Is this how Banking works?

As an Adviser, Goldman Guaranteed Its Payday

By ANDREW ROSS SORKIN
Andrew Harrer/Bloomberg NewsLloyd C. Blankfein of Goldman Sachs, which advised El Paso in its sale to Kinder Morgan, in which Goldman owns a stake.
Lloyd C. Blankfein had a script for his phone call.

“Hello, Doug — it’s been a long time since we have had the chance to visit,” say the notes prepared for his call with Douglas L. Foshee, chief executive of the El Paso Corporation, the big energy company that last fall was in talks to be sold to Kinder Morgan. “I was very pleased you reached out to us on this most recent matter,” the script goes, thanking Mr. Foshee for using Goldman as El Paso’s adviser in the transaction. Mr. Blankfein added that he knew Mr. Foshee was aware of Goldman’s investment in Kinder Morgan “and that we are very sensitive to the appearance of conflict.”

Somewhat awkwardly, Goldman had a 19.1 percent stake in Kinder Morgan, the pipeline and energy storage company, and two seats on its board. So the script went on, “We have asked our board members to recuse themselves and I know you have taken on a second adviser.” He added, “Really just wanted to reach out and say thank you.”

About a month later, Kinder Morgan announced it had agreed to acquire El Paso for $21.1 billion in cash and stock.

When the deal was announced, buried at the end of the news release was a list of Wall Street banks that had advised on the deal, including Goldman Sachs. Goldman received a $20 million fee for playing matchmaker for El Paso. The fee, of course, was not disclosed, nor was the Kinder Morgan stake owned by Goldman Sachs’s private equity arm, worth some $4 billion. Nor did the release disclose that the Goldman banker who advised El Paso to accept Kinder Morgan’s bid owned $340,000 worth of Kinder Morgan stock.

Now, however, a court ruling in a shareholder lawsuit has laid bare the truth:

Goldman was on every conceivable side of the deal.

As a result, El Paso may have unwittingly sold itself far too cheaply. Mr. Blankfein may have said he was “very sensitive to the appearance of conflict,” but the judge’s order ruling “reluctantly” against a motion to block the merger made it clear that Goldman’s conflicts went far beyond mere appearances.

Here’s just one example: In an effort to help mitigate its clear conflict, Goldman Sachs recommended that El Paso hire an additional adviser so that El Paso would be able to say that it had received completely impartial advice. Goldman did not say it would step down, and lose its fee, it simply suggested that El Paso hire one more bank — in this case, Morgan Stanley.

But then came this: “When a second investment bank was brought in to address Goldman’s economic incentive for a deal with, and on terms that favored, Kinder Morgan, Goldman continued to intervene and advise El Paso on strategic alternatives, and with its friends in El Paso management, was able to achieve a remarkable feat: giving the new investment bank an incentive to favor the merger by making sure that this bank only got paid if El Paso adopted the strategic option of selling to Kinder Morgan,” Chancellor Leo E. Strine Jr. of Delaware’s Court of Chancery wrote last week in a must-read opinion that has been whizzing around the in-boxes of Wall Street.

“In other words,” Chancellor Strine continued, “the conflict-cleansing bank only got paid if the option Goldman’s financial incentives gave it a reason to prefer was the one chosen.”

Goldman denied that it was involved with the structure of Morgan Stanley’s fee.

It must be noted that Chancellor Strine’s irritation was not just reserved for Goldman. He lambasted El Paso’s chief, Mr. Foshee, for what he described as his “velvet glove negotiating strategy,” which he said was “influenced by an improper motive” to enrich himself through the deal because he planned to later buy El Paso’s exploration and production unit from Kinder Morgan.

Goldman’s brazenness in this deal is nothing short of breathtaking. It is just another example of why Goldman’s reputation has been dented as questions have circled about the firm’s loyalty to its clients over itself. Other firms have conflicts, but rarely do you hear about them being so incestuous. A Morgan Stanley banker involved in the deal wrote in an e-mail at the time: “This is GS at its most shameless.”

What’s even more surprising about Goldman’s role working for El Paso is that it came just six months after the firm issued a new set of guidelines by its “business standards committee.” The firm had just agreed to a $550 million settlement with the Securities and Exchange Commission over allegations that it knowingly sold its clients financial instruments meant to fail. In the guidelines, the firm pledged that its most important principle is that “our clients’ interests always come first.”

In the case of El Paso, that’s now debatable. The company on Monday delayed its shareholder vote on the deal for a few days, until Friday, to give its investors time to digest Mr. Strine’s rebuke of the process.

In fairness to Goldman, the firm was completely upfront with El Paso about its conflict and the company chose to continue working with Goldman. (The firm, however, did not disclose the personal stock ownership in Kinder Morgan by its banker, Steve Daniel.) Perhaps that would have been disclosure enough several years ago. But in this environment, why would Goldman take the chance? After all, the firm’s $4 billion investment in Kinder Morgan meant that it had much more on the line on the other side of the negotiating table. Compare that to a $20 million advisory fee.

In a statement, Goldman said, “We respect the judge’s opinion but want to be clear that we stood by our client through this process, encouraging them to get independent views from another adviser. We were also transparent with El Paso about our relationship with Kinder Morgan and the related issues.”

Even if Goldman had perfect Chinese walls, as the firm has said, it stretches the mind to believe that the conflict could truly be contained — or could be worth the trouble it has created.

“I am unwilling to view Goldman as exemplifying an Emersonian nonfoolishly inconsistent approach to greed, one that involves seeking lucre in a conflicted situation while simultaneously putting the chance for greater lucre out of its ‘collective’ mind,” Chancellor Strine wrote. “At this stage, I cannot readily accept the notion that Goldman would not seek to maximize the value of its multibillion-dollar investment in Kinder Morgan at the expense of El Paso, but, at the same time, be so keen on obtaining an investment banking fee in the tens of millions.”

 

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