Our Take On 'Why I Am Leaving Goldman'

| About: Goldman Sachs (GS)

The op-ed in Wednesday’s New York Times written by a retiring Goldman Sachs (NYSE:GS) Executive Director, Greg Smith, is the talk of Wall Street. We think we know Goldman well, as the company has been our prime broker for the past seven years and Goldman (both stock and call options) is one of our largest positions, so we wanted to add our comments.

Our direct experience as a client of Goldman has been universally positive. The many people we have dealt with there have all been exceptionally talented and high-grade, and never once have we had a negative experience in which we felt that they took advantage of us or didn’t do what they said they would do.

That said, we are not naïve. In all of our dealings with Wall Street firms, we assume that they are looking out for their own bottom lines, not ours. And we are certainly aware that the old, gentlemanly culture in which integrity and a customer-first attitude generally prevailed is long gone – not just at Goldman, but across all of Wall Street – and, in fact, across the entire financial industry (the reasons for this and what should be done about it are the subject for another day).

When we think about investing in any company – especially a financial one, which is heavily regulated, leveraged, and particularly difficult for an outsider to analyze – we factor into our investment equation our assessment of the company’s culture and values, and, if we have any concerns, what the potential associated risks are, such as unexpected losses and regulatory action. In light of our view of the moral decay across the U.S. financial sector, we aggressively haircut our estimates of intrinsic value in the sector – for some companies more so than for others. But, of course, at some price any stock is a buy, and last August and September we felt that the negativity surrounding the financial sector was way overdone and hence, made a big – and, so far, very profitable – bet on Goldman and a number of other U.S. financial firms.

With the run-up in Goldman’s stock – after falling below $90 as recently as December, it’s now over $120, just above tangible book value of $119.72 as of 12/31/11 – we’ve been debating whether to trim or exit our position, so yesterday’s op-ed is timely. But is it relevant to our investment thesis? We think probably not, for two reasons:

1) The argument that Goldman has become increasingly profit driven, sometimes at the expense of clients’ best interests, and that some employees use vulgar and disrespectful language, is hardly news. What’s the next “shocking” headline: “Prostitution in Vegas!”?

2) We highly doubt that Goldman is truly as corrupt as Smith makes it out to be. Goldman has more than 30,000 employees (including nearly 12,000 vice presidents, of which Mr. Smith is one) and has gone through wrenching changes in the past year, including savage cuts to bonuses and extensive layoffs. As such, it doesn’t surprise us that there are many disgruntled employees, especially those who are leaving. Is Smith one of them? It’s hard to tell, but here’s an email sent to me this morning by a former partner at Goldman (who generally agrees that the firm’s culture is not what it once was):

There are a couple of things out of place. 1) This guy has been at firm for 12 years and is only a VP…a piss ant of sorts. He should have been an MD-light by now, so clearly he has been running in place for some time. 2) He was in U.S. equity derivatives in London…sort of like equities in Dallas…more confirmation he is a lightweight. Somewhere along the line he has had sand kicked in his face…and is not as good as he thinks he is. That happens to a lot of high achievers there.

In summary, we think it’s likely that Goldman does the right thing for its clients the vast majority of the time – but certainly not as it used to in the old days. Times have changed and the trend is unfortunate, but it is not unique to Goldman. In fact, we believe that Goldman still has a better culture and is more ethical than most of its competitors – though this is a very low bar to be sure.

Our investment thesis on Goldman is simple: when all the dust settles, it will remain the premier investment banking franchise in the world – and, if so, it will be worth a substantial premium to tangible book value. Smith’s column is a warning flag that we’ll be monitoring closely, but we believe our investment thesis remains intact and the stock is still cheap, so we’re not selling.

Below is a response to the op-ed by Goldman CEO Lloyd Blankfein and President Gary Cohn (which came out after we drafted our thoughts above):

March 14, 2012

Our Response to Today’s New York Times Op-Ed:

By now, many of you have read the submission in today’s New York Times by a former employee of the firm. Needless to say, we were disappointed to read the assertions made by this individual that do not reflect our values, our culture and how the vast majority of people at Goldman Sachs think about the firm and the work it does on behalf of our clients.

In a company of our size, it is not shocking that some people could feel disgruntled. But that does not and should not represent our firm of more than 30,000 people. Everyone is entitled to his or her opinion. But, it is unfortunate that an individual opinion about Goldman Sachs is amplified in a newspaper and speaks louder than the regular, detailed and intensive feedback you have provided the firm and independent, public surveys of workplace environments.

While I expect you find the words you read today foreign from your own day-to-day experiences, we wanted to remind you what we, as a firm – individually and collectively – think about Goldman Sachs and our client-driven culture.

First, 85 percent of the firm responded to our recent People Survey, which provides the most detailed and comprehensive review to determine how our people feel about Goldman Sachs and the work they do.

And, what do our people think about how we interact with our clients? Across the firm at all levels, 89 percent of you said that that the firm provides exceptional service to them. For the group of nearly 12,000 vice presidents, of which the author of today’s commentary was, that number was similarly high.

Anyone who feels otherwise has available to him or her a mechanism for anonymously expressing their concerns. We are not aware that the writer of the opinion piece expressed misgivings through this avenue, however, if an individual expresses issues, we examine them carefully and we will be doing so in this case.

Our firm has had its share of challenges during and after the financial crisis, but your pride in Goldman Sachs is clear. You’ve not only told us, you have told external surveys.

Just two weeks ago, Goldman Sachs was named one of the best places to work in the United Kingdom, where this employee resides. The firm was the highest placed financial services company for the third consecutive year and was the only one in its peer group to make the top 25.

We are far from perfect, but where the firm has seen a problem, we’ve responded to it seriously and substantively. And we have demonstrated that fact.

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. But, our response is best demonstrated in how we really work with and help our clients through our commitment to their long-term interests. That priority has distinguished us in the past, through the financial crisis and today.

Thank you.

Lloyd C. Blankfein Gary D. Cohn

Upon further reflection, we think Greg Smith’s op-ed will ultimately prove to be a good thing for Goldman Sachs and, to a lesser extent, the investment banking industry. Here’s why: every company and industry has a certain percentage of people who regularly do the wrong thing, especially when it results in making a quick buck. Our long experience in the hedge fund and investment banking industries leaves us with no doubt that such people are overrepresented in the financial sector, where there are ample opportunities to make a lot of money quickly by screwing others.

There are plenty of such people at Goldman – we don’t think Greg Smith is making them up – but we are quite certain that he paints a grossly distorted picture of the firm. Based on everything we know, the people and behavior he describes are not typical of the firm. But to the extent they exist at all, this is bad news both for shareholders like us, as well as the tens of thousands of hard-working, high-integrity employees at the firm.

To put some numbers around it (which we’re making up, but you get the idea), in the old days we’d guess that Goldman people did the right thing 99.9% of the time, which means the “ethical error rate” was a mere 10 basis points. Then, after the company went public, and as sheer greed and insanity gripped the entire industry, Goldman probably slipped to only doing the right thing 95% of the time. This might sound okay, but it’s not – the 50x increase in the ethical error rate led to horrible consequences, both for the firm and our country, especially when the rest of the industry was doing similar things – or much worse. So where is Goldman today? We’d guess that it’s rebounded to 99%, a big improvement – but still a lot worse than it was in the old days.

We would like to see Goldman get back to 99.9%, and think that Smith’s op ed, however unfair, will help that happen. It has created a shock wave that is reverberating through Goldman – and, hopefully, the entire industry – that will likely remain in everyone’s mind for a long time to come, making it more likely that no-one at Goldman will go anywhere close to any ethical lines. In other words, Smith’s article was bad for the small number of people doing the wrong thing at Goldman, and very good for shareholders and the vast majority of Goldman employees.

Disclosure: Author holds a position in Goldman Sachs stock and other U.S. financial firms.