash and $7 in securities. Freeman was so confident that this bid would go through that he invested almost 40 percent of his family's "at risk" trading accounts in Beatrice. . . On Jan 6, KKR began to fear that the deal could not be financed at that lofty price. The next morning, Freeman bought an additional 22,500 shares in Beatrice for his own account. During the day, trading volume was heavy ... and the price edged downward, which concerned Freeman. At the end of the day, Goldman Sachs's position was worth approximately $66 million, or $16 million over the usual limit for friendly takeover situations. . . On Jan 7, Goldman Sachs executed a large sale for a well-known arbitrageur named Dick Nye. When Freeman learned of this trade he grew even more concerned. During the course of that afternoon Freeman spoke to Marty Siegel three times and once to Henry Kravis of KKR... Freeman then proceeded to sell all the shares he had purchased that morning. The following morning, Jan 8, Freeman put orders in the market to sell his entire personal holding and to reduce Goldman Sachs's position to below the $50 million level. Later that morning, a floor trader known as Bernard "Bunny" Lasker called Freeman to say he had heard that there was a problem with the Beatrice deal. Freeman telephoned Siegel, KKR's banker. According to Freeman, "I told Mr. Siegel that I had heard there was a problem with the Beatrice LBO. He asked from whom I had heard that. When I answered Bunny Lasker, Martin Siegel said, 'Your bunny has a good nose'." Early that afternoon, an announcement was made that the deal would be restructured . . . The share price of Beatrice immediately dropped $4, closing the day at $43.25. . . . The options sales that followed Freeman's conversation with Siegel had saved the firm $548,000. . . By the summer of 1989, worn down by the lengthy legal process, Freeman was ready to plead guilty to the "bunny" charge. . . . On April 17, 1990, Freeman was sentenced to one year, with eight months suspended, of which he served one hundred nine days (including time off for good behavior) at Saufley Federal Prison Camp in Florida. He was also fined $1.1 million by the SEC . . . After Freeman's admission of guilt, the government dropped any further investigation and Goldman Sachs sought to put the entire episode behind it. . . . * * * THE CHANGING OF THE GUARD, heralded for so long, finally came to pass on Dec 1, 1990, when Steve Friedman and Robert Rubin were named senior partners and co-chairmen of the management committee. . . . * * * GOLDMAN SACHS entered the 1990s in an extremely strong position relative to its American investment banking competition. . . . After years of indulging in speculative financing vehicles, there was now a price to pay for the excesses of the decade. For Drexel there would be Chapter 11, scandal rocked E. F. Hutton, and Kidder Peabody would be sold. First Boston, one of the firm's major competitors in mergers and acquisitions, would be stretched to the limit by ill-advised bridge loans (short-term unsecured loans, many of which looked good in the 1980s and failed in the early 1990s) and later aided by its wealthy parent, Credit Suisse. Lehman Brothers, once one of Goldman Sachs's most formidable investment banking competitors, would be torn apart by political infighting and forced to sell itself to the American Express conglomerate. The SEC investigation of Solomon Brothers's activities in the government bond market followed by the departure of its chairman John Gutfreund would weaken this once-insurmountable competitor, allowing Goldman Sachs's fixed income department to escape from its enormous shadow. . . . In the 1970s, Gus Levy had sold the firm's asset management business because he did not want to compete with the firm's clients. . . . The notion of not competing with clients, however, would soon become ludicrous as clients began to compete with their investment bankers and the margins on many client businesses collapsed. Companies like General Electric would initiate their own asset management business, and American International Group (AIG), the insurance giant, would become a major force in derivatives products. . . . * * * GOLDMAN SACHS had been expanding the size of its partnership steadily for decades. There had been fifty partners in 1973; there were seventy-five in 1983 and one hundred fifty by 1993. But as the size of the partnership increased, the profits of the firm had to grow at breakneck speed if existing partners' income levels were to be maintained. . . . With his ascendency in 1990, Rubin openly discussed with the partnership the need for an expanding pie . . . In addition to the firm's limited partners (retired partners who choose to leave capital in the firm), Goldman Sachs has taken on three groups of financial partners. Sumitomo's investments in 1986 entitled the Japanese bank to 12.5 percent of the firm's annual profits. Kamehameha Schools/Bishop Estate, the giant Hawaiian education trust, which also made two major cash infusions into the firm, first in 1992 and again in 1994, receives about 11 percent of what the firm makes every year. Finally, a group of insurers has injected $225 million into the capital structure. Limited partners do not receive a percentage of the profits, but rather receive interest rate payments as compensation for the use of their capital. Payments made to outsider investors, before the partners see a dime, have run between $300 million and $400 million a year. . . . Goldman Sachs will go down in history as the last major partnership on Wall Street. . . * * * Quoting one former partner: "Greed changed the firm, and the view was to take as much risk as we can, and make it as fast as we can." . . . * * * "NINETEEN EIGHTY-SIX," Institutional Investor magazine proclaimed, "was the year they sold Wall Street." During the five preceding years John Weinberg had watched his major competitors incorporate, merge, or simply cease to exist. . . . "GOLDMAN SACHS, TOO, SOLD A BIT OF ITSELF IN 1986. The roots of the transaction took hold the year before when one morning a man who refused to identify himself telephoned Ann Ericson, John Weinberg's secretary. Would Mr. Weinberg, he asked, be in the office on a Tuesday, three weeks hence? . . . Two weeks later the same unidentified caller contacted Ericson to confirm the date, and this time she indicated that Weinberg would be in the office. When the appointed day arrived two Japanese men, a speaker and his interpreter, appeared in Weinberg's office. The man who spoke only Japanese identified himself through his assistant: I am the president of Sumitomo Bank, Koh Komatsu told Weinberg. I came here in disguise to see you. Komatsu had tried to hide his tracks. From Tokyo he flew to Seattle, Washington. There he changed planes for a flight to Washington, D.C. From Washington, he boarded the shuttle to La Guardia. He felt certain that he had made the journey undetected. . . . Weinberg was baffled by the visit. He had no way of knowing that Sumitomo Bank had long been interested in gaining a toehold in the U. S. investment banking market and had been looking at Goldman Sachs. Sumitomo, at that time the world's third largest and Japan's most profitable bank . . . As Weinberg listened to Komatsu's proposal he was amazed. The valuation given to Goldman Sachs by Sumitomo was far above the firm's own. Komatsu was offering cash, an equity injection, in return for a share of the profits. The deal was almost too good to be true. By offering to make a $500 million investment in exchange for 12.5 percent of the firm's profits, Sumitomo was implicitly valuing Goldman Sachs at $4 billion -- four times book value. Morgan Stanley had just floated itself at under three times book value, and other publicly traded investment banks were selling for less. The deal, it was stipulated, would be conducted in total secrecy, with Goldman Sachs acting as its own investment banker. . . ." * * * ----- Aloha, He'Ping, Om, Shalom, Salaam. Em Hotep, Peace Be, All My Relations. Omnia Bona Bonis, Adieu, Adios, Aloha. Amen. Roads End <A HREF="http://www.ctrl.org/";>www.ctrl.org</A> DECLARATION & DISCLAIMER ========== CTRL is a discussion & informational exchange list. Proselytizing propagandic screeds are unwelcomed. Substance—not soap-boxing—please! 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