Saturday, September 8, 2007

Goldman Sachs - Strategy and Growth

Goldman Sachs: World's most powerful investment bank

Neil Weinberg, Forbes
January 17, 2007

Goldman Sachs has emerged from the market bust as a trading colossus. New Chief Lloyd Blankfein must fuel growth -- and avoid an unforeseeable blowup.

No wonder this nebbishy Master of the Universe is smiling: Lloyd Blankfein, 52, has spent seven months now as chief executive of Goldman Sachs Group, the richest, shrewdest and most powerful investment bank in the world.

He just earned $53 million. The firm hit $9.5 billion in net income in 2006 -- even as it paid out an astonishing $16.5 billion in compensation to the faithful, most of it in year-end bonuses.

Blankfein, in charge since predecessor Henry Paulson quit in June to become Secretary of the Treasury, inherited growth that would make an Internet venture squeal with delight.

Goldman's earnings set an all-time high for investment banks in 2005 -- then grew 76% last year to set a new record. In 2006 revenue rose 50% to $38 billion (net of interest cost). Its dealmakers handled an industry-high $1.1 trillion in mergers and acquisitions; its wealth managers raked in $94 billion in new customer money. Its stock climbed 55% to hover near $200.

Yet Blankfein can't sleep some nights, fretful over what could go wrong "when the unforeseeable happens," he says. "What keeps me up nights is how changes in sentiment because of unforeseen events could unravel years of wealth creation."

He adds: "How much wealth would leave how quickly? And what would be the knockoff effects? I worry about scenarios like that."

Fun guy. But you might worry, too. Goldman Sachs, to fuel prodigious profit growth and keep shareholders as giddy as its own bonus-hungry bankers, is more dependent than ever before on income from trading, a volatile, random and risky business.

That means it could be more vulnerable in a worldwide market meltdown. Goldman is, in effect, a giant hedge fund with some consulting services attached. Hedge funds sometimes get into trouble, even when they are run by geniuses. Long-Term Capital Management was run by geniuses.

This is why Goldman, for all its power and potent performance, is valued by a skittish Wall Street at significantly less, pound for pound, than two giants it outperforms: Merrill Lynch and Morgan Stanley. Goldman trades at ten times expected 2007 earnings; Merrill is valued 40% higher, Morgan 20% higher.

Yet Goldman's profit per employee, number one on Wall Street at $360,000, is two to three times that of Merrill or Morgan.

Blankfein should take this dismissive P/E ratio personally. A Goldman lifer since 1981, he took charge of much of the firm's trading operation in the late 1990s and helped make it the centerpiece of Goldman Sachs. Since Goldman went public in 1999, trading revenue has risen fourfold to $25 billion; it grew 50% last year.

Trading now provides 68% of the firm's revenue (and a like portion of profits), up from 43% in 1999. Asset management provides 17%. The smallest slice, 15%, comes from Goldman's birthright, investment banking.

Thus Blankfein and two lieutenants, both of them well-versed in the brash world of traders, now run a high-tech-infused high roller -- one that is trapped inside a 138-year-old firm whose refined, white-shoe gentlemen bankers of yore took public some of America's lasting corporate icons (Sears, Roebuck & Co. in 1906, Ford Motor in 1956).

Some of its old-world gentility remains: Goldman agreed to talk for this story only reluctantly, wary of looking like a braggart.

But Blankfein says Goldman needs all three businesses to fuel its future. The firm has meshed these parts -- trading, asset management, investment banking -- to form a perpetual money machine. Goldman aims to serve as an adviser, trader, asset manager and investor, preferably all in the same deal.

The investment bankers who help corporations raise capital form the "front end of the house," Blankfein says. This is where corporate clients first encounter Goldman. The trading arm can make money for these clients -- and for Goldman's own account.

Asset management can put investors' cash into the deals and stocks of the companies advised by Goldman's investment bankers -- and woo new customers among the newly rich execs at the client companies that Goldman has taken public or sold in the M&A market. Goldman's star players, meanwhile, invest their own personal wealth right alongside all these other bets.

"It's called leverage inside Goldman," says Nomi Prins, a managing director who left the firm in 2002. "It might help set up a fund, be banker to the fund and then turn the chief into a private client. Connecting business is Goldman's business plan."

The firm began dabbling in this approach at the start of the decade and now aims to apply it to almost any deal it can. Inevitably, this sparks complaints that Goldman holds too much power -- and is too quick to wield it. "I don't know anyone who does business with Goldman who doesn't curse them regularly," says Richard Bove, an analyst at Punk, Ziegel & Co. "But they always go back."

In the sizzling leveraged buyout business, Goldman is both an investor and an adviser -- often at the same time, in the same transaction. In hedge funds Goldman manages $21 billion in client money, making it the biggest player on the planet; this sum does not count the assets it puts into its own trading.

Yet Goldman also handles "back office" bookkeeping for hundreds of outside hedge funds, with $138 billion in combined assets. And it reigns as a leading "prime broker," handling trades for these funds and for itself. A corporate Web page promoting prime brokerage nudges visitors to click to a page on private wealth management, should anyone want to sign on; it says 43% of the Forbes 400 list of richest Americans are clients.

Risky? Quite apart from the risk that some crisis in a currency or stock or credit swap market could cause a meltdown on Wall Street, there is the risk that the public could turn against securities firms, especially those that so visibly wear multiple hats.

Suppose a crack in the market jolts a few million investors. Might some ambitious politician or a pack of plaintiff attorneys go after financial institutions? Then what had been seen as seamless synergy could look more like seamy self-dealing. Contemplate the fall from grace of superstar analyst Jack Grubman of Salomon Smith Barney or the rise of just-elected New York Governor Eliot Spitzer.

Goldman boasts that managing conflicts of interest is one of its skills, but some backlash has erupted. In London last spring BAA Plc., an airport operator, got an unwanted takeover offer, and Goldman approached, offering to help fight off the bid.

BAA spurned Goldman's services -- so Goldman then made a bid itself. Ultimately the original bidder preempted Goldman by buying up $1.9 billion in BAA stock on the open market. Goldman lost out -- and got slammed in the Fleet Street press.

In the U.S. an investor lawsuit pending in a state court in Houston, Tex. argues that Goldman, in advising pipeline operator Kinder Morgan in a going-private buyout last year, shortchanged public shareholders.

In the $22 billion deal, the largest management buyout ever, Goldman's investment bankers were the sole advisers to the buyers -- who included the Goldman Sachs Capital Partners private equity investing pool, and a second Goldman entity; the debt financing was provided by still another Goldman unit, Goldman Sachs Credit Partners. Goldman denies any wrongdoing -- and clearly takes pride in the deal.

Blankfein is utterly undaunted by any of the conflict-of-interest criticisms. He hopes to extend the firm's cozy ways to some of the hottest new markets in the world, the bric countries (Brazil, Russia, India and China); and to midsize companies to which Goldman can cross-sell its services; and to governments looking to privatize highways and airports. His job, he explains rather genially, "isn't to get people to run faster and jump higher. It's to get people to seize new opportunities in today's world."

Lloyd Blankfein ended up in the chairman's suite at Goldman after sneaking into the firm through a back door. Bronx-born and Brooklyn-bred, he grew up in a federal housing project in the blue-collar East New York neighborhood and still betrays a Brooklyn accent. In high school he earned money selling sodas during baseball games at Yankee Stadium. At age 16 he made it to Harvard on financial aid and a scholarship.

"We always felt like we grew up on the other side of the tracks," says an old chum, Howard Schultz, who has known Blankfein since high school. "It gave us an inner drive to want to overachieve." Today Schultz is the billionaire chairman of Starbucks Coffee, and both the coffee chain and Schultz himself are Goldman clients.

Blankfein graduated with a Harvard law degree in 1978, spent three years at a big law firm and applied for a job at Goldman Sachs -- and was summarily rejected. (He also got turned down by the former Dean Witter and by Morgan Stanley.) So in 1981 he joined a small commodities-trading outfit, J. Aron. A few months later J. Aron got bought by Goldman -- and Blankfein was in.

J. Aron brought new blood and trading savvy to Goldman, and the young lawyer spent the next 13 years in sales. By 1994 Blankfein was cohead of trading in currencies and commodities, overseeing everything from coffee and grain futures to precious metals and energy.

In 1997 Blankfein landed the job that would clinch his career: He was tapped to run a trading unit called Fixed Income, Currencies & Commodities.

"That was the inflection point when we saw a unique advantage in stacking the house with quants, analysts and salespeople and piled it on," says one longtime Goldman partner, now retired. The firm keeps secret the details on who, how many and what kind of brainiacs were brought in.

A year later Blankfein watched, up close, the unfolding of one of those unforeseen events he ponders on sleepless nights: the August 1998 collapse of hedge fund Long-Term Capital Management. LTCM had used its $4 billion of equity to place $125 billion in bets on government bonds and take $1.25 trillion in positions in interest rate derivatives.

When Russia defaulted on government bonds and panic spread through Asia's markets, the steeply leveraged edifice collapsed, ultimately requiring a $3.6 billion bailout funded by Wall Street giants.

A year later, in 1999, Goldman did its own initial public offering, despite fears the change would unravel its chummy partnership spirit. And Goldman, pushing for a tech edge, bought Hull Group, a Chicago outfit that was an early user of trading algorithms to electronically search out the best prices across multiple markets.

Blankfein's bond-currency-commodity operation soon was providing more than half of Goldman's booming trading revenue.

His profile rose with it, and he came to be seen, in some eyes, as more Woody Allen than Gordon Gekko -- a genial, funny, regular guy whose self-deprecating style masked a sharp intensity and a knack for nasty infighting when necessary.

By 2002 Blankfein had risen to vice chairman and had expanded his turf to also oversee equities trading. The world's stock markets were in a prolonged slump, but Goldman invested in new growth and more trading technology. It also pushed into asset management, despite investor qualms.

In 2000 Goldman had paid $6.5 billion in cash and stock for Spear, Leeds & Kellogg, a marketmaker at the New York Stock Exchange -- just as trading volumes on the Big Board were collapsing along with stock prices. But Spear held a hidden gem: It had built a computerized trading platform known as RediPlus, and Goldman built this into the centerpiece of its electronic trading business.

These days Goldman's trading arm is the technology and volume leader at the New York Stock Exchange, where it executes 70% of the transactions electronically, versus less than half of trading for its rivals. That edge let Goldman's equities division chop half of its workforce, cutting 2,700 jobs; yet the group's revenue has almost tripled in five years to $8.5 billion.

"There was a lot of pain in reducing head count 50%, but we were quick to see the shift coming and couldn't abdicate our leadership," says Duncan Niederauer, a Goldman managing director in equities.

Goldman also used the global slump to expand abroad, especially in Asia, going on a shopping spree for distressed assets. In 2003 the firm paid $1.3 billion for convertible preferred stock in then troubled Sumitomo Mitsui Financial Group; that investment now is worth $4.9 billion.

The markets' rebound, fueled by the boom in leveraged buyouts and hedge funds, has given Goldman new opportunities to wear myriad hats in the same deal. Its private equity operation is so well-integrated with the rest of Goldman that, last year, Goldman's investment bankers earned $105 million in fees from Goldman's private equity buyouts, Dealogic says.

For one client, KarstadtQuelle, a troubled German retailer, Goldman set up a joint venture with 174 properties. The client retained 49% and Whitehall Group, Goldman's real estate arm, 51%. Then KarstadtQuelle landed a $4.8 billion cash infusion via debt and equity financing -- all of it done by Goldman.

Goldman played a similar multicharacter role in 2005 when the New York Stock Exchange bought Archipelago Holdings. Goldman's chief at the time, Hank Paulson, had helped oust NYSE chief Richard Grasso, who ultimately was succeeded by Paulson's former number two at Goldman, John Thain.

The firm, which owned stakes in both the NYSE and Archipelago, then suggested they merge and served as adviser on the deal -- to both sides. Now the NYSE itself has gone public, and Thain is replacing its antiquated floor-trader model with the electronic wave he pushed at Goldman. Goldman is at once one of the NYSE's largest clients, its second-largest market maker and a shareholder, with a 4.6% stake.

For the next round of growth, Blankfein looks abroad, where Goldman already generates 45% of its revenue. Electronic trading isn't as far along in Europe and Asia. In China Goldman is the only foreign firm licensed to underwrite domestic offerings. As part of its "long-term greedy" mantra, Goldman forged ties at the highest levels as ex-chairman Paulson made dozens of visits to the country.

In the past few years Goldman has led several of China's biggest privatizations, including those of China Mobile Communications, PetroChina and Bank of China. Last April Goldman paid $2.6 billion for a 6% stake in Industrial & Commercial Bank of China, using capital from both Goldman itself and from its wealth-management clients.

Then, in October, the firm's investment bankers took the government-owned bank public on the Shanghai and Hong Kong exchanges, raising $22 billion in the largest initial offering ever and pocketing a fortune in fees; it helped the bank with everything from wealth-management products to ways to manage risk.

Goldman trains ICBC's employees alongside its own. And ICBC's board got a new member: John Thornton, who retired as Goldman's co-president in 2003 to teach at Tsinghua University in Beijing.

As for the 6% ICBC stake, it would now be worth five times as much. A slice of the shares have been sold.

In Japan, where Goldman has invested for 30 years, the firm has been buying once-coveted golf courses at depressed prices, and similarly cheap office buildings and businesses. It has also tapped Norinchukin, the giant ($500 billion assets) farmers' bank, for massive off-balance-sheet financing of M&A deals at a big discount to what rivals pay for capital, says one Goldman alum. "This is Goldman's secret weapon," he says. Goldman and Nochu won't disclose details of their tie.

But this same ex-Goldman person says the firm's penchant for serving in so many capacities on a single deal can create an unwieldy organization and spark internecine squabbles. The London office, he says, has been in disarray since 2004, when 20% of staff quit after cashing in shares following the public offering.

Investment bankers and their counterparts in private equity were competing to grab the same deals, prompting then-chairman Paulson to deliver what the Financial Times called a "Spank from Hank," shuffling some execs as others quit.

The vaunted firm also failed in making bids for ITV, a British broadcaster, and Mitchells & Butlers, a pub chain. Amid the missteps, Goldman fell from its usual perch atop the investment banking league tables in Europe, whose buyout market is even frothier than America's.

A mere flesh wound, Blankfein says: "It's considered newsworthy that there's a place in the world where we aren't number one in M&A," he says. "If it ever became commonplace, we'd have a problem."

To rebuild the Europe front, Goldman in the summer tapped its Asia chief, Richard Gnodde, to be co-president of Europe operations alongside Michael (Woody) Sherwood, Goldman's London trading boss. Gnodde sees a comeback and points to a "defining transaction": the $34 billion takeover by Amsterdam-based Mittal, the world's largest steelmaker and a Goldman client, of its closest rival, Arcelor of Luxembourg.

In ten days Goldman raised billions in bank and debt financing. When Arcelor resisted and turned to a white knight in Russia, Goldman rallied support for Mittal's bid among hedge funds and other big investors, as well as with politicians in Brussels and elsewhere. In the end Arcelor succumbed. "We delivered the right access and messages in every capital city in Europe and, brick by brick, took down Arcelor's defenses," Gnodde says.

Goldman has to stay out ahead of its rivals in trying daring and innovative approaches that push the outer edge of the boundary between what is okay and what may not be. Blankfein tells Goldman folks the job of compliance lawyers is to tell them where that edge is -- because otherwise, "we'd stay in bed with a blanket over our heads" and not try anything.

That edge is where Goldman can reap the richest profits, far wider margins than on the floor of the NYSE. The firm creates ever more exotic new instruments. Lately it has been working on a futures product that would let clients hedge their real estate risk and a derivative for trading in biodiesel futures.

Five years ago, Blankfein says, the urgent topic of discussion would be "whether we needed to merge with a commercial bank. . Now the size of our balance sheet and our ability to finance makes that irrelevant. The world five years from now will be different still. Our job is to make sure that we are still Goldman Sachs, no matter what it takes."


Huge Profit at Goldman Brings Big Bonuses
Published: December 12, 2006

The Goldman Sachs Group reported today that it earned $9.34 billion this year, the most in Wall Street history, and that it would set aside $16.5 billion for salaries, bonuses and benefits for employees.

That figure works out to an average of $622,000 for each employee, although the payouts will be far from uniform: the investment bankers at Goldman who arrange mergers and acquisitions or sell corporate stock to investors will receive much more, and support staff and other kinds of employees much less.

In the company’s fourth fiscal quarter, which ended Nov. 24, profits increased 93 percent over the year before, to $3.16 billion, or $6.59 a share, exceeding the forecasts of most analysts.

News Release
Monday 10 July 2006, 10:30 GMT Monday 10 July 2006

MatlinPatterson Joined by Goldman Sachs to Make SecurLog Germany's Leading Cash and Securities Handling Company

DUSSELDORF, Germany, July 10 /PRNewswire/ --

- Goldman Sachs and MatlinPatterson to Share Ownership of SecurLog

- SecurLog Attracts Stable Shareholders Committed to its Success

- Alvarez & Marsal Restructuring Experts Complete SecurLog Management Team

Goldman Sachs acquires a 50 per cent stake in Dusseldorf-based cash and securities handling company SecurLog. MatlinPatterson and Goldman Sachs each now own 50 per cent of SecurLog.

Under the stable ownership of Goldman Sachs and MatlinPatterson, SecurLog will become the industry leader in cash and securities handling in Germany. The shareholders are committed to creating a well managed company which will become the partner of choice in its market with a new operating structure and nationwide reach.

"MatlinPatterson and Goldman Sachs are both experienced at working with companies to help them become leaders in their industry. Together we will make SecurLog the partner of choice in cash and securities handling," MatlinPatterson partner Peter Schoels said.

"SecurLog has excellent long term prospects and its ability to attract new business has been impressive which has given us confidence to invest in this business," a spokesman of Goldman Sachs said.

Since mid-June, when it took over operations from insolvent Heros group, SecurLog has successfully retained a number of its old clients and also won several high-profile new accounts. SecurLog has agreed a multi million euro nationwide contract with Deutsche Post and Postbank and also been named partner of choice with drugstore chain Ihr Platz.

Michael Keppel, a senior director at Alvarez & Marsal, a consulting company that specialises in managing turnarounds, has teamed up with SecurLog's new CFO Michael Pies, who is also with A&M.

"We are proud to have won these new clients. As we offer a nationwide service to both financial institutions and retail companies, we anticipate winning more market share in the near future," Keppel said.

For SecurLog and Alvarez & Marsal:

Mirko Wollrab, CNC - Communications & Network Consulting AG
T +49-(0)69-5060-375-62, M +49-(0)172-673-3826

About MatlinPatterson:

MatlinPatterson was founded in July 2002 by a group of experienced investment professionals. The company invests primarily in the securities and obligations of companies in distressed situations with the goal of obtaining corporate control over these companies. MatlinPatterson has significant restructuring experience and provides substantial investments and qualified personnel. MatlinPatterson manages more than USD 3.8 billion and its partners have made investments in more than 25 countries. MatlinPatterson makes long-term investments in order to create sustainable value added. The experienced team comprises investment professionals for North America, Europe, Asia and Latin America, and has offices in New York, London and Hong Kong.

About Alvarez & Marsal:

Alvarez & Marsal is one of the world's leading consulting companies, offering support to companies and institutions in the public sector so that they can respond to challenges in their organisational structures and cope with financial and operational problems. The company has an unmistakable direct approach and co-operates with its clients, their management and stakeholders to solve any existing problems. Alvarez & Marsal was founded in 1983, and provides services tailored to the needs of its clients including turnaround and management advice, global corporate finance, tax consulting, business consulting, real-estate consulting and transactions advice. Leadership, problem solving and value enhancement are key competencies of A&M, and A&M secures these skills through its network of experienced executives with offices in the United States, Europe, Asia and Latin America.

Distributed by PR Newswire on behalf of SecurLog

14 June 2001 - 15:58
Goldman Sachs acquires Epoch from Ameritrade
Goldman Sachs is to acquire Ameritrade's interest in Epoch Partners, an online investment bank established in November 1999 as a joint venture with Charles Schwab, and TD Waterhouse Group. Terms of the transaction were not disclosed.

Through the acquisition, Goldman Sachs will obtain the exclusive right to distribute equity offerings, including IPOs, to Charles Schwab and TD Waterhouse customers. In addition, customers of these firms will receive access to US equity research from Goldman Sachs. Together, Schwab and TD Waterhouse have nearly 10 million active accounts and approximately $1 trillion in customer assets.

"This is a next step in our strategy to develop new distribution channels by leveraging technology," says Henry Paulson, chairman and chief executive officer of Goldman Sachs. "Epoch provides us exclusive access to the important individual investor segment through one of the largest brokerage networks in the United States, together with sophisticated data management analytics, both of which will further enhance our market leading equity business."

For Ameritrade the deal represents an opportunity to rethink its business, which has been badly hit by the downturn in dotcom stocks and initial public offerings. Joe Moglia, CEO of Ameritrade, comments: "This is a time of transition for both Ameritrade and Epoch. In the coming weeks, we will be announcing a realignment of Ameritrade's organisation around our client base. Monetizing our investment in Epoch enables us to deliver immediate value to our shareholders and allows us maximum flexibility to assess all options at our disposal. One of those options would be to decide how best to deliver IPOs."

Ameritrade expects the transaction to close in 30 to 60 days, after customary approvals are obtained from the regulatory authorities.

Spear, Leeds & Kellogg (acquired on Gs in 2000)

30 Hudson Street
Jersey City, New Jersey 07302

Telephone: (212) 433-7000
Fax: (212) 433-7310

Wholly Owned Subsidiary of The Goldman Sachs Group, Inc.
Founded: 1931 as Spear, Leeds & Co.
Employees: 2,500
Operating Revenues: $1.3 billion (2000)
NAIC: 523120 Securities Brokerage

Company Perspectives:
With over 70 years of dominance in the U.S. equities markets, Spear, Leeds & Kellogg (SLK) provides one of the industry's most comprehensive suites of prime brokerage solutions.

Key Dates:
1931: Harry Spear and Larry Leeds start a specialist brokerage.
1941: Jimmy Kellogg joins the firm.
1951: Kellogg becomes a named partner.
1957: Kellogg becomes managing partner.
1967: Kellogg's son, Peter, joins the firm.
1978: Kellogg retires, replaced by Peter Kellogg.
2000: Goldman Sachs acquires the firm.

Company History:
A subsidiary of The Goldman Sachs Group, Inc., Spear, Leeds & Kellogg (SLK) is a Jersey City-based company that offers execution and clearing services to the investment community. SLK has long been known as a leading specialist on the New York Stock Exchange. Such firms have been at the heart of the system since 1792 when the open auction approach for each stock trade was introduced. Specialists manage the sale of stocks on the floor of the exchange, in effect "making a market" by matching up sellers and buyers at a fixed price, a service for which they receive a commission. Specialists also step in to buy stock when there is an imbalance between sellers and buyers, and make most of their money through buying and selling from their own account, a practice known as "principal" trading. Because of their unique position in the stock market, possessing inside knowledge about the demands to buy and sell specific stocks, specialists hold a highly profitable advantage, one open to abuse. In 2004 SLK and four other specialist firms paid $240 million to settle with the Securities and Exchange Commission (SEC), which accused them of "front-running," artificially inflating the price of shares they held as a way to skim additional profits. In recent years, SLK has expanded beyond its traditional function as a market maker to offer other services, such as clearing, trading, and reporting tools. SLK also offers financing to customers and loans out stocks, especially hard-to-borrow securities. In addition SLK provides custody reporting services--helping customers to keep track of their daily trading activity, combined with profit and loss information--and a Web-based portfolio accounting system.

Origins Dating to the Early 1930s

SLK was founded as a partnership in 1931 by Harold Spear and Lawrence Leeds. Spear bought his seat on the floor of the New York Stock Exchange in 1927, and Leeds bought his the following year. In 1941 they took on a third partner, 26-year-old James Crane Kellogg III, who would be highly influential in the growth of the firm. "Jimmy" Kellogg was born in New York City in 1915. His family ran a detergent bluing company that struggled with the advent of the Great Depression, and with the death of his father, Kellogg was forced at the age of 16 to leave Williams College to find work to help support his family. He became an odd lot broker with Carlisle, Mellick & Co. In 1936 he was able to raise $125,000 to buy a seat on the New York Stock Exchange and at the age of 21 became the youngest seatholder. Although his mother's connections helped Kellogg establish himself on the Exchange, Kellogg also proved to be highly talented. According to the recollections of SLK partner Al Rubin, "Jimmy Kellogg was one of the finest professional short players I've seen in my life." It was no wonder that Spear and Leeds, in search of new blood, would eagerly bring in the young man. Not only was he a good clubman, able to use his natural geniality to his advantage in doing business, he also possessed strong organizational skills.

In 1951 Kellogg became a managing partner in the firm, which in 1954 became known as Spear, Leeds & Kellogg, L.P. In 1955 he became the managing partner when Spear and Leeds retired and became limited partners. Under his leadership the company was quick to buy out the books of stock owned by other specialists, and Kellogg helped drum up new business by playing the old boy's network, always ready to help out fellow Exchange members. As a result, when specialists retired, SLK often picked up their business. In many ways Kellogg laid the foundation for today's firm, responsible for its diversification beyond market making, into such areas as clearing. In the early 1950s he became a New York Stock Exchange governor and in 1956 was elected chairman of the Exchange. Also in 1955 Kellogg became a commissioner of the Port Authority of New York and New Jersey. He played a crucial role in the building of the World Trade Center, serving as an unpaid chief executive from 1968 to 1974.

Kellogg's son, Peter Rittenhouse Kellogg, although not the eldest of four sons, would be the one to carry on the Kellogg tradition on Wall Street and build upon what his father started. Unlike his father, however, Peter Kellogg preferred to operate in the background and shunned the press. Nevertheless he would become, in the words of the Investment Dealer's Digest, "the most powerful and feared man on Wall Street. ... Kellogg's detractors call him 'Peter the Predator.'" He grew up in Elizabeth, New Jersey, attended the exclusive Berkshire School, a 100-year-old prep school that primarily served the monied classes and where his father served as a trustee. Kellogg studied at the Babson Institute of Business Administration but dropped out after only four semesters. Because his father had instituted a rule at SLK that forbade the hiring of kin, Kellogg found a job on Wall Street in the early 1960s with Stern, Frank Meyer & Fox, initially working as a clerk on the New York Stock Exchange floor. It was here that he gained a practical education from the people who worked for his employer's agent, Dominick & Dominick. Like his father, he proved to be an adept trader, so much so that the partners at SLK petitioned the elder Kellogg to bend his rules and bring Peter into the firm. Thus, in 1967, Peter Kellogg became a partner at SLK at the age of 25.

Becoming Computer-Oriented in the 1960s

Some of SLK's attempts at diversification in the 1960s did not prove as successful as the firm envisioned. For a time it sold a mutual fund and launched a retail branch network, but neither made much money and were discontinued. "The real master stroke," according to the Investment Dealer's Digest, "proved to be clearing--settling trades for other firms for a fee. Clearing forced Spear Leeds to pay strict attention to costs, unhindered by optimism of a retail sales department. Transaction processing forced the firm to apply computer technology, long before the iron discipline of economics made it a necessity. Finally back office work prepared the firm for the large trading volumes that became routine as the decades progressed." Unlike other securities firms that used operations as support for the sales office, SLK ran "from the back office outward." By focusing on cost control, SLK made sure that revenues generated by the front of the operation ended up as profits on the balance sheet.

SLK started the 1970s with just 50 employees, but over the course of the next decade it swallowed up a number of longtime Wall Street specialist firms, such as Pears Duffy & Stern; Frost Stamler & Klee; Schaefer, Collins & Tuttle; Murray & Co.; Wisner Declairville & Hoffman; and R.S. Dodge. Jimmy Kellogg retired in 1978, replaced as SLK's managing partner by his son. Jimmy Kellogg died from a stroke in December 1980, and although his death was unexpected, he had recently established trusts that allowed the firm to continue acquiring specialty firms, so that by the early 1980s SLK employed more than 700 people.

Many of the acquisitions were a response to changing conditions that diminished the role of market making. According to the Investment Dealers' Digest, "Most of Spear Leeds' acquisitions in the late 1970s and beyond stem from an attempt to capture the flow of orders leaving the specialists' order books. The deregulation of commission rates contributed--as did institutional trading in blocks of stocks far too large for the specialist to handle--to what is euphemistically called upstairs trading by major firms. Spear Leeds pursued the business off the exchange, because the specialist saw less and less of the order flow." One of SLK's most successful upstairs traders was John Mulheren, who made a great deal of money for the firm with a takeover bid on Conoco. He left to start his own firm and in 1985 offered $350 million to acquire SLK. The bid was rejected, but the firm then floated the idea of making an initial public offering (IPO). Brokerage firms like Bear, Stearns & Co. and Morgan Stanley & Co. had recently completed highly successful offerings, making the idea of taking advantage of investor interest in Wall Street firms an attractive one. SLK went as far as to retain the investment banking firm Drexel Burnham Lambert Inc. to study options, including an IPO, a leveraged buyout, or selling to a larger corporation. Another area SLK entered as a way to pick up some of the business moving away from the exchange floor was over-the-counter dealers. In 1977 SLK acquired dealer Troster Singer, making it a subsidiary, and later forged a less direct relationship with another dealer, Sherwood Securities.

The partners ultimately dismissed the idea of an IPO, opting instead to raise money in 1986 by selling a valuable asset, First Options, the largest clearing operation in the stock option business. Continental Illinois Bank of Chicago paid $125 million for First Options plus $35 million in subordinated debt. To outside observers the deal appeared too expensive and too risky for Continental. When the stock market crashed in October 1987, Continental was severely crippled. Five years later, SLK was able to reacquire First Options for a song, paying just $15 million and a small percentage of future earnings. SLK was then able to successfully rebuild the business.

In the 1980s SLK started to get caught up in controversies in which its conduct was called into question. In 1988 the firm's arbitrage operation came under the scrutiny of the SEC, an outgrowth of the Ivan F. Boesky case concerning illegal stock parking. This practice conceals the ownership of securities by having one investor buy stock for a party, which might want to quietly accumulate large positions in the stocks of takeover targets. But such arrangements run afoul of disclosure regulations. In 1989 SLK paid $2.5 million to settle a class action lawsuit by investors who claimed that the firm profited from deceptive practices involving shares of J.P. Morgan & Co. in October 1987. SLK was accused of setting the opening price artificially high, well aware that it would fall, and knowing it could buy back the shares at a lower price. On the day of the market crash in 1987 the price of Morgan stock increased 69 percent between the final trade of the day and the opening price for the next day, which was set at $47. Within hours, the price plunged to $29. According to the suit, SLK sold about half of the 500,000 shares traded at the opening from its own account. A fair opening price, according to plaintiffs, would have been around $34, the stock's closing price for the day. In settling the suit, SLK admitted to no wrongdoing. Later SLK and one of its specialists would be fined by the New York Stock Exchange for a number of violations during the mini-crash of the stock market in 1989. The firm also would be fined by the New York Stock Exchange for violations of exchange rules and federal securities laws for a large account transfer done by its futures division in 1990.

Peter Kellogg began cutting back his role at SLK during the 1990s. According to the firm he relinquished his role as senior partner in mid-1990. Whatever his title at SLK, he retained control of the firm and remained a powerful force on Wall Street. In 1994 SLK acquired Foster, Marks, Natoli & Safir, a medium-sized specialist firm, the addition of which gave SLK control over some 11 percent of the Exchange's 2,343 listings. Only recently had the New York Stock Exchange increased its longtime rule of limiting specialist firms to no more than 10 percent of the listings. The next largest specialist controlled a 7 percent share of the listings, prompting many on the Street to view SLK "as a subtle threat to the NYSE's ability to regulate the auction system." In the words of the Investment Dealers' Digest: "Unlike the NYSE, Spear Leeds Kellogg refuses all public comment and is under the control of one man." SLK also had ties to more listings through Sherwood, which owned a controlling interest in another specialist with 40 New York Stock Exchange stocks. Other than market making, there was concern about SLK's other activities: "Spear Leeds has diversified into all forms of trading, from over-the-counter markets which handle NASDAQ listed shares and bonds, to options and block trading. These holdings give Spear Leeds an equally vested interest in the dealer markets." Moreover, SLK could influence the market in more subtle ways by acting as the clearing broker for several specialists, thereby gaining "an insider's advantage when it comes to acquiring firms."

New Century, New Ownership

SLK continued to diversify in the 1990s, especially in the area of electronic communication networks (ECN). It developed RediBook, a system that connected customers to various exchanges and integrated order routing. To supplement the business, in 1999 SLK acquired TLW Securities LLC, a big program trading operation, and Pantechnia LLA, a technology firm that designs trader work stations. It was the breadth of the firm's capabilities that led to Goldman Sachs buying SLK for $6.3 billion in September 2000. Because there was uncertainty about the future structure of the market, Goldman Sachs was in effect hedging its bet in picking up SLK. Whether trades would one day go completely electronic or not, there would still remain the need for the match-making intervention of market makers like SLK.

With Peter Kellogg now out of the picture, SLK was headed by Todd J. Christie, who had joined the firm in 1987 when he was in his early 20s and used his talent as a trader to quickly rise through the ranks. SLK was initially allowed to operate as an autonomous unit, but the marriage between SLK and Goldman Sachs soon proved rocky in a number of ways. It became apparent, although Goldman Sachs officials were reluctant to admit it, that SLK was bought at the top of the stock market. Business fell off sharply, leading to the March 2003 resignation of Christie without explanation, and the retirement of Joe Della Rosa, the head of the institutional trading business. Senior Goldman stock managers John Lauto and Duncan Neideraurer were installed as co-CEOs to oversee the business.

SLK also was implicated in more regulatory problems. In 2001 SLK agreed to pay $1 million to the American Stock Exchange for failing to supervise an executive accused of making fraudulent trades. In 2003 the firm and four former employees paid $435,000 to the American Stock Exchange for violations such as quoting erroneous prices and putting their own interests ahead of their customers. Later in 2003 SLK agreed to pay $450,000 to settle accusations from the SEC that in 1999 its employees helped Baron Capital to inflate the share price of the Southern Union Company, which was more than 10 percent owned by Baron affiliates. Southern Union was then able to use more of its stock in its acquisition of Pennsylvania Enterprises, thus saving a significant amount of cash. Also in 2003 SLK and four other specialist firms came under investigation by the New York Stock Exchange for questionable trading practices, such as using inside information about pending orders to engage in "front-running"--buying stock low and reselling at a high amount after the orders start driving up the price. The matter would be settled in March 2004 when the five firms agreed to return a combined $154.1 million and pay $87.7 million in civil penalties. In exchange, they neither admitted nor denied guilt. The New York Stock Exchange also had been caught up in scandal, which led to the resignation of its chairman, Richard Grasso. The Exchange cleaned house, hiring a new CEO and approving major governance changes. How these changes would affect the business of SLK remained to be seen.

Principal Operating Units: Clearing Services; Prime Brokerage; SLK Fixed Income; Electronic Transaction Services; SLK Specialists LLC.

Principal Competitors: Bear/Hunter Specialists; Knight Trading Group, Inc.; LaBranche & Co. Ince.

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