BUSINESSWEEK ONLINE : JANUARY 25, 1999 ISSUE
COVER STORY

The Coup at Goldman
How the fight over going public and a banker-trader clash helped topple Jon Corzine

Monday, Jan. 11, was a painful day for Jon S. Corzine, the leader of Wall Street's most prestigious investment bank, Goldman, Sachs & Co. That morning, from his unassuming office at 85 Broad Street in the heart of New York's financial district, Corzine called clients and regulators to tell them his astonishing news: He was no longer chief executive of Goldman Sachs. One call was to William J. McDonough, president of the Federal Reserve Bank of New York. ''I think he is a very fine human being and a high-quality professional,'' says McDonough, who negotiated with Corzine the rescue of Long-Term Capital Management last September. ''Personally, I will regret that I will not be able to work with him as closely as I did in his previous capacity.''

Later that morning, Goldman put out a terse press release, with the news that Corzine ''has decided to relinquish the CEO title.'' He would remain co-chairman to help with the initial public offering of Goldman's stock, which was postponed when the stock market plunged in August and September. The news about Corzine shocked the Street. Employees were ''blown away,'' says one senior manager. Securities & Exchange Commission Chairman Arthur Levitt Jr. says: ''I think he's probably as broad-gauged a leader as the industry has seen since [former Goldman Senior Partner] John Whitehead.'' Some Goldman clients were equally unnerved by Corzine's demotion, with one corporate client even saying he may take his investment banking business elsewhere. ''My confidence in Goldman Sachs depends on my confidence in Jon Corzine,'' he says.

Insiders and competitors alike say Corzine was ousted in a coup within Goldman's all-powerful five-man executive committee. Corzine was forced aside by a troika of senior bankers: his co-chief executive, Henry ''Hank'' M. Paulson Jr.; Goldman's top investment banker, John L. Thornton; and Corzine's protege, Chief Financial Officer John A. Thain. ''Everyone liked Corzine. No one likes to see someone ganged up on,'' says one insider.

Yet talk to Paulson, now Goldman's sole chief executive, and all is running like clockwork in Goldman's executive suite. Paulson insists that the changes have nothing to do with the IPO or the trading losses Goldman suffered last fall. Paulson describes the management shakeup as an ''orderly transition.'' He adds that Goldman just wanted to make these long-planned changes before the firm went public. ''We saw a window of opportunity and decided it was the best time to make that change,'' says Paulson. All Corzine will say is: ''I think this is in the best interests of the firm.''

While Paulson may quibble with the word ''coup,'' he doesn't really deny that one took place. ''A group of members of the executive committee got together and made a management decision that we think is in the best interests in terms of how we manage the firm,'' says Paulson.

Whatever Paulson wants to call it, Corzine's ouster was a dramatic departure for the world's premiere investment bank, a firm that prides itself on harmonious relations. But the move toward public ownership has brought to the fore conflicts that generally had remained suppressed. A key example is the split between the trading and investment banking divisions, with their very different cultures. Corzine is a trader. Paulson and Thornton are career investment bankers. Thain is a hybrid, working as both a banker and trader. In planning for an IPO, they knew that securities firms focused on stable revenues, including investment banking fees, are accorded higher multiples than those that rely on high-risk trading. But a huge slice of Goldman's earnings come from proprietary trading. Says one analyst: ''Embedded in the center of Goldman Sachs is a hedge fund.'' No surprise, then, that Paulson and Thornton, along with Thain, wanted to put as much of an investment banking face on the firm as possible.

A ROCKY RELATIONSHIP. Yet this strategy raises several sticky problems for the future: Can Paulson, Thornton, and Thain pull the firm together? Will the messy coup alienate clients? Should the firm curtail its usually remunerative proprietary trading operation? Most important, can the firm maintain its primacy in an increasingly ruthless competitive financial arena?

Many factors contributed to the erosion of Corzine's power. Beyond the culture gap, he and Paulson had a rocky relationship, despite Goldman's constant pitch about their inbred teamwork. The tension made it harder to deal with trading-related mistakes in 1998. True, the firm earned near-record pretax profits of almost $3 billion, with a hefty chunk from investment banking. But Goldman's vaunted ability to manage risk took a hit as it lost an estimated $500 million to $1 billion when the market cratered last summer. Corzine took a lead role in the Long-Term Capital Management bailout because of Goldman's own exposure. He bid for the overleveraged hedge fund and then shelled out $300 million for the rescue. And after finally announcing that the firm would go public in June, 1998, Corzine was forced to pull Goldman's offering in September.

Add to all that the discontent of the investment bankers. They were unhappy that their lush profits got flushed down the toilet in the bond market fiasco. In mergers and acquisitions, Goldman's bankers blew the lights out, leaving competitors agog. Goldman racked up $960 billion in global deals, which was almost three times its 1997 record total. Still, Goldman's pretax earnings were down 81% in the fourth quarter, while those of rival Morgan Stanley Dean Witter (MWD) were up 6%.

The most pressing issue now is whether the new management team can pull off Goldman's long-delayed IPO. Paulson says it's definite: ''We are going to go public,'' and ''we will be disappointed if we don't get a deal done in 1999.'' On the face of it, the management shakeup sends a mixed message about whether Goldman will go public. Corzine is the one most closely associated with the firm's wrenching 1998 decision to do so. As far back as 1986, he began championing the idea and ran into stiff opposition from the three men who are now running the firm. Paulson, Thornton, and Thain believed that by going public, Goldman would lose its unique partnership culture.

Goldman has gone too far down the road toward becoming a public company to turn back. Now, the triumvirate must wrestle with the same problem as Bankers Trust (BPR) and J.P. Morgan (JPM) face: Too much of their profits comes from risky proprietary trading, or trading for the house account. Says one analyst: ''As a public firm, you suffer the J.P. Morgan phenomenon'': the perception that Morgan is a trading machine. ''The guy that had a lot to do with that was Corzine.''

Investors penalize firms that depend on proprietary trading because it is so unpredictable, producing huge profits one quarter and huge losses the next. By marketing itself as an investment bank and deemphasizing its proprietary trading prowess, Goldman can sell its stock at a higher price (box). Investors are willing to pay more for the stock of companies whose earnings come from stable fees from commissions, mutual funds, and underwriting.

As Goldman gets set for the IPO, it may be better to have an investment-banker CEO pitching the firm to investors than one who is a trader. ''If Jon had to get whacked, now's the right time. You want to do that before you go public. It helps your positioning in the road show,'' says the analyst. Paulson, a reserved, highly organized Midwesterner, is one of the best bankers in the business. He spent his entire career as a banker until being promoted to chief operating officer in 1994. ''Jon is a brilliant, intuitive leader. Hank embodies a quality that distinguishes a Goldman banker. His ability to execute is legendary,'' says one Goldman partner.

Paulson says that he, along with Thornton and Thain, have been involved with trading as well as investment banking. Further, the firm has no intention of downgrading its trading businesses. ''This is not about emphasizing one business to the detriment of the other,'' says Paulson. ''Both businesses are very, very important to us.''

For Corzine, a natural leader with a low-key, rumpled style, it wasn't supposed to turn out like this. After all, it was Corzine who stepped into the breach in 1994, when Goldman was struggling with trading losses and the sudden resignation of senior partner Stephen Friedman. Thirty-six other Goldman partners fled, taking their capital with them. Corzine was named chairman, and Paulson was his No. 2, though the two maintained that they enjoyed a partnership in the style of former Goldman chiefs Robert E. Rubin and Stephen Friedman. It was Corzine who stabilized the firm and helped it raise morale and profitability. He also instituted better risk-management procedures.

The experience left Corzine even more deeply convinced that Goldman needed to protect itself from market instability by going public and securing permanent capital--rather than remaining hostage to fickle capital that partners could withdraw. Paulson never embraced the idea. On May 27, the executive committee decided to promote Paulson to co-chairman and co-chief executive, just two weeks before the entire partnership voted to go public. Some insiders and competitors say Paulson's vote was bought--that he was promoted to be Corzine's equal in exchange for supporting the IPO.

While Goldman is a partnership, power is concentrated in the men on the executive committee. At the time, there were six, with three for an IPO and three against. In June, 1998, Paulson's new support for the IPO broke the tie on the executive committee, sources say. Corzine already had the backing of Vice-Chairman Roy J. Zuckerberg and Vice-Chairman Robert J. Hurst Jr.

CIRCLING THE GLOBE. Paulson and others deny there was a quid pro quo. ''Hank's elevation to co-chief executive was the unanimous decision of the executive committee and absolutely, categorically, had nothing to do with whether Hank was going to support an IPO,'' says Robert J. Katz, general counsel. Further, Paulson told the meeting of all the partners last June that he did not support the firm's going public but was bound to carry out their collective decision.

In the following months, though, several factors weakened Corzine's hand. First, Zuckerberg retired from the executive committee on Nov. 27. And in August and September, Goldman was hit with huge trading losses. Part of the losses stemmed from Goldman's proprietary trading positions. When Long-Term Capital's crisis shook up the market, Goldman got socked, since it had many of the same trading positions.

Corzine was at the heart of the Long-Term Capital bailout, marshaling the key Wall Street firms that chipped in $3.6 billion to save it. While world financial markets were stabilized, the $300 million that Goldman ponied up for the rescue--and possibly Goldman's and Warren E. Buffett's well-publicized bid for Long-Term Capital as well--did not endear him to his investment banking colleagues. ''I assume that all the [Goldman] bankers hated'' Goldman's taking a big role in the bailout, says someone close to Long-Term Capital.

Another long-simmering issue between Corzine and the troika was how the IPO process would be handled. Corzine was committed to having about 200 voting managing directors cast ballots on the IPO, since they own the firm. However, Paulson and Thornton believed that this was too unwieldy and time-consuming an approach and that the executive committee should make a decision for the full partnership, say sources close to the firm.

In June, 1998, Corzine did put the issue of the IPO to the full partnership, and it was approved. But the process of Corzine and others circling the globe to meet with Goldman's far-flung partners to win their support for an IPO delayed the offering. After the markets crashed, Goldman was forced to cancel its offering, a major embarrassment to a firm that advises clients on IPOs. It was a humiliating experience for Goldman--an intensely proud institution.

LESS THOROUGH? Delaying the IPO may have damaged Goldman's reputation with clients, even though by that time, the firm had little choice. It may just be market sniping, but competitors in London think they detect a falloff in the firm's performance. They say that Goldman's senior investment bankers did not seem to be covering important clients with quite their usual thoroughness. Some sources say that not being chosen to represent BP, a frequent Goldman client, on the $52 billion Amoco deal was a blow. Despite their huge success in M&A everywhere in the world, in the U.S., Goldman has slipped in the IPO rankings from No. 1 in 1997 to No. 3 in 1998, with market share falling from 15.7% to 9.4%, says Securities Data Co.

The hiatus certainly created major difficulties for Goldman internally. After going full steam ahead and grappling with the highly emotional issues of how to carve up the very fat Goldman goose among some 200 owners, an additional 345 managing directors, and 16,500 employees, delay was excruciating. Most key professionals had been told exactly how much they would make from the IPO--from $200,000 to $200 million. This accentuated the fault lines in the firm between the two tiers of managing directors, within the tiers of managing directors, and between the managing directors and the many driven professionals who staff the firm.

On top of that, long-simmering friction between Corzine and Paulson increased, making it difficult for them to share the top job. By the week of Jan. 4, tensions had come to a head. At a series of executive committee meetings, it became clear that Paulson was viewed as a better executor of the IPO than Corzine and that he could work more smoothly with Thornton and Thain. The decision was made that Corzine must step down. On Jan. 11, the firm issued a press release saying that the executive committee would be dissolved, that a 15-man management committee chaired by Paulson and including Thain and Thornton would take its place, and that Thain and Thornton would chair a new 15-person partnership committee. Corzine's name was not on the list of management committee members. ''The view was that Jon would step down after the firm went public,'' says one insider. ''And the view in the executive committee was that it should happen now. They wanted to do it now, and he didn't want to.''

''DIRTY LAUNDRY.'' Until now, Goldman has escaped the normal scrutiny that most public companies are subjected to from the press, shareholders, and securities analysts. This has allowed Goldman to maintain its mystique. ''I've always been in awe of Goldman's ability to keep their dirty laundry private. So the story is, some laundry is getting washed in public,'' says a rival investment banker whose firm has taken its share of knocks.

Several Goldman partners insist that Corzine's stepping down has nothing to do with the delay of the IPO or the trading losses. Further, these partners strongly downplay the notion that investment bankers are rising at the expense of traders. But within the firm, traders are nervous that Goldman is pulling back from its historic commitment to trading, especially proprietary trading. One source says proprietary traders have been quietly allowed to shift to other jobs at the firm so they don't look outside it and alert the market to the fact that Goldman is firing proprietary traders. Paulson says: ''Proprietary trading is very important to us; our strategy is to be a leading player in global financial flows for the benefit of our clients and our firm.''

At least one former proprietary trader isn't going anywhere anytime soon. In a public company, Corzine might have jumped ship or been forced out. But this is a partnership whose members are bound together by their pocketbooks. As one of Goldman's biggest owners, Corzine has hundreds of millions of dollars tied up in the firm. Despite his embarrassing public removal from the helm, he will stay on as co-chairman with the task of helping with the IPO. How well that IPO is received in the market may portend whether Goldman can maintain its vaunted position in global finance.



By Leah Nathans Spiro, with Gary Silverman in New York and Stanley Reed in London

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