Authors: William D. Cohan
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O
NCE THE TURMOIL
caused by partners leaving—and those staying being upset by their low pay—calmed down, Corzine saw one of his first responsibilities as the firm’s leader as needing to resolve the outstanding Maxwell litigation against the firm. On May 2, 1994, two
pension funds representing Maxwell’s employees—who were facing a loss of £400 million as a result of the Maxwell scandals—filed suits against Goldman in New York State court claiming that Goldman had sold 25 million
Maxwell Communications Corporation shares in April 1991 owned by the pension funds, and instead of returning the proceeds of the sale—about $94 million—to the pension funds, Goldman had transferred the money to two Swiss companies controlled by Maxwell himself. The complaints claimed that Goldman and
Eric Sheinberg, the London partner who was Maxwell’s banker, sold the 25 million Maxwell shares “despite their knowledge” that the pension funds would not get the proceeds and that Goldman had followed the instructions of
Kevin Maxwell “without asking reasonable questions about the knowledge which the pension-fund trustee had of the transaction or taking reasonable steps to insure that the trustee was fully informed and approved such an extraordinary transaction.” For its part, Goldman called the suits “invalid, misdirected and [representing] an expensive and time-consuming distraction” and said it was merely acting as an agent on behalf of its client, Kevin Maxwell. The lawsuits sought a return of the $94 million, plus damages.
Exacerbating the two pension-fund lawsuits against the firm were other potential claims from banks and other creditors seeking a piece of Goldman’s hide, especially since the firm had made $2.7 billion in 1993. Quietly, Goldman’s limited partners had asked Jim Gorter and H. Fred Krimendahl, another former partner, to research Goldman’s behavior in the Maxwell matter and the charges being lodged against the firm. Gorter and Krimendahl came back with startling news: to wit, “
if we were the plaintiffs we would not settle.” Gorter told
Charles Ellis, “With Robert
Maxwell, supervision was lax. We didn’t have the necessary checks and balances. A trading relationship that started out okay got bigger and bigger and became so different in composition that it was not okay. In the end, it cost us a lot of money.”
Goldman was headed for more trouble, and Corzine knew he had to get the Maxwell matter behind him. Goldman tried to get the judge in the pension suits to dismiss the cases but, instead, she ordered them to proceed and claimed that Goldman had “virtually ignored all the allegations at the heart of the plaintiffs’ case” when it filed its motion to dismiss. With the litigation hanging over the firm, Corzine decided to pay $254 million to settle the two pension cases plus the remaining potential claims against the firm. (He thought the actual cost to Goldman was closer to $400 million, once the cost of unrecovered loans, lost business, and fines was included.) According to the
New York Times,
the amount Goldman paid was more than twice what the market had expected. Worse, the paper reported, the cost of the settlement would be borne by those people who had been partners in 1989, 1990, and 1991—with 80 percent of the settlement cost paid by the 1991 partners. “
Assigning the costs caused a rift at Goldman because 84 of the 164 partners who were asked to pay are limited partners and have no day-to-day responsibility for managing the firm,” the paper reported. “These partners wanted active colleagues, called general partners, to share the burden.” In a memo to the partners, the
Management Committee wrote that the settlement “should meet the appropriate expectations that anyone who has been a general partner should have developed regarding how a matter such as this would be handled if it ever arose.”
Less well known was the fact that if Gene Fife, the partner negotiating on behalf of Goldman with Sir
John Cuckney, the government-appointed arbitrator, had been unable to reach a settlement, Goldman would have been charged criminally. “
Gene, I think you might be interested in this document,” Cuckney told Fife after they reached an agreement. “Had we been unable to agree to terms as we have just done, it had already been decided that our negotiations would have been terminated completely and Goldman Sachs would have been formally charged this day.” Corzine knew in his gut the time had come to get the matter behind the firm. “
I have one of these theories, you turn up a rock at almost any place, any time, particularly where there’s trouble, there’s gonna be more trouble,” he said. “That’s how I felt about Maxwell.… I figured we were going to take a lot of flak for settling, but we were going to take a lot more flak every day and every month if we didn’t. For the life of me, I still don’t
know for sure what happened. But it was one of these episodes that felt to me like it could go very negative for the firm.”
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I
N ADDITION TO
believing that he had to get the Maxwell lawsuits resolved, Corzine also wanted to expunge the fog of pessimism that seemed to have curled into every corner of the firm in 1994. “
There was a psychology that needed to be broken about whether we could be successful at Goldman Sachs,” Corzine explained. “The ‘culture of excellence’ had come unwound and deeply bruised. And there were a bunch of pessimists who were willing to accept that, and I just wanted to challenge that psychology.”
At the annual partner offsite, at Arrowwood in January 1995, he put up a slide that caused audible gasps in the room. “I’m not really good at the vision thing,” Corzine told his partners, “but I’m gonna do the vision thing.” Coming off one of the worst years in the firm’s history, Corzine challenged the partners to generate $10 billion in pretax profits in the five years between 1995 and 1999, or $2 billion pretax per year. “There were a lot of people who were mumbling and grumbling; I could tell the minute the slide went up,” he said. “Some people thought it was ridiculous, some thought that I had undermined myself by doing that.”
Corzine said he didn’t mind the cynicism because he
wanted
to challenge the status quo at Goldman. He said that was “the art of leadership” and it was unacceptable to “sit around accepting that just because the immediate past was what it was, that’s what the future held.” He said it was “essential to change the attitude” at the firm “about whether we could be successful” again “and I absolutely believed that we could be successful again.”
The financial markets, though, were still concerned about Goldman’s financial health. As a follow-up to the $250 million in equity it had raised from the
Bishop Estate in November 1994, in March 1995 Goldman “
quietly raised” another $272 million in the private debt markets, according to the
Wall Street Journal
. “The latest capital drive is remarkable because it shows that while Goldman may be the top-rated brokerage firm by the credit agencies, institutional investors aren’t quite as sanguine about the firm’s credit prospects,” the
Journal
reported. The paper reported that Goldman had to pay an interest rate of close to 9.5 percent to attract investors for a ten-year security, significantly above the 8.846 percent rate that
Lehman Brothers had to pay two weeks earlier to sell its own ten-year bonds.
A month later, two of the
Journal
’s investigative reporters, Alix
Freedman and Laurie Cohen, wrote a 4,200-word front-page story about how the Bishop Estate was able to maintain its tax-exempt charitable status at the same time that it had an increasing array of profitable investments—for instance, its investment in Goldman Sachs—that it was permitted to shield from income taxes after winning one private favorable tax ruling after another from the
IRS. Freedman and Cohen revealed that Bob Rubin, who had by then replaced
Lloyd Bentsen as treasury secretary, had sought out the Bishop Estate with an unusual request in December 1992, when he was leaving Goldman—along with a reported $26 million pay package—to take the reins at the National Economic Council. Most of Rubin’s net worth was tied up in his partnership interest in Goldman, of course, and he was anxious to preserve the wealth he had meticulously built during his Goldman tenure. While it was not clear what the origin of the idea was, just after the Bishop Estate finished its first investment in Goldman and just as Rubin was leaving Goldman, the firm placed a call to the Bishop Estate, which agreed to guarantee—for a $1 million fee—the value of Rubin’s stake in Goldman, in the unlikely event that Goldman ever went bankrupt. “Bishop will get to pocket about $1 million in fees from Mr. Rubin and to enjoy the satisfactions, however intangible, of having a lasting relationship with the man who now, it turns out, oversees the IRS,” the
Journal
reported. Rubin also faced criticism for using the Treasury’s $20 billion discretionary fund to help bail out
Mexico, which suffered a financial crisis shortly after devaluing the peso in December 1994. One of the main beneficiaries of the Mexican bailout was Goldman Sachs, which was one of the chief underwriters of Mexico’s sovereign debt and would surely have faced billions of dollars in lawsuits had the rescue financing not been put in place, which helped restore confidence in the Mexican economy and kept its bonds from defaulting.
Freedman and Cohen were granted a rare audience with two of the Bishop Estate trustees,
Henry Peters and Richard “Dickie” Wong. During the interview, Peters and Wong “broke out of their reserve to lavish praise” on Goldman: the firm was an “astronomical opportunity” and a “long-term play” for the foundation because it was the “crème de la crème” of Wall Street. Soon enough, Freedman and Cohen elicited from Peters and Wong that what the Bishop Estate wanted from its $500 million investment in Goldman was a massive payday, the kind a Goldman IPO could provide. “Without being asked, Mr. Peters raises the topic of Goldman’s ‘IPO potential,’ ” the
Journal
reported, “then coyly says he won’t comment. But in the next breath, Mr. Peters blurts out: ‘Heck, I see an opportunity.’ ”
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A
COMBINATION OF
a general improvement in market conditions in the middle of the decade—coming out of the credit crunch of the late 1980s and early 1990s—plus the power of Corzine’s positive thinking began to have its intended effect on the type A personalities at Goldman Sachs. “He had enormous energy, unbounded energy,” one partner said, “and he was, in that sense, an energizing element in the firm. From where I sat in 1995, he looked like a good thing.” Corzine seemed to motivate people at Goldman. “
Jon is inspirational,”
David Schwartz said. “He would come to London three or four times a year. We’d all go into the conference room, and we would leave feeling so great about being a part of Goldman Sachs.… Corzine was able to convey the culture in a really profound way.”
Another cultural change that Paulson and Corzine instituted after they took over and that seemed to ignite the troops was the new system of risk controls, accountability, internal police, and open lines of communication. Around that time, Goldman partner
Robert Litterman, a former professor at MIT who had joined Goldman in 1985, created the “value-at-risk” model, which attempts to quantify how much Goldman could lose trading on any given day. (Many Wall Street firms still use a version of Litterman’s model, including Goldman, although the model’s ability to gauge genuine risk remains controversial.) Goldman created a risk committee that met regularly. The firm empowered internal accountants and risk assessors and gave them the authority to challenge traders on a regular basis about what they were doing. A chief risk officer position was created. Goldman completely transformed the way risk was assessed, calculated, and communicated on Wall Street—although no other firm on Wall Street took the matter nearly as seriously as did Goldman, in part because the firm had survived so many near-death experiences and in part because, unlike nearly every other large firm on Wall Street, the firm’s partners had their own money at risk on a daily basis. (In November 1996, the firm would become a limited liability partnership in order to further limit some of downside risks partners faced.)
One of the people who became a partner during the 1994 turmoil was Armen Avanessians, a 1981 graduate of MIT with a master-of-science degree from Columbia University. Before joining Goldman in 1985 as a foreign exchange strategist, he was an engineer at Bell Laboratories, in New Jersey, where he worked in the common subsystems laboratories. Avenessians, more than perhaps anyone else at Goldman, was responsible for creating the internal, proprietary computer system that gave the firm an enormous competitive advantage in the assessment and
monitoring of risk. Together with
Mike Dunbo—who is now in charge of technology at Bank of America’s Global Markets Group—Avenessians created at Goldman what is called “SecDB,” short for “Securities Database,” an internal, homegrown computer system that tracks all the trades that Goldman makes and their prices, and closely monitors on a regular basis the risk that the firm faces as a result. “It meant that you didn’t have the corporate bond guys in New York doing something different than the corporate bond guys in London,” according to someone familiar with SecDB. As important, SecDB put sophisticated real-time securities pricing information in the hands of both the bankers and the traders, allowing bankers to have conversations with their clients about how a security might be priced in the market without having to consult with traders, which was often the path that bankers at other firms were required to follow. “You can have sophisticated bankers thinking about the same problems, but with exactly the same tools that the guys on the desk are using that were trading the billions of dollars,” this person continued. “You had a holistic view of how you looked at things. It’s been broadened out over fifteen or twenty years. It’s taken a long time, but it’s grown so that there’s a real uniformity to the way the risk is viewed.”
These changes began to pay off, and the firm became immensely profitable. By the second half of 1995, Goldman had turned its business around. In the last six months of the year, the firm earned $750 million, pretax, and its annual run rate for pretax profitability had improved to $1.5 billion. Corzine was becoming increasingly confident that his $10 billion pretax goal was within reach. The old culture had been a trading free-for-all, where, according to one partner, “if you were trading Treasuries and you liked oil, you just put a bet on for oil. And if you were trading equities and you wanted to buy corn, you just put on a corn bet. There weren’t a lot of limits. People were just doing things all over the place.” It now changed to a far more disciplined machine where risks were closely monitored. “
What came out of the 1994 debacle was best practices in terms of risk management,” Paulson said. “The quality of the people, and the processes that were put in place—anything from the liquidity management to the way we evaluated risk and really the independence of that function—changed the direction of the firm.” When the firm “post-mortemed” 1994, Corzine said, the Goldman leaders had to parse between a “failure of strategy” and “a failure of execution.” They agreed that the strategy had been correct but the execution had been flawed, at least that year.