Goldman resignation tip of iceberg

While Greg Smith's public resignation has attracted media attention, regulators and Wall Street insiders say Goldman Sachs' problems come as no surprise.

The young banker whose dramatic public resignation stung Goldman Sachs this week joins officials from every corner of the government in questioning whether the august investment house deals honestly with all its clients.

In separate cases, judges, lawmakers and regulators have suggested the bank ignores conflicts of interest and sells to its clients investments it knows are weak, all in the pursuit of profit.

The resignation Wednesday by Greg Smith, a 33-year-old banker for Goldman in London, was a shot from within Goldman's ranks. In an Op-Ed article for The New York Times, Smith said the bank sells financial products "that we are trying to get rid of."

"It makes me ill how callously people talk about ripping their clients off," Smith wrote.

The essay was widely circulated online, and Smith became a trending topic on Twitter. But his charges were only the latest embarrassment for Goldman, which has built a sterling reputation over 143 years on Wall Street.

The bank paid $550 million in 2010 to settle civil charges that it misled investors while selling them investments in the U.S. housing market as the bubble burst — even as Goldman reaped hundreds of millions from its own bets against housing.

A congressional committee recommended that law enforcement authorities look into a series of deals that Goldman sold while executives derided them in emails as "junk," ''crap" and another profane adjective.

And last month, a Delaware court nearly blocked a merger between Kinder Morgan and El Paso, two energy companies, because Goldman had ties to both companies, raising questions about a conflict of interest.

"This is the latest entry into a long-running narrative that they don't put their clients first," said Michael Robinson, a former official with the Securities and Exchange Commission. "If your business is built on trust, that's not going to fly."

Robinson, who now works for Levick Strategic Communications, a public relations company, said regulators, Congress and prosecutors are almost certain to look into Smith's claim that Goldman sold investments to clients that it wanted to get rid of.

The SEC, the FBI and federal prosecutors in Manhattan declined comment. A spokesman for Goldman also declined comment.

Legal experts said the bar for proving wrongdoing by executives at the bank would be high. The real danger for Goldman, Robinson said, is that clients will lose faith and abandon it.

"Whether what they're doing is legal or not, it sure is going to keep them in the headlines — and remind people that they can't always trust what they're hearing from their banker," he said.

On Wednesday, as Smith's essay was read millions of times on the Times' website and circulated by countless others online, Goldman's leadership suggested he had not portrayed the bank's culture accurately.

"It is unfortunate that all of you who worked so hard through a difficult environment over the last few years now have to respond to this," Goldman CEO Lloyd Blankfein and President Gary Cohn wrote in an open letter to employees.

Blankfein, 57, has been at the helm of Goldman through one of the most trying times for the bank. He was named CEO in June 2006 and was at the helm during the financial crisis in 2008, when Goldman took $10 billion in bailout money.

He is regarded as an intelligent and hardworking banker, though not the most charismatic among his peers. A published report last month suggested Blankfein was considering stepping aside this summer, though Blankfein has not said so publicly.

Michael Farr, president of the Farr, Miller & Washington investment firm, which owns Goldman stock, predicted Blankfein would "weather this just fine."

"These are tough people with resilient attitudes who are focused on the bottom line," Farr said, "and Blankfein has delivered nicely."

Senators questioned Blankfein and other Goldman executives an April 2010 subcommittee hearing. A subcommittee report said Goldman marketed four sets of complex mortgage securities to investors but failed to tell them the securities were very risky.

The committee report also said Goldman secretly bet against the clients and deceived them about the bets so that they would pay for Goldman's earlier, doomed housing investments.

Subcommittee chairman Sen. Carl Levin, D-Mich., questioned the accuracy of the executives' testimony.

"Did anyone ever really think that Goldman was doing what was best for their clients?" said Rep. Brad Miller, D-N.C., a regular critic of the banking industry who serves on the House Financial Services Committee. "Goldman may have denied it, but I never really believed their denials."

The Delaware case illustrates Goldman's reach. The state judge declined to block the Kinder Morgan-El Paso deal but expressed misgivings. Goldman advised El Paso, owned a 19 percent stake in Kinder Morgan and controlled two of Kinder Morgan's board seats.

The judge, Leo Strine, said Goldman took steps to separate its advisers to each company, but said the efforts were not effective.

"This kind of furtive behavior engenders legitimate concern and distrust," he wrote.

In his essay, Smith wrote that young bankers could become leaders at Goldman by getting clients "to invest in the stocks or other products that we are trying to get rid of because they are not seen as having a lot of potential profits."

He also said bankers could "hunt elephants," a practice he explained this way: "Get your clients — some of whom are sophisticated, and some of whom aren't — to trade whatever will bring the biggest profit to Goldman."

"Call me old-fashioned," he concluded, "but I don't like selling my clients a product that is wrong for them."

Smith did not present specifics about the bank's marketing to customers.

The young banker, a Rhodes Scholarship finalist in 2002 who attended Stanford University, still had not spoken publicly Thursday beyond the Times Op-Ed.

A Twitter account that appeared to be Smith's had been protected Thursday, meaning only his confirmed followers could read it.

Any regulatory or criminal probe of Goldman that grows from Smith's charges would face high hurdles, legal experts said. The recent SEC charges against Goldman relied on misleading statements in the marketing materials Goldman produced to sell the risky deal.

In a well-known 2003 case that didn't involve Goldman, regulators accused a research analyst from Merrill Lynch of pushing companies that he insulted in private. But that case relied on rules that govern published research about stocks and do not apply to sales pitches.

To defend itself against charges that it sold bad investments, Goldman would only need to prove that the investments it sold were "suitable" for clients. That's a looser standard than the rules for investment advisers, who are required to act in their clients' best interests.

"While these may be revelations to the marketplace, they likely are not revelations to anyone inside Goldman or to the securities regulators," said Jacob Frenkel, a former SEC enforcement attorney now practicing with the firm Shulman Rogers.

"Goldman's clients tend to be so loyal because they're among the top tier of investors," with enough assets that the law considers them capable of making investment decisions with less disclosure by their brokers, he said.

For some investors, the case against Goldman is already closed. Joe Gordon, managing partner at Gordon Asset Management in North Carolina, said he has not recommended investing in Goldman since before 2008.

"We just wanted to avoid the black-box hedge-fund companies and anything like them," Gordon said.

William Atwood, executive director of the Illinois State Board of Investment, which handles public employees' retirement funds, said he was not convinced that Wall Street had changed its ways, despite an outcry since the 2008 crisis.

He said the board dropped Goldman as an investment manager four years ago.

"To say there's still arrogance on Wall Street is like saying the sky is still blue," Atwood said. "There's this sense of entitlement, this outrageous compensation that people still get and think somehow they earned it."