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Sensitive Boundaries
Goldman Faces New Tensions
In Trading, Serving Hedge Funds
Salesmen Both Advised Clients
Of Firm and Influenced
Its Own Bets on Market
Word of a Stock Sale Leaks
By ANITA RAGHAVAN
Staff Reporter of THE WALL STREET JOURNAL
June 6, 2005; Page A1
LONDON -- One day two years ago, as Goldman Sachs Group was readying a sale of millions of shares held by German industrial giant Siemens AG's pension arm, the stock started falling, suggesting that word of the deal had leaked. Early word of it would have given an investor valuable information that the stock was about to face downward pressure.
When Goldman investigated, it found that a managing director in its London office had tipped off an important hedge-fund client of the firm. While it didn't appear the tip had caused the stock's fall, Goldman fired the managing director.
The incident opened a window on new tensions inside investment banks as their business models shift. When stock markets are flush, as in the 1990s, big securities firms like Goldman rake in cash by underwriting numerous new stock offerings for corporate clients and collecting commissions from stock investors. The bursting of the stock-market bubble in 2000 hurt both of those traditional mainstays. Goldman and its rivals have since looked increasingly to other activities that could still offer rich profits.
One of these is playing the markets with their own money, known as proprietary trading. Another is serving the one set of clients that still provides lush trading commissions: hedge funds, or lightly regulated investment pools for institutions and the rich. In the increasing focus on these lines, new possibilities for conflicts of interest arise. The tensions are well illustrated at Goldman's stock-trading operation in London, which has been aggressive in pursuit of these activities.
Goldman hasn't drawn any regulatory flak for its practices here. But in some cases it has faced questions about its practices from within its own ranks. It also has discontinued some of them. Goldman says employee concerns weren't the reason, while adding that it always investigates such concerns.
A look at the London stock operation shows how the big securities firm has periodically reassessed its practices as it seeks to find the proper boundaries. "Changing market dynamics bring new challenges," says a Goldman spokesman, "and we are particularly mindful of the way in which we conduct business."
In 2002, the London office set up a small group of stock traders, taking proprietary positions, who sat near the salesmen and traders who handled transactions for clients. Many securities firms physically isolate their proprietary traders, to make sure they don't overhear clients' orders and take unfair advantage of the information.
Goldman, for a time, also gave this set of traders access to a computer system that showed client buy orders and sell orders. (Client names were usually omitted.) No rules bar such access. But some former Goldman traders and salesmen say this practice posed a risk that the traders would be tempted to jump in with their own orders ahead of clients. That could put the investment bank in the position of profiting from trades that in turn drive up the cost paid by clients.
"It's only logical that banks would use information they glean from clients such as trading intentions...to support their own proprietary-trading activities," says Richard Kramer, a former top-ranked Goldman analyst now at Arete Research in London. Indeed, he says, "we think proprietary trading could be the next scandal" in financial services.
In another move, Goldman allowed stock salesmen who gave investment ideas to an important hedge-fund client to contribute some of the same ideas to Goldman traders taking proprietary positions. Here, one concern was that Goldman and the hedge fund could benefit at the expense of less-favored clients who might be pitched these same ideas later.
In later discontinuing these practices, Goldman says it found no evidence its traders had acted improperly. It also said its reason for putting traders who took proprietary positions adjacent to salesmen wasn't to overhear client orders.
For hedge funds, Goldman and other major securities firms offer a wide array of services: executing hedge funds' many trades; lending them money; lending them shares to "short" when they want to bet on a stock to fall; sometimes investing in the funds; and providing them with research and investment ideas for sometimes-complex trades.
Wall Street and hedge funds "are feeding off each other -- the broker-dealer needs the order flow from the hedge fund and the hedge fund needs the information," says Matthew Nestor, a former Massachusetts securities regulator. Goldman got more than a third of its stock revenue last year by doing business with hedge funds, according to a Merrill Lynch & Co. analyst's estimate. Goldman has no comment on that.
At the forefront in nurturing Goldman's ties to hedge funds in London is Phillip Hylander, chief of its European stock-products group and head trader in Europe.
Until Mr. Hylander arrived at the London office in 2002, its top traders -- the people who actually execute trades -- shied away from speaking to clients during market hours. Client interaction was left to stock salespeople.
Direct trader-client contact is risky, says Gary Williams, who was Goldman's European stock-trading chief until the end of 2001. The reason is that each side often has information the other would like to know, but some of this may be confidential, such as how a competitor's deal is faring or insight into the placing of a block of stock. "Head traders are privy to information that neither clients nor those speaking to clients should know," Mr. Williams says.
But one of Mr. Hylander's strengths when Goldman hired him as a trading executive was his close relationships with hedge funds. Colleagues say they often heard him on the trading floor chatting with clients, using his cellphone. And after the botched 2003 stock sale for Siemens, Goldman investigated whether Mr. Hylander might have used his cellphone to tip a client to the impending sale. It concluded he hadn't.
Goldman says it's no longer out of the ordinary for traders, at Goldman or elsewhere, to talk to investment clients. "Our clients want to talk to traders to get a sense of the market," says J. Michael Evans, co-head of Goldman's global securities division. Mr. Hylander, for his part, says he talks to clients because "they demand it. It would be a mark against you if you didn't."
Mr. Hylander, 36 years old, was behind some of the proprietary-trading initiatives, such as setting up a small group of traders who sat on the mammoth stock-trading floor and made bets with the firm's own money. He encouraged stock salesmen to tell the proprietary traders if they had gleaned "useful information" from dealing with clients, according to three people familiar with the situation.
Asked about this, Mr. Hylander said, "There is a very pure reason for people to talk to each other, and that was the context for this remark." A Goldman spokesman, Lucas van Praag, elaborated, saying, "An important component of every broking business is open debate about investment ideas...internally with colleagues and externally with clients.... Needless to say, this sharing of information does not include anything price-sensitive or otherwise inappropriate."
This group of traders was known as the Risk Unit. Mr. Hylander says it had been set up not just to do proprietary trading but primarily to "manage franchise risk," and for that reason it needed access to client orders.
Still, the firm took away the Risk Unit's access to client orders in October 2003, a year after giving it access. Goldman did so to "avoid any perception of impropriety," its spokesman says. Several months later, in 2004, it closed the Risk Unit altogether. Mr. Evans says this was because "it wasn't making money."
Mr. Hylander also gave salesmen -- the people who pitch investment ideas to clients -- a say in investing a small amount of Goldman's own money. They could contribute ideas to proprietary-trading portfolios that bore their initials.
'I Just Tipped It'
One of Mr. Hylander's client relationships was with a London hedge fund called Marshall Wace Asset Management. Colleagues tell of hearing him chatting on the trading floor with a founder of the fund, Ian Wace. Mr. Hylander and Mr. Wace, through spokesmen, describe their conversations as infrequent.
Con't
Sensitive Boundaries
Goldman Faces New Tensions
In Trading, Serving Hedge Funds
Salesmen Both Advised Clients
Of Firm and Influenced
Its Own Bets on Market
Word of a Stock Sale Leaks
By ANITA RAGHAVAN
Staff Reporter of THE WALL STREET JOURNAL
June 6, 2005; Page A1
LONDON -- One day two years ago, as Goldman Sachs Group was readying a sale of millions of shares held by German industrial giant Siemens AG's pension arm, the stock started falling, suggesting that word of the deal had leaked. Early word of it would have given an investor valuable information that the stock was about to face downward pressure.
When Goldman investigated, it found that a managing director in its London office had tipped off an important hedge-fund client of the firm. While it didn't appear the tip had caused the stock's fall, Goldman fired the managing director.
The incident opened a window on new tensions inside investment banks as their business models shift. When stock markets are flush, as in the 1990s, big securities firms like Goldman rake in cash by underwriting numerous new stock offerings for corporate clients and collecting commissions from stock investors. The bursting of the stock-market bubble in 2000 hurt both of those traditional mainstays. Goldman and its rivals have since looked increasingly to other activities that could still offer rich profits.
One of these is playing the markets with their own money, known as proprietary trading. Another is serving the one set of clients that still provides lush trading commissions: hedge funds, or lightly regulated investment pools for institutions and the rich. In the increasing focus on these lines, new possibilities for conflicts of interest arise. The tensions are well illustrated at Goldman's stock-trading operation in London, which has been aggressive in pursuit of these activities.
Goldman hasn't drawn any regulatory flak for its practices here. But in some cases it has faced questions about its practices from within its own ranks. It also has discontinued some of them. Goldman says employee concerns weren't the reason, while adding that it always investigates such concerns.
A look at the London stock operation shows how the big securities firm has periodically reassessed its practices as it seeks to find the proper boundaries. "Changing market dynamics bring new challenges," says a Goldman spokesman, "and we are particularly mindful of the way in which we conduct business."
In 2002, the London office set up a small group of stock traders, taking proprietary positions, who sat near the salesmen and traders who handled transactions for clients. Many securities firms physically isolate their proprietary traders, to make sure they don't overhear clients' orders and take unfair advantage of the information.
Goldman, for a time, also gave this set of traders access to a computer system that showed client buy orders and sell orders. (Client names were usually omitted.) No rules bar such access. But some former Goldman traders and salesmen say this practice posed a risk that the traders would be tempted to jump in with their own orders ahead of clients. That could put the investment bank in the position of profiting from trades that in turn drive up the cost paid by clients.
"It's only logical that banks would use information they glean from clients such as trading intentions...to support their own proprietary-trading activities," says Richard Kramer, a former top-ranked Goldman analyst now at Arete Research in London. Indeed, he says, "we think proprietary trading could be the next scandal" in financial services.
In another move, Goldman allowed stock salesmen who gave investment ideas to an important hedge-fund client to contribute some of the same ideas to Goldman traders taking proprietary positions. Here, one concern was that Goldman and the hedge fund could benefit at the expense of less-favored clients who might be pitched these same ideas later.
In later discontinuing these practices, Goldman says it found no evidence its traders had acted improperly. It also said its reason for putting traders who took proprietary positions adjacent to salesmen wasn't to overhear client orders.
For hedge funds, Goldman and other major securities firms offer a wide array of services: executing hedge funds' many trades; lending them money; lending them shares to "short" when they want to bet on a stock to fall; sometimes investing in the funds; and providing them with research and investment ideas for sometimes-complex trades.
Wall Street and hedge funds "are feeding off each other -- the broker-dealer needs the order flow from the hedge fund and the hedge fund needs the information," says Matthew Nestor, a former Massachusetts securities regulator. Goldman got more than a third of its stock revenue last year by doing business with hedge funds, according to a Merrill Lynch & Co. analyst's estimate. Goldman has no comment on that.
At the forefront in nurturing Goldman's ties to hedge funds in London is Phillip Hylander, chief of its European stock-products group and head trader in Europe.
Until Mr. Hylander arrived at the London office in 2002, its top traders -- the people who actually execute trades -- shied away from speaking to clients during market hours. Client interaction was left to stock salespeople.
Direct trader-client contact is risky, says Gary Williams, who was Goldman's European stock-trading chief until the end of 2001. The reason is that each side often has information the other would like to know, but some of this may be confidential, such as how a competitor's deal is faring or insight into the placing of a block of stock. "Head traders are privy to information that neither clients nor those speaking to clients should know," Mr. Williams says.
But one of Mr. Hylander's strengths when Goldman hired him as a trading executive was his close relationships with hedge funds. Colleagues say they often heard him on the trading floor chatting with clients, using his cellphone. And after the botched 2003 stock sale for Siemens, Goldman investigated whether Mr. Hylander might have used his cellphone to tip a client to the impending sale. It concluded he hadn't.
Goldman says it's no longer out of the ordinary for traders, at Goldman or elsewhere, to talk to investment clients. "Our clients want to talk to traders to get a sense of the market," says J. Michael Evans, co-head of Goldman's global securities division. Mr. Hylander, for his part, says he talks to clients because "they demand it. It would be a mark against you if you didn't."
Mr. Hylander, 36 years old, was behind some of the proprietary-trading initiatives, such as setting up a small group of traders who sat on the mammoth stock-trading floor and made bets with the firm's own money. He encouraged stock salesmen to tell the proprietary traders if they had gleaned "useful information" from dealing with clients, according to three people familiar with the situation.
Asked about this, Mr. Hylander said, "There is a very pure reason for people to talk to each other, and that was the context for this remark." A Goldman spokesman, Lucas van Praag, elaborated, saying, "An important component of every broking business is open debate about investment ideas...internally with colleagues and externally with clients.... Needless to say, this sharing of information does not include anything price-sensitive or otherwise inappropriate."
This group of traders was known as the Risk Unit. Mr. Hylander says it had been set up not just to do proprietary trading but primarily to "manage franchise risk," and for that reason it needed access to client orders.
Still, the firm took away the Risk Unit's access to client orders in October 2003, a year after giving it access. Goldman did so to "avoid any perception of impropriety," its spokesman says. Several months later, in 2004, it closed the Risk Unit altogether. Mr. Evans says this was because "it wasn't making money."
Mr. Hylander also gave salesmen -- the people who pitch investment ideas to clients -- a say in investing a small amount of Goldman's own money. They could contribute ideas to proprietary-trading portfolios that bore their initials.
'I Just Tipped It'
One of Mr. Hylander's client relationships was with a London hedge fund called Marshall Wace Asset Management. Colleagues tell of hearing him chatting on the trading floor with a founder of the fund, Ian Wace. Mr. Hylander and Mr. Wace, through spokesmen, describe their conversations as infrequent.
Con't