Authors: William D. Cohan
In 1996, Ingram got passed over for partner at Goldman, losing out to
Steve Mnuchin, the son of the longtime Goldman partner
Robert Mnuchin. “He was livid,” remembered a former colleague. “He was much smarter than Steven, had accomplished a lot more, but his dad wasn’t Robert Mnuchin. And he left.” In short order,
Deutsche Bank hired Ingram to lead its global asset-backed trading desk. (Sadly, years
later, Ingram would engage in a tawdry money-laundering scheme and would go to prison.)
As blame began to be apportioned in the fallout from the collapse of the
Internet bubble, Goldman came in for more than its fair share of criticism. For instance, in early October 2002, the House Financial Services Committee, under the leadership of Representative
Michael Oxley, a Republican from Ohio, issued a report accusing Goldman of distributing chunks of shares in so-called
hot IPOs—including Goldman’s own IPO—to twenty-one CEOs of big companies with which Goldman did significant amounts of investment banking and trading business. After receiving the shares of the much-sought-after IPOs, the CEOs often sold them quickly into the market—in a process known as “spinning”—at prices substantially higher than what they paid for the shares, often netting huge profits. Some observers quickly took to likening what Goldman did in facilitating spinning for favored clients to bribery. According to Representative Oxley, Margaret “Meg” Whitman, then the billionaire CEO of
eBay and a Goldman director, and
Jerry Yang, one of founders of
Yahoo!, each received shares in more than one hundred hot IPOs managed by Goldman and then flipped the shares for a fast profit. EBay had paid Goldman $8 million in investment banking fees since 1996.
According to Representative Oxley’s report, Goldman’s generosity seemed to be reciprocated in spades. For instance, Goldman served up shares in more than twenty-five IPOs to
Edward Lenk, the former CEO of
eToys, which paid Goldman $5 million in fees.
Martin Peretz, former director of
TheStreet.com
Inc., received more than twenty-five IPOs, and his company paid Goldman $2 million in fees. Goldman allocated shares in more than fifty IPOs to
iVillage co-founder
Nancy Evans; iVillage paid Goldman $2 million in fees. Then there were the IPOs Goldman allocated to executives of companies that ended up at the center of the meltdown, including
Enron,
WorldCom,
Global Crossing, and
Tyco. Three of these four were Goldman clients—Tyco, which had paid Goldman $57 million in fees since 1996; Global Crossing, which had paid Goldman $45 million in fees; and WorldCom, which had paid Goldman $19 million in fees. Representative Oxley also found that Goldman’s own IPO, which rose in price dramatically on the first day of trading, was a way for Goldman to reward favored clients and investors. For instance,
Michael Eisner, CEO of Walt Disney Co., received thirty thousand Goldman shares at the IPO price. Disney had paid Goldman $51 million in investment banking fees since 1996. William Clay (“Bill”) Ford Jr., a director of Ford Motor Company and Thornton’s friend from
Hotchkiss, received four hundred thousand shares of Goldman’s IPO; Ford had paid Goldman
$87 million in banking fees since 1996. “
There is no equity in the equity markets,” Representative Oxley proclaimed in releasing his report.
Naturally, Goldman found Representative Oxley’s report to be outrageous.
Lucas van Praag, Goldman’s spokesman, said that Goldman had simply made IPO stock available to its high-net-worth clients—of which there were seventeen thousand with investable funds of more than $25 million—and the CEOs Oxley singled out just happened to be among them. In addition, the information he was basing his claim on had been given to Congress by Goldman. “
Their conclusion is not based on anything in fact,” he said. “We provided the information they asked for and they never asked us a single question about anything we gave them.” Asked about Ford, in particular, van Praag said, “We chose to give [Goldman] shares to people who we thought would be useful to our business and would be long-term holders. Bill Ford was one of them. He bought a lot of shares and still owns every one of them.” But Goldman’s logic—giving valuable IPO shares to people “useful to our business”—was hardly exculpatory.
When Paulson heard about Oxley’s report and his interpretation of the information Goldman had shared, he was apoplectic. He said he was “absolutely stunned” and “furious.” He called Oxley four times in the next two days, and when they finally connected, Paulson told him that while the information he relied on for his conclusions was accurate, his interpretation of those facts was “meaningless and insulting.” When
Eliot Spitzer, then New York State’s attorney general, heard about the spinning scandal, he wanted to put an end to it immediately (although his fellow Wall Street regulators
Mary Schapiro and
Robert Glauber were not supportive of him). “
If an investment bank wants to curry favor with a company, and give that company a discount on a fee to get it to do business, great, wonderful,” he said in an interview. “If an investment bank wants to give the company a hot stock allocation and it goes into the corporate treasury, that’s great. That’s a business transaction. But if the investment bank gives it to the CEO, that’s—not to mince words—that’s bribery, because it’s a corporate asset, not the individual’s asset. It’s no different than a contractor giving somebody money under the table to get the bid. So the ban was premised on the notion that the CEOs had a fiduciary duty to the company and that when they took those shares into their own personal account, they’re violating their obligation to the company.”
Then, in November 2002, came word that the SEC had sent Goldman a Wells notice of its intention to bring civil charges for a practice known as “
laddering,” whereby Goldman was supposedly allocating the shares of hot IPOs to investors that it knew would buy more of the stock
in the aftermarket at higher prices, thus ensuring the (then) much-coveted first-day trading “pop,” or rapid increase in the stock’s price. The investors’ reward was to get greater and greater allocations of other hot IPOs in the future that would also likely accelerate in price. The investor would also get the reward of buying the IPO low and selling it high. Spitzer might have referred to this practice as “bribery” as well. Goldman was outraged by the SEC’s investigation. “We categorically deny any allegations of wrongdoing and believe there is no basis for the SEC to take such a position,” Goldman said in a statement.
Goldman’s view that the SEC’s charge was fiction was severely challenged by
Nicholas Maier, who worked for Jim Cramer at the hedge fund he set up after leaving Goldman. Maier joined Cramer’s hedge fund in January 1994 and, for the next five years, his job, in part, was to make sure Cramer’s hedge fund got serious allocations of the hot IPOs, many of which came from Goldman. To do that, he claimed in a May 2005 deposition in Brattleboro, Vermont, he would do everything he could to convince brokers at Goldman and other Wall Street firms that Cramer was a long-term investor and wouldn’t flip the stock for a quick profit. But that was a fiction. “Our company was very, very rarely in for the long haul,” Maier testified. “And with IPOs, I would say the average turnover was within a few hours of the opening. I mean, there were occasions where we held on to it. But overall it was, as my boss [Jim Cramer] said, you know, ‘If someone comes up and gives you twenty bucks, put it in your pocket and walk away.’ ”
Then he explained how laddering worked at Goldman and how he and Cramer would play along to get the IPO allocations that they coveted—and the free profits that came with them. During the process of allocating the stock of a hot Internet company, the demand from institutional investors, including hedge funds, would be so strong that Goldman would create a checklist of behavior that would be required for a fund to get an allocation. These would include attending the “road show,” where the company would present its story to investors; calling the research analyst at the Wall Street firm that was covering the company “and act[ing] as if he really loved the stock”; putting in an order for 10 percent of the stock, knowing that such an amount would never be granted; and paying millions in trading commissions to the Wall Street firm in a given year, which he testified was the “most important” factor “and why the little guy can never expect to get in on hot IPOs.” And then came the whole process known as the “aftermarket order.”
Maier explained how in order for Cramer to get the IPO allocation, Goldman would demand that Cramer buy stock in the aftermarket at set
prices. “If you really are very interested and deserve your five thousand shares in the IPO price[d] at twenty dollars,” he testified his broker at Goldman told him, “you should promise to buy fifty thousand more shares wherever the thing opens, be it fifty dollars or five hundred dollars. Take a typical ‘hot’ deal. I get five thousand shares of an IPO price[d] at twenty dollars that we think is going to open at fifty. I want it so much that I agree to buy another fifty thousand at any price. I therefore wholeheartedly agree with the investment bank that the IPO is a legitimate and valuable company. Nearly all of the major investment banks made us commit to aftermarket orders, and they kept score. The investment bankers went to their brokerage house’s trading desk to make sure that if Cramer and Company committed to buying in the aftermarket, Cramer and Company bought in the aftermarket. This was their way of making sure hot deals stayed hot. If we didn’t buy in the aftermarket, we wouldn’t get any shares in the next IPO.”
In a July 2002 article in the
Washington Times,
Maier was quoted as saying about Goldman and laddering: “Goldman from what I witnessed, they were the worst perpetrator. They totally fueled the [market] bubble. And it’s specifically that kind of behavior that has caused the market crash. They built these stocks upon an illegal foundation[, then] manipulated [the stock] up, and ultimately, it really was the small person who ended up buying in” and losing money. He added, “Goldman created the convincing appearance of a winner, and the trick worked so well that they seduced further interest from other speculators hoping to participate in the gold rush. The general public had no idea that these stocks were actually brought into the world at unnaturally high levels through illegal manipulation.”
In his Brattleboro deposition, Maier made clear that Cramer told him how to deal with Goldman on these matters. “They are going to tell you what to do, and you are going to do it,” he said Cramer told him when he started on the job. “And all I care about is that. If there is a deal that opens up, I want to be there. You play the game they tell you to play so that we can make as much money as possible.” He acknowledged that since these Internet companies by and large had no earnings and barely any revenue, doing a fundamental analysis of their value was not only not possible, it was beside the point. “It was too much of an intangible,” he said. “We chose what was not an intangible, which was that, by playing this game and having somebody walk up to me, like Goldman Sachs, and put half a million bucks in my pocket for a couple of lunches, a couple of phone calls, and a little playing around in the trading, that was tangible. That was, you know, easy money, and we would take it.” He recalled this
happening in at least two Goldman underwritten hot IPOs, for
Amazon and for
Exodus Communications.
Much the same version of Maier’s assertions in his
Brattleboro deposition were contained in his March 2002 book,
Trading with the Enemy,
about his time on Wall Street working for Cramer. Cramer was not pleased by Maier’s account of what occurred at his hedge fund and threatened to sue Maier for libel but never did.
In January 2005, Goldman paid $40 million to settle a civil suit with the SEC related to its penchant for laddering investors in the hot IPOs it underwrote. One of the many examples the SEC cited in its complaint involved Goldman’s handling of investors in the IPO of
WebEx, an Internet video-conferencing company that Goldman took public in July 2000. On July 27, the institutional sales rep for an investor told the Goldman “deal captain” about his client’s willingness to buy WebEx shares in the aftermarket: “They’ll take the full amount and will hold it for at least 30 days unless you say longer BUT this is a relatively new relationship with a lot of business to do and I’d like to avoid hurting them too much if this one is in serious trouble.” The deal captain responded, “We’re looking for something longer term. No lack of demand. Want to wait for the next one?” The salesman responded, “They’ll hold it for at least 90 days and they’ll buy 3 for 1 up to $17” in the aftermarket. The next day, when WebEx started trading, the deal captain wrote to the salesman about when it would be good for his client to buy in the aftermarket: “first trade would be great.” The salesman replied that his client had complied: “Just sent it in—they got 10 so they’re buying 30 with a 17 top. These guys ALWAYS do what they say—if they got 100 they would be buying 300.”
But the spinning and laddering, while seemingly illegal and unethical, were a mere sideshow to the massive deception that Goldman—and nearly every other major underwriter of Internet stocks during the 1990s—participated in by rewarding with big bonuses their supposedly independent research analysts for writing favorable reports about the stocks of the Internet companies the Wall Street firms were taking public. Even though many research analysts did not believe what they were writing about these stocks, the pressure on them from their own firms’ investment bankers to write favorably was intense because the fees that the bankers could reap by underwriting and trading the hot IPOs were irresistible. Big fees meant big bonuses in an era where bankers were rewarded with huge bonuses based on how much revenue they generated rather than how much profit the firm overall generated.
Spitzer and the SEC led the charge against Wall Street in the Internet research scandal and successfully got the firms to collectively cough
up fines totaling $1.4 billion. Goldman was far from the most egregious violator of the compact that allegedly existed between underwriters and investors—that title belonged to Salomon Brothers, which forked over $400 million—but Spitzer got Goldman to pay $110 million. Even from the evidence in a smattering of e-mails, it was clear that Goldman was helping to rig the game just like everyone else. “Certain research analysts at Goldman Sachs were subjected to investment banking influences and conflicts of interest between supporting the investment banking business at Goldman Sachs and publishing objective research,” the SEC wrote in its complaint against the firm. “The firm had knowledge of these investment banking influences and conflicts of interest yet failed to establish and maintain adequate policies, systems, and procedures that were reasonably designed to detect and prevent those influences and manage the conflicts.”