Wall Street Morality: Three Related Stories


The Good, Bad and Ugly of Capitalism


New York Times

March 16, 2012



On Wednesday, Howard Schultz, the chairman and chief executive of Starbucks, will take the podium at his company’s annual meeting and talk about the importance of morality in business.

Yes, morality. I don’t know that he’ll use that exact word. But there can be little doubt that in recent years, especially, Schultz has been practicing a kind of moral capitalism. Profitability is important, he believes, but so is treating customers, employees and coffee growers fairly. Recently, Schultz has defined Starbucks’s mission even more broadly, creating programs that have nothing at all to do with selling coffee but are aimed at helping the country recover from the Great Recession.

In the speech, Schultz plans to make a direct link between Starbucks’s record profits and this larger societal role the company has embraced. He will make the case that companies that earn the country’s trust will ultimately be rewarded with a higher stock price. “The value of your company is driven by your company’s values,” he plans to say.

I bring up Schultz and Starbucks because this week we saw a different kind of American capitalism on display — the “rip your eyeballs out” capitalism of Goldman Sachs. In the corporate equivalent of the shot heard round the world, Greg Smith, a former Goldman executive, wrote an Op-Ed article in The Times as he was walking out the door in which he described a corporate culture that values only one thing: making as much money as possible, by whatever means necessary. According to Smith, Goldman views clients as pigeons to be plucked rather than customers to be valued. Goldman traders vie to see how much profit they can make at the expense of their clients, even if it means selling them products that are sure to “blow up” eventually. “It makes me ill how callously people talk about ripping their clients off,” Smith wrote.

In the wake of Smith’s article, plenty of people raced to Goldman’s defense. Michael Bloomberg, New York’s billionaire mayor, whose company sells Goldman expensive computer terminals, went to Goldman Sachs’s headquarters in a show of support. The editors of his eponymous firm published an editorial that mercilessly mocked Smith. They and others pointed out that Goldman clients are big boys who can take care of themselves. Even some clients agreed. “You better not turn your back on them,” one Goldman customer told The Financial Times. Yet, he added, “They are also highly competent.”

But there’s a reason Smith’s article has struck such a chord. It is the same reason that Goldman Sachs, despite having come through the financial crisis largely unscathed, has become the target of such astonishing venom, described as a vampire squid and the like. The reason is that the kind of amoral, eat-what-you-kill capitalism that Goldman represents is one that most Americans instinctively find repugnant. It confirms the suspicions many people have that Wall Street has become a place where sleazy practices are the norm, and where generating profits in ways that are detrimental to society is the ticket to a successful career and a multimillion-dollar bonus.

Goldman bundled terrible subprime mortgages that helped bring about the financial crisis. Smelling trouble, it unloaded its worst mortgage bonds by cramming them down the throats of its clients. It secretly allowed a short-seller, John Paulson, to pick some especially toxic mortgage bonds that were bundled and sold to Goldman clients — with Paulson profiting by taking the “short” side of the trade. Just recently, Goldman had to admit that one of its investment bankers had acted as a merger adviser to the El Paso Corporation while holding stock in Kinder Morgan, which was trying to acquire El Paso. It would be hard to imagine a more blatant conflict — yet no one at Goldman bothered to tell El Paso.

These practices may not be illegal, but can you really say they represent the values that we want to see on Wall Street or in our corporations? I can’t.

And Goldman shouldn’t either. What has been amazing is that, despite three years of nonstop criticism — including Congressional hearings and settlements with the government — Goldman has not changed one iota. That is another reason Smith’s article resonated. It confirmed that suspicion as well. Goldman’s response to every controversy these past three years has been to bury them in a blizzard of public relations. And this has been its response to the Smith article, releasing, for instance, a companywide e-mail from Lloyd Blankfein, its chief executive, insisting that Goldman does, too, care about clients. Consistently, Goldman’s attitude has been: This, too, shall pass.

So far, though, it hasn’t. And maybe, just maybe, it won’t. Maybe the time has come for Blankfein to watch what Howard Schultz is doing at Starbucks. Sometimes, the best way to do well really is to do good.

Paving Path to Fraud on Wall St.


March 15, 2012



Nearly 20 years ago, Bankers Trust was riding high. The bank, based in New York, had become known as an expert in then-newfangled derivative securities, and the profits were flowing in. In an era where commercial banks were often viewed as stodgy and unimaginative, it stood out as a shining light. Corporate treasurers sought its insights about ways to maximize income from idle cash. Wall Street firms scrambled to compete.

Then the tapes came out.

On those tapes, recorded in 1993 and 1994, Bankers Trust executives were heard to discuss how they were misleading customers who did not understand what they were doing. Speaking among themselves, bankers used the term “R.O.F.” It stood for “rip-off factor,” the amount the bank could take from unsuspecting clients.

Those clients included Procter & Gamble and Gibson Greetings, which had entered into contracts with Bankers Trust for complex interest-rate swaps that would raise the companies’ incomes a little if interest rates continued to fall — as the conventional wisdom then said they would — but result in enormous losses if rates rose only a little bit. Rates rose more than a little, and the companies soon found evidence they had been told lies and sued. Eventually, Bankers Trust was forced to settle.

Bankers Trust was never the same after that. It was still a swashbuckling trading firm, but in 1998 it made some bad bets of its own. It wound up being acquired by Deutsche Bank. On the way out, the company pleaded guilty to defrauding the state of New York by seizing abandoned funds that should have gone to the state.

The fate of Bankers Trust came to mind this week when a midlevel Goldman Sachs banker chose to leave the company with a blast delivered through the Op-Ed page of The New York Times. “I attend derivatives sales meetings where not one single minute is spent asking questions about how we can help clients,” wrote Greg Smith. “It’s purely about how we can make the most possible money off of them.”

Bankers Trust gave us the term “R.O.F.” Mr. Smith says Goldman referred to its clients as “Muppets,” talked about “ripping eyeballs out” and rewarded employees for “hunting elephants,” a term he said meant persuading clients to do whatever would be most profitable for Goldman.

In finance, acting like a shark who will rip your opponents into little pieces has long been viewed as a positive thing. Such a reputation will even draw in clients who want to harness those tactics for their own benefit. The catch for Goldman could be, as it was for Bankers Trust, that the clients will flee if they think the firm intends to rip them off.

Goldman has a far stronger market position now than Bankers Trust ever did. Its competitors may not be as publicly aggressive as Citi was back in the 1990s, when it went after Bankers Trust customers with an ad proclaiming, “You expect derivatives to solve problems, not create them.” But they will be quietly courting clients by saying they will work for the customer, not against him.

Mr. Smith will be offered opportunities, possibly by clients whose trades did not work out, to get specific about how Goldman ill-served its customers. If he takes any of them, Goldman’s pain may endure.

One of the amazing stories of this year has been the fact that Wall Street, for all its public opprobrium, is on the brink of a major legislative victory to roll back decades of regulation and rules aimed at preventing underwriters from ripping off customers.

Last week, the House of Representatives, with the support of every Republican and most Democrats — as well as a White House endorsement — passed something it called the “Jump-start Our Business Start-ups Act,” or JOBS for short. The logic is that if we can just make it easier for companies to raise capital, they will hire more people.

Do you remember the scandals of the dot-com era? Then Wall Street firms got business by promising companies that they would write positive research reports if the company would only hire them to underwrite an initial public offering of stock. Companies went public at a feverish pitch, often rising to amazing heights without much in the way of sales, let alone profits. Then it all came crashing down.

In the aftermath, the brokers were forced by the Securities and Exchange Commission, as well as the New York attorney general, to mend their ways. No longer would analysts be allowed to go on such I.P.O. sales calls.

This bill would end that rule for all but the biggest new offerings — those that involved companies with sales of over $1 billion. And it would go much further. As the law stands now, to keep underwriters from making sales pitches that go beyond what companies are allowed to say, the underwriters are prohibited from publishing research on a company while its initial public offering is under way. This bill would allow such research, and would say that the company bore no responsibility for what was said in it. Effectively, there would be a second prospectus — one largely immune to securities laws and free to hype the offering by making forecasts not otherwise allowed.

Why is this needed? Advocates point to the fact there are fewer initial public offerings now than there were during the Internet bubble. That most of those offerings were horrible investments is conveniently ignored. Nor is any consideration given to the idea that once-burned investors might be more wary. The explanation must be excessive and unreasonably expensive regulation.

The bill also relaxes rules for new offerings in other ways. There are limits now to keep private offerings private, rather than allow them to be pitched widely. Forget that. The bill endorses the wonderful concept of “crowdfunding,” in which anyone can post an idea on the Web and raise money for it. If you raise only $1 million that way, then you don’t even have to provide financial statements. You are under no obligation whatever to keep investors informed. If you are willing to put out a financial statement when you seek the money, you can get up to $2 million.

One interesting aspect of the bill is that while it would make it a lot easier for companies to raise capital without disclosing very much, it would also make it easier for companies that are public — and have the capital — to “go dark” and stop providing financial information to their shareholders. The basic message to investors would seem to be: Give us your money and then don’t bother us any more.

Last year, the S.E.C., worried about a spate of frauds, required Chinese companies to follow the same rules that American ones do, with prospectuses made public as soon as they were filed. Since last summer, there have been no new Chinese initial public offerings in the United States. That tightening of regulation would be reversed by this bill.

“If you like those e-mails from Nigerian scammers, wait until you see the new round about to come from shady Chinese companies looking for investment — and they will be legal,” said Paul Gillis, a former auditor for PricewaterhouseCoopers in China who is now a visiting professor of accounting at Peking University.

In an interview, Mr. Gillis praised Section 404, the part of the Sarbanes-Oxley Act of 2002 that requires companies going public to have effective internal controls, and for auditors to certify them. “When companies list, they hire consultants to help them design internal control systems to provide integrity in their reports,” he said. “These control systems are new to these countries. They have helped significantly. There have been only a couple of Chinese companies subject to 404 that have been frauds.”

As a result of intense lobbying by small businesses, Section 404 never was enforced on American companies with market values under $75 million. The new bill would exempt any newly public company for five years, unless it grew to the point that it had shares worth $700 million in public hands or had revenue of over $1 billion.

Any company that chose to go public in the conventional way, with a prospectus, could file privately with the S.E.C., so the public would see the offering only when it was cleaned up after commission review. If the commission missed something, there would be little time for anyone else to notice.

Securities regulators were almost invisible when the House passed its bill last week. This week a group of state regulators — concerned in part by the way state regulation is pre-empted — and Mary Schapiro, the S.E.C. chairwoman, wrote to senators seeking changes to make the bill less outrageous. They failed to get any changes made before the bill went to the floor this week, but the Senate is slated to vote Tuesday on a substitute that would add some investor safeguards, proposed on Thursday by three Democratic senators, Jack Reed, Carl Levin and Mary Landrieu.

It gives some flavor of just how far the House bill goes that one of the changes the three senators are pushing would force a company trying to raise money from the public to show investors an audited balance sheet. Even if their substitute is adopted, we will still get “crowdfunding,” but with a few extra safeguards. Wall Street will still have a major victory, and investors will have less protection than they do now.

“In three years, or maybe five years, they’ll be back to fix these loopholes, because there will be a huge amount of fraud,” Mr. Gillis forecast.

He suggested the bill be renamed the “Jump-start Our Bilking of Suckers Act.”

Why I Am Leaving Goldman Sachs


March 14, 2012




TODAY is my last day at Goldman Sachs. After almost 12 years at the firm — first as a summer intern while at Stanford, then in New York for 10 years, and now in London — I believe I have worked here long enough to understand the trajectory of its culture, its people and its identity. And I can honestly say that the environment now is as toxic and destructive as I have ever seen it.

To put the problem in the simplest terms, the interests of the client continue to be sidelined in the way the firm operates and thinks about making money. Goldman Sachs is one of the world’s largest and most important investment banks and it is too integral to global finance to continue to act this way. The firm has veered so far from the place I joined right out of college that I can no longer in good conscience say that I identify with what it stands for.

It might sound surprising to a skeptical public, but culture was always a vital part of Goldman Sachs’s success. It revolved around teamwork, integrity, a spirit of humility, and always doing right by our clients. The culture was the secret sauce that made this place great and allowed us to earn our clients’ trust for 143 years. It wasn’t just about making money; this alone will not sustain a firm for so long. It had something to do with pride and belief in the organization. I am sad to say that I look around today and see virtually no trace of the culture that made me love working for this firm for many years. I no longer have the pride, or the belief.

But this was not always the case. For more than a decade I recruited and mentored candidates through our grueling interview process. I was selected as one of 10 people (out of a firm of more than 30,000) to appear on our recruiting video, which is played on every college campus we visit around the world. In 2006 I managed the summer intern program in sales and trading in New York for the 80 college students who made the cut, out of the thousands who applied.

I knew it was time to leave when I realized I could no longer look students in the eye and tell them what a great place this was to work.

When the history books are written about Goldman Sachs, they may reflect that the current chief executive officer, Lloyd C. Blankfein, and the president, Gary D. Cohn, lost hold of the firm’s culture on their watch. I truly believe that this decline in the firm’s moral fiber represents the single most serious threat to its long-run survival.

Over the course of my career I have had the privilege of advising two of the largest hedge funds on the planet, five of the largest asset managers in the United States, and three of the most prominent sovereign wealth funds in the Middle East and Asia. My clients have a total asset base of more than a trillion dollars. I have always taken a lot of pride in advising my clients to do what I believe is right for them, even if it means less money for the firm. This view is becoming increasingly unpopular at Goldman Sachs. Another sign that it was time to leave.

How did we get here? The firm changed the way it thought about leadership. Leadership used to be about ideas, setting an example and doing the right thing. Today, if you make enough money for the firm (and are not currently an ax murderer) you will be promoted into a position of influence.

What are three quick ways to become a leader? a) Execute on the firm’s “axes,” which is Goldman-speak for persuading your clients to invest in the stocks or other products that we are trying to get rid of because they are not seen as having a lot of potential profit. b) “Hunt Elephants.” In English: get your clients — some of whom are sophisticated, and some of whom aren’t — to trade whatever will bring the biggest profit to Goldman. Call me old-fashioned, but I don’t like selling my clients a product that is wrong for them. c) Find yourself sitting in a seat where your job is to trade any illiquid, opaque product with a three-letter acronym.

Today, many of these leaders display a Goldman Sachs culture quotient of exactly zero percent. I attend derivatives sales meetings where not one single minute is spent asking questions about how we can help clients. It’s purely about how we can make the most possible money off of them. If you were an alien from Mars and sat in on one of these meetings, you would believe that a client’s success or progress was not part of the thought process at all.

It makes me ill how callously people talk about ripping their clients off. Over the last 12 months I have seen five different managing directors refer to their own clients as “muppets,” sometimes over internal e-mail. Even after the S.E.C., Fabulous Fab, Abacus, God’s work, Carl Levin, Vampire Squids? No humility? I mean, come on. Integrity? It is eroding. I don’t know of any illegal behavior, but will people push the envelope and pitch lucrative and complicated products to clients even if they are not the simplest investments or the ones most directly aligned with the client’s goals? Absolutely. Every day, in fact.

It astounds me how little senior management gets a basic truth: If clients don’t trust you they will eventually stop doing business with you. It doesn’t matter how smart you are.

These days, the most common question I get from junior analysts about derivatives is, “How much money did we make off the client?” It bothers me every time I hear it, because it is a clear reflection of what they are observing from their leaders about the way they should behave. Now project 10 years into the future: You don’t have to be a rocket scientist to figure out that the junior analyst sitting quietly in the corner of the room hearing about “muppets,” “ripping eyeballs out” and “getting paid” doesn’t exactly turn into a model citizen.

When I was a first-year analyst I didn’t know where the bathroom was, or how to tie my shoelaces. I was taught to be concerned with learning the ropes, finding out what a derivative was, understanding finance, getting to know our clients and what motivated them, learning how they defined success and what we could do to help them get there.

My proudest moments in life — getting a full scholarship to go from South Africa to Stanford University, being selected as a Rhodes Scholar national finalist, winning a bronze medal for table tennis at the Maccabiah Games in Israel, known as the Jewish Olympics — have all come through hard work, with no shortcuts. Goldman Sachs today has become too much about shortcuts and not enough about achievement. It just doesn’t feel right to me anymore.

I hope this can be a wake-up call to the board of directors. Make the client the focal point of your business again. Without clients you will not make money. In fact, you will not exist. Weed out the morally bankrupt people, no matter how much money they make for the firm. And get the culture right again, so people want to work here for the right reasons. People who care only about making money will not sustain this firm — or the trust of its clients — for very much longer.

Greg Smith is resigning today as a Goldman Sachs executive director and head of the firm’s United States equity derivatives business in Europe, the Middle East and Africa.