Authors: William D. Cohan
The plaintiffs in the lawsuit against Goldman were
Fundamental Investors, a $1 billion mutual fund that held $20 million
of Penn Central’s commercial paper bought in a ten-day period near the end of 1969;
C. R. Anthony, an Oklahoma City retailer with $1.5 million of the paper;
Welch Foods, Inc., of Westfield, New York, the maker of Welch’s grape juice, with a $1 million investment; and
Younkers Inc., a Des Moines–based retailer, which bought $500,000 of the Penn Central notes. In their fifteen-page complaint, the creditors charged Goldman
with “
fraud, deception, concealment, suppression and false pretense” in the sale of the
commercial paper to them. They claimed Goldman had “made promises and representations as to the future [of the company] which were beyond reasonable expectations and unwarranted by existing circumstances,” had made “representations and statements which were false,” that Goldman had represented that Penn Central was “prime quality,” and that Goldman had made “an adequate investigation of, and kept under continuous current review, the financial condition of Penn Central.” The plaintiffs also claimed that Goldman had agreed to buy back the commercial paper. “
For the commercial paper holders this was an extremely big event,” explained
Daniel Pollack, the plaintiffs’ attorney, about the Penn Central default. “For example, for the farmers at Welch’s this was all their money. One bad harvest and the potential loss of cash equivalents was a potential catastrophic event for them.”
Penn Central had been Gus Levy’s client, but in the grand Wall Street tradition of success having many fathers and failure being an orphan, the firm’s defense in the media was left to
Robert G. Wilson, the partner in charge of Goldman’s commercial paper business. “
[T]here is absolutely no merit to the claims which have been made against Goldman Sachs,” he told the
Times
. “We regret that anyone is facing a potential financial loss as a result of the unforeseen circumstances, but the action against Goldman Sachs has no basis in fact. We intend to resist it vigorously.” He added that during the time that Goldman was selling Penn Central’s commercial paper, “we were confident that the transportation company was credit worthy” and “had access to credit at least sufficient to cover its current obligations and repay commercial as it became due.” He said that even in late May 1970—a few weeks before the company’s bankruptcy filing—Wilson had “every expectation” that Penn Central would be able to get a government-guaranteed loan, which did not happen, despite the company’s final appeals to Congress and to President Nixon.
A day after the Fundamental Investors suit, a subsidiary of American Express sued Goldman, too, for $2 million, as a result of sales of the Penn Central commercial paper, even though Goldman was also American Express’s commercial paper dealer (American Express’s claim was later increased to $4 million). Then, in February 1971, the
Walt Disney Company sued Goldman for $1.5 million as a result of the collapse of Penn Central after Disney had bought $1.5 million of the commercial paper. A month later, the
Mallinckrodt Chemical Works sued Goldman, among others, on account of its loss in the Penn Central commercial paper. In the end, some forty lawsuits were filed against Goldman.
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T
HIS WAS YET
another precarious time on Wall Street. The crux of the problem, which Wall Street historians have dubbed the “back-office crisis,” was that during 1967 trading volumes on the major stock exchanges exploded, and the private, poorly capitalized Wall Street partnerships were ill equipped to handle the extensive paperwork involved with settling trades occasioned by the “sudden and unexpected upsurge” in volume. Many firms were slow to add the back-office personnel required to handle the new flow. Unfortunately, when the personnel were eventually hired—in a rush, of course—performance suffered. Some firms were drowning in a sea of unprocessed, and inaccurately accounted for, paper. But by the end of 1969, “
the worst of the paperwork problems had been surmounted,” according to
Lee Arning, then a
New York Stock Exchange executive.
The crisis, though, had just begun, for at the very moment that many brokerages had increased their personnel costs to scale the mountain of paper, the volume of business fell off a cliff. There was a feeling that 1970 was capitalism’s most acute test since 1929. These were not Goldman’s problems, though. The firm had virtually no retail customers and did not have the back-office problems experienced by retail brokers. Indeed,
in 1970, the firm’s profits “
topped $20 million,” Levy told the
Wall Street Journal,
the third highest in its 101-year history. The “gratifying” results came from Goldman’s role in underwriting sixty-four debt and equity offerings, raising more than $3.5 billion, and an 80 percent increase in the volume of the firm’s block trades. Goldman’s capital increased to $49 million, from $46 million, and its leverage ratio—aggregate indebtedness to net capital—was 6.5, well within the 20:1 stock exchange regulations. But, thanks to the Penn Central bankruptcy, Goldman’s problems were every bit as acute as those of its Wall Street brethren. Not that most people had any idea. For instance, in July 1971, despite the ongoing existential threat, Goldman appeared to get the full cooperation of
John H. Allan, a Wall Street reporter at the
New York Times,
for a lengthy feature about the firm that discussed everything but Goldman’s precarious legal and financial prospects. Goldman, Allan reported, was doing just fine.
The story was a coup for
Edward Novotny, a young former journalist turned public-relations guru, who quietly started working for Goldman in 1970 and continued until his death in 2004. Over time, Goldman paid Novotny upward of $200,000 a year to manage its PR from his home office at Tudor Tower, on the east side of Manhattan. Goldman’s aggressive public-relations efforts became part of its legend. “He was the invisible
man,” explained a former Goldman executive. “You dialed Ed Novotny’s extension at the firm and it rang in his home office in Tudor Towers where it was, and he had a secretary in there, and he operated on a deep well of power.” He said that Novotny’s “whole thing” was “this incredible paranoia,” where “the firm would never go on the record.” If Novotny told a reporter something it would always be on “deep, deep, deep, deep, deep—five ‘deeps’ in a row—background,” the former Goldman executive said. “Every time he would describe a reporter to me it would be he or she ‘is
very, very, very
dangerous.’ Even
Bill Cunningham, the society photographer, was ‘
very, very, very
dangerous. So watch it.’ ”
The conceit of the
Times
article was that Goldman was unusual on Wall Street for having equally respected and profitable investment banking and trading operations under one roof, in this case with trading on the fourth floor of 55 Broad Street, “
which rips with action,” and banking one floor above, where the “atmosphere is subdued and Ivy League and the action more difficult to see.” But, the
Times
reported, Goldman “seems to have no trouble at all in accommodating them under a single business roof and, in fact, has continued to look for more activities.” The firm’s next moves, the paper reported, would be in growing its bond underwriting and trading for both corporations and municipalities. Goldman was considering becoming a
government bond dealer and was moving into
real-estate finance,
lease finance, and
international markets. The goal was to boost profits beyond the $20 million Goldman made in 1970, an astounding almost 50 percent return on its $49 million in capital. By then, Goldman had opened its first foreign office—in London—as part of “a major international effort,” Levy explained, which was separate from the alliance Goldman once had with Kleinwort Benson.
The
Times
article not only glorified Levy but also showcased the new generation of leaders at the firm. There was John Whitehead—a “49-year-old amiable, reflective investment banker” and graduate of both Haverford College and
Harvard Business School—who was responsible for the firm’s New Business Group within investment banking. Whitehead had taken to his role with such relish that not only had he identified the four thousand U.S. companies that made at least $1 million in profits a year, but he also had figured out which of Goldman’s bankers would call on them and try to convince them to do business with Goldman Sachs.
The idea for a more systematic and aggressive calling effort came to Whitehead as Sidney Weinberg was getting older and Whitehead realized that Weinberg seemed like the only person at the firm capable of bringing in investment banking business, such as debt or equity underwriting
or M&A deals. “Every single piece of investment banking business … every single one during at least a ten-year period, was produced by Sidney Weinberg,” Whitehead said in a May 2003 speech. He wrote a confidential memo for Weinberg’s eyes only about how a new group, inside investment banking, could be organized as a new business effort. “I knew the memo had to be approved by Sidney,” Whitehead said, “so I wrote it in a delicate way. I said nobody will ever duplicate Sidney Weinberg—we don’t have anybody here and couldn’t get anybody, but if we could have ten people who each produced 20 percent of the business that Sidney Weinberg produces every year, our business would be twice as big as it is today.” Weinberg stuffed the memo in his desk drawer and ignored it. One day, months later, after he had become a partner, Whitehead summoned the courage to ask Weinberg about his idea. He opened his desk drawer, looked at the forlorn document. “What a crazy idea,” Weinberg responded. “We don’t need anything like this. Do you really want to do it?”
Whitehead did. He had hoped to discuss the idea at the next partners’ meeting. But “there weren’t any partners’ meetings,” he said. “There never was a partner meeting. The only partner meeting was the annual event, which took place at various different exclusive places. And the year I first became a partner it took place in the private room of the ‘21 Club.’ And the partners came. It was all in tuxedos.” He later convinced the partnership to approve the plan by discussing it with them individually and getting their support. By July 1971, Whitehead was happy to report to the
Times
that, by his analysis, Goldman had made significant market share gains in investment banking. In 1968, Whitehead figured Goldman had 7.8 percent of the market—what he described as the “public and private financing we would have done if asked”—and that Goldman’s share had increased to 11.6 percent in 1970 and so far in 1971 it was “higher still.”
The
Times
article also featured John Weinberg, Sidney’s son, and the continuity he provided at the firm with the Weinberg legacy, including the fact that John Weinberg took over his father’s seat on nine corporate boards, including
General Electric and B. F. Goodrich. Despite the controversy starting to percolate about the potential conflicts that emerge when investment bankers sit on corporate boards, the article made clear that Goldman Sachs and John Weinberg were outspoken believers that such conflicts could be managed. (At that time, Goldman partners sat on the boards of some seventy-five companies.)
Along with Levy, both Whitehead and Weinberg served on Goldman’s six-man
Management Committee, which ran the firm. The committee
met at 9:00 a.m. every Monday morning for around an hour. The creation of the Management Committee was one of the prices that Sidney Weinberg extracted from Gus Levy when Levy moved Weinberg out of 55 Broad Street. The other members of the powerful committee were Howard “Ray” Young, head of Securities Sales;
George Doty, a former senior partner at
Coopers & Lybrand and head of the Administrative Department;
Edward Schrader, head of the Buying Department. Levy described Whitehead as being the head of the New Business Group and John Weinberg as “free-lancing” with no specific departmental responsibility. This group was ably assisted, according to the article, by Tenenbaum and
Robert Mnuchin, the block trader.
At the very end, Allan mentioned the problems in Goldman’s
commercial paper business and that Robert Wilson reported to his boss John Weinberg. “Unlike the founder of the firm,” the
Times
observed, “Mr. Wilson does not scurry about the financial district stuffing notes in a stove-pipe hat, but instead he supervises a 46-man staff that raises as much as $40 billion a year in short-term funds for industry.” As for the Penn Central lawsuits, Wilson said there was “absolutely no merit to the claims” and that the commercial paper business had picked up considerably since the credit freeze brought on by the collapse
of Penn Central. While Allan noted that ongoing write-offs of commercial paper losses by big banks was the “chief potential trouble spot” at Goldman, he concluded by pointing out that Goldman had settled the claims against the firm in the Mill Factors matter by paying $50,000, a tiny fraction of the losses suffered by the buyers of the paper.
Unmentioned in the
Times
article was the fact that in March 1971, Goldman had decided to limit the liability of its partners to the amount of cash they had tied up in the company; formerly they had each been liable for their entire net worth. Although the
Wall Street Journal
reported that the move was “in line with a growing trend among many leading securities firms,” which was true, one could not help thinking the move was also prompted by the severity of the Penn Central litigation against the firm. Also left out of the
Times
paean was the February 1971 news of yet another lawsuit—for $125 million—brought against Goldman and Sidney Weinberg Jr., known as “Jimmy,” by
American Cyanamid Corporation, the chemical manufacturer and consumer products company. American Cyanamid accused Goldman and Jimmy Weinberg of arranging to scuttle its deal to purchase
Elizabeth Arden—which Goldman had been hired to sell—for $35 million by turning around and then encouraging
Eli Lilly, a Cyanamid rival, to buy Elizabeth Arden for $38.5 million.
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F
AR LESS OF
a coup for Novotny was a June 1972
Wall Street Journal
article describing a racial discrimination lawsuit brought against Goldman by James E. Cofield Jr., a black
Stanford University MBA, one of only two black students in his class. Two years earlier, according to Cofield’s lawsuit, while Cofield was an MBA student at Stanford, he applied for a job at Goldman. Cofield had previously worked at the
First National City Bank and
Blair & Co., a regional brokerage. He was a graduate of the University of North Carolina and had attended Howard University’s school of law. He first applied for a summer job at Goldman in March 1969, hoping to work in corporate finance. His résumé was sent to
John Jamison, a partner in the firm’s Corporate Finance Department, and who had been recruiting students at Stanford. Cofield wrote a follow-up letter to Jamison on March 18 and offered to meet with him when he was in New York on March 25. On April 11, Jamison wrote to Cofield that Goldman could not “work you into our operations this summer” and added, “[f]rankly, we have been so bust we haven’t been able to spare the people over the last several years to develop or supervise a program that would be meaningful to any summer employee or useful to us.” Jamison encouraged Cofield to “drop by to visit with us again if you get the chance.” Cofield ended up working at Blair & Co. that summer.