On March 14, Greg Smith, '01, a resigning Goldman Sachs vice president, wrote an op-ed for the New York Times that was subsequently talked about around the globe. In the piece, he criticized the company and its culture. Smith described the environment as "toxic and destructive" and told of a company whose culture had changed in his 10-plus years there. Integrity had eroded, he said, and the interests of the client (whom, he says, his colleagues call "Muppets,") had been sidelined in the face of making the most possible money off of them.
To make sense of this all, and speak to its complexity, we turned to Stanford Law Professor, and former Securities and Exchange Commissioner, Joseph Grundfest, JD '78.
Excerpts:
What do you make of what's going on with Goldman Sachs right now?
There is an extent to which this recent incident is a self-inflicted wound. The reality is that Goldman Sachs is a very complicated multi-function international financial firm. They have many different kinds of relationships with individuals and organizations all of whom they call clients. In some cases, they owe these clients very powerful fiduciary obligations, and Goldman must put the clients' interests ahead of their own. In other situations, organizations that are called clients are actually trading with and against Goldman, and they are trying to rip Goldman’s lungs out and Goldman is returning the favor.
Can you describe an example of the latter case?
If you are trading, for example, foreign exchange with a sophisticated counter-party. You're selling the Yen because you think the Yen is going to go down, [and] they're buying the Yen because they think it's going to go up. You think they're an idiot, they think you're an idiot.
That is one piece of Goldman's business. It's certainly not all of it. [But] in my view, Goldman creates a real problem for itself when it doesn't distinguish among its different clients. And by saying that they always put clients' interests first, they mischaracterize reality and they also paint a picture that knowledgeable market participants know is not true. So from that perspective, Goldman taking that position of we always put clients first, without defining with precision who they mean as a client, really means they are painting themselves into a corner that's almost impossible to defend.
Also, from another perspective, if you're going to use the word "client" in that broad a sense, nobody ever believes that Goldman or any other financial firm always puts the clients' interests first.
Is that change a cultural shift for these companies, or was that always the case?
It's not so much that it's a cultural shift that may have been happening over the years—there may well have been, I don't know; I've never been inside Goldman—but the thing that has clearly happened throughout the financial services industry is that a much larger percentage of profits are being driven by trading activity than by traditional investment banking in counseling activity. And this is an important point. Because if we go back to the origin of the phrase "the clients' interests always come first," that came about in the 1960s, when the vast majority of the investment banking business was, in a certain sense, advisory. You were giving advice to companies about selling securities, capital market transactions and the like, and you weren't making most of your money by trading complicated financial instruments in the marketplace.
In today's world, trading drives the business. The amount of money that's made in a traditional advisory role is significantly smaller. So it may once have been true for the large majority of clients at Goldman and at other firms that [their interests came] first. In today's world, where the majority of "clients" are really your trading counterparties and not people that you are advising in any sort of a fiduciary relationship, it's not at all clear or true that you put your clients' interests first, or that those clients even expect that you put their interests first.
Was there anything specific that brought about an increased emphasis on trading?
Yes, there were fundamental changes in the technology of the marketplace.
You had the evolution of derivatives markets, you had the evolution of computerized technology, you had intellectual innovations in the form of the Black–Scholes model and other techniques for evaluation and pricing complicated instruments. So there really was a technological revolution in finance in the 1980s and the 1990s that helped spur this change in the fundamental economics of the large banks and evolved them into trading firms more than advisory firms.
Goldman became a public company in 1999. Did that play a role in how it conducted business?
There's debate about that, too. When you become a trading firm you need a lot more capital in order to support your trading activities. If you're an advisory firm, you don't need that much capital because you're not putting your own capital at risk. One of the reasons Goldman went public—though certainly not the only reason—was it wanted to be able to raise more capital at a lower price.
There are other reasons, including making more money for its partners. Anybody who denies that is being unrealistic. And it almost goes without saying that governance mechanisms and incentive compensation mechanisms are different at large, [publicly] traded organizations than they are at small, privately-held organizations.
What do you think is in the future for Wall Street firms, in terms of how they operate and how people view them?
There are several important factors to look at. Number one, to what extent will the nature of the business be changed by the regulations that are going to be adopted under Dodd-Frank, and by the operation of the Basel III capital requirements?
And the other important point, very simply is, to what extent will this debate change the behavior of Goldman clients? I think, from Goldman's perspective, that's probably the piece of the puzzle that they're looking at most carefully. Because in a certain sense, at the end of the day, if the clients don't feel they are getting the best service at the best price from Goldman Sachs, they'll go somewhere else.
By the same token, if the clients feel that they're getting the best service at the best price, even if some salesman [calls] them "Muppets," they’ll be coming back to Goldman again and again.
What are some of the reactions you've heard since Smith's Op-Ed Appeared?
It's interesting. My phone has been busy since this article appeared. And the responses that I've heard have been bimodal. Half of them criticize Smith. Half of them criticize Goldman. The half that criticize Smith basically say, "He knew he wasn't joining a convent. So what is he complaining about? He was a salesperson marketing complex derivative products. And what does he not understand about being a salesperson marketing complex derivative products?"
The other half of the calls were along the lines of, "This is what I always thought was going on behind the scenes at Goldman, and isn't it great that someone is finally standing up and speaking truth to power?"
So, to me, it was really fascinating to hear these two very, very different views.
It feels like this is a continued debate, and that it has been written about and discussed in the past, too.
Anybody [who] thinks that Wall Street is populated by a bunch of choir boys simply needs to get a life. These are very smart people. Many of them are very sharp elbowed. But in my experience, the vast majority of them certainly don't want to violate the law, and they want to conduct their business with integrity in a highly competitive manner.
A sports analogy is not a bad one. These are people who are competing at the very, very highest levels. They're always looking to gain an edge. But they know that they've got to play the game within the rules.
Brian Eule, '01, is a frequent Stanford contributor.
