Case Study.pdf

INS521

Goldman Sachs Group, Inc.: Sustaining the Franchise

04/2014-6057

This case was written by Ingo Walter, Visiting Professor at INSEAD and Professor of Finance, Stern School of Business, New York University, assisted by Sohail Rana, New York University Abu Dhabi. It is intended to be used as a basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation.

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In mid-April 2010, the US Securities and Exchange Commission accused Goldman Sachs of civil fraud during the financial crisis, alleging that the firm had failed to disclose to clients serious conflicts of interest and was in violation of its fiduciary obligations in the sale of a collateralized debt obligation (CDO) called Abacus. After the news broke, Goldman’s shares slid by 12.8% within a few hours, closing at $160.70, a fall of over $12 billion in the firm’s market value. Within two weeks the stock was down 21% and had lost nearly $21 billion in market value (Figure 1).

A few months later, Goldman Sachs agreed to pay $550 million in fines and penalties to the Securities and Exchange Commission, one of the largest ever paid by a Wall Street firm, to settle charges of securities fraud linked to mortgage investments. Under the terms of the settlement, Goldman paid $300 million in fines to the Treasury Department and $250 million in restitution to investors in the Abacus deal, but without admitting any wrongdoing. Goldman did admit that its marketing materials for the investment had “contained incomplete information”. The firm also agreed to change several business practices, including the way it developed marketing materials for complex mortgage-related securities and educated employees in that part of its business. The amount of the settlement was small compared to the firm’s reported $39 billion in revenues and $8.35 billion net income for 2010.

A civil fraud settlement was one thing; a criminal indictment was another. In view of persistent public and political resentment of the role banks and bankers had played in the global financial crisis – yet “nobody went to jail” and contrition was virtually non-existent – it was only a matter of time before pressure to bring criminal charges materialized. If the law had actually been flouted and people or financial firms had knowingly broken it, the public expected criminal charges to be filed. Goldman was a prime target for a Department of Justice criminal probe, but evidence “beyond reasonable doubt” and mens rea (intent to commit) had to be proven for a grand jury to indict and for a criminal jury to convict.

Despite the political pressure, the Department of Justice decided not to charge Goldman or any of its employees with a criminal offense. The decision followed a high-profile investigation of the bank’s subprime mortgage deals – including the Abacus transaction – based on information provided in an April 2011 US Senate report. In August 2012, the Department of Justice concluded that – based on the law and evidence as they existed at the time – there was no viable basis to bring a criminal prosecution against the firm. Goldman responded “…we are pleased that this matter is behind us.”

Nevertheless, Senator Carl Levin, who commissioned the 2011 report, commented that “Goldman’s actions did immense harm to its clients, and helped create a financial crisis that nearly plunged us into a second Great Depression…. Whether the decision by the Department of Justice is the product of weak laws or weak enforcement, Goldman Sachs’ actions were deceptive and immoral.”1 He promised unrelenting regulatory pressure on Goldman and its competitors.

With a stellar track record, highly talented employees, close relationships with policymakers and regulators, and a peerless franchise with clients, Goldman had long been a leader in global investment banking. The firm claimed a unique risk management culture that seemed to execute superbly during the global financial crisis, outperforming most competitors under 1 http://www.politico.com/news/stories/0812/79566.html



severe stress conditions and coming out of the episode firing on all cylinders. In the process, Goldman was forced to convert to a bank holding company – thereby accepting tighter regulatory burdens in order to obtain access to Federal Reserve financing – as financial markets melted down following the failure of rival Lehman Brothers.

The Heritage

Goldman Sachs was founded in New York in 1869 by Marcus Goldman, a German immigrant. The firm adopted the name Goldman Sachs Co. after Goldman’s son-in-law, Samuel Sachs, joined the firm in 1882. From the start the business was organized as a partnership, with all key decisions and commitments undertaken by the firm’s partners. Ownership and management were one and the same. The partnership mindset came to define the firm’s culture and persisted over the ensuing decades more durably than any of its investment banking competitors, all of which likewise started as partnerships.

The early Goldman Sachs partnership was both resourceful and innovative. It was one of the first firms to introduce the use of commercial paper to raise funds for corporations in the 1890s, giving clients an alternative to bank credit lines. The firm was invited to join the New York Stock Exchange (NYSE) in 1896. It was a player in establishing the initial public offering (IPO) market in the early 20th century, and in 1906 managed one of the largest IPOs for Sears, Roebuck and Company.

There were misses as well as hits along the way. In the early 1920s, Goldman established a closed-end fund, Goldman Sachs Trading Corp, which collapsed in the stock market crash of 1929 and the Depression that followed in the 1930s, creating reputation problems that took time to overcome. The Depression was a difficult period for Goldman Sachs, as for its Wall Street competitors. The volume of business was at a low ebb for close to a decade.

It was during the worst of this period that the Goldman partners appointed one of the firm’s most charismatic leaders, Sidney Weinberg, as senior partner in 1930. Weinberg shifted focus away from trading and toward investment banking – raising capital and providing advisory services for corporate clients. Weinberg was a very social individual and maintained contact with key people in the business and government communities. He effectively welded Goldman’s partnership culture to a corporate finance service culture. Client interests were the primary focus, and this long defined the Goldman Sachs approach to the business. Under his leadership, Goldman was lead advisor on the Ford Motor Company’s IPO in 1956, a major coup on Wall Street at the time, made possible by Weinberg’s contacts with the family of Henry Ford. He was also responsible for creating an investment research division and a municipal bond department, as well as establishing risk arbitrage as a distinct line of business.

Weinberg’s eventual successor, Gus Levy, joined the firm in the 1950s as a securities trader. Levy was a pioneer in block trading, in which the firm risked a large amount of capital to provide trading clients with liquidity and effective low-cost execution by buying large blocks of securities at a fixed price and then selling them in the market, hopefully at a profit. Competitors were slower or more risk averse in adopting the practice, so Goldman was able to gain market share, notably with large institutional investors. As he rose through the firm, Levy was influential in gradually changing the profile of Goldman Sachs and the balance between its two powerful divisions, investment banking and securities trading.



Levy took over from Weinberg as Goldman’s senior partner in 1969, and continued to build the firm’s trading franchise. He famously introduced the term “long-term greedy” to the Goldman vocabulary – denoting a focus on making money in the long term while helping clients meet their objectives. Short-term trading losses happened from time to time but were to be tolerated as the cost of doing business.

Goldman partners reinvested almost all of their earnings in the firm, except for a “draw” needed to live a reasonable lifestyle, and the focus was firmly on the future, not the present. In a sense, the firm was married to its clients and the partners were married to the firm in what became an uncommonly successful business model.

Like its competitors, Goldman suffered a financial setback in 1970, when Penn Central Transportation Company went bankrupt with over $80 million in commercial paper outstanding, much of which had been underwritten by Goldman Sachs. In the face of large investor losses, Goldman was forced to mount a sustained defence of its due diligence practices and underwriting standards, and rebuild its reputation with investors.

Like its American rivals, Goldman Sachs had plenty of business opportunities in the US domestic market during the high-growth 1950s and 1960s, having been protected in the securities business by the Glass-Steagall provisions of the Banking Act of 1933, which kept out the large commercial banks with much bigger balance sheets and much larger capital-bases. In the 1970s, new opportunities were emerging in Europe, Japan and elsewhere that offered US investment banks a chance to migrate their financial know-how into markets mainly dominated by big local universal banks. Most of these banks were well entrenched, with close connections to industry and resistant to importing disruptive new ideas that could threaten their long-standing business models. Creating a viable competitive footprint abroad was a long slog for the American investment banks, but one with a potentially massive payoff as companies and markets globalized. Goldman opened its first international office in London in 1970, creating a Private Wealth division along with a Fixed Income division in 1972.

In the market for corporate restructuring in the US and abroad, Goldman tended to focus on the defence – adviser to the target – both because fees were highly likely to get paid and because conflicts associated with hostile takeovers could be avoided. This was important for the firm with the most impressive client list in the industry. Goldman famously created a “white knight” strategy in 1974 during its defence of Electric Storage Battery against a hostile takeover bid from International Nickel (advised by rival Morgan Stanley), an innovation that burnished the firm’s advisory reputation.

Two capable partners led the firm at the time – John L. Weinberg (son of Sidney Weinberg) and John C. Whitehead. Both were named co-senior partners in 1976. With Weinberg’s trading background and Whitehead’s leadership in corporate finance, this arrangement avoided internecine battles for power across divisions and set a pattern of co-leadership that was to last for some time. Weinberg and Whitehead defined much of the culture of Goldman Sachs, including the firm’s 14 business principles (see Annex A).

With corporate finance earnings under pressure during the recession of the early 1980s, Goldman once again ramped up its reliance on trading. In 1981, the firm acquired J. Aron & Company, a commodities trading business that merged with Goldman’s Fixed Income



division to create Fixed Income, Currencies, and Commodities (FICC). The Aron acquisition also spawned important Goldman Sachs leaders in later years.

Business in the 1980s was good. Goldman underwrote the largest REIT offering in history for the Rockefeller Center. Deals like Microsoft’s IPO, major advisory assignments for GE and admission to the Tokyo Stock Exchange propelled Goldman Sachs to the top echelons of the investment banking league tables by the late 1980s. The firm launched a lucrative privatization practice as Margaret Thatcher privatized whole sectors in the UK, German reunification brought sell-offs of state-owned enterprises to East Germany, and various governments in continental Europe and emerging markets followed suit. There was plenty to privatize and Goldman Sachs got more than its share of the advisory work. To help rebalance the firm on the buy-side of the market Goldman Sachs Asset Management was formed in 1986 to manage in-house mutual funds and hedge funds offered to clients.

Continuing under a dual leadership structure, Robert Rubin and Stephen Friedman became co-senior partners in 1990, and built on the firm’s string of successes and innovations. Goldman introduced paperless trading to the NYSE, and lead-managed the first global debt offering by a US corporation. It launched the Goldman Sachs commodity index (GSCI) and opened a Beijing office in 1994. Mexico’s $20 billion bailout during the Tequila crisis with the involvement of Robert Rubin stopped-out significant potential losses for Goldman, although the Fed’s abrupt turn in 1994 toward a much tighter monetary policy wreaked havoc on the firm’s fixed income portfolio and left partners to take large losses in their capital accounts. Accustomed to consistently growing personal wealth intended to be harvested at retirement, many Goldman partners were shocked by the losses they had to bear, even if only temporarily.

Jon Corzine assumed sole leadership of Goldman Sachs in 1994 with Rubin’s move to the US Treasury and Friedman’s retirement. The collapse of Long Term Capital Management (LTCM) and the financial crisis of 1998 posed significant but not cataclysmic challenges for the securities industry, and Goldman weathered them better than most.

The IPO

For years the Goldman Sachs partners had periodically debated the pros and cons of going public. All of its major competitors had already taken the decision to go public, notably Morgan Stanley, Merrill Lynch and Lehman Brothers, leaving Goldman Sachs as the last partnership holdout. Several points were seemingly in favour:

� Partners could finally cash-out in what looked to be a favourable market for financial stocks, instead of remaining locked in until retirement and subject to a five-year withdrawal schedule. Diversification made sense for partners’ wealth, and an IPO would make this possible.

� The repeal of Glass-Steagall in 1999 allowed the model of universal banking to be introduced into the United States and ended the protected status of the full-service investment banks. The big commercial banks were already entering investment banking aggressively using their enormous balance sheets, which was likely to produce erosion of margins and force greater use of leverage.



� Failure of LTCM and the earlier bond losses left many partners concerned about the value of the firm’s capital account in the event of a future financial crisis. In an extreme case, given their limited wealth diversification and partnership liability, they could be wiped-out financially. As shareholders in a listed company, their losses would be limited to the value of the stock.

� The partnership form constrained Goldman’s strategic alternatives, since any acquisitions would have to be paid for in cash as opposed to shares as a form of acquisition currency.

� Since Goldman as a partnership could not be acquired by another firm, it was not “contestable”, which could put a lid on the value of the company in the market for corporate control.

Arrayed against these arguments were a number of points, strongly defended by some of the partners, that going public – even at an attractive valuation – would be the wrong thing to do:

� Loss of control by the partners. Even with limited distribution of IPO shares to friendly hands, former partners and other senior executives were unlikely to retain their dominant role in shaping the firm going forward.

� As a public company, Goldman could be slower to respond to challenges and opportunities, possibly a critical issue in a fast-moving business like investment banking.

� With the public disclosure requirements of a listed company, the competitive freedom allowed by financial and operational confidentiality could be lost, while the cost of regulatory requirements would certainly rise.

� As a public company whose key people were no longer “married to the firm”, a key element of Goldman’s culture would eventually dissipate, including fierce loyalty to its clients. An extraordinary firm would soon become an ordinary firm, losing much of its distinctiveness.

After a sometimes bitter debate, on May 4th 1999 Goldman Sachs gave up the partnership form of organization and went public. The IPO raised $3.6 billion, the second largest IPO in US history at that time. The stock issue was offered at $53 per share and was fully subscribed. This put Goldman’s market capitalization at $33 billion. The first shares to be traded on the secondary market sold at $76 and the stock reached a first-day high of $77 before closing at $70.37.

For 133 years, Goldman Sachs had been owned and managed by its partners. Following the IPO there were 221 “managing partners”, the top echelon of executives with profit participation rights. They retained 48.3% of the outstanding shares, while 8.5% went to retired partners and 21.2% to non-partner employees. Two investors in Goldman’s subordinated debt, Sumitomo Bank of Japan and the Kamehameha Activities Association of Hawaii, received 9.4% of the shares. So only 12.6% was sold to the general public in the IPO, and most were sold to clients, primarily loyal and wealthy customers. No shares were allocated to the syndicate managing the IPO and hence the general public.



Leadership of the newly public company was vested in Henry Paulson, a strong advocate of the IPO who was instrumental in ousting his predecessor, Jon Corzine, after bruising policy disagreements. Paulson reverted to the classic Goldman ‘long-term greedy’ view of the conduct of business and focused on Weinberg-Whitehead’s 14 basic business principles.

Not long after the IPO in 1999, Goldman Sachs became enmeshed in an industry-wide scandal involving biased research and underwriting practices during the dot-com bubble. With one of the largest IPO market shares, Goldman had underwritten 56 new tech issues in 1998-1999. Of these, 40% fell below their offering price shortly after issuance and some soon lost as much as 75%. All had been touted as “strong buys” by the firm’s analysts, who had faced the impossible task of providing unbiased opinions to investors while at the same time under pressure to help move the paper for IPO clients who paid the bills. Again, Goldman was not unique in facing this conflict. Aggressive legal action was brought against the investment banks by New York State Attorney General Elliott Spitzer, leading to a civil settlement of $1.435 billion against the securities industry, of which Goldman Sachs paid $110 million.

Building-out the Firm

These potholes aside, a key motivation for the IPO had been to allow Goldman Sachs to expand its business platform across high-potential clients, financial products and techniques, and geographies, calibrated to take optimum advantage of the firm’s evolving competitive capabilities.

Trading for clients (market making) and for its own book (proprietary trading) had reaped large profits prior to 1999, amplified by the earlier acquisition of J. Aron in 1981. The IPO was a way to raise capital to further expand trading, and once again refocused the firm’s balance towards trading and positioning, and away from corporate finance, advisory work and institutional asset management. Increasingly, Goldman served as both principal and agent in its evolving competitive profile, with its agency role in the “flow” businesses for major clients providing a useful information edge for its proprietary trading business.

Goldman made three additional acquisitions designed to support trading. One was the July 1999 $531 million purchase of the Hull Group Inc., a leading electronic trading company. This signalled Goldman’s view that profitable trading growth would increasingly require electronic, high-frequency, algorithm-driven platforms. In 2001, Goldman acquired the specialist assets of TFM Investment Group, LLC, a leading options specialist firm. And in 2000, Goldman purchased the NYSE market-maker Spear Leeds & Kellogg LP for $6.5 billion in stock and cash.

To compete in the evolving trading environment with the investment banking divisions of the massive US and foreign financial conglomerates like Citigroup, UBS and Deutsche Bank, a much larger balance sheet and increased leverage would be needed. One option was to merge with JPMorgan & Co. – itself the product of Chase Manhattan’s acquisition of the legacy J.P. Morgan in 2000 – which was working to build its own investment banking and trading capability, sometimes with mixed success. Some considered this a match made in heaven, and Goldman looked set to join with Morgan in 2003.



The deal never happened, reportedly due in part to reservations of CEO Henry Paulson. In an effort to “rent” a large balance sheet, Goldman instead created a strategic alliance with Sumitomo of Japan. This facilitated a market positioning for Goldman that combined agency functions for clients with an active capital-intensive proprietary trading and investment book of its own.

In 2006, Paulson was named US Secretary of the Treasury by President George W. Bush and was succeeded by Lloyd Blankfein, who had joined the firm with the highly successful acquisition of J. Aron some 25 years earlier. Blankfein was supportive of a workable balance between agency business, trading and principal investing that had originated with Friedman and Rubin and gathered force with Paulson. The persistent swing toward trading as a source of earnings (over investment banking and asset management) continued to the point that uncharitable observers characterized Goldman Sachs as “a hedge fund with some investment banking activities attached”. Nevertheless, investors were amply rewarded by Goldman’s impressive stock price performance in the mid-2000s (see Exhibit 1).

Surviving the Financial Crisis

Unlike most of its competitors, Goldman Sachs was able to profit from the collapse in subprime mortgage securities and their derivatives in the spring and summer of 2007 by shorting the impacted asset classes. Adroit risk management on the part of the firm and its CFO, David Viniar, together with two Goldman traders, Michael Swenson and Josh Birnbaum, was credited with this success. Goldman turned in a gain of $4 billion by betting on the market’s collapse, while others among its competitors and its own clients held disastrous long positions which had to be written down – a difficult exercise in the absence of a viable secondary market for the toxic assets. Goldman’s performance during the onset of the global financial crisis was widely lauded in the media, although it did not come without collateral damage.

As losses of financial intermediaries and institutional investors mounted in the second half of 2007 and into 2008, it became increasingly difficult for firms to profit from the market turbulence, conditions that worsened dramatically after the collapse of Lehman Brothers in September 2008 in a Chapter 11 bankruptcy filing. Mortally wounded, Merrill Lynch was taken over by Bank of America in a controversial transaction.

With two independent investment banks gone, that left Goldman Sachs and Morgan Stanley still standing. On September 21, 2008, both firms confirmed that they would convert to traditional bank holding companies in order to obtain access to the Federal Reserve for liquidity, and both ultimately obtained funding under the government’s Troubled Asset Relief Program (TARP) for injecting taxpayer capital into banks. This brought an end to 75 years of independent investment banks on Wall Street.

Goldman Sachs received a $10 billion TARP investment of preferred stock from the U.S. Treasury in October 2008. All of its US competitors were likewise forced to accept TARP funds, although Goldman and its wholesale banking competitors needed hefty doses of additional private capital to stabilize the firms and the system as a whole. Various options were available, but all were expensive. Goldman Sachs turned to Warren Buffet and Berkshire Hathaway. On September 23, 2008, Berkshire agreed to purchase $5 billion of Goldman



preferred stock, paying 10% interest, accompanied by warrants to buy another $5 billion of Goldman's common stock exercisable over a five-year term. In June 2009, Goldman Sachs repaid the government’s TARP investment with 23% interest (in the form of $318 million in preferred dividend payments and $1.418 billion in warrant redemptions).

The US TARP exercise was highly unpopular politically and remained so for years. It was perceived as taxpayers – in the deepest and longest recession in memory – bailing out the “fat cats” of Wall Street, socializing risk and privatizing returns. Goldman Sachs did not help build the banks’ political credibility by rewarding 953 employees with over $1 million each immediately after receiving its share of TARP funds, followed by announcements of impressive earnings rebounds a year later. Taking a hard media line, Goldman insisted that it had not in fact needed any government bailout at all, but given the possibility of a global financial melt-down, this argument struck most people as disingenuous.

Besides Treasury capital injections, in 2008 the Federal Reserve had introduced a number of short-term credit and liquidity facilities to help stabilize financial markets and institutions. Some of the transactions under these facilities provided liquidity to banks whose failure could have severely stressed an already fragile financial system.

Goldman Sachs was one of the heaviest users of the Fed’s loan facilities, with large borrowings between March 18, 2008 and April 22, 2009. The Primary Dealer Credit Facility (PDCF), the first Federal Reserve facility ever to provide overnight loans to investment banks, lent Goldman Sachs a total of $589 billion against collateral such as corporate debt instruments and mortgage-backed securities. The Term Securities Lending Facility (TSLF) additionally allowed primary dealers to borrow liquid Treasury securities for one month in exchange for less liquid collateral. TSLF lent Goldman Sachs a total of $193 billion during this period. In all, Goldman Sachs's borrowings from the Federal Reserve totalled $782 billion in 2008 and 2009. All loans were fully repaid and the collateral returned.

Sustaining a Hard-Earned Reputation

Prior to its IPO, Goldman Sachs was revered as a firm with an overriding fiduciary focus on clients. Ownership and management were the same, and the firm could afford possible short-term costs to reap the benefits of long-term relationships. The IPO seemed to shift the goalposts, elevating the importance of fiduciary obligations to public shareholders on the part of management and the board – at a time when Goldman increasingly served as both principal and agent as a key element of its competitive strategy.

Combined with the aggressive push of commercial banks into investment banking, technology advances in financial products and processes, and financial globalization, the likelihood of conflicts of interest increased accordingly. The issue was not whether conflicts of interest existed in the Goldman business model; they did. The issue was how conflicts of interest could be managed in ways that safeguarded Goldman’s core franchise. Risk governance rose – or should have risen – to the top of the agenda in a politically-charged post-crisis environment that was unlikely to spend a great deal of time listening to excuses for future slip-ups.



Unfairly or not, Goldman Sachs was the target of a series of allegations across a number of its business lines which seemed to call into question the firm’s overall business model and its market conduct.

Regulatory Capture

Numerous Goldman Sachs partners and employees served in the US government and vice versa in a relatively uncontroversial combination of public service and business motivations. But the firm’s uncommon success in navigating the financial turbulence of 2008 and 2009 generated much criticism of an alleged “revolving door” through which Goldman employees and consultants moved in and out of high government positions. Critics saw a troubling potential for conflicts of interest involving three axes – Goldman’s interest, clients’ interests and the public interest (see Exhibits 2 and 3).

Treasury Secretary Paulson had been CEO of Goldman, as had former Treasury Secretary Robert Rubin. The firm’s lobbyist Mark Patterson had served as chief of staff to Treasury Secretary Timothy Geithner. Stephen Friedman, a former senior Goldman partner, was named Chairman of the Federal Reserve Bank of New York in January 2008, although he continued to own Goldman stock and was a member of the board. Former Goldman partner William Dudley became President of the Federal Reserve Bank of New York. Goldman's conversion from a securities firm to a bank holding company meant that its primary regulator was now the Fed and not the SEC. Former Goldman partner Gary Gensler became head of the Commodities Futures Trading Commission (CFTC), a key financial regulator.

In Europe, as in the United States, commentators noted the close relationship between Goldman Sachs and government officials in many countries, as well as at EU and Eurozone levels. Examples included Lucas Papademos, Greece's prime minister, who was in charge of the Greek central bank when a swap deal with Goldman Sachs allowed Greece to hide public debt. Likewise Petros Christodoulou, head of Greece's debt management agency, began his career at Goldman Sachs. Mario Monti, Italy's prime minister and finance minister, was an international adviser to Goldman Sachs, and Mario Draghi, head of the European Central Bank, was formerly Managing Director of Goldman Sachs International. António Borges, former head of the IMF's European Department, served as vice chairman of Goldman Sachs International. Peter Sutherland, former Attorney General of Ireland and head of the World Trade Organization, was a non-executive director of Goldman Sachs International. Karel van Miert, former EU Competition Commissioner, was an ex-international adviser to Goldman Sachs. With a reported gross exposure of some $33.6 billion to Portugal, Italy, Ireland, Greece and Spain in mid-2012, its peerless European contacts couldn’t hurt.

Goldman’s tradition seemed to encourage successful employees to “give back” in the form of public service, and Goldman offered uncommonly remunerative career opportunities to former public employees. There was nothing to suggest the exploitation of conflicts of interest, but when assembled as a montage by industry critics accusing it of hijacking of public policy, there was plenty to discuss in the media. Perceptions matter. Nor did it help that CEO Lloyd Blankfein once reportedly described conditioning the public policy environment as “our seventh line of business”.



Doing Well in the AIG Bailout

American International Group (AIG) was famously rescued by the US Treasury and Federal Reserve in September 2008. AIG was heavily exposed to credit default swaps (CDSs) linked to mortgage-related securities through an affiliate of the AIG holding company, AIG Financial Products (AIGFP) in London. The AIG holding company itself was lightly regulated by the US Office of Thrift Supervision. Although AIG’s insurance business remained sound – regulated by the New York State Insurance Department – the impending collapse of the holding company was deemed to threaten the financial system.

Counterparties of CDSs written by AIG successively demanded additional capital to secure their interests. In the absence of sufficient capital, the Federal Reserve initially lent AIG $85 billion to stay afloat. To the extent the banks avoided “haircuts” on their AIG CDS exposures, the Fed was indirectly supporting the banks by bailing out AIG. US and foreign banks received billions during the unwinding of AIG credit default swap contracts, including $12.9 billion from funds provided by the US Federal Reserve.2 (See Exhibit 4)

This triggered controversy in the media and among politicians as to whether counterparty banks had benefited excessively from the massive bailout and whether they had been overpaid. In the event of a looming bankruptcy, it was argued, creditors could expect to suffer a haircut and make a contribution to the firm’s restructuring. Goldman Sachs and a number of foreign banks took a very hard line in refusing to accept any haircuts. Lloyd Blankfein was reportedly the only Wall Street representative present at a meeting at the Federal Reserve Bank of New York where the options for resolving the AIG crisis were considered.

For its part, Goldman maintained that its net exposure to AIG was not material, and that the firm was protected by hedges (in the form of CDSs with other counterparties) and $7.5 billion of AIG collateral posted with the firm. Others considered this position disingenuous. In any financial meltdown, nobody would be spared and hedges would inevitably fail.3

Abacus Mortgage-Backed CDOs

In July 2009, Goldman Sachs received a so-called “Wells Notice”, alleging that it had defrauded investors of more than $1 billion by wilfully mis-marketing toxic sub-prime mortgage-related securities. The SEC case, launched in April 2010, was described by Goldman as “baseless and factually incorrect”.

The charge was based on a financial vehicle, Abacus 2007-AC CDO, that Goldman had created and sold. The SEC claimed that Goldman had deliberately placed poor-quality (guaranteed to fail) mortgage loans into the Abacus vehicle at the request of US hedge fund Paulson & Co., which was seeking to build on its massive short position in that asset class. The structure and performance of the deal are depicted in Exhibits 5 and 6. Goldman sold the ill-fated Abacus CDO structure as highly-rated CDOs to investors, especially in Europe, while

2 http://www.businessweek.com/the_thread/economicsunbound/archives/2009/03/german_and_ fren.html#more 3 http://dealbook.nytimes.com/2009/03/20/goldman-maintains-it-had-no-aig-exposure/;

http://www.nytimes.com/2010/02/07/business/07goldman.html?pagewanted=all; http://www.goldmansachs.com/media-relations/comments-and-responses/archive/aig-nyt-response.html)



shorting its own position in the same assets. Goldman and one of its traders, Fabrice Tourre, were the main targets of an SEC civil enforcement action alleging securities fraud.

In April 2010, Tourre was stripped of his license to operate in the City of London and sent on permanent leave by Goldman, based on emails suggesting he was aware of the complex and toxic nature of the trades and the intent to deceive investor clients. Later that month, Tourre appeared before the US Senate Permanent Subcommittee on Investigations, and denied misleading clients. The Senate hearing received further testimony on other derivative financial products that turned sour. One, a $1 billion CDO package called Timberwolf, was branded in an internal email as a “shitty deal” by Thomas Montag, then Goldman's head of Sales and Trading for the Americas.

It then emerged that US federal prosecutors had likewise begun a criminal investigation into Goldman over allegations that investors who bought complex mortgage-backed securities had been knowingly deceived by the firm.

On 16 July 2010, Goldman settled the civil fraud case with the SEC for $553 million in fines and penalties over its allegations that it had misled investors in the Abacus 2007-AC1 deal by not disclosing the involvement of a hedge taking a short position, or the fact that the hedge fund stood to benefit if the CDO failed. Fabrice Tourre was subsequently charged by the SEC. In September 2010, the UK's Financial Services Authority (FSA) fined Goldman £17.5 million for not alerting the British authorities about the original SEC probe.

In April 2011, the Senate Permanent Subcommittee on Investigations released its report on Goldman Sachs. Goldman was accused of deliberately selling mortgage-linked derivatives at inflated prices after it had concluded that the housing market was about to crash. Chairman Carl Levin argued that regulators could take further action against Goldman. In February 2012, Goldman Sachs received notice from the SEC that the agency might bring further charges related to mortgage-backed securities, but in August the prosecution was dropped. Meanwhile, Goldman was named in a $1.07 billion civil lawsuit related to the Timberwolf transaction.4

Trouble in China

In 2009, the State-owned Assets Supervision and Administration Commission (SASAC) in China accused Goldman Sachs of bringing complex products to market that had damaged investors. The complaint related to a series of oil price hedges structured by a number of investment banks, predominantly Goldman, for Chinese airlines and energy companies. Li Wei, SASAC vice president, claimed that the companies had lost RMB 11.4 billion of RMB 125 billion in derivative contracts. Goldman likewise was refused payment by Shenzhen Nanshan Power, a listed utility which owed the firm $80 million on hedges that went bad, on the grounds of excessive complexity. Goldman ascribed these disputes to regulatory constraints in China, where the firm was only one of two investment banks with a full license to conduct domestic business (the other being UBS).

4 http://www.reuters.com/finance/stocks/GS/key-developments/article/2424057;

http://nymag.com/daily/intel/2010/04/sec_charges_goldman_sachs_with.html; http://www.reuters.com/article/2010/04/16/us-goldman-idUSTRE63F3JX20100416)



The Facebook IPO

Facebook was a fast-growing privately owned tech company when Goldman Sachs invested $450 million at a share price which valued Facebook at $50 billion, in early January 2011. Facebook was looking to raise an additional $1.5 billion from investors but without going public. Goldman Sachs created a plan to offer Facebook shares to its own wealthy American clients by creating an SPV (special purpose vehicle) which would allow Goldman to raise cash from large numbers of investors while declaring the SPV as a single owner on the books of the limited partnership (LP) listed as undertaking the investment – with Goldman as the general partner. This structure would allow important Goldman clients to obtain early entry as Facebook shareholders at what was likely to be a substantially lower price than an eventual IPO issue price to the general public.

Within two weeks, Goldman reconfigured the deal under pressure from the SEC, which considered the structure biased in favour of Goldman and its clients. Instead the shares were offered to wealthy Goldman clients overseas. Interested US investors felt they had been cheated out of a potentially lucrative investment opportunity.

The Facebook IPO was launched in May 2012. Goldman and other banks in the syndicate put substantial effort into marketing and roadshows, and demand seemed strong. However, Goldman failed to tell clients about a recent drop in Facebook revenues. Moreover, an asset management unit of Goldman Sachs had rejected the Facebook investment, a fact that likewise was not revealed to customers for Facebook shares. There was no obligation to do so but it looked bad after the fact.

The Facebook IPO price was targeted at the high end of the price range ($38) and the IPO had a dismal start, the share price initially staying barely above the offering price and later dropping below half that level. Underwriters including Morgan Stanley and Goldman Sachs as well as the NASDAQ took serious reputational losses in a disastrous deal for investors.

Europe’s Sovereign Debt Crisis

Goldman Sachs was widely criticized for its role in the European sovereign debt crisis, particularly in its first phase. The firm allegedly helped the Greek government mask the true facts concerning its national debt between the years 1998 and 2009.5 Reports circulated that in September 2009 Goldman Sachs had tried to benefit from the deteriorating fiscal situation in Greece by creating a special credit default swap (CDS) index to cover the high risk of Greece's financial situation. (Exhibit 7 shows comparative bank exposures in troubled European countries). Since Goldman had been involved with the Greek Government for over a decade, it implied a conflict of interest which drew attention from the regulators, notably the Federal Reserve.6 The fact that the EU statistical arm, Eurostat, found no fault with the accounting or disclosure failed to improve perceptions after the fact.

5 http://www.spiegel.de/international/europe/greek-debt-crisis-how-goldman-sachs-helped-greece-to-mask-

its-true-debt-a-676634.html. 6 http://www.usatoday.com/money/economy/2010-02-25-bernanke-fed-greece_N.htm.



Persistent Compliance Issues

In April 2003, the SEC charged Goldman Sachs and its competitors over conflicts of interest among its research analysts. This led to a fine of $110 million for Goldman and $4.1 billion for the industry as a whole. In July 2004, Goldman paid fines of $10 million to the SEC for improperly promoting a stock sale involving PetroChina. In January 2005, Goldman paid the SEC $40 million over charges that it violated securities laws in promoting initial public offerings. In March 2007, Goldman Execution and Clearing, a Goldman subsidiary, paid the SEC $2 million over allegations in a case of faulty oversight that allowed customers to make illegal trades. This unit was involved in another charge by the SEC in March 2009, when it settled for $1.2 million over improper proprietary trading by employees, and again in May 2010 when the SEC fined Goldman $225,000 for violating a rule aimed at regulating short selling.

It was arguable whether the string of regulatory and compliance problems faced by Goldman Sachs was more or less severe than those of its competitors. Observers seemed to conclude that there was money to be made in the grey areas of the market that tested the rules and the likelihood of getting caught, and that industry practice developed accordingly. Having no backlog of regulatory allegations or tolerable “cease and desist” settlements came to be regarded by some as flabbiness on the competitive playing field, and the penalties as little more than the cost of doing business.

Insider Trading

In November 2003, a former Goldman economist, John Youngdahl, pleaded guilty to insider trading, which led to a fine of $4.2 million on the firm. Three years later two former Goldman employees, Eugene Plotkin and David Pajcin, were charged with running an international insider trading ring while they were at the firm. Both were convicted and sentenced to prison terms. Yet another insider trading incident occurred in July 2009, when the SEC charged a former Goldman Sachs trader, Anthony Perez, and his brother with insider trading based on information Perez had obtained on the job at Goldman Sachs – both were fined. And in September 2011 the SEC charged a Goldman employee, Spencer Midlin, and his father with insider trading based on information Midlin had gained from his position at Goldman Sachs –both were fined. Goldman Sachs was not accused of wrongdoing in any of these cases. But while not deemed to be at fault, the string of cases brought back painful memories of Goldman partner Robert Freeman’s conviction and imprisonment on insider trading charges decades earlier.

Indeed, Goldman was itself the victim of insider trading by one of its own board members in the biggest case in decades. In April 2010, director Rajat Gupta, a former long-time managing partner of McKinsey & Co. who was also a board member of Procter & Gamble and AMR Corp. (parent of American Airlines), was named in an insider-trading case. According to the charges, Gupta had provided information to Raj Rajaratnam, CEO of the Galleon Group of hedge funds, about the September 2008 $5 billion Berkshire Hathaway investment in Goldman Sachs. That information earned $17 million for Rajaratnam's funds. Confidential boardroom information from Proctor & Gamble was likewise passed on to Rajaratnam and created illegal profits of more than $570,000.



Following a high-profile criminal trial by a jury of eight women and four men in Manhattan, Rajaratnam was found guilty in May 2011 on all 14 counts against him in a seven-year conspiracy involving $63.8 million in illegal profits. He was sentenced to 11 years in a federal prison and fined $10 million. Gupta was likewise criminally charged with insider trading and found guilty in June 2012 on three counts of securities fraud and one count of conspiracy. He faced up to 20 years in prison for his conviction on securities fraud, while the conspiracy change carried a maximum term of five years. Gupta appealed.

Lloyd Blankfein testified at the trial, noting that issues discussed at Goldman board meetings were strictly confidential: “The fact that anything discussed in a board meeting is a confidential fact.”(Exhibit 8 shows Goldman’s board at the time).

Greg Smith

On March 14, 2012, a Goldman employee, Greg Smith, announced his resignation in an open letter to the New York Times. He questioned the culture of Goldman Sachs and claimed CEO Lloyd Blankfein and President Gary Cohn had “lost hold of the firm’s culture on their watch”. According to Smith, “…the interests of the client continue to be side-lined in the way the firm operates and thinks about making money.” 7 His letter apparently had a swift impact on the Goldman’s share price, which slid by 3.4% the next day in a strong market (a loss of $1.7 billion in market capitalization). Goldman Sachs responded: “We disagree with the views expressed, which we don’t think reflect the way we run our business.” “…In our view, we will only be successful if our clients are successful. This fundamental truth lies at the heart of how we conduct ourselves.” 8

For shareholders, the Goldman stock price had delivered a bumpy ride since the 1999 IPO (Exhibit 1) ending mid-2012 about where it began.9 On 21 June 2012, Moody’s Investor Service cut the ratings of 15 banks including Goldman Sachs by two notches. Earlier, Fitch had earlier downgraded Goldman Sachs by one notch in December 2011.

Perceptions

Goldman’s response to the various compliance issues and criticism faced following its 1999 IPO were generally tight-lipped: Never complain. Never explain. Work the system. Rarely was there a sign of contrition or bending with the wind. The firm seemed to rely heavily on its network to ease outsize pressure or in extremis take a combative stand. Some scandals, such as Libor manipulation, were industry-wide, and Goldman Sachs could not be singled out. At times the approach worked well, at others not. When the SEC charged Goldman with civil fraud in the Abacus case, it vigorously fought the allegations and then submitted to a $550 million fine for securities fraud, deferred prosecution, and the admission that it had made a “mistake”.10

7 http://www.nytimes.com/2012/03/14/opinion/why-i-am-leaving-goldman-sachs.html?pagewanted=all). 8 http://blogs.wsj.com/deals/2012/03/14/goldman-rejects-claims-made-by-disgruntled-executive/ 9 Exhibits 9-12 provide Goldman Sachs operating and valuation data. 10 It was a sign of the times and the Goldman resonance that an interview with Lloyd Blankfein caught

worldwide attention:



Difficult as it might have been, Goldman Sachs significantly evolved its public persona in an environment of deep and lasting hostility toward banks and bankers. It launched a $500 million programme to help small businesses, and a new “Citizenship” tab on the firm’s website covering initiatives from “10,000 Women” to “Goldman Gives”.

Along the way it set up an active public relations department that responded to many issues appearing in the print and electronic media. Reports that cut close to the bone, such as the article by Greg Smith on corporate culture, were swiftly deflected by the firm. Criticism of specific deals, including one alleging poor due diligence and uncharacteristically sloppy responsibility to a corporate client, were vigorously challenged in the media.11

Reporter: Is it possible to make too much money? “Is it possible to have too much ambition? Is it possible

to be too successful?” Blankfein shoots back. “I don’t want people in this firm to think that they have accomplished as much for themselves as they can and go on vacation. As the guardian of the interests of the shareholders and, by the way, for the purposes of society, I’d like them to continue to do what they are doing. I don’t want to put a cap on their ambition. It’s hard for me to argue for a cap on their compensation.”

Reporter: So, it’s business as usual, then, regardless of whether it makes most people howl at the moon with rage? Goldman Sachs, this pillar of the free market, breeder of super-citizens, object of envy and awe will go on raking it in, getting richer than God? An impish grin spreads across Blankfein’s face. Call him a fat cat who mocks the public. Call him wicked. Call him what you will. He is, he says, just a banker “doing God’s work”.

Source: Wall Street Journal at http://blogs.wsj.com/marketbeat/2009/11/09/goldman-sachs-blankfein-on-banking-doing-gods-work/

11 http://www.goldmansachs.com/media-relations/comments-and-responses/current/nyt-dragon-systems-response.html



Case Questions

1. What are the 3 or 4 key issues raised in this case?

2. How might the Goldman story be perceived by key interest groups:

� Nonfinancial corporations

� Sovereign states

� State/local governments and public entities.

� Financial services firms (FICC)

� Private equity

� Hedge funds

� Mutual funds

� Pension funds

� Private clients

� Financial regulators

3. What are the strategic options that face Goldman Sachs today? How should the firm proceed and what should be the role of the board?

4. Would you buy Goldman Sachs shares today?



Exhibit 1 Goldman Sachs Share Price, 1999 IPO – 21 August 2012 vs. SPX



Exhibit 2 Some Goldman Sachs Employees Migrating to Government

Henry Paulson: Served as Treasury Secretary under President George W. Bush. Was CEO of Goldman from 1999 to 2006.Robert Rubin: Served as Treasury Secretary under President Clinton.Previously, he was co-Chairman of Goldman from 1990 to 1992. Robert K. Steel: Served as Under-Secretary of the Treasury for Domestic Finance, the principal adviser to the Secretary on matters of domestic finance and led the department's activities with respect to the domestic financial system, fiscal policy and operations, governmental assets and liabilities, and related economic and financial matters. Retired from Goldman as a Vice Chairman in 2004, where he worked as Head of Equities for Europe and Head of the Equities Division in New York. Mark Patterson: Chief of Staff to Secretary Tim Geithner. Was Director of Government Affairs at Goldman.Dan Jester: Key adviser to Geithner, who played a key role in shaping the takeover of Fannie Mae and Freddie Mac.Was Strategic Officer at Goldman.Steve Shafran: Adviser helping to shape Treasury's effort to guarantee money market funds. Was an expert in Corporate Restructuring at Goldman.Kendrick Wilson: Brought in to advise former Treasury Secretary Henry Paulson, another Goldman alum -- after a personal call from his old Harvard Business School classmate George W. Bush. Was a senior investment banker at Goldman.Neel T. Kashkari: Appointed by Paulson to oversee the $700 billion TARP fund and was considered Paulson's right hand man during the crisis. Was technology investment banker for Goldman in San Francisco from 2004 to 2006.Reuben Jeffrey: Selected by fellow Goldman alum Kashkari as the interim Chief Investment Officer for the bailout. Was executive for 18 years at Goldman, beginning in 1983. Edward C. Forst: Left his post as Executive Vice President at Harvard to serve as an advisor on setting up TARP, but has since returned to the school. Was global head of the Investment Management Division at Goldman for 14 years.William Dudley: President of the Federal Reserve Bank of New York. Was former Chief Economist and Advisory Director at Goldman where he worked from 1986 to 2007.Stephen Friedman: Was Chairman of the Federal Reserve Bank of New York until May 2009, when he was pressured to resign after buying Goldman shares in December and January. Previously he was Director of President George W. Bush's National Economic Council. Joined Goldman in 1966 and was co-Chairman from 1990 to 1994.Gary Gensler: Appointed by Obama to head the CFTC. Was a partner in Goldman from 1979-1996 Sonal Shah: Appointed to Office of Social Innovation and Civic Participation and an advisory board member for the Obama-Biden Transition Project in 2008. Was Vice President at Goldman from 2004 to 2007. Joshua Bolten: Former Chief of Staff of the Bush administration as well as Director of the Office of Management and Budget until 2006. Was Executive Director of Government Affairs for Goldman Sachs from 1994 to 1999. Jon Corzine: A strong supporter and political ally of Obama, Corzine was Governor of New Jersey until 2009. Began working for Goldman in 1975 and worked his way up to Chairman and co-CEO before being pushed out in 1998.Robert Zoellick: President of the World Bank and previously deputy Secretary of State.Was previously a Managing Director at Goldman, which he joined in 2006.James Johnson: Was involved in the vice-presidential selection process for the Obama campaign and served as President and CEO of Fannie Mae. Board member of Goldman.Kenneth D. Brody: Former President and Chairman of the Export-Import Bank of the US.Worked for Goldman for 20 years. Sidney Weinberg: Served as Vice-Chairman of FDR's War Production Board during World War II.Head of Goldman from 1930 to 1969, nicknamed "Mr. Wall Street."



Exhibit 3 Government Officials Migrating to Goldman Sachs

Some Government Officials Joining Goldman Sachs

E. Gerald Corrigan was President of the New York Fed from 1985 to 1993. He joined Goldman Sachs in 1994 and currently is a partner and managing director. Lori E Laudien: Former counsel for the Senate Finance Committee in 1996-1997. Has been a lobbyist for Goldman since 2005. Marti Thomas: Executive Floor Assistant to Dick Gephardt from 1989-1998, he went on to serve in the Treasury Department as Deputy Assistant Secretary for Tax and Budget from 1998-1999, and as Assistant Secretary in Legal Affairs and Public Policy in 2000. Joined Goldman as the Federal Legislative Affairs Leader from 2007-2009. Kenneth Connolly: Was staff director of the Senate Environment & Public Works Committee. Became a Vice President at Goldman in 2008. Arthur Levitt: The longest-serving SEC chairman (1993 to 2001). Hired by Goldman in June 2009 as an adviser on public policy and other matters.

Some Ex-government Lobbyists for Goldman Sachs

Richard Gephardt: Was House Majority Leader from 1989 to 1995 and House Minority Leader from 1995 to 2003. His lobbying firm was hired by Goldman to represent its interests on issues related to TARP.Michael Paese: Former top staffer to Rep. Barney Frank, the chairman of the House Financial Services Committee. Is Goldman's new top lobbyist - previously worked at JPMorgan and Mercantile Bankshares and was senior minority counsel at the Financial Services Committee.Faryar Shirzad: Former top economic aide to President George W. Bush and Republican counsel to the Senate Finance Committee. He now lobbies the government on behalf of Goldman Sachs as the firm's Global Head of the Office of Government Affairs.Richard Y. Roberts: Former SEC commissioner. Now working as a principal at RR&G LLC, which was hired by Goldman to lobby on TARP.Steven Elmendorf: Former chief of staff to then-House minority Leader Rich Gephardt.Now runs his own lobbying firm, where Goldman is one of his clients.Robert Cogorno: Former Gephardt aide and one-time floor director for Steny Hoyer (D-Md.), the No. 2 House Democrat. Works for Elmendorf Strategies, where he lobbies for Goldman and Citigroup.Chris Javens: Ex-tax policy adviser to Iowa Senator Chuck Grassley. Now lobbies for Goldman.

Exhibit 4 Largest Recipients of AIG CDS Bailout at Par, Sept-Dec 2008

2.6

3.5

4.9

5.0

5.2

6.8

8.5

11.8

11.9

12.9

European Banks Using AIG CDS to Reduce Basle 2 Capital Ratios:Barclays HSBCBNP Paribas LloydsCalyon RabobankDanske Bank RBSDeutsche Bank SantanderDresdner Bank SocGen

UBS



Exhibit 5 Synthetic Collateralized CDO

Goldman Sachs Abacus 2006-hgs 1



Exhibit 6 Investor Losses on Goldman Sachs Abacus 2006-hgs 1



Exhibit 7 Gross and New Exposures to Greece, Italy,

Ireland, Portugal and Spain (June 2012)

Exhibit 8 Goldman Sachs Board of Directors, April 2010

William GeorgeEx-CEO Medtronic

Lloyd BlankfeinChairman & CEO

Rajat GuptaEx-MP, McKinsey*

James JohnsonEx-CEO, FNMA

Lois JuliberEx-VC, Colgate

Lakshmi GuptaCEO, ArcelorMittal

James SchiroEx-CEO, Zurich

Ruth Simmons**President, Brown Univ.

Gary CohnPresident & COO

John BryanEx-CEO Sara Lee

Claes DahlbäckInvestor AB

Steve FriedmanStone Point Capital

* Subsequently resigned (insider trading scandal). ** Resigned (university pressure).



Exhibit 9 Goldman Sachs Net Revenue

0

5000

10000

15000

20000

25000

30000

35000

40000

45000

50000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Net Revenue

Exhibit 10 Goldman Sachs Net Revenue Breakdown 2000-2009

0

5000

10000

15000

20000

25000

30000

35000

40000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

IB

Trading

Asset Management



Exhibit 11 Goldman Sachs Net Revenue Breakdown 2009-2011

0

5000

10000

15000

20000

25000

30000

35000

2009 2010 2011

Institutional Client Services

Investing and Lending

Investment Management

IB

Exhibit 11 Goldman Sachs ROE vs. ROA

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

ROE

ROA



Exhibit 13 Goldman Sachs Market to Book Value

0

0.5

1

1.5

2

2.5

3

3.5

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Market value/Book value

Exhibit 14

PerformanceMetrics for Global Whole-sale Banks

1Q 2012, $ billionsRanked by YTD Total Cost ofMarket CapitalizMV MV/BV© MV/EPS ROE © Tier 1© Assets ©Beta Capital(a) RoE-COC

JPM 176 0.97 9.90 12.00 12.60 2,230 1.27 9.96 2.04C 105 0.63 9.40 7.30 13.26 1,948 2.57 18.00 -10.70BAC 103 0.48 12.80 0.62 13.37 2,181 2.27 16.15 -15.53BNP 57 0.59 5.36 11.50 12.20 2,555 1.41 10.83 0.67UBS 48 0.91 9.50 6.20 18.70 1,343 1.76 12.99 -6.79GS 61 0.92 9.90 12.20 14.70 951 1.42 10.89 1.31DB 47 0.75 6.90 5.50 12.30 2,516 2.19 15.66 -10.16BCS 48 0.52 8.60 -4.00 12.90 2,409 2.59 18.13 -22.13CS 35 0.94 11.10 0.50 15.60 1,098 1.39 10.70 -10.20MS 38 0.64 9.70 -0.25 16.80 794 1.56 11.76 -12.01Average 72 0.74 9.32 5.16 14.24 1,803 1.84 13.51 -8.35US Average 97 0.73 7.80 6.37 14.15 1,621 1.82 13.35 -6.98

(a) Cost of capital = risk free rate + (equity risk premium x company beta) (b) as of Dec. 31, 2011. RF = 10yr UST (2.10%) and risk premium = 6.19 (Damodaran)(c) as of 9/30/2011

WFC 183 1.34 10.20 12.14 11.50 1,314 1.32 10.27 1.87HSBC 164 1.02 6.50 6.40 11.90 2,637 1.20 9.53 -3.13Royal Bank Cana 84 2.09 11.70 19.70 12.20 807 1.26 9.90 9.80Toronto Domini 77 1.80 11.20 14.00 12.70 650 1.30 10.15 3.43Santander 68 0.68 7.70 8.13 11.05 1,693 1.69 12.56 -5.17Std Chartered 58 1.38 10.80 12.20 13.70 599 1.52 11.51 0.69BBVA 39 0.71 9.80 9.90 10.70 792 1.80 13.24 -4.79Average 96 1.29 9.70 11.78 11.96 1,213 1.44 11.02 0.39

Cost of capital = 10 year T + (ERP*beta)2.10 + (6.19 x beta)

PerformanceMetrics for Global Com-mercialBanks

Exhibit 14

Source: Roy C. Smith



Annex A Goldman Sachs 14 Business Principles12

Our clients’ interests always come first.

Our experience shows that if we serve our clients well, our own success will follow.

Our assets are our people, capital and reputation.

If any of these is ever diminished, the last is the most difficult to restore. We are dedicated to complying fully with the letter and spirit of the laws, rules and ethical principles that govern us. Our continued success depends upon unswerving adherence to this standard.

Our goal is to provide superior returns to our shareholders.

Profitability is critical to achieving superior returns, building our capital, and attracting and keeping our best people. Significant employee stock ownership aligns the interests of our employees and our shareholders.

We take great pride in the professional quality of our work.

We have an uncompromising determination to achieve excellence in everything we undertake. Though we may be involved in a wide variety and heavy volume of activity, we would, if it came to a choice, rather be best than biggest.

We stress creativity and imagination in everything we do.

While recognizing that the old way may still be the best way, we constantly strive to find a better solution to a client’s problems. We pride ourselves on having pioneered many of the practices and techniques that have become standard in the industry.

We make an unusual effort to identify and recruit the very best person for every job.

Although our activities are measured in billions of dollars, we select our people one by one. In a service business, we know that without the best people, we cannot be the best firm.

We offer our people the opportunity to move ahead more rapidly than is possible at

most other places.

Advancement depends on merit and we have yet to find the limits to the responsibility our best people are able to assume. For us to be successful, our men and women must reflect the diversity of the communities and cultures in which we operate. That means we must attract, retain and motivate people from many backgrounds and perspectives. Being diverse is not optional; it is what we must be.

12 http://www.goldmansachs.com/who-we-are/business-standards/business-principles/index.html



We stress teamwork in everything we do.

While individual creativity is always encouraged, we have found that team effort often produces the best results. We have no room for those who put their personal interests ahead of the interests of the firm and its clients.

The dedication of our people to the firm and the intense effort they give their jobs are

greater than one finds in most other organizations.

We think that this is an important part of our success.

We consider our size an asset that we try hard to preserve.

We want to be big enough to undertake the largest project that any of our clients could contemplate, yet small enough to maintain the loyalty, the intimacy and the esprit de corps that we all treasure and that contribute greatly to our success.

We constantly strive to anticipate the rapidly changing needs of our clients and to

develop new services to meet those needs.

We know that the world of finance will not stand still and that complacency can lead to extinction.

We regularly receive confidential information as part of our normal client relationships.

To breach a confidence or to use confidential information improperly or carelessly would be unthinkable.

Our business is highly competitive, and we aggressively seek to expand our client

relationships.

However, we must always be fair competitors and must never denigrate other firms.

Integrity and honesty are at the heart of our business.

We expect our people to maintain high ethical standards in everything they do, both in their work for the firm and in their personal lives.


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