Fellow Shareholders:

  • Gary D. Cohn President and Chief Operating Officer
  • Lloyd C. Blankfein Chairman and Chief Executive Officer

We began 2011 encouraged by an increase in client activity, greater CEO confidence, and early signs that economies were on the mend, but soon after experienced new measures of macro uncertainty that ultimately hindered a broad-based recovery.

Challenges facing the Euro area advanced from a regional consideration to a global issue, leading to concerns about the potential for sovereign defaults, contagion and growing skepticism about the willingness of policymakers to address the situation. Not surprisingly, the operating environment led our clients across a variety of businesses to be materially more risk averse. The firm’s perspective on managing its risk exposures mirrored the sentiment of the broader market, and consequently, our risk exposures remained low in 2011. Ultimately, the confluence of macro-economic concerns, heightened market volatility, lower corporate activity and decreased risk appetite among our institutional clients translated into a fundamentally lower level of revenue opportunities over the course of the year, hampering our returns.

For 2011, the firm produced net revenues of $28.81 billion with net earnings of $4.44 billion. Diluted earnings per common share were $4.51 and our return on average common shareholders’ equity was 3.7 percent for the year. Excluding the impact of a $1.64 billion preferred dividend associated with our redemption of the firm’s preferred stock issued to Berkshire Hathaway, diluted earnings per common share were $7.46 and our return on average common shareholders’ equity was 5.9 percent. Throughout the year, we continued to manage our liquidity and capital conservatively. At year-end, the firm’s Global Core Excess liquidity was $172 billion, and our Tier 1 capital and common ratios under Basel 1 were 13.8 percent and 12.1 percent, respectively.

While our results suffered as a consequence of global conditions and dampened activity levels, we are pleased to report that the firm retained its industry-leading positions across our global investment banking client franchise. We finished 2011 with one of our best performances as a public company across the global league tables, ranked first in worldwide announced mergers and acquisitions (M&A), equity and equity-related offerings, common stock offerings and IPOs.

Given the strength of our client franchise across global capital markets, when economies and markets improve — and we see some encouraging signs of this — we are confident Goldman Sachs will be well-positioned to provide further value to our clients and shareholders. As we help our clients manage through this period, we will continue to focus on their evolving needs while prudently managing risk, shareholder capital and expenses to generate attractive returns.

In this year’s letter, we would like to discuss how we are approaching the current operating environment as well as review — through the lens of priorities articulated by our clients — the long-term growth opportunities for Goldman Sachs. We spent more than one-half of our time last year away from the office meeting with clients around the world. Through these ongoing discussions, we gain a better understanding of emerging trends, the challenges and goals our clients are focused on and the role we can play to help them. Taken individually and as a whole, these interactions are fundamental to our client-driven strategy.

We will also share with you the significant progress we have made in implementing the recommendations of our Business Standards Committee, and talk about the people of Goldman Sachs, the contribution they make every day on behalf of our clients, and the critical role they play in our future success. Finally, we will update you on our corporate engagement initiatives designed to help drive job creation and growth.

The Operating Environment in 2011

While each downturn has its unique characteristics, our industry has operated through a number of economic contractions over the past decade or so. In each instance, we saw more precipitous declines in U.S. growth expectations than what we experienced more recently. Nevertheless, last year’s weak economic conditions initiated a pullback in our clients’ strategic objectives and financing demands, a slowdown in market-making activities and depressed asset values across the investing spectrum.

From a historical perspective, the reduction in our investment banking volumes during 2011 was, in many respects, in line with the drop we experienced following the Internet bubble during 2001. M&A declined as CEOs worried about execution risk, and debt and equity underwriting slowed due to higher volatility across markets. Lower asset prices and weakness in credit indices resulted in a negative impact on our Investing & Lending business. It is important to note, however, that losses in our asset portfolio were due to our mark-to-market discipline and are largely unrealized; the ultimate assessment of our investing and lending activities must be over a period of years, rather than a narrow snapshot.

Risk, Discipline and Returns

As we do in all market conditions, our approach amidst uncertainty has been to manage our risk levels prudently. Our adjusted leverage ratio at the end of 2011 was down approximately 50 percent from the end of 2007. We have further strengthened our liquidity position relative to pre-crisis levels. Our average Global Core Excess (highly liquid securities and cash instruments) is at near record levels, up more than twofold from four years ago, comprising close to 28 percent of our average adjusted assets. We have also made a concerted effort to reduce our level 3 (illiquid) assets which, since the end of 2007, are down 30 percent and represented approximately 5 percent of our 2011 year-end balance sheet.

Of course, as underlying conditions change, we will recalibrate our capital and liquidity profile to be in an optimal position to serve our clients, and to ensure that we are being strategic in managing the firm’s financial resources for our investors. If client demand for risk capital remains muted and opportunities to invest and generate attractive returns are scarce, we may elect to reduce capital intensive portions of our balance sheet and return excess capital to shareholders through repurchases or dividends.

Since the beginning of 2010, we have repurchased more than $10 billion of common stock or approximately 16 percent of our common equity relative to 2009 year-end levels. We have also bought back the equivalent of close to 80 percent of the share count issued during the height of the crisis, while growing our book value per common share by a compounded annual growth rate in excess of 9 percent since the end of 2007. At the same time, we have increased our common equity by nearly 70 percent over this period while maintaining capital ratios near the top of our industry.

Controlling Costs

In addition, we have targeted approximately $1.4 billion of annual run-rate expense savings in order to function more efficiently, and believe we can further benefit from greater operational leverage in terms of infrastructure, technology and people in a number of key markets and businesses. As we gain a better understanding of where to deploy capital and resources and at what level, we will make the necessary adjustments to achieve stronger returns.

It is important to note that, as for many of our clients and financial institutions to varying degrees, the costs of conforming to new regulations have been significant. At the end of 2011, the firm’s regulatory-related headcount had nearly doubled from pre-financial crisis levels across a variety of functions. Our regulatory-related expenses have also nearly doubled during this period.

In the shorter term, the heightened regulatory focus will continue to demand considerable effort and expense; however, over time, we expect this trajectory to even out as infrastructure, systems and processes are rationalized and we and our regulators have gained greater clarity around final requirements. Ultimately, we hope to see the pendulum come to rest at a point that better reconciles effective oversight with the need to continue driving towards investment and growth. We will address other aspects of regulatory reform — particularly as they relate to our clients — later in the letter.

Lastly, our focus on cost discipline includes adhering to our pay for performance philosophy. In 2011, net revenues were down 26 percent and compensation and benefits expenses for our people were down 21 percent, with discretionary compensation down significantly more than net revenues. Over the past few years, we have also reduced compensation and benefits to net revenue ratios, with our average ratio over the past three years of approximately 39 percent being materially lower than our average ratio of approximately 45 percent from 2005 through 2007.

Our Client-Driven Strategy

More than three years since the onset of the financial crisis, many institutions remain focused on working through its aftermath and managing risk in all its forms — whether related to liquidity, credit, market or regulation. Lower revenues and more subdued growth forecasts are causing some to question whether the industry is undergoing secular change, or more specifically, whether the model of providing advice, financing, market making, asset management and co-investing will continue to be relevant in the future landscape.

Based on what we hear from our clients and the work we do on their behalf, put succinctly — we believe the core model remains more viable and important than ever.

Among the forces affecting our industry, some are certainly cyclical — such as economic growth, corporate activity and risk appetite — and some are secular, such as those related to market structure, the influence of the growth markets, technological advancements, or the regulatory landscape. Secular change requires that over time we evolve and position ourselves in ways that continue to add value for our clients; for example, many services we provided over the telephone to our equity clients ten years ago are today both priced and executed automatically, promoting a more liquid and efficient marketplace for investors. Similar structural developments have occurred in foreign exchange, U.S. Treasuries and other areas. Our commitment of people and resources to growth markets also represents our response to long-term secular demands.

It may be too early to conclude to what degree the current industry slowdown is secular versus more broadly cyclical. In any scenario, our strategy remains informed and driven by the insights and demands of our clients around the world. And, what we’ve heard consistently is that as they respond to the long-term trends of globalization and technology, as well as macro-economic and demographic changes, what we do for them is not only still relevant — but critical.

Every day our clients seek advice and financing; they look to us to take the other side of a transaction to help hedge their risk; they need an asset manager to invest on their behalf and a co-investor ready to deploy capital towards promising growth opportunities. In short, clients look to us for these core client services both through periods of transition and at any stage of the economic cycle. Time and again in 2011, we saw sentiment shift rapidly, confirming that our strategy must always be rooted in the fundamental needs of our clients and in our ability to act quickly and effectively in their service.

Investing in Long-Term Trends

Comprehensive Advice and Risk Management

A more global market has also yielded a more multi-faceted, and potentially more risky, business environment; this, in turn, has put demands on the quality and breadth of services that companies, institutions and governments require in order to operate with greater scale. For example, a client may need to hedge its exposure to currency fluctuations, navigate integration issues across borders, or manage the volatility of commodity prices. To address these types of needs, our ability to partner our Investment Banking franchise with our Institutional Client Services businesses enables clients to benefit from seamless advice and transfer risk directly to the firm to manage. Importantly, it allows our clients to get back to focusing on their underlying businesses and strategic objectives.

In a similar vein, a growing practice among companies is to outsource the non-core or sub-scale parts of their business. In particular, we have seen an increase in the outsourcing of insurance asset management globally, which has been accelerated by new capital regimes, greater demand as a result of the financial crisis and a sustained low interest rate environment, making it more difficult to generate returns. Since 2004, industrywide growth in outsourced general account assets has more than doubled from $500 billion to more than $1 trillion. Goldman Sachs is making a substantial investment in this area, having grown these assets by approximately $40 billion since 2008, representing an over 20 percent compounded annual growth rate.

Global Opportunity Set

While it is impossible to say how long economies will remain under pressure, when more consistent growth does return, our revenues tend to grow at a multiple of that growth. This drives our efforts to operate in more places — or put another way, to chase GDP growth.

Between 2005 and 2010, international revenues for Dow Jones companies grew by 35 percent while domestic revenue grew by just 15 percent. FTSE 50 companies have seen a similar trend as international revenue grew by 36 percent compared to a 4 percent decrease in domestic revenue over the same period. This also holds true in cross-border M&A, with aggregate volumes up 56 percent from 2007 relative to the four years prior. Since 2010, cross-border deals represent nearly 40 percent of overall M&A volumes.

Consistent with these themes, we see opportunities across a number of regions and businesses driven by client demand. As companies have become more global and growth economies have benefited from greater wealth creation, market capitalization has also increased. China’s market capitalization has tripled as a percentage of world market capitalization from 2002 through 2010, with the U.S. contribution shrinking to 65 percent of its 2002 levels. Net revenues from our Asia business have more than doubled in 2011 compared with 2002.

More than ever, our clients seek “local” expertise and advice. In response, over the past six years we have hired more than 1,350 professionals into countries such as Brazil, Russia, India, China and Korea. Around the world we now serve 4,000 more Investment Banking clients and approximately 3,000 more counterparties within our Institutional Client Services businesses over the same period.

In the year ahead, cross-border M&A activity is poised to continue and grow: in Europe, due to outbound activity from institutions looking to diversify; in China as clients look for greater access to natural resources and end markets; and in Japan where companies are seeking external growth prospects with currency exchange rates close to post-war highs. Emerging markets M&A activity is also likely to regain momentum, led by inbound activity into Brazil, which has the most open foreign investment policy among the BRICs, and by enterprises in developing countries seeking brands and sales and marketing expertise which they lack in their home markets.

We also see market share expansion opportunities. The recent retrenchment by some financial institutions, especially in Europe, has the potential to change the competitive landscape. European peers have announced plans to lower headcount, shed risk-weighted assets and exit certain businesses altogether. Such deleveraging may lead to reduced lending capacity, higher new issuances, and greater secondary trading, creating opportunities for Goldman Sachs to intermediate asset sales to our investing clients.

Clients and Regulatory Reform

As mentioned, the potential impact of regulation has been an important theme over the past few years and certainly in 2011. We are working constructively with regulators around the world to contribute to effective and realistic implementation of new legislation and regulations, and remain focused on what reforms may mean for our industry, for our firm, and, most importantly, for our clients. In many of our conversations, clients have expressed concern about the impact their businesses may experience, including new margin requirements, potentially less market liquidity, wider spreads and less available, more expensive inventory.

These and other factors will affect not only how clients serve their customers but also their technological infrastructure, legal documentation and compliance areas. It is critical for us to understand the issues confronting our clients and to adapt our services accordingly to better meet their needs. When rules begin to take final shape, we will increasingly allocate resources to developing trading tools and clearing and settlement systems that will help our clients address these new realities.

More broadly, we recognize that translating the statutory language into workable outcomes is challenging, and appreciate the effort made by all parties to strike the balance between flexibility and specificity. This is especially important with respect to the Volcker Rule — which restricts banking entities’ proprietary trading activities and certain interests in, and relationships with, hedge funds and private equity funds. As the process moves forward, it is critical that rulemaking proceed in a way that is not counterproductive to the ability of companies and investors to continue to use the capital markets to accomplish their business objectives.

We believe it is critical that the final version of the Volcker Rule reflects a meaningful evolution from the one currently under proposal. This includes drawing an essential distinction between prohibited proprietary trading and the vitally important — and statutorily protected — market-making related, underwriting and hedging activities.

Getting these issues right has serious, real-world consequences for our clients and other market participants who rely on the vital financial intermediation and capital-raising services that financial institutions such as Goldman Sachs provide. For example, if the constraints of the proposed rule define our ability to hedge in a way that makes it prohibitively expensive, or so narrowly that effectively prohibits it in some cases, our clients will be forced to hold more risk on their own books. This will increase the volatility of their earnings and hurt their share prices, which in turn will raise their cost of capital, reduce their capacity to invest, lower their returns to shareholders and diminish their appeal as strategic partners.

The proposed restrictions on market making could also have wide-ranging adverse effects. For example, a company wishing to issue bonds to finance expansion plans, or a pension fund looking to sell a stake in its portfolio to fund near-term obligations, may turn to Goldman Sachs to underwrite or execute the transaction. In either case, we would typically engage in market-making related activities, and in doing so, may hold some of the assets on our books.

Because market makers are willing to buy from and sell to clients in different market conditions, we need to know that we can carry this inventory for the optimal time, not a minimal time, and have judgments made by people who are trying to determine an appropriately effective manner in which to dispose of the position; if restricted from doing this, market makers will provide less liquidity and at worse prices. For the bond issuer, this raises its cost of capital, and for the pension fund, this erodes savings, raises costs for employers and reduces pension security for the fund’s participants.

Liquid capital markets are the jewel of America’s financial and economic system, the benefits of which are felt by every industry and by all investors. Reduced liquidity and other inadvertent byproducts of the proposed rule pose obstacles to the free flow of capital and efficient allocation of resources throughout the global economy. This is capital that could otherwise go to investment and job creation, or be returned to shareholders.

While the consequences of an overly restrictive application of the Volcker Rule are formidable, we are optimistic that the intended results can be achieved in a way that will ultimately be better for all constituencies, including investors and companies around the world looking to access capital, expand and grow. To this end, we are recommending constructive changes to the proposed rule that would provide a much stronger foundation as market participants and regulators move forward.

Implementation of Business Standards Committee Recommendations

In January 2011, we released the Report of the Business Standards Committee (BSC), which was the culmination of an extensive eight-month review across every major business, region and activity of the firm. A significant amount of time and resources last year were devoted to implementing the report’s 39 recommendations. Over 400 of our people were directly involved, and many more indirectly, as the BSC recommendations are integrated into the day-to-day operations of the firm. To monitor and supervise the implementation process, we created an oversight group comprising senior leaders across the firm. Employee participation in implementation has spanned every level, division and region, demonstrating the commitment and openness within our organization to improving and strengthening Goldman Sachs.

To date, our efforts have served to catalyze a renewed focus on client service and client communication; on strengthening our controls, processes and committee governance; on greater personal accountability and reputational risk management; and on reinforcing attributes of our culture and values. Importantly, we established the Firmwide Client and Business Standards Committee, which is composed of many of the firm’s most senior leaders, and puts clients at the heart of our approach to governance. This includes applying an elevated standard of professional judgment to all aspects of our business activities and in everything we do. As nearly every facet of the recommendations has a training component, we are implementing over 30 new BSC training programs, and embedding BSC-related content into over 90 existing training programs.

In particular, the BSC emphasized the importance of articulating clearly both to our people and to our clients the nature of the roles we are asked to undertake across our various businesses, whether acting as advisor, fiduciary, market maker or underwriter. As part of the BSC, we retained an independent consultant to conduct non- attributable, in-depth, in-person discussions with senior management of a number of clients worldwide. Among the feedback we received was their desire for us to communicate more clearly the roles and responsibilities we undertake depending on the nature of the transaction and the objectives of the client.

To this end, we implemented the Role-Specific Client Responsibilities framework, which does not capture every possible client interaction, but is designed to facilitate better communication with clients about our specific responsibilities in a given transaction type or business activity. To date, over 8,000 of our people have taken part in training focused on the different roles and responsibilities we assume in working with our clients. A central theme of the training is the need to be clear to ourselves and to our clients about the capacity in which we are acting and the responsibilities we have assumed.

Chairman’s Forum

Last year, we launched the third iteration of the Chairman’s Forum, a global initiative for managing directors designed to emphasize the importance of — and our commitment to — reputational excellence and individual accountability. Structured to incorporate key BSC recommendations, each of the 23 three-hour sessions featured an interactive case study presenting complex and multi-faceted scenarios for intensive discussion. This deep commitment of time by our senior leadership reinforces the priority we place on weighing reputational risk when making difficult business decisions, thinking broadly about individual responsibilities and escalating issues as appropriate. Our reputation is built upon our service to clients, our performance and the integrity of our people, each of whom carries with them responsibility for protecting the firm’s reputation in the judgments, actions and communications they undertake.

Ongoing Evaluation

As formal implementation of the BSC winds down, this is not the end of this process, but in many respects it is the beginning. Because the focus of this effort is rooted more in the judgment of our people than a formal rule set for decision making, we will also look to multiple sources of feedback — our clients, our people, regulators and other key stakeholders — to ensure that our commitment to improvement is a living, breathing and dynamic process.

Our People

Notwithstanding the forces of technology and globalization, ours is ultimately a human business, conducted person to person. A client relationship is only as strong as the Goldman Sachs professionals managing that relationship. The most important thing we can do to enhance the value of our client franchise is to continue to retain our people and to hire the most talented individuals from around the world. We benefit from committed, seasoned leadership across the firm’s businesses and divisions, with an average tenure of over 20 years for members of our Management Committee. At the same time, almost 300,000 people applied for full-time positions at Goldman Sachs for 2010 and 2011. We hired less than 4 percent of that population, and though most had multiple offers, nearly nine out of ten people offered a job with us accepted. Once they arrive at Goldman Sachs, we do everything we can to ensure they have productive and stimulating careers.

We go to great lengths to engage our people, listen to what’s on their minds, and where necessary, implement changes to ensure we remain an attractive and dynamic place to work. This past year, we conducted our People Survey, a biennial effort to solicit thoughts and opinions on how to maintain a strong culture and rewarding environment. The 2011 survey garnered more than 22,000 comments and suggestions, reflecting strong participation from across all levels and offices. Among the findings, our people indicated they remain excited to work at the firm and continue to value our culture of teamwork, and also pointed out areas where we can do better. These suggestions and other data will continue to drive our key people initiatives, just as they have since we first polled our people in 2001.

We are especially pleased that Goldman Sachs was named one of Fortune magazine’s “100 Best Companies to Work For” on its most recent list, a distinction we have earned each year since the list’s inception 15 years ago. We are one of only 13 companies to do so. In addition, the firm placed fourth in the most recent The Sunday Times “Best Companies to Work For” survey in the “Best Big Companies” category and was the highest-placed financial services company for the third consecutive year. Our commitment to diversity was also recognized when Working Mother named us to its “100 Best Companies for Working Mothers” and when the Human Rights Campaign Foundation awarded us the “Innovation Award for Workplace Equality” and included us on its “Best Place to Work for LGBT Equality” list.

Corporate Engagement

Since 2008, Goldman Sachs has committed in excess of $1.4 billion to philanthropic initiatives, including 10,000 Women, 10,000 Small Businesses and Goldman Sachs Gives, representing one of the largest contributions ever made by a corporation. Our efforts include working hand-in-hand with a global network of more than 100 academic and non-profit partners, as well as local and national leaders. A record 26,500 of our people, their friends and family participated in our global volunteer initiative Community TeamWorks last year, which celebrated its fifteenth season. In particular, we were pleased to receive the Committee Encouraging Corporate Philanthropy’s 2011 Chairman’s Award for 10,000 Women, which speaks to the power of partnership between business, government and the non-profit sector.

10,000 Women

Having recently celebrated the program’s fourth anniversary, 10,000 Women has reached 5,500 women across 42 countries, including Rwanda, Nigeria, Brazil and China. In March, we were honored to join U.S. Secretary of State Hillary Clinton and First Lady Michelle Obama to announce a new public-private partnership to expand the effort, and through Goldman Sachs Foundation’s 10,000 Women Department of State Women’s Entrepreneurship Partnership, we have already reached women in ten additional countries. In December, we were also pleased to partner with the Government of Denmark to provide 10,000 Women alumnae in Tanzania with affordable sources of capital. Most importantly, these women are applying what they learn to multiply the program’s impact: within 18 months of graduating, 80 percent have increased their revenues, 66 percent have added new jobs and 90 percent are mentoring other women and girls in their communities.

10,000 Small Businesses

Goldman Sachs continues to work with community colleges, Community Development Financial Institutions and non-profit organizations to provide small businesses with the education, business services and capital they need to grow and create jobs. Through 10,000 Small Businesses, we have forged partnerships with more than 40 organizations, across six cities in the U.S. — New York, Los Angeles, Long Beach, New Orleans, Houston and Chicago — and four cities in the U.K. — London, Leeds, Manchester and Birmingham. Participating businesses range from metal fabrication shops to cafés, and from first-generation enterprises to long-standing family-owned companies. As we see with our 10,000 Women scholars, these small business owners are translating the knowledge they garner from the program into immediate growth in their local communities.

Goldman Sachs Gives

The tradition of individual philanthropy remains a core tenet of our culture. In recent years, firm compensation was reduced by nearly $900 million to support Goldman Sachs Gives, a donor-advised fund which allows partners at Goldman Sachs to recommend donations to qualified nonprofits globally. Through the program, the firm has distributed nearly 7,000 grants to organizations that seek to build and stabilize communities, honor service and veterans, increase educational opportunities, and create jobs and economic growth.

Since 2010, Goldman Sachs Gives has provided approximately $70 million in need-based financial aid to students at more than 100 colleges and universities across the globe. In advance of the 2012 Olympic Games, Goldman Sachs Gives also launched a sports initiative with two leading charities — Greenhouse and Right To Play — to improve the lives of at-risk youth in the U.K. and Middle East through access to athletic coaching. Goldman Sachs Gives continues to support nonprofits working to reintegrate wounded veterans into the civilian workforce, and is donating $20 million over five years as a catalyst for new partnerships pertaining to veteran job placement and readiness, as well as support and counseling for family members.

Looking Ahead

As we continue to navigate the cross currents of change, we are faced with the challenge of remaining highly adaptive while also anchored in the traditions, tenets and values that have formed the foundation for our success. These recent years have tested the firm like few other times in our history, but over this period, we have worked every day to demonstrate Goldman Sachs’ resiliency, resolve and commitment to our bedrock principles. Most importantly, we are thankful to our clients for entrusting us to work with them to achieve their most critical goals and objectives. Their demands will continue to drive our long-term strategy and we will remain acutely attuned to understanding and responding to their needs.

It is difficult to predict with any accuracy which businesses will outperform in the months and years to come. However, looking ahead, while the trajectory of corporate activity in 2012 will depend largely on the return of macro-economic stability, management teams and boards are showing renewed interest in engaging in strategic discussions, suggesting pent-up demand for new opportunities. When you consider that activity relative to overall market capitalization is near historical lows, financing costs are attractive and cash reserves are flush, the potential is promising. At the same time, the complexities in executing for clients in this environment presents opportunities for Goldman Sachs. We believe our people and teams possess the experience and innovative insights to help our clients succeed.

We are optimistic that the set of opportunities will expand with resuming growth, and feel confident that when the economy turns — and it will — the firm is poised to perform strongly as economies and markets develop and prosper. As we move forward, we will continue to make the decisions and investments we believe are necessary to attract and retain the best people, meet the needs of our clients, control costs, manage our risks and produce over-the-cycle returns to create long-term value for our shareholders.

  • Lloyd C. Blankfein Chairman and Chief Executive Officer
  • Gary D. Cohn President and Chief Operating Officer