Goldman Sachs has some serious questions to answer

Back in 2010, Goldman Sachs faced a near existential threat. Sued by the US Securities and Exchange Commission over allegations it had misled clients about mortgage-backed securities, Goldman appeared in internal emails to personify the arrogant self-interest that had helped cause the global financial crisis. Its executives were lambasted by the US Senate and its rivals scented blood.

But then chief executive Lloyd Blankfein acted quickly to lance the boil. The bank paid $550 million (€483 million) to settle the allegations, he launched a top-to-bottom cultural review and spent 18 months visiting clients to reassure them that Goldman had got the message on ethics and was putting clients first.

Recovery

It worked. Goldman recovered more quickly from the crisis than many of its competitors, grabbed new business and rushed into new markets. It leads the Financial Times league tables this year for fees in both equities and mergers and acquisitions, and is second overall only to JPMorgan.

But a new scandal threatens to undermine Goldman’s claims to be cleaner and more ethical, and raises questions about whether its leaders lost control of their empire amid their fervour for growth.

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Last week, the US Department of Justice revealed that two former senior Goldman bankers had been criminally charged with helping to loot 1MDB, a Malaysian state investment fund that authorities allege was victim of one of the biggest frauds of all time.

Goldman, which took home $600m for underwriting three 2012-13 1MDB bond offerings worth $6.5bn, an unusually high share of the proceeds, is under investigation. It has warned investors that its potential losses related to legal proceedings including 1MDB could run as high as $1.8 billion above the money it had previously set aside for such matters. A spokesman declined to comment further.

In some ways, Goldman is in a much stronger position than it was in 2010. Anger against banks has eased, and the SEC is controlled by Republicans who have publicly raised doubts about the efficacy of big fines. Goldman’s role in the 1MDB scandal has been leaking out for several years and the share price ended higher last week.

Tim Leissner, has pleaded guilty; a former managing director, Roger Ng, has been charged with money-laundering and bribery offences; and the bank has put Andrea Vella, a former co-head of Asian investment banking excluding Japan, on leave

Allegations

But the allegations have the potential to cut much deeper this time around. In 2010, Goldman’s leadership was able to distance itself from the furore – the worst emails were written by a mid-level trader who was just 31 when the scandal broke.

This time, a former partner, Tim Leissner, has pleaded guilty; a former managing director, Roger Ng, has been charged with money-laundering and bribery offences; and the bank has put Andrea Vella, a former co-head of Asian investment banking excluding Japan, on leave, after the DoJ alleged that a managing director, whose description fits him, knew of Mr Leissner's activities. He has not been charged with wrongdoing.

Prosecutors also wrote that the bank’s “business culture. . . particularly in south-east Asia, was highly focused on consummating deals, at times prioritising this goal ahead of the proper operation of its compliance functions”.

The 1MDB deals were scrutinised by at least 30 Goldman executives, including Mr Blankfein and his successor David Solomon, sources have said. But they focused on making sure 1MDB officials fully understood that they had picked a fundraising structure that would allow Goldman to make unusually large sums in exchange for taking on additional risk.

By contrast, when the outsized nature of Goldman’s 1MDB fees first emerged, senior executives at rival banks told me they would never have dared take such proposals to their internal risk committees for fear of being laughed out of the room.

Scrutiny

Mr Leissner, meanwhile, found Goldman’s “system of internal accounting controls …could be easily circumvented,” the DoJ said, and his supervisors let him charm his way out of scrutiny. People familiar with Goldman’s set up in south-east Asia say he operated with a virtually free hand.

That all this could happen within two years of Mr Blankfein’s much-touted ethics revamp raises serious questions about whether it had any impact at all. After all, the chief executive publicly praised Mr Leissner and Mr Vella’s efforts in Malaysia at a 2014 meeting about growth efforts in emerging markets.

The pressure is now on Mr Solomon to prove that the bank really does care enough to ask tough questions about how and where the profits come from. This time, investors and clients should say that another highly public listening tour won’t cut it.

– Copyright The Financial Times Limited 2018