Response to The New York Times Article, “Clients Worried About Goldman’s Dueling Goals”
Today, The New York Times published an article, “Clients Worried About Goldman’s Dueling Goals,” describing certain transactions in which it alleges the firm did not treat broker-dealer clients appropriately. We disagree.
The article includes grave inaccuracies, cites accusations from anonymous sources and is fundamentally misleading.
The inaccuracies begin with the lead anecdote about certain positions the firm held in Washington Mutual. The article implies that the firm made a profit on these positions – in fact the firm had a net loss. This, and other facts, was pointed out to the Times.
In addition, a fundamental premise of the story, that Goldman Sachs made a directional bet on the housing market, is wrong. The fact is we lost $1.2 billion in our residential mortgages business during the 2007-2008 period.
As it was preparing the article the Times asked us a number of questions. The relevant questions and our answers are provided below. The selective portions of our responses which the Times chose to use are shown in bold.
Q. The first of Goldman’s 14 business principles states that the firm and its employees must put clients first. Such a principle sounds to some like an expression of duty to Goldman’s clients and yet the firm’s executives in testimony before the Senate last month said they did not have a duty to customers. What is Goldman’s view on this?
A. Of course Goldman Sachs has obligations to all of its clients. What is important to recognize is that our clients look to us to perform different roles in each of our businesses. The question put to some of our executives at last month’s Senate Subcommittee hearing was whether, as a market maker, we had a fiduciary duty to our clients. The answer to that question is no, market makers do not have a fiduciary duty to their clients.
Market makers are primarily engaged in the business of assisting clients in executing their desired transactions and are responsible for providing fair prices. This business is client-driven and serves an intermediary function, and in this role we are not giving our clients advice -- a fact our clients understand.
Q. In addition to the 14 principles, former employees contend that there is an additional, unwritten principle urging workers to embrace the conflicts of interest inherent in the firm’s business model and to consider such conflicts to be part of a healthy tension between client and firm. Could you comment on this?
A. We’re not aware of this so-called “unwritten principle”, but every large financial institution, in fact virtually any business in any industry, has potential conflicts and we all have an obligation to manage them effectively.
Q. On the topic of putting clients first, Goldman’s Mortgage Compliance Training Manual from 2007 notes that putting clients first is “not always straightforward” because the firm is a market maker for a wide variety of companies, and because the firm’s traders are in a position to gather and use information from a variety of sources— a mosaic constructed of all of the pieces of data received, is how the manual describes it. How does the firm, in practice, address this nuance? And what does Goldman mean by “not always straightforward”?
A. We strive to provide all our sales and trading clients with excellent execution. This manual recognizes that like many businesses, and certainly all our competitors, we serve multiple clients. In the process of serving multiple clients we receive information from multiple sources. This policy and the excerpt cited from the training manual simply reflects the fact that we have a diverse client base and gives our sales people and traders appropriate guidance.
Q. At the Congressional hearings in April, documents were produced showing that Goldman’s mortgage department put on short equity positions in securities of four big clients in the mortgage arena: Bear Stearns, National City, Washington Mutual, Countrywide Financial. Were these clients aware at the time that you were betting against their stocks? Because of Goldman’s dealings with these companies in the mortgage area, was Goldman using nonpublic information (the ‘mosaic’) about these companies’ weaknesses when the firm put on these negative trades? Does Goldman have internal guidelines about when the firm can and cannot take short positions in a client’s stock? How does shorting a client’s stock or buying puts on it comport with Goldman’s goal of putting clients’ interests ahead of the firm’s?
A. One of the important functions we perform is to allow clients to increase or reduce various types of risk and we need to stand ready to allow them to accomplish that objective. Another very important obligation for any financial institution is to ensure its safety and soundness. To that end, it is essential that we appropriately manage our risks. It is only by doing this that we can continue to provide liquidity to a market place. Clients understand this. What is important is that we have the policies and procedures in place to ensure that we are conducting ourselves in an appropriate manner. Our goal is to always be best in class in this regard.
Shorting stock or buying credit protection in order to manage exposures are typical tools to help a firm reduce its risk. The intent is not to disadvantage anyone. In this regard, it is important to note that many institutions have long exposure to Goldman Sachs and it would be entirely consistent with prudent risk management practice if they bought credit protection or had a short position on our stock.
Q. Our article will cite several examples of situations where it’s unclear whether Goldman is placing its clients’ interests ahead of its own and we’d appreciate receiving some very specific guidance from you to help us sort that out. One involves UPMC, the Pittsburgh healthcare concern that was a Goldman client from 2002 until 2008. The firm advised UPMC to issue auction rate securities, which it did. After ARS spreads began to widen in late 2007, UPMC asked Goldman if it should exit the market. In mid-January, 2008, Goldman advised it to stay in. Less than a month later, Goldman was the first dealer to withdraw support from the market and ARS froze up. UPMC tried to redeem the securities it had issued and submitted a redemption notice to the trustee. Goldman advised the trustee not to honor it, saying that the contract it had struck with UPMC required 30 days to pass before a redemption request could be honored. This forced UPMC to pay very elevated interest rates on its ARS for another 30-45 days and allowed Goldman to continue earning auction fees and to generate commissions selling the securities to its hedge fund clients. UPMC officials felt that Goldman put its interests first in this instance and fired the firm. What is Goldman’s view of these events?
A. Goldman Sachs was not the first dealer to withdraw support for the auction rate securities market. The legal agreements that governed UPMC’s ARS securities did not allow UPMC to bid for its own securities in the auctions. The bond trustee has its own fiduciary responsibility to investors to interpret the provisions on redemptions.
Q. Another case we cite involves Thornburg Mortgage, which had a line of credit with Goldman in the summer of 2007. That August, Goldman began aggressively marking down the collateral held on behalf of Thornburg and began calling for margin. Shortly after, a Goldman investment banker began pitching Thornburg on helping it raise capital. In making the margin call, Goldman cited transactions it had seen in the market as justification, but according to Goldman employees, the firm had not seen those trades. Instead, the Goldman employees said, the valuations used to call for margin from Thornburg were the result of Dan Sparks’ demands that his traders mark their books down significantly. After arguing over Goldman’s marks, Thornburg capitulated. But some of its employees believe Goldman may have had an interest in depressing prices on its marks to generate margin calls for the firm’s other counterparties. What is Goldman’s response to this contention of client arbitrage?
A. We are a “mark to market” institution and we mark our positions on a daily basis to reflect what we believe is the current value for a security if we decided to sell it. Those marks are verified by our Controllers Department, which is independent from the Securities Division. We use consistent marks for multiple purposes across the firm, including for our own books and records. Subsequent events clearly indicated that our marks were accurate and realistic.
Not all institutions mark their positions to market and, as a result, it is quite possible that our marks differed from those of others.
Q. We will also mention complaints made in late 2008 by Gary S. Schaer, a New Jersey Assemblyman, about Goldman’s recommendation to buy protection on NJ bonds even as the firm has managed the state’s bond issues since 2002. We intend to quote from the letter Mr. Schaer received from Kevin Willens in your public finance unit but if you have any other comments on this interaction please let us know.
A. As we said in the letter we sent to Mr. Schaer: “Keeping trading and investment banking origination functions strictly separated by a “Chinese Wall” is important both for regulatory reasons as well as to maintain trusted relationships with both investors and issuers.”
* Q. Does Goldman see any conflicts in the fact that it offers countries like Greece financial advice and help raising funds in the capital markets while also simultaneously engaging in trades that profit from financial woes in those same countries? Does Goldman have internal guidelines detailing when the firm can take negative trading positions on the debt of sovereign entities when Goldman is also advising those states?
* A. We have an obligation to our shareholders and, more broadly, to the financial system, to manage our business prudently. We, and other financial institutions, aggregate our risk exposure and hedging. This is considered prudent risk management. The fact that we may hedge our exposure is well known to our clients.
Implicit in the question is the suggestion that we have been “shorting” Greece. We have, in fact, had a generally net “long” bias in our exposure to Greece for a number of years, and that has also been the case recently.
Q. Goldman has said that it bought CDS protection on AIG to protect itself if the insurer failed. Goldman purchased this protection when it had information about margin calls it was making on AIG and which AIG was resisting. Did Goldman tell the counterparties from whom it bought the CDS protection on AIG about the margin call information Goldman had on the insurer? Does Goldman feel that there were any conflicts involving its purchase of protection on AIG at the same time that it had nonpublic information about the insurer’s financial position?
A. The premise of the question is wrong: we did not have material non-public information about AIG’s financial position. We had a series of disputes with AIG about the valuation of assets for which they were providing protection. That is quite different from having material non-public information about the financial condition of the company.
Also, if we had told another counterpart about our dispute with AIG, we would have been violating the confidentiality obligation we had to AIG.
* Q. What does Goldman think of Senator Levin's legislation on client conflicts?
* A. We have no comment on this matter.
Q. Would Goldman’s forthcoming business review committee likely find what occurred with UPMC, Thornburg or N.J. to fall below Goldman’s standards of serving clients first? Will the committee be reviewing the firm’s policies regarding shorting or betting against its clients, as it did with several players in the mortgage space?
A. We believe that our practices were appropriate and consistent with our obligations to our clients. It would be premature to comment on the work to be conducted by our Business Standards Committee.
* Q. Also wanted to ask you about whether Goldman gained helpful info on Litton Loans in its role advising MGIC and Radian on sale of stake in C-Bass. The stake in C-Bass was never sold, but Goldman bought Litton. Was there a conflict in that situation?
* A. No. We participated in negotiations to purchase Litton as part of a competitive auction established by C-Bass and their advisor, and only did so after it was clear that the sale of the stakes held in C-Bass would not proceed. As part of the auction process, C-Bass and their advisors made available to bidders information relevant to a purchase of Litton.
Q. Also, we forgot to ask re the negative bet on Bear Stearns shares in the Mtg NYC ABS Equities Portfolio: how much did GS make on that bet? And was GS still holding a negative position on Bear stock when it collapsed in March 2008?
A. In the month of March 2008, our trading activity in Bear Stearns shares and options was very balanced. We had no directional positions, just normal two-way market making activity.
Regarding the mortgage desk trading portfolio, we had no positions in Bear Stearns at the beginning and end of March and there was no meaningful trading during the month.
Q. We would like to know how much Goldman's mortgage unit made on the short bets it had on WaMu (puts and credit protection evidenced in documents from early 2007) and whether those or similar positions were still on Goldman's books when WaMu failed.
A. We closed out our puts months before WaMu filed for bankruptcy and we lost more money on WaMu's bonds than we made on the credit protection we'd bought.
* As we said above, The New York Times asked us a number of questions. We posted the questions and our responses related to their story published on May 19, 2010. Subsequently, the Times has asked that we post their other questions and our answers. Even though these questions relate to topics which are not mentioned in the story, we are happy to do so.