What Happened to Goldman Sachs: An Insider's Story of Organizational Drift and Its Unintended Consequences (13 page)

Changing Underwriting Standards

When I joined Goldman, strict underwriting guidelines were in place for taking a company public. The process required the team to write an extensive memo for the commitments committee by a certain day and time to be considered in the following week’s meeting. The committee was responsible for the standards that governed which companies Goldman would finance, take public, and be associated with. The memo had to follow a specific format and address standard questions. Mistakes in the memo or unanswered questions usually resulted in a severe dressing down at the meeting. The committee was notoriously tough.

Typically, Goldman would not take a company public if it had not been in business for three years, and it had to show profitability. But then came the technology and internet boom, and suddenly companies with little track record and no profits started being taken public by competitors. The requirement at Goldman was reduced to two years of profitability, then to one year, and then to one quarter, until finally the firm was not even requiring profitability in the foreseeable future.

Goldman has denied that it changed its underwriting standards during the internet years, but as Matt Taibbi pointed out in a
Rolling Stone
article, “its own statistics belie the claim.”

After [Goldman] took a little-known company with weak financials called Yahoo! public in 1996, once the tech boom had already begun, Goldman quickly became the IPO king of the Internet era. Of the 24 companies it took public in 1997, a third were losing money at the time of the IPO. In 1999, at the height of the boom, it took 47 companies public, including stillborns like Webvan and eToys, investment offerings that were in many ways the modern equivalents of Blue Ridge and Shenandoah. The following year, it underwrote 18 companies in the first four months, 14 of which were money losers at the time.
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In addition, Goldman’s behavior in managing IPOs was questioned. As Taibbi noted, Goldman took eToys public in 1999. On the first day of trading, eToys, which was originally priced at $20 per share, opened at $79 per share, rose as high as $85, and closed at $76.56. By the end of the year, the shares had declined to $25. In 2001, eToys filed for Chapter 11 protection in bankruptcy court. Later, the eToys creditors committee filed a lawsuit alleging that eToys relied on Goldman for its expertise as to the pricing of its IPO and that Goldman gave advice to eToys without disclosing that it had “a conflict of interest,” allegedly an arrangement with Goldman’s customers to receive a kickback of a portion of any profits they made from the sale of eToys shares after the IPO. In addition, the complaint alleged that Goldman had an incentive to underprice the IPO because an initial lower price would result in higher profits to its customers and therefore a higher payment to Goldman.
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The case was dismissed in court on the grounds that there was “no fiduciary relationship” between eToys and Goldman: “[W]e find no issue of fact as to whether Goldman Sachs assumed a fiduciary duty to advise eToys with respect to its IPO price,” Justice DeGrasse wrote. “We therefore need not consider whether such a duty was breached. Were we to consider the issue, we would find that Goldman Sachs met its burden of establishing that there was no breach.”
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The Rise of Stars and “Super League” Clients

In 1970, long before he drafted Goldman’s business principles, Whitehead had written a set of statements to guide internal investment banking (IBS) business development, including, “Important people like to deal with other important people. Are you one?”
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One partner told me Whitehead’s original statement had been reinterpreted and repeated verbally over the years as, “You can’t run with the big dogs if you pee with the puppies.” By the mid-1990s the slogan, meant to remind bankers to cultivate contacts and relationships with corporate CEOs and decision makers, was reinterpreted further and socialized to mean cultivating only the most important companies and most important people. This shift represented the preference given in partner elections to those who had relationships with important CEOs and important companies, because they had a higher value to the firm than did bankers who covered middle-market companies. Formerly, partners who covered many of these middle-market companies had been considered culture carriers and their role was deemed important, but that view had faded.

This change was dramatically represented by John Thornton when he spoke in the late 1990s at the annual internal investment banking conference held in New York each December. In his book
The Accidental Investment Banker
, Jonathan Knee describes the conference. Instead of employing the usual elaborate PowerPoint presentation, Thornton conveyed his message with a plain black marker, drawing a few dots that he said represented the “important people in the world,” of whom, he conceded, there were not many. He added circles representing the orbits of these important people and said, “Pretty much everything important that happens in the world, happens in these circles.” He then marked the point where the greatest number of circles intersected and said, “This is where I want to be. This is our strategy. Thank you.”
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Few of the people in the room dealt with Goldman’s most important clients or had access to the world’s most important people. The Goldman culture had always prevented stars from emerging and eclipsing their peers. Thornton’s new strategy singled people out, and it was accepted—a clear signal that the “no stars” policy had changed. When discussing “stars” and in explaining how much the policy continued to change, one retired partner pointed out that CEO Lloyd Blankfein was allegedly seen attending a pre-Oscars party in Los Angeles in 2013, and the partner said he guessed that it must have been a first for the head of Goldman.

This shift coincided with a new practice of designating “star clients.” Clients were categorized and prioritized to help Goldman prioritize and allocate resources, and the largest clients that offered the most revenue opportunities and that had influence or influential CEOs were classified as “Super League.”
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Super League clients received increased attention from management committee members, and Goldman systematically tracked the firm’s relationship and progress with these clients. Employees were also held strictly accountable for these relationships. Many bankers wanted to work on Super League clients’ business, resulting in fights for clients and internal politics.

The prioritization and metric-measuring culture rose in the firm during my time. For example, senior people asked me to develop lists of the top one hundred people in business and determine who at the firm had relationships with them so that Goldman could identify any gaps. Goldman executives were assigned to make sure they personally called and met with these influential people regularly, conveyed proprietary information or views or “out of the box” ideas, and connected them to other important people. When I was in Hong Kong as an analyst, I was given a list of about ten clients and told to focus primarily on them. I was told these people made all the important decisions and that we wanted to focus all our attention and resources on them—and, if possible, coinvest with them, because that was the closest relationship the firm could have with a client. I was told that if people called me about any other clients to refer them to my bosses.

Partners pointed out that, starting in the mid-1990s, Goldman introduced time sheets (records of how much time was being spent on Super League clients and on which transactions and products) and revenue scorecards. That led to increasing contention about who got credit for what, with implications for compensation and promotion. In describing this change over time, some partners said it had brought a “FICC or trading subculture” to the banking side, a mark-to-market mentality. Before this increased emphasis on quantification and accountability, people were willing to make more time for each other and help think through issues. Bankers didn’t worry about filling out time sheets or taking credit. They worried instead more about giving clients better advice.

This practice clearly signaled a shift of emphasis, and it changed the firm’s culture, but it also seems to have had positive financial results, at least in the short to medium term. Conceding that Goldman is run more efficiently and with more accountability now than in the past, one partner told me that the client metrics have perhaps gone too far in measuring investment banking clients as if they were trading clients, and investment bankers as if they were traders. The prioritization has made people more accountable and productive and has improved Goldman’s management, but he wondered whether it was really good for the clients—and in the firm’s best long-term interest.

Rehiring People and Making Counteroffers

When I started at Goldman, departing employees were persona non grata. While I was an analyst in the M&A department, someone spoke to one of the department heads about being approached by another firm and admitted to thinking about the offer. The senior partner told him to hold on for a minute, picked up the phone, and called security to escort the offender off the floor, telling security to retrieve his suit jacket from his cubicle. Naturally, then, rehiring someone who had left the company was unthinkable.

This policy changed slowly in the mid- to late 1990s as talented people left for tech firms or hedge funds and, later, regretting the move, wanted to return. Goldman was desperate for talented people, and in many instances made a “bid to match or top” the offer from competitors to keep them. By the time I left banking, there had been several exceptions to the “no rehire” rule. One of the more visible cases was Michael Sherwood, known internally as Woody, currently vice chairman and co-CEO of Goldman Sachs International. He left for a few weeks in 1994 before quickly changing his mind and returning to the firm.

As one partner explained, in the 1990s the bids to keep people were another example in the changing culture. Some employees had come to believe they needed to produce an offer from a competitor and have Goldman match or top it; otherwise, they would be lost in a crowd of many talented people. Those who were good soldiers—formerly viewed as important role models (because they didn’t complain, worked hard, didn’t politick or lobby for promotions or compensation)—were now considered either naive or not desirable enough to get another offer.

An example of the change was John Thornton, who was quoted in the
New York Times
as saying he would consider going to work at Lazard, a competitor, but “only for the top job.” At the time, a Goldman banker being singled out or quoted in the press was highly unusual, possibly a reason for getting fired, much less what was generally interpreted as public negotiation for a promotion. But surprisingly, there were no visible repercussions, and, in fact, Thornton would become copresident, which signaled that something had changed.
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Changing Compensation and Promotion Practices

When I started at Goldman, compensation and promotion were handled by class, according to the year one graduated from business school and started at Goldman. The vast majority of a class (I would guess 90 percent) was paid within a tight range. Associates in banking got bonuses that increased by about $100,000 per year; the range was less than 10 percent to 25 percent when I started. As competitive pressure to retain people increased and there were large differences in backgrounds, the ranges expanded. According to interviews, the original 90 percent had dropped to 75 percent, and the range was more like 25 percent to 100 percent. The goal was to retain and reward people, but the changing ranges also reflected the fact that the quality of the talent, which was very consistent across a class when I started, now varied more widely as more people were hired.

The way the partners were compensated also changed. I was told that in the 1980s partners were generally paid by class, according to the year they were elected. If two people were elected partner—one in M&A and the other in IT or operations—I was told they generally made the same amount at least in the first few years, because the attitude was that everyone worked hard and contributed, and, to succeed in IT or operations, a person had to be truly exceptional. But this changed over time. Steve Friedman and Bob Rubin tied partner compensation more closely to performance in the early 1990s. Also, to strengthen the link, to extend the policy to other employees, and to create a new source of developmental feedback, Goldman instituted 360-degree performance reviews in the early 1990s.

Promotions to partner typically were made a certain number of years after business school; usually it took eight to ten years after business school before someone was up for partner. Exceptions had often been made in trading. The rationale was that traders made enormous sums of money for the firm and possessed a specialized skill that was transferable to any firm (a hedge fund or another bank). Not so for bankers, whose only choice upon leaving Goldman would be to work for a competing firm, which would be a step down in social prestige. Traders did not care as much about prestige and could work at hedge funds or start their own, so exceptional traders began to make partner early. (One of the most notable exceptions was Eric Mindich, who ran equity arbitrage proprietary trading and made partner at the age of twenty-eight.)

The new attitude began to seep into other areas and then into banking. The idea that Goldman had stars and had to promote them earlier or compensate them differently set into motion a different dynamic. Some partners told me there was a deliberate effort to make exceptions and make a few people partners early, thereby creating more incentive, demonstrate a meritocratic culture, and drive people harder.

I see now that the changes—in compensation and in promotion—represent a fundamental shift in the 1980s’ practices of the firm.

Lateral Partner Hires from Other Banks

When I started at Goldman, it was unusual for the M&A department to hire senior bankers from other firms laterally, because, as I was told at the time, their deal experience, training, habits, and sacrifices would not be on par with those of their Goldman peers. When I was an analyst in the early 1990s, I remember a department meeting to discuss hiring an exceptional associate from another firm—a meeting of the entire department about one associate lateral hire. In contrast, by the time of the IPO, when the firm hired three outside senior M&A professionals as partners there was no department meeting to discuss it, even though Goldman probably had fewer than a dozen M&A partners worldwide.

As the firm grew, it needed more partners. It also needed to replace pre-IPO partners who wanted to “take the money and run—I mean, retire,” in the paraphrased words of one partner I interviewed. Goldman especially needed partners in FICC and in proprietary investing areas where it seemed there was tremendous growth, but a disproportionate percentage of partners retired and sought to start their own investing businesses. The IPO provided the currency to attract people from competitors. Goldman had hired laterally before, as it did with a few trading partners from Salomon Brothers in 1986, but this was a deviation from the norm.

The lateral partner hiring accelerated after the IPO. When I was in FICC, I noticed that several lateral partners were brought in at senior positions to replace departing pre-IPO partners.