Goldman Sachs (GS) was once a punchline. During the Great Depression, the then-small partnership on Pine Street became a target of national ridicule because of a scandal involving the Goldman Sachs Trading Corporation, a publicly traded investment trust that blew up after the stock market crash of 1929. For years, comedian Eddie Cantor, who had lost $100,000 and sued Goldman for $100 million, made Goldman Sachs a running joke in his stand-up routines. In one of his bits, Cantor would appear onstage with a stooge who tried to squeeze juice from a dry lemon. “Who are you?” Cantor would ask. Without missing a beat, the stooge would say, “The margin clerk for Goldman Sachs.”
Ever since being subjected to Cantor’s barbs, Goldman Sachs has cultivated an image not just as Wall Street’s preeminent firm but also as a paragon of financial virtue. But Goldman’s supposedly pristine reputation has always been more invented than earned. In 2010 the Securities and Exchange Commission, Goldman’s principal regulator at the time, sued the firm for failing to make adequate disclosures regarding a synthetic collateralized debt obligation it manufactured and sold at the height of the housing bubble. Rather than fight the SEC, Goldman settled the charges for $550 million, the largest fine ever extracted from a Wall Street firm. Around the same time, Goldman Chairman and Chief Executive Officer Lloyd Blankfein received a public flogging from Michigan Senator Carl Levin, chairman of the Senate’s Permanent Subcommittee on Investigations, which also released 900 pages of internal Goldman documents that exposed the role the firm played in fomenting and exacerbating the 2008 financial crisis. Goldman subsequently convened a group of its powerful insiders to review the firm’s “Business Standards.” The committee’s report, issued in January 2011, rehashed the firm’s mantras about putting its clients’ interests before its own. “Conflicts of interest and the firm’s approach to dealing with them are fundamental to our client relationships, our reputation and our long-term success,” Goldman boasted.
Is this true? Has being dragged through the proverbial mud time and time again—most recently in a March 14 New York Times op-ed by Greg Smith, a departing Goldman executive director—made the firm any more responsive to the criticism directed its way? In a place as secretive as Goldman, what’s really going on inside its sleek, new $2.4 billion downtown Manhattan headquarters is difficult to discern. But a blistering opinion handed down Feb. 29 by a Delaware judge makes a convincing case that Goldman’s heads-I-win, tails-you-lose approach to business hasn’t changed at all. And it goes a long way toward explaining why, nearly four years after the financial crisis, the system is still rigged.
In 2011, El Paso (EP), a leading producer and transporter of natural gas, which Goldman was advising, agreed to a $38 billion merger with Kinder Morgan (KMI), a pipeline and storage company in which Goldman owns a big chunk of equity. In response, a group of El Paso shareholders asked Leo Strine, the chancellor of the Delaware Court of Chancery, to block the merger, in part because of Goldman’s conflicts.
Strine’s opinion detailed the labyrinthine history of the El Paso-Kinder merger and Goldman’s role in it. Bear with me here. Through one of its private equity funds, Goldman owned a 19 percent stake in Kinder Morgan—worth $4 billion—and controlled two seats on the company’s board. Goldman did not serve as an M&A adviser to Kinder Morgan—that fell to Evercore Partners (EVR) and Barclays Capital (BCS)—but Goldman possessed considerable influence inside the Kinder Morgan boardroom (even though Goldman board members recused themselves during the El Paso negotiations).
Goldman had another role, as M&A adviser to El Paso, and this is where things got tricky. Goldman’s involvement with El Paso began around the time the firm released the “Business Standards” report. El Paso hired Steve Daniel, a senior oil-and-gas banker at Goldman with an undisclosed $340,000 stake in Kinder Morgan, to advise El Paso on the spin-off of its oil and natural-gas exploration business. Last May 24, El Paso announced a planned spin-off of the exploration assets, which Goldman valued at between $8 billion and $10 billion. If the spin-off was successfully completed, Goldman would receive a $25 million fee.
Then, on Aug. 30, Kinder Morgan informed El Paso that it was interested in buying the company for $25.50 in cash and stock, so that it could get its hands on El Paso’s pipeline business, which it wanted to keep. In essence, Kinder Morgan was bidding to buy all of El Paso and then continue with the sale of the exploration business.
The El Paso board rejected the first Kinder Morgan offer as too low. A week later, Kinder Morgan threatened to launch a hostile deal against El Paso. Given the obvious Goldman conflict, El Paso decided to add Morgan Stanley (MS) as an adviser but, according to Strine, Goldman refused to amend its engagement letter with El Paso to allow Morgan Stanley to get a fee if the exploration business was spun off but the merger didn’t take place. Morgan Stanley would receive its $35 million fee only if El Paso agreed to merge with Kinder Morgan. (Goldman would receive $20 million.) If the spin-off alone occurred, only Goldman would get paid ($25 million). Heads-I-win, tails-you-lose.
On Sept. 18, El Paso’s CEO, Douglas Foshee, reached a deal with Richard Kinder, the co-founder of Kinder Morgan, to sell El Paso for $27.55 a share in cash and stock. But then Kinder reneged, claiming the projections used were too optimistic. Instead of walking away, Foshee agreed to a lower deal at $26.87 per share. The merger agreement, signed on Oct. 16, included a $650 million break-up fee and a no-shop provision that prevented El Paso from actively seeking higher offers. Meanwhile, Goldman lowered its estimate of the value of the spin-off of the exploration business by $2 billion, making the merger appear better than that alternative. The merger also worked to the benefit of Goldman’s $4 billion principal position in Kinder Morgan.After agreeing to sell his company to Kinder for the lower price, Foshee asked Kinder for permission to pursue a management buyout of the exploration business. According to Strine, “[T]he reality is that Foshee was interested in being a buyer of a key part of El Paso at the same time he was charged with getting the highest possible price as a seller of that same asset. At no time did Foshee come clean to his board about his self-interest.” On Feb. 24, El Paso’s management, along with Apollo Global Management (APO) and Riverstone Holdings—founded by two former senior Goldman executives—announced that it was buying El Paso’s exploration business for $7.15 billion.
Despite all this evidence of double-dealing, the transaction went through. Strine decided not to enjoin the merger since no other offer for El Paso was on the table. El Paso shareholders approved it on March 9. Upon closing, Goldman will get its $20 million fee for advising on the El Paso merger and, presumably, its $25 million fee for advising on the sale of the exploration assets to Foshee, Apollo, and Riverstone. Morgan Stanley will get its $35 million fee for advising El Paso. Foshee will get his chance to make a fortune, beyond the $90 million he is getting in the Kinder Morgan merger, as a principal in the Apollo/Riverstone deal. Foshee also got, according to Strine, an “obsequious” thank-you call from Blankfein. And Goldman’s $4 billion investment in Kinder Morgan will continue to grow because it was able to buy the El Paso assets it wanted on the cheap, without a true market test. “This kind of furtive behavior engenders legitimate concern and distrust,” Strine concluded.
Some at Goldman will retort that the conflicts were disclosed—except for Steve Daniel’s stake in Kinder Morgan—and accepted by all parties. El Paso’s shareholders received a 37 percent premium to the closing price of the stock the day before the deal was announced. So who was harmed? The short answer is that El Paso’s shareholders deserved a CEO and M&A adviser who were free of entanglements with Kinder Morgan and could be trusted to work solely in the best interests of the company’s investors, rather than themselves. The longer answer is that the behavior of Goldman and Foshee is a serious affront to our collective sense of fair play.
In his extraordinarily public resignation letter, Greg Smith, who had spent time recruiting the best and the brightest to Goldman Sachs, wrote, “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.” The proper functioning of Wall Street is too vital to the economy to tolerate the duplicitous practices of Goldman and firms like it, especially after what the American people did to rescue these businesses in their darkest hours. The country’s political class appears to lack the power or will to hold large financial institutions to account. There is a massive leadership vacuum at the top of Wall Street today; and it’s quite possible that only continued, relentless public shaming will force the leaders of these firms to make the kinds of cultural changes necessary to bring their actions in line with normative behavior. Where have you gone, Eddie Cantor?
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