Authors: William D. Cohan
Judge Medina’s opinion is indeed a remarkable document. It demonstrated in vivid detail how investment banks garner business. Medina ruled that the investment banking firms did not violate the law. But his lengthy analysis raised the question of whether Wall Street’s practices at that time furthered its ostensible mission—to help companies raise capital for growth—or whether much of the banks’ activity was designed to increase the bank
accounts of their senior partners. An activity may be legal, but is it just?
Although Goldman was not the main defendant, the antitrust case laid bare how the firm used its connections to get deals. The government’s charge that these firms put their partners on the boards of directors of their clients to insure control over their future investment banking business was particularly germane to Goldman. To try to get a handle on whether these banker-directors influenced their clients’ decisions over where to direct investment banking
business, Judge Medina looked at all 1,117 underwritten securities issues from 1935 to 1949. The first observation he made was that a mere 140 of these underwritings, or 12.5 percent, were from issuers during this period where a partner from an investment banking house sat on the board. He further found that most of these 140 issues were underwritten by Goldman, Lehman, and
Kuhn, Loeb, “
the older firms who had in the early days
become more or less accustomed to have a partner on the board of an issuer because of their sponsorship of the issue, and as a measure of protection for the investors to whom the securities were sold.”
Medina’s chart did show that of the fifty issues Goldman underwrote
for its clients during this fifteen-year period, some twenty-seven of them, or 55 percent, were for clients where a Goldman partner was on the board of directors, by far the most of any of the seventeen defendants. But the judge remained unconvinced by either the government’s documentary evidence or these numbers that any conspiracy existed.
As evidence for his conclusion, he cited the example of the extraordinary lengths Goldman and a smaller, regional Minneapolis investment bank,
Piper, Jaffray & Hopwood, went to keep another competitor, White Weld, out of a financing for
Pillsbury, the Minneapolis-based food company, a battle that lasted almost ten years. Both Piper and Goldman—in the person of Henry Bowers—had a partner on Pillsbury’s
board.
Goldman and Piper had been “in privity with Pillsbury” according to Medina since 1927, when the two firms worked together on a financing for the company. Seven years later, in 1934, Pillsbury was thinking about refinancing $6 million of 6 percent first mortgage bonds, and quite naturally Goldman and Piper expected to win the mandate to do it and began proposing ideas for it in early 1935.
The complicating factor, though, was that
Harold B. Clark, or Ben as he was known, a senior partner at White, Weld, had become a “close friend” of
John S. Pillsbury, the chairman and largest shareholder of the company. Pillsbury had asked Clark to serve as a trustee for his children’s trust fund, consulted him about where the boys should go to school, and kept a bunch of his money in an account—and
“a very valuable one”—at White, Weld and sought his advice on a myriad of other financial matters.
Goldman fought this threat to their business ferociously, using Bowers’s position on the board as a cudgel and issuing not-so-subtle threats to White, Weld.
At one point, Bowers telephoned a White, Weld partner,
Faris Russell. “[A] neat little sparring match ensued,” Medina observed, and then quoted from Bowers’s account of the conversation from a letter that same day that Bowers wrote to Piper. “He and Benny Clark are friends of John,” Bowers wrote. “I told him, of course, John would talk with him,
as with everybody,
but that I was absolutely confident
that you and we could hold the business and all that White, Weld would do would be to bother us and make us do the business on a closer basis than was fair; that if White, Weld, who claimed to be high-toned people, felt that that was a sound and fine action to take in competing with other friendly houses, members of whom were on the Board of Pillsbury, it would be a surprise to me. I tried to put a little shame into him, and to leave him with a feeling that his conscience would have
to be his guide.” While it is rare to get
a ringside seat into how the sausage is made inside an investment bank—and rarer still in 1935, no less—it is worth recalling how desperate Goldman Sachs must have been at that time to win a meaningful piece of new business in the middle of the Great Depression and in the years after the firm’s reputation had been so badly sullied by the collapse of the
Goldman Sachs Trading
Corporation.
The battle raged on. More than two years later the deal had still not been done and Goldman and Piper were still fighting for it and trying to keep White, Weld out. On June 8, 1938, Bowers wrote to Piper that he had spoken to Pillsbury and learned that Ben Clark had introduced Pillsbury to
Thomas Parkinson, the president of the
Equitable Life Assurance Society, which was looking to provide Pillsbury the capital needed to
refinance the mortgage securities. This was a serious threat to Goldman and Piper, for if Pillsbury ended up doing the deal with the Equitable, and Clark had provided the introduction to the Equitable, Goldman and Piper would be hard-pressed to make the case for a fee. Bowers recounted to Piper that Pillsbury “went on … to state that he wouldn’t think of doing anything more than explain to the Equitable President your position and my position on the
board, the idea being that if they do anything, or could do anything with an insurance company, we should arrange it for the Company. He asked the direct question, how could it be worked out that a refunding be arranged with an insurance company or companies and you and I be taken care of?”
In the end, Pillsbury met with Parkinson, and the Equitable refinanced Pillsbury’s mortgage bonds. Unfortunately—much “to the amazement and disappointment” of Clark—White, Weld got nothing for its effort, and Goldman and Piper, Jaffray split the fee for the private placement between Pillsbury and the Equitable. The power of being in the Pillsbury boardroom for both Goldman and Piper can clearly be seen in an October 1939 letter from
Bowers to Piper where he laments the possibility—being then discussed—that either Piper or Bowers, or both, might be removed from the Pillsbury board. Bowers expressed the view that he wanted to remain on the Pillsbury board “not only from my own personal point of view, but from the point of view of what seems best for the interests of G.S. & Co.” and that if both he and Piper remained “we can do some more good, constructive work.”
Judge Medina deemed this outcome legal and fair.
In a later episode, in August 1944, Pillsbury was thinking about selling equity. Once again, White, Weld sought a piece of the action, and once again, Henry Bowers at Goldman tried to shut them out.
This time White, Weld did get an allocation of the 75,000-share
equity offering—a mere 2,000 shares, or a 2.7 percent slice. From this ten-year saga at one company in the Midwest, Judge Medina concluded that this was normal, fierce competition on Wall Street. “It was downright competition of the most ruthless variety,” Medina wrote.
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F
AR MORE COMPLICATED
for Medina to parse and to defend—for it did look for a time like downright collusion—was the eighteen-year arrangement that Goldman had with Lehman Brothers for the underwriting of equity offerings. Although the explicit arrangement ended in the 1920s, they came to an “amicable” agreement in January 1926 about how the firms would split fees and clients in the future.
The document was extraordinary in that it existed at all. The idea that Goldman Sachs and Lehman Brothers—fierce competitors and archrivals for much of the second half of the twentieth century and for the first eight years of the twenty-first—would have an underwriting joint venture for so many years was a testament to the difficulty these two predominantly Jewish firms had in breaking into the established order on Wall Street at the time.
Except for a brief exchange of letters toward the end of January 1926, where Catchings, for Goldman, and
Philip Lehman, for Lehman Brothers, did some tweaking to the language about how the two firms’ trading accounts were exempt from the agreement, this reconfigured arrangement lasted another ten years, until it blew up in spectacular fashion. The proximate cause of the “acrimonious discussions” between the two firms, according
to testimony Walter Sachs gave in July 1951, was the “division of the management fee” between them after an underwriting. The management fee was a relatively new phenomenon among underwriters, following the passage of the Securities Act of 1933, and was designed to compensate the lead underwriter for the additional work required to comply with the SEC requirements.
In a February 6, 1936, letter to “Messrs. Goldman, Sachs & Co,” Lehman partner
John Hancock made it clear he believed Goldman had breached their revised agreement. After referring to the written agreements from the 1920s, Hancock asserted, “We believe we have proceeded completely in accordance with these memoranda and their spirit.” Then, citing recent financings Goldman had done for Brown Shoe, National Dairy, and
Endicott-Johnson, Hancock wrote that they “indicate clearly that you have not felt bound by your agreements with us, in spite of the fact that no notice has as yet been given us of the termination of the arrangement to which both firms were parties. In view of the situation, we see no alternative for us but to inform you that inasmuch as
the arrangement has not been controlling on you for some time, we cannot accept any longer any
commitment inherent within our written arrangements which we have always assumed as controlling upon us. We feel that we have done our utmost to fulfill an arrangement which both of us had decided to continue; but we feel also that you have made further continuance of our arrangement no longer possible.”
The next day, Goldman responded in writing. “We find ourselves unable to agree with the statement of the facts contained herein, but we cannot see that it will serve any useful purpose to enter into a discussion of these issues which are apparently highly controversial,” Sidney Weinberg wrote on behalf of his partners. “Therefore we shall content ourselves with saying that while we cannot accept your statement of the premises upon which your action
is based, we, nevertheless, accept your conclusion that the arrangement between us has been terminated.”
The antipathy between the two firms reached a nadir of sorts on February 18, 1936, when
Herbert Lehman, a partner at Lehman Brothers, wrote to
Thomas H. McInnerney, the CEO of
National Dairy Products Corporation, tendering his resignation as board member of the company and then lashed into McInnerney and the company for siding with Goldman Sachs on which firm would lead an upcoming financing. The following
year, Lehman and Goldman had a similar dispute over a piece of business involving
Cluett, Peabody, which Goldman also won.
In his July 1951 testimony during the antitrust trial, Sachs also described how during a discussion with General Foods about a financing, the two firms once again were acrimonious about roles and the splitting of the management fee. “This controversy annoyed the executives of the issuer,” Sachs said, “who threatened to take their business elsewhere unless GS and LB got together, and may have even gone to the extent of having preliminary discussions
with other bankers.” Sidney Weinberg was on the board of General Foods at that time. “In the interests of peace,” Sachs said, “the General Foods issue was done jointly by GS and LB.”
In order to stanch the increasing animosity between the two firms, Sachs sought out
William Hammerslough, a Lehman partner, to try to figure out a way of preventing future public displays of animal spirits. A new memorandum, dated June 30, 1938, divided up a new list of forty-two companies between
Goldman and Lehman and parsed how they would allocate underwriting fees between the two of them should they be lucky enough to win
financing business from these companies in the future. This memorandum was an effort to avoid another public incident similar to the National Dairy dispute. “The inclusion of a second house”—be it either Goldman or Lehman, depending on the client—“in
a particular piece of business, and if included, its position in such business, is subject to acquiescence on the part of the Company involved and subject to pre-existing rights of
any other house,” the memo declared. “Both houses are to use their best efforts so that the basis of mutual participation may be as set forth above [in the memo].” The term of the new arrangement was to be a mere six months, until January 1, 1939, unless extended by the parties. The agreement was largely adhered to subsequently, with the lone exception of a financing that Goldman and Dillon, Read underwrote, in 1945, for B. F. Goodrich, the tire manufacturer,
without Lehman.
Despite all of these agreements—both oral and written—between Goldman and Lehman during the thirty-two-year period, Judge Medina found “nothing in these agreements to support the government’s claims of an over-all, integrated conspiracy and combination, as there is no evidence that any of the other defendant firms were parties to the arrangements between Lehman Brothers and Goldman Sachs, or that they knew of the existence of these
memoranda.”
Notwithstanding Medina’s conclusion about this arrangement, Walter Sachs, at Goldman, and
John Hancock, at Lehman Brothers, found themselves having to defend publicly the arrangement and explain to a skeptical public why they weren’t conspiring together to hurt corporations seeking to finance their businesses.
In his opening statement to Judge Medina, in room 1505 of the federal courthouse in Foley Square,
Henry V. Stebbins, the special assistant to the attorney general who argued the case, suggested—eerily reminiscent of words Senator Carl Levin would utter five decades later—that these bankers were playing on both sides of the ball to the detriment of their clients. “They sit on one side of the table and advise their clients on what
they should sell and the price at which they should sell it,” he said. “Then they go around to the other side of the table and buy it.”