Goldman Sachs is a leading global investment banking and securitiesfirm with three principal business lines:
- Investment Banking;
- Trading and Principal Investments; and
- Asset Management and Securities Services.
Our goal is to be the advisor of choice for our clients and a leadingparticipant in global financial markets. We provide services worldwide to asubstantial and diversified client base, which includes corporations, financialinstitutions, governments and high net worth individuals.
Because we believe that the needs of our clients are global and thatinternational markets have high growth potential, we have built upon ourstrength in the United States to achieve leading positions in other parts of theworld. Today, we have a strong global presence as evidenced by the geographicbreadth of our transactions, leadership in our core products and the size of ourinternational operations. As of February 1999, we operated offices in 23countries and 36% of our 13,000 employees were based outside the UnitedStates.
We are committed to a distinctive culture and set of core values. Thesevalues are reflected in our Business Principles, which emphasize placing ourclients' interests first, integrity, commitment to excellence and innovation,and teamwork.
Goldman Sachs is managed by its principal owners. Simultaneously withthe offerings, we will grant restricted stock units, stock options or interestsin a defined contribution plan to substantially all of our employees. Followingthe offerings, our employees, including former partners, will own approximately65% of Goldman Sachs. None of our employees are selling shares in theofferings.
Goldman Sachs is the successor to a commercial paper business foundedin 1869 by Marcus Goldman. Since then, we have grown our business as aparticipant and intermediary in securities and other financial activities tobecome one of the leading firms in the industry.
In 1989, The Goldman Sachs Group, L.P. was formed to serve as theparent company of the Goldman Sachs organization. As of November 30, 1996, TheGoldman Sachs Group, L.P. was restructured. On that date, the non-retiringformer general partners of The Goldman Sachs Group, L.P. converted their generalpartner interests into limited partner interests and became profit participatinglimited partners of The Goldman Sachs Group, L.P. Concurrently, The GoldmanSachs Corporation was admitted as The Goldman Sachs Group, L.P.'s sole generalpartner. The common stock of The Goldman Sachs Corporation is owned by ourmanaging directors who are profit participating limited partners, all of whomare active in our businesses.
The Goldman Sachs Group, Inc. was formed to succeed to the business ofThe Goldman Sachs Group, L.P. Simultaneously with the offerings, we willcomplete a number of transactions in order to convert from partnership tocorporate form. See "Certain Relationships and RelatedTransactions Incorporation and Related Transactions" for additionalinformation concerning these transactions.
Except as otherwise indicated, all amounts with respect to the volume,number and market share of mergers and acquisitions and underwritingtransactions and related ranking information have been derived from informationcompiled and classified by Securities Data Company. Securities Data Companyobtains and gathers its information from sources it considers reliable, butSecurities Data Company does not guarantee the accuracy or completeness of theinformation. In the case of mergers and acquisitions, data are based upon thedollar value of announced transactions for the period indicated, taken as awhole, with full credit to each of the advisors to each party in a transaction.In the case of underwritings, data are based upon the dollar value of totalproceeds raised (exclusive of any option to purchase additional shares) withequal credit to each bookrunner for the period indicated, taken as a whole. As aresult of this method of compiling data, percentages may add to more than100%.
Our strategy is to grow our three core businesses InvestmentBanking, Trading and Principal Investments, and Asset Management and SecuritiesServices in markets throughout the world. Our leadership position ininvestment banking provides us with access to governments, financialinstitutions and corporate clients globally. Trading and principal investing hasbeen an important part of our culture and earnings, and we remain committed tothese businesses irrespective of their volatility. Managing wealth is one of thefastest growing segments of the financial services industry and we arepositioning our asset management and securities services businesses to takeadvantage of that growth. Our assets under supervision, for example, have grownfrom $92.7 billion as of November 1994 to $369.7 billion as of February 1999,representing a compound annual growth rate of 38%.
Our business lines are comprised of various product and serviceofferings that are set forth in the following chart:
| Investment Banking | Trading and Principal Investments | Asset Management and Securities Services |
| Equity and debt underwriting Financial restructuring advisory services Mergers and acquisitions advisory services Real estate advisory services | Bank loans Commodities Currencies Equity and fixed income derivatives Equity and fixed income securities Principal investments Proprietary arbitrage | Commissions Institutional and high net worth asset management Margin lending Matched book Merchant banking fees Increased shares of merchant banking fund income and gains Mutual funds Prime brokerage Securities lending |
Investment Banking
Investment Banking represented 39% of 1998 net revenues and 35% of 1997net revenues. We are a market leader in both thefinancial advisory and underwriting businesses, serving over 3,000 clientsworldwide. For the period January 1, 1994 to December 31, 1998, we had theindustry-leading market share of 25.3% in worldwide mergers and acquisitionsadvisory services, having advised on over $1.7 trillion of transactions. Overthe same period, we also achieved number one market shares of 15.2% inunderwriting worldwide initial public offerings and 14.4% in underwritingworldwide common stock issues.
Trading and Principal Investments
Trading and Principal Investments represented 28% of 1998 net revenuesand 39% of 1997 net revenues. We make markets in equity and fixed incomeproducts, currencies and commodities; enter into swaps and other derivativetransactions; engage in proprietary trading and arbitrage; and make principalinvestments. In trading, we focus on building lasting relationships with ourmost active clients while maintaining leadership positions in our key markets.We believe our research, market-making and proprietary activities enhance ourunderstanding of markets and ability to serve our clients.
Asset Management and Securities Services
Asset Management and Securities Services represented 33% of 1998 netrevenues and 26% of 1997 net revenues. We provide global investment managementand advisory services; earn commissions on agency transactions; manage merchantbanking funds; and provide prime brokerage, securities lending and financingservices. Our asset management business has grown rapidly, with assets undersupervision increasing from $92.7 billion as of November 25, 1994 to $369.7billion as of February 26, 1999, representing a compound annual growth rate of38%. As of February 26, 1999, we had $206.4 billion of assets under management.We manage merchant banking funds that had $15.5 billion of capital commitmentsas of the end of 1998.
We pursue our strategy to grow our three core businesses through anemphasis on:
Expanding High Value-Added Businesses
To achieve strong growth and high returns, we seek to build leadershippositions in high value-added services for our clients. For example, we havesubstantially increased the number of professionals in investment banking toimprove and expand our ability to execute mergers and acquisitions, initialpublic offerings and high-yield financings. In trading, we structure and executelarge and complex transactions for institutional investors, pension funds andcorporate clients around the world. In asset management, we emphasize equity andalternative investment products and use our established international presenceto build a global asset management franchise.
Increasing the Stability of Our Earnings
We seek to balance the stability of our earnings with return on equityand long-term earnings growth. We believe our trading businesses are keyingredients to our success. While we plan to continue to grow our tradingbusinesses, the financial market shocks of the past year underscored theimportance of our strategy of emphasizing growth in our investment banking,asset management and securities services businesses. Through a greater relativeemphasis on these businesses, our goal is to gradually increase the stability ofour earnings.
Pursuing International Opportunities
We believe that our global reach will allow us to take advantage ofgrowth in international markets. In Europe, for example, we anticipate that therecent establishment of the European Economic and Monetary Union will, overtime, create a large pan-European market rivaling the U.S. capital markets insize and liquidity. We believe this will generate increased activity across ourbusinesses in the region. In Asia, we believe that an increase in corporaterestructurings and in the need for liquidity will increase our mergers andacquisitions and trading opportunities. In the longer term, we anticipateadditional opportunities in asset management activities due to a shift weanticipate toward the privatization of pension systems and in demographics.
Leveraging the Franchise
We believe our various businesses are generally stronger and moresuccessful because they are part of the Goldman Sachs franchise. Our culture ofteamwork fosters cooperation among our businesses, which allows us to provideour clients with a full range of products and services on a coordinated basis.Our investment bankers, for example, refer clients who are selling theirbusinesses to those in Goldman Sachs who manage wealth. In addition, ourmerchant banking investments in companies lead to future clients for investmentbanking.
Strong Client Relationships
We focus on building long-term client relationships. In 1998, over 75%of our Investment Banking revenues represented business from existing clients.We also aggressively pursue new client relationships as evidenced by the over400 investment banking transactions we completed for first-time clients in 1998.In our trading businesses, we structure and execute transactions across a widearray of markets and countries to meet our clients' needs. In our assetmanagement business, we managed assets for three of the five largest pensionpools in the United States as ranked as of September 30, 1998 by Pensions &Investments and maintain accounts for 41% of the 1998 "Forbes 400 List of theRichest Americans".
Distinctive People and Culture
Our most important asset is our people. We seek to reinforce ouremployees' commitment to our culture and values through recruiting, training, acomprehensive 360-degree review system and a compensation philosophy thatrewards teamwork. We were ranked number seven in Fortune magazine's "The100 Best Companies to Work for in America" in January 1999 and were rankednumber three in Fortune magazine's 1999 "The Top 50 MBA Dream Companies",the highest-ranked investment banking and securities firm in each case.
Global Reach
Over the past decade, we have made a significant commitment to buildinga worldwide business. We have achieved leading positions in major internationalmarkets by capitalizing on our product knowledge and global research, as well asby building a local presence where appropriate. In doing so, we have become oneof the few truly global investment banking and securities firms with the abilityto execute large and complex cross-border transactions. We had the number onemarket share of 23.2% in cross-border mergers and acquisitions for the periodJanuary 1, 1994 to December 31, 1998. In addition, in Japan, we were the largestnon-Japanese mutual fund manager as of the end of February 1999, according toThe Investment Trusts Association.
| Year Ended November | Three Months Ended February | ||||
|---|---|---|---|---|---|
| 1996 | 1997 | 1998 | 1998 | 1999 | |
| Net revenues: | |||||
| Investment Banking | $2,113 | $2,587 | $3,368 | $ 633 | $ 902 |
| Trading and Principal Investments | 2,693 | 2,926 | 2,379 | 1,182 | 1,357 |
| Asset Management and Securities Services | 1,323 | 1,934 | 2,773 | 657 | 736 |
| Total net revenues | $6,129 | $7,447 | $8,520 | $2,472 | $2,995 |
Goldman Sachs provides a broad range of investment banking services toa diverse group of over 3,000 clients worldwide, including corporations,financial institutions, governments and individuals. Our investment bankingactivities are divided into two categories:
- Financial Advisory. Financial advisory includes advisory assignments with respect to mergers and acquisitions, divestitures, corporate defense activities, restructurings and spin-offs; and
- Underwriting. Underwriting includes public offerings and private placements of equity and debt securities.
| Year Ended November | Three Months Ended February | ||||
|---|---|---|---|---|---|
| 1996 | 1997 | 1998 | 1998 | 1999 | |
| Financial advisory | $ 931 | $1,184 | $1,774 | $363 | $522 |
| Underwriting | 1,182 | 1,403 | 1,594 | 270 | 380 |
| Total Investment Banking | $2,113 | $2,587 | $3,368 | $633 | $902 |
In Investment Banking, we provide our clients with quality advice andexecution as part of our effort to develop and maintain long-term relationshipsas their lead investment bank.
Organization
We have continuously adapted our organizational structure to meetchanging market dynamics and our clients' needs. Our current structure, which isorganized along regional, execution and industry groups, seeks to combineclient-focused investment bankers with execution and industry expertise. Becauseour businesses are global, we have adapted our organization to meet the demandsof our clients in each geographic region. Through our commitment to teamwork, webelieve that we provide services in an integrated fashion for the benefit of ourclients.
We believe an important competitive advantage in our marketing effortis Investment Banking Services, a core group of professionals who focus ondeveloping and maintaining strong client relationships. These bankers, who areorganized regionally and/or by industry group, work with senior executives ofour clients to identify areas where Goldman Sachs can provide capital-raising,financial advisory or other products and services. The broad base of experienceand knowledge of our Investment Banking Services professionals enables them toanalyze our clients' objectives efficiently and to bring to bear the appropriateresources of Goldman Sachs to satisfy those objectives.
Our Corporate Finance, Debt and Equity Capital Markets, LeveragedFinance and Mergers and Acquisitions groups bring product expertise andinnovation to clients in a variety of industries. These groups are responsiblefor the execution of specific client transactions as well as the building ofstrong client relationships.
In an effort to serve our clients' needs in targeted industries, wehave established several industry focus groups. These include: Chemicals;Communications, Media and Entertainment; Energy and Power; FinancialInstitutions; Healthcare; Technology; Hotels and Gaming; Real Estate;Retailing; and Transportation. Drawing on specialized knowledge ofindustry-specific trends, these groups provide the full range of investmentbanking products and services to our clients.
Reflecting our commitment to innovation, Investment Banking hasestablished a New Products group whose professionals focus on creating newfinancial products. These professionals have particular expertise in integratingfinance with accounting, tax and securities laws and work closely with otherinvestment banking teams to provide innovative solutions to difficult clientproblems. Our structuring expertise has proven to be particularly valuable inaddressing client needs in areas such as complex cross-border mergers andacquisitions and convertible and other hybrid equity financings.
Financial Advisory
Financial advisory includes a broad range of advisory assignments withrespect to mergers and acquisitions, divestitures, corporate defense activities,restructurings and spin-offs. Goldman Sachs is a leading investment bank inworldwide mergers and acquisitions. During calendar 1998, we advised on 340mergers and acquisitions transactions with a combined value of $957 billion.
Our mergers and acquisitions capabilities are evidenced by oursignificant share of assignments in large, complex transactions where we providemultiple services, including "one-stop" acquisition financing, currency hedgingand cross-border structuring expertise. Goldman Sachs advised on seven of theten largest mergers and acquisitions transactions through December 31, 1998. Wehave also been successful in Europe, including in intra-country transactions,and weare a leading mergers and acquisitions advisor in France, Germany and Spain.
The following table illustrates our leadership in the mergers andacquisitions advisory market for the indicated period taken as a whole:
| Category | Rank(1) | Market Share | Volume | Number of Transactions |
|---|---|---|---|---|
| Worldwide | 1 | 25.3% | $1,715 | 1,334 |
| Worldwide, transactions over $500 million | 1 | 34.8 | 1,593 | 470 |
| Worldwide, transactions over $1 billion | 1 | 38.4 | 1,470 | 297 |
| United States | 1 | 32.8 | 1,316 | 907 |
| United States, transactions over $500 million | 1 | 41.3 | 1,228 | 339 |
| United States, transactions over $1 billion | 1 | 44.3 | 1,142 | 221 |
(1) Rank in any one year during the period presented may vary from the rank for the period taken as a whole.
Mergers and acquisitions is an example of how one activity can generatecross-selling opportunities for other areas of Goldman Sachs. For example, aclient we are advising in a purchase transaction may seek our assistance inobtaining financing and in hedging interest rate or foreign currency risksassociated with the acquisition. In the case of dispositions, owners and seniorexecutives of the acquired company often will seek asset management services. Inthese cases, our high net worth relationship managers provide comprehensiveadvice on investment alternatives and execute the client's desired strategy.
Underwriting
From January 1, 1994 through March 31, 1999, Goldman Sachs has servedas lead manager in transactions that have raised more than $1 trillion ofcapital for clients worldwide. We underwrite a wide range of securities andother instruments, including common and preferred stock, convertible securities,investment grade debt, high-yield debt, sovereign and emerging markets debt,municipal debt, bank loans, asset-backed securities and real estate-relatedsecurities, such as mortgage-backed securities and the securities of real estateinvestment trusts.
Equity Underwriting. Equity underwriting has been a long-termcore strength of Goldman Sachs. The following table illustrates our leadershipposition in equity underwriting for the indicated period taken as a whole:
| Category | Rank(1) | Market Share | Total Proceeds Raised | Number of Issues(2) |
|---|---|---|---|---|
| Worldwide initial public offerings | 1 | 15.2% | $ 44 | 300 |
| Worldwide initial public offerings, proceeds over $500 million | 1 | 23.3 | 25 | 59 |
| Worldwide public common stock offerings | 1 | 14.4 | 101 | 634 |
| U.S. initial public offerings | 1 | 15.3 | 31 | 179 |
| U.S. initial public offerings, proceeds over $500 million | 1 | 30.1 | 16 | 29 |
| U.S. public common stock offerings | 2 | 14.3 | 71 | 381 |
(1) Rank in any one year during the period presented may vary from the rank for the period taken as a whole.
(2) The number of issues reflects the number of tranches; an offering by a single issuer could have multiple tranches.
As with mergers and acquisitions, we have been particularly successfulin winning mandates for large, complex equity underwritings. As evidenced in thechart above, our market share of initial public offerings with total proceedsover $500 million is substantially higher than our market share of all initialpublic offerings. We believe our leadership in large initial public offeringsreflects our expertise in complex transactions, research strengths, track recordand distribution capabilities. In the international arena, we have also acted aslead manager on many of the largest initial public offerings. We were named theAsian Equity House of the Year by International Financing Review in1998.
We believe that a key factor in our equity underwriting success is theclose working relationship between the investment bankers, research analysts andsales force as coordinated by our Equity Capital Markets group. Goldman Sachs'equities sales force is one of the most experienced and effective salesorganizations in the industry. With 350 institutional sales professionals and420 high net worth relationship managers located in every major market aroundthe world, Goldman Sachs has relationships with a large and diverse group ofinvestors.
Global Investment Research is critical to our ability to succeed in theequity underwriting business. We believe that high quality equity research is asignificant competitive advantage in the market for new equity issues. In thisregard, Goldman Sachs' research has been consistently ranked among theindustry's global leaders. See " Global Investment Research" for detailedinformation regarding our Global Investment Research Department.
Debt Underwriting. We engage in the underwriting and originationof various types of debt instruments that we broadly categorize as follows:investment grade debt for corporations, governments, municipalities andagencies; leveraged finance, which includes high-yield debt and bank loans fornon-investment grade issuers; emerging market debt, which includes corporate andsovereign issues; and asset-backed securities. We have employed a focusedapproach in debt underwriting, emphasizing high value-added areas in servicingour clients.
We believe that the leveraged finance market is a key growthopportunity for our debt underwriting business. Over the last three years, wehave more than doubled the number of debt underwriting professionals dedicatedto this area.
The table below sets forth our rank, market position, our totalproceeds raised and the number of debt transactions in which we have acted as underwriter in the following areas for the indicated periodtaken as a whole:
| Category(1) | Rank(5) | Market Share | Total Proceeds Raised | Number of Issues(6) |
|---|---|---|---|---|
| Worldwide debt(2) | 3 | 8.4% | $695 | 4,684 |
| Worldwide straight debt(3) | 3 | 8.9 | 559 | 4,165 |
| U.S. investment grade straight debt(3) | 3 | 12.0 | 419 | 3,590 |
| U.S. investment grade industrial straight debt(3) | 1 | 19.5 | 81 | 517 |
| U.S. high-yield debt(4) | 5 | 8.0 | 33 | 184 |
(1) All categories include publicly registered and Rule 144A issues.
(2) Includes non-convertible preferred stock, mortgage-backed securities, asset-backed securities and taxable municipal debt.
(3) "Straight debt" excludes non-convertible preferred stock, mortgage-backed securities, asset-backed securities and municipal debt.
(4) Excludes issues with both investment grade and non-investment grade ratings, often referred to as "split-rated issues".
(5) Rank in any one year during the period presented may vary from the rank for the period taken as a whole.
(6) The number of issues reflects the number of tranches; an offering by a single issuer could have multiple tranches.
Our Trading and Principal Investments business facilitates customertransactions and takes proprietary positions through market-making in andtrading of fixed income and equity products, currencies, commodities, and swapsand other derivatives. In order to meet the needs of our clients, our Tradingand Principal Investments business is diversified across a wide range ofproducts. For example, we make markets in traditional investment grade debtsecurities, structure complex derivatives and securitize mortgages and insurancerisk. A fundamental tenet of our approach is that we believe our willingness andability to take risk distinguishes us and substantially enhances our clientrelationships. Our Trading and Principal Investments business includes thefollowing:
- Fixed Income, Currency and Commodities. Goldman Sachs makes markets in and trades fixed income products, currencies and commodities, structures and enters into a wide variety of derivative transactions and engages in proprietary trading and arbitrage activities;
- Equities. Goldman Sachs makes markets in and trades equities and equity-related products, structures and enters into equity derivative transactions and engages in proprietary trading and equity arbitrage; and
- Principal Investments. Principal investments primarily represents Goldman Sachs' net revenues from its investments in its merchant banking funds.
| Year Ended November | Three Months Ended February | ||||
|---|---|---|---|---|---|
| 1996 | 1997 | 1998 | 1998 | 1999 | |
| FICC | $1,749 | $2,055 | $1,438 | $ 741 | $ 876 |
| Equities | 730 | 573 | 795 | 365 | 455 |
| Principal investments | 214 | 298 | 146 | 76 | 26 |
| Total Trading and Principal Investments | $2,693 | $2,926 | $2,379 | $1,182 | $1,357 |
Fixed Income, Currency and Commodities
FICC is a large and diversified operation through which we engage in avariety of customer-driven market-making and proprietary trading and arbitrageactivities. FICC's principal products are:
- Bank loans
- Commodities
- Currencies
- Derivatives
- Emerging market debt
- Global government securities
- High-yield securities
- Investment grade corporate securities
- Money market instruments
- Mortgage securities and loans
- Municipal securities
In our proprietary activities, we assume a variety of risks and devotesubstantial resources to identify, analyze and benefit from these exposures. Weleverage our strong research capabilities and capitalize on our proprietaryanalytical models to analyze information and make informed trading judgments. Weseek to benefit from perceived disparities in the value of assets in the tradingmarkets and from macroeconomic and company-specific trends.
FICC has established itself as a leading market participant by using athree-part approach to deliver high quality service to its clients. First, weoffer broad market-making, research and market knowledge to our clients on aglobal basis. Second, we create innovative solutions to complex client problemsby drawing upon our structuring and trading expertise. Third, we use ourexpertise to take positions in markets when we believe the return is at leastcommensurate with the risk.
A core activity in FICC is market-making in a broad array of securitiesand products. For example, we are a primary dealer in many of the largestgovernment bond markets around the world, including the United States, Japan,the United Kingdom and Canada; we are a member of the major futures exchanges;and we have interbank dealer status in the currency markets in New York, London,Tokyo and Hong Kong. Our willingness to make markets in a broad range of fixedincome, currency and commodity products and their derivatives is crucial both toour client relationships and to support our underwriting business by providingsecondary market liquidity. Our clients value counterparties that are active inthe marketplace and are willing to provide liquidity and research-based pointsof view. In addition, we believe that our significant investment in researchcapabilities and proprietary analytical models are critical to our ability toprovide advice to our clients. Our research capabilities include quantitativeand qualitative analyses of global economic, currency and financial markettrends, as well as credit analyses of corporate and sovereign fixed incomesecurities.
Our clients often confront complex problems that require creativeapproaches. We assist our clients who seek to hedge or reallocate their risksand profit from expected price movements. To do this we bring to bear theability of our experienced professionals to understand the needs of our clientsand our ability to manage the risks associated with complex solutions toproblems. In recognition of our ability to meet these client needs, we wereranked by Institutional Investor in February 1999 as the number twoderivatives dealer for the second straight year. In addition, we were named byEuroweek in January 1999 as the "Best provider of swaps and otherderivatives".
Equities
Goldman Sachs engages in a variety of market-making, proprietarytrading and arbitrage activities in equity securities and equity-relatedproducts (such as convertible securities and equity derivative instruments) on aglobal basis. Goldman Sachs makes markets and positions blocks of stock tofacilitate customers' transactions and to provide liquidity in the marketplace.Goldman Sachs is a member of most of the major stock exchanges, including NewYork, London, Frankfurt, Tokyo and Hong Kong.
As agent, we execute brokerage transactions in equity securities forinstitutional andindividual customers that generate commission revenues. Commissions earned onagency transactions are recorded in Asset Management and SecuritiesServices.
In equity trading, as in FICC, we generate net revenues from ourcustomer-driven business in three ways. First, in large, highly liquid principalmarkets, such as the over-the-counter market for equity securities, we undertakea high volume of transactions for modest spreads. In the Nasdaq National Market,we were the second largest market maker, by aggregate volume, among the top 100most actively traded stocks in calendar 1998. Second, by capitalizing on ourstrong market relationships and capital position, we also undertake largetransactions, such as block trades and positions in securities, in which webenefit from spreads that are generally larger. Finally, we also benefit fromstructuring complex transactions.
Goldman Sachs was a pioneer and is a leader in the execution of largeblock trades (trades of 50,000 or more shares) in the United States and abroad.In calendar 1998, we executed over 50 block trades of at least $100 millioneach. We have been able to capitalize on our expertise in block trading, ourglobal distribution network and our willingness to commit capital to effectincreasingly large and complex customer transactions. We expect corporateconsolidation and restructuring and increased demand for certainty and speed ofexecution by sellers and issuers of securities to increase both the frequencyand size of sales of large blocks of equity securities. We believe that we arewell positioned to benefit from this trend. Block transactions, however, exposeus to increased risks, including those arising from holding large andconcentrated positions and decreasing spreads. See "Risk Factors MarketFluctuations Could Adversely Affect Our Businesses in Many Ways HoldingLarge and Concentrated Positions May Expose Us to Large Losses" for a discussionof the risks associated with holding a large position in a single issuer and"Risk Factors The Financial Services Industry Is Intensely Competitive andRapidly Consolidating" for a discussion of the competitive risks that weface.
We are active in the listed options and futures markets, and westructure, distribute and execute over-the-counter derivatives on marketindices, industry groups and individual company stocks to facilitate customertransactions and our proprietary activities. We develop quantitative strategiesand render advice with respect to portfolio hedging and restructuring and assetallocation transactions. We also create specially tailored instruments to enablesophisticated investors to undertake hedging strategies and establish orliquidate investment positions. We are one of the leading participants in thetrading and development of equity derivative instruments. We are an activeparticipant in the trading of futures and options on most of the major exchangesin the United States, Europe and Asia.
Equity arbitrage has long been an important part of our equityfranchise. Our strategy is based on making investments on a global basis througha diversified portfolio across different markets and event categories. Thisbusiness focuses on event-oriented special situations where we are not acting asan advisor and on relative value trades. These special situations includemergers and acquisitions, corporate restructurings, recapitalizations and legaland regulatory events. Equity arbitrage leverages our global infrastructure andnetwork of research analysts to analyze carefully a broad range of trading andinvestment strategies across a wide variety of markets. Investment decisions arethe product of rigorous fundamental, situational and, frequently, regulatory andlegal analysis. Although market conditions led us to decrease the number andsize of positions maintained by our equity arbitrage business during 1998, webelieve that over time, as opportunities present themselves, our equityarbitrage business will likely increase its activity.
Trading Risk Management
We believe that our trading and market-making capabilities are keyingredients to our success. While these businesses have generally earnedattractive returns, we have in the past incurred significant trading losses inperiods of market turbulence, such as in 1994 and 1998. Our trading riskmanagement process seeks to balance our ability to profit from trading positionswith our exposure to potential losses. Risk management includes input from alllevels of Goldman Sachs, from the trading desks to the Firmwide Risk Committee.See "Management's Discussion and Analysis of Financial Condition and Results ofOperations Risk Management" for a further discussion of our risk managementpolicies and procedures.
1998 Experience. From mid-August to mid-October 1998, theRussian economic crisis, the turmoil in Asian and Latin American emergingmarkets and the resulting move to higher quality fixed income securities by manyinvestors led to substantial declines in global financial markets. Investorsbroadly sold credit-sensitive products, such as corporate and high-yield debt,and bought higher-rated instruments, such as U.S. Treasury securities, whichcaused credit spreads to widen dramatically. This market turmoil also caused awidespread decline in global equity markets.
As a major dealer in fixed income securities, we maintain substantialinventories of corporate and high-yield debt. We regularly seek to hedge theinterest rate risk on these positions through, among other strategies, shortpositions in U.S. Treasury securities. In the second half of 1998, we sufferedlosses from both the decline in the prices of corporate and high-yield debtinstruments that we owned and the increase in the prices of the U.S. Treasurysecurities in which we had short positions.
These market shocks also led to trading losses in our fixed incomerelative value trading positions. Relative value trading positions are intendedto profit from a perceived temporary dislocation in the relationship between thevalues of different financial instruments. From mid-August to mid-October 1998,the components of these relative value positions moved in directions that we didnot anticipate and the volatilities of certain positions increased to threetimes prior levels. When we and other market participants with similar positionssimultaneously sought to reduce positions and exposures, this caused asubstantial reduction in market liquidity and a continuing decline inprices.
In the second half of 1998, we also experienced losses in equityarbitrage and in the value of a number of merchant banking investments.
Risk Reduction. Over the course of this period, we activelyreduced our positions and exposure to severe market disruptions of the typedescribed above. Our current scenario models estimate our exposure to asubstantial widening in credit spreads and adverse movements in relative valuetrades of the type experienced in mid-August to mid-October 1998. These modelsindicate that, as of November 1998, our exposure to a potential reduction in nettrading revenues as a result of these events was over 40% lower than in August1998. In addition, the daily VaR of substantially all of our trading positionsdeclined from $47 million as of May 29, 1998 to $43 million as of November 1998.The November 1998 daily VaR reflects the reduction in positions discussed above,offset by the higher market volatility, changes in correlation and other marketconditions experienced in the second half of 1998. If the daily VaR as ofNovember 1998 had been determined using the volatility and correlation data asof May 29, 1998, the daily VaR would have been $31 million. See "Management'sDiscussion and Analysis of Financial Condition and Results ofOperations Risk Management" for a discussion of VaR and itslimitations.
As part of the continuous effort to refine our risk management policiesand procedures, we have recently made a number of adjustments to the way that weevaluate riskand set risk limits. See "Management's Discussion and Analysis of FinancialCondition and Results of Operations Risk Management Market Risk" for afurther discussion of our policies and procedures for evaluating market risk andsetting related limits.
Notwithstanding these actions, we continue to hold trading positionsthat are substantial in both number and size, and are subject to significantmarket risk. In addition, management may choose to increase our risk levels inthe future. See "Risk Factors Market Fluctuations Could Adversely AffectOur Businesses in Many Ways" and " Our Risk Management Policies andProcedures May Leave Us Exposed to Unidentified or Unanticipated Risk" for adiscussion of the risks associated with our trading positions.
Principal Investments
In connection with our merchant banking activities, we invest with ourclients by making principal investments in funds that we raise and manage. As ofNovember 1998, we had committed $2.8 billion, of which $1.7 billion had beenfunded, of the $15.5 billion total equity capital committed for our merchantbanking funds. The funds' investments generate capital appreciation ordepreciation and, upon disposition, realized gains or losses. See " AssetManagement and Securities Services Merchant Banking" for a discussion ofour merchant banking funds. As of November 1998, our aggregate carrying value ofprincipal investments held directly or through our merchant banking funds wasapproximately $1.4 billion, which was comprised of corporate principalinvestments with an aggregate carrying value of approximately $609 million andreal estate investments with an aggregate carrying value of approximately $753million.
Asset Management and Securities Services is comprised of thefollowing:
- Asset Management. Asset management generates management fees by providing investment advisory services to a diverse and rapidly growing client base of institutions and individuals;
- Securities Services. Securities services includes prime brokerage, financing services and securities lending and our matched book businesses, all of which generate revenue primarily in the form of fees or interest rate spreads; and
- Commissions. Commission-based businesses include agency transactions for clients on major stock and futures exchanges. Revenues from the increased share of income and gains derived from our merchant banking funds are also included in commissions.
| Year Ended November | Three Months Ended February | ||||
|---|---|---|---|---|---|
| 1996 | 1997 | 1998 | 1998 | 1999 | |
| Asset management | $ 242 | $ 458 | $ 675 | $139 | $202 |
| Securities services | 354 | 487 | 730 | 170 | 207 |
| Commissions | 727 | 989 | 1,368 | 348 | 327 |
| Total Asset Management and Securities Services | $1,323 | $1,934 | $2,773 | $657 | $736 |
Asset Management
Goldman Sachs is seeking to build a premier global asset managementbusiness. We offer a broad array of investment strategies and advice across allmajor asset classes: global equity; fixed income, including money markets;currency; and alternative investment products (i.e., investment vehicleswith non-traditional investment objectives and/or strategies). Assets undersupervision are comprised of assets under management and other client assets.Assets under management typically generate fees based on a percentage of theirvalue and include our mutual funds, separate accounts managed for institutionaland individual investors, our merchant banking funds and other alternativeinvestment funds. Other client assets are comprised of assets in brokerageaccounts of primarily high net worth individuals, on which we earncommissions.
Over the last five years, we have rapidly grown our assets undersupervision, as set forth in the graph below:
(in billions)
The following table sets forth the amount of assets under management byasset class:
| As of November | As of February | |||||
|---|---|---|---|---|---|---|
| 1994 | 1995 | 1996 | 1997 | 1998 | 1999 | |
| Asset Class | ||||||
| Equity | $ 6 | $ 9 | $34 | $ 52 | $ 69 | $ 73 |
| Fixed income and currency | 17 | 19 | 26 | 36 | 50 | 53 |
| Money markets | 18 | 20 | 27 | 31 | 46 | 48 |
| Alternative investment(1) | 3 | 4 | 8 | 17 | 30 | 32 |
| Total | $44 | $52 | $95 | $136 | $195 | $206 |
(1) Includes private equity, real estate, quantitative asset allocation and other funds that we manage.
Since the beginning of 1996, we have increased the resources devoted toour asset management business, including adding over 850 employees. In addition,over the past three years, Goldman Sachs has made three asset managementacquisitions in order to expand its geographic reach and broaden its globalequity and alternative investment portfolio management capabilities.
Our global reach has been important in growing assets under management.From November 1996 to February 1999, our assets under management, excluding ourmerchant banking funds, sourced from outside the United States grew by over $35billion. As of February 1999, we managed approximately $46 billion sourced fromEurope.
In Japan, deregulation, high individual savings rates and low localrates of return have been important drivers of growth for our asset managementbusiness during the 1990s. Over the last three years, we have built asignificant asset management business in Japan, and, as of February 1999, wemanaged $23 billion of assets sourced from Japan. In Japan, as of the end ofFebruary 1999, we were the largest non-Japanese investment trust manager,according to The Investment Trusts Association, and we managed four of the top15 open-ended mutual funds ranked by mutual fund assets, according to IFIS Inc.We believe that substantial opportunities exist to grow our asset managementbusiness in Japan, by increasing our institutional client base and expanding thethird-party distribution network through which we offer our mutual funds.
Clients. Our primary clients are institutions, high net worthindividuals and retail investors. We access clients through both direct andthird-party channels.
The table below sets forth the amount of assets under supervision bydistribution channel and client category as of November 1998:
| Assets Under Supervision(1) | Primary Investment Vehicles | |
|---|---|---|
| Institutional | $ 121 | Separate managed accounts Commingled vehicles |
| High net worth individuals | 156 | Brokerage accounts Limited partnerships Separate managed accounts |
| Institutional and retail | 48 | Mutual funds |
| Total | $ 325 |
(1) Excludes $12 billion in our merchant banking funds.
Our institutional clients include corporations, insurance companies,pension funds, foundations and endowments. We managed assets for three of thefive largest pension pools in the United States as ranked as of September 30,1998 by Pensions & Investments, and we have 18 clients for whom we manageat least $1 billion each.
In the individual high net worth area, we have establishedapproximately 10,000 high net worth accounts worldwide, including accounts with41% of the 1998 "Forbes 400 List of the Richest Americans". We believe this is ahigh growth opportunity because this market (defined as the market forindividual investors with a net worth in excess of $5 million) is highlyfragmented and growing rapidly and accounts for approximately $10 trillion ofinvestable assets according to a study by McKinsey & Co. At the center of oureffort is a team of over 420 relationship managers, located in 12 U.S. and sixinternational offices. These professionals have an average of over seven yearsof experience at Goldman Sachs and have exhibited low turnover and superiorproductivity relative to the industry average.
In the third-party distribution channel, we distribute our mutual fundson a worldwide basis through banks, brokerage firms, insurance companies andother financial intermediaries. As of December 31, 1998, we were the thirdlargest manager in the U.S. institutional money market sector according toinformation compiled by Strategic Insight. In Japan, we also utilize athird-party distribution network consisting principally of the largest Japanesebrokerage firms.
Merchant Banking
Goldman Sachs has an established successful record in the corporate andrealestate merchant banking business, having raised $15.5 billion of committedcapital for 15 private investment funds, as of November 1998, of which $9.0billion had been funded. We have committed $2.8 billion and funded $1.7 billionof these amounts; our clients, including pension plans, endowments, charitableinstitutions and high net worth individuals, have provided the remainder. Someof these investment funds pursue, on a global basis, long-term investments inequity and debt securities in privately negotiated transactions, leveragedbuyouts and acquisitions. As of November 1998, these funds had total committedcapital of $7.7 billion, which includes two funds with $1.0 billion of committedcapital that are in the process of being wound down. Other funds, with totalcommitted capital of $7.8 billion as of November 1998, invest in real estateoperating companies and debt and equity interests in real estate assets.
Our strategy with respect to each merchant banking fund is to investopportunistically to build a portfolio of investments that is diversified byindustry, product type, geographic region and transaction structure and type.Our merchant banking funds leverage our long-standing relationships withcompanies, investors, entrepreneurs and financial intermediaries around theworld to source potential investment opportunities. In addition, our merchantbanking funds and their portfolio companies have generated business for otherareas of Goldman Sachs, including equity underwriting, leveraged and otherfinancing fees and merger advisory fees.
Located in eight offices around the world, our investment professionalsidentify, manage and sell investments on behalf of our merchant banking funds.Goldman Sachs has two subsidiaries that manage real estate assets, The ArchonGroup, L.P. and Archon Group (France) S.C.A. In addition, our merchant bankingprofessionals work closely with other departments and benefit from the expertiseof specialists in debt and equity research, investment banking, leveraged andmortgage finance and equity capital markets.
Merchant banking activities generate three revenue streams. First, wereceive a management fee that is generally a percentage of a fund's committedcapital, invested capital, total gross acquisition cost or asset value. Theseannual management fees, which are included in our asset management revenues,have historically been a recurring source of revenue. Second, we receive fromeach fund, after that fund has achieved a minimum return for fund investors, anincreased share of the fund's income and gains that is a percentage, typically20%, of the capital appreciation and gains from the fund's investments. Revenuesfrom the increased share of the funds' income and gains are included incommissions. Third, Goldman Sachs, as a substantial investor in these funds, isallocated its proportionate share of the funds' unrealized appreciation ordepreciation arising from changes in fair value as well as gains and losses uponrealization. These items are included in Trading and Principal Investments.
Securities Services
Securities services consists predominantly of Global SecuritiesServices, which provides prime brokerage, financing services and securitieslending to a diversified U.S. and international customer base, including hedgefunds, pension funds and high net worth individuals. Securities services alsoincludes our matched book businesses.
We offer prime brokerage services to our clients, allowing them theflexibility to trade with most brokers while maintaining a single source forfinancing and portfolio reports. Our prime brokerage activities providemulti-product clearing and custody in 50 markets, consolidated multi-currencyaccounting and reporting and offshore fund administration and servicing for ourmost active clients. Additionally, we provide financing to our clients throughmargin loans collateralized by securities held in the client's account. Inrecent years, we have significantly increased our prime brokerage clientbase.
Securities lending activities principally involve the borrowing andlending of equity securities to cover customer and Goldman Sachs' short salesand to finance Goldman Sachs' long positions. In addition, we are an activeparticipant in the securities lending broker-to-broker business and thethird-party agency lending business. Trading desks in New York, Boston, London,Tokyo and Hong Kong provide 24-hour coverage in equity markets worldwide. Webelieve the rapidly developing international stock lending market presents asignificant growth opportunity for us.
Lenders of securities include pension plan sponsors, mutual funds,insurance companies, investment advisors, endowments, bank trust departments andindividuals. We have entered into exclusive relationships with certain lendersthat have given us access to large pools of securities, some of which are oftenhard to locate in the general lender market, providing us with a competitiveadvantage. We believe that a significant cause of the growth in short sales,which require the borrowing of securities, has been the rapid increase incomplex trading strategies, such as index arbitrage, convertible bond andwarrant arbitrage, option strategies, and sector and market neutral strategieswhere shares are sold short to hedge exposure from derivative instruments.
Commissions
Goldman Sachs generates commissions by executing agency transactions onmajor stock and futures exchanges worldwide. We effect agency transactions forclients located throughout the world. In recent years, aggregate commissionshave increased as a result of growth in transaction volume on the majorexchanges. As discussed above, commissions also include the increased share ofincome and gains from merchant banking funds as well as commissions earned frombrokerage transactions for high net worth individuals. For a discussionregarding our increased share of the income and gains from our merchant bankingfunds, see " Merchant Banking" above, and for a discussion regarding highnet worth individuals, see " Asset Management Clients" above.
In anticipation of continued growth in electronic connectivity andonline trading, Goldman Sachs has made strategic investments in alternativetrading systems to gain experience and participate in the development of thismarket. See "Risk Factors The Financial Services Industry Is IntenselyCompetitive and Rapidly Consolidating Our Revenues May Decline Due toCompetition from Alternative Trading Systems" for a discussion of thecompetitive risks posed by alternative trading systems generally.
Our Global Investment Research Department provides fundamental researchon economies, debt and equity markets, commodities markets, industries andcompanies on a worldwide basis. For over two decades, we have committed theresources on a global scale to develop an industry-leading position for ourinvestment research products. We believe that investment research is asignificant factor in our strong competitive position in debt and equityunderwritings and in our generation of commission revenues.
Major investors worldwide recognize Goldman Sachs for its value-addedresearch products, which are highly rated in client polls across the Americas,Europe and Asia. Our Research Department is the only one to rank in the topthree in each of the last 15 calendar years in Institutional Investor's"All-America Research Team" survey. In December 1998, the Research Departmentalso achieved top honors for global investment research from InstitutionalInvestor. In Europe, based on the Institutional Investor "1999 All- Europe Research Team" survey, the Research Department ranked number one forcoverage of pan-European sectors and number three in European Strategy andEconomics.
Global Investment Research employs a team approach that provides equityresearch coverage of approximately 2,300 companies worldwide, 53 economies and26 stock markets. This is accomplished through four groups:
- the Economic Research group, which formulates macroeconomic forecasts for economic activity, foreign exchange, and interest rates based on the globally coordinated views of its regional economists;
- the Portfolio Strategy group, which forecasts equity market returns and provides recommendations on both asset allocation and industry representation;
- the Company/Industry group, which provides fundamental analysis, forecasts and investment recommendations for companies and industries worldwide. Equity research analysts are organized regionally by sector and globally into more than 20 industry teams, which allows for extensive collaboration and knowledge sharing on important investment themes; and
- the Commodities Research group, which provides research on the global commodity markets.
We believe that Internet technology and electronic commerce will, overtime, change the ways that securities are traded and distributed, creating bothopportunities and challenges for our businesses. In response, we have a programof internal development and external investment.
Internally, we are extending our global electronic trading andinformation distribution capabilities to our clients via the Internet. Thesecapabilities cover many of our fixed income, equities and mutual fund productsin markets around the world. We are also using the Internet to improve the easeand quality of communication with our institutional and high net worth clients.For example, investors have on-line access to our investment research, mutualfund data and valuation models and our high net worth clients are increasinglyaccessing their portfolio information over the Internet. We have also recentlyestablished GS-Onlinesm, which, in conjunction with Goldman, Sachs &Co., will act as an underwriter of securities offerings via the Internet andother electronic means. GS-Onlinesm will deal initially only with otherunderwriters and syndicate members and not with members of the public.
Externally, we have invested in electronic commerce concerns such asBridge Information Systems, Inc., TradeWeb LLC, Archipelago, L.L.C., The BRASSUtility, L.L.C., OptiMark Technologies, Inc. and, most recently, Wit CapitalGroup, Inc. Through these investments, we gain an increased understanding ofbusiness developments and opportunities in this emerging sector. For adiscussion of how Goldman Sachs could be adversely affected by thesedevelopments, see "Risk Factors The Financial Services Industry IsIntensely Competitive and Rapidly Consolidating Our Revenues May DeclineDue to Competition from Alternative Trading Systems".
Technology is fundamental to our overall business strategy. GoldmanSachs is committed to the ongoing development, maintenance and use of technologythroughout the organization, with expenditures, including employee costs, ofapproximately $970 million in 1998 and a budget of $1.2 billion in 1999. We havedeveloped significant software and systems over the past several years. Ourtechnology initiatives can be broadly categorized into three efforts:
- enhancing client service through increased connectivity and the provision of high value-added, tailored services;
- risk management; and
- overall efficiency and control.
We have also developed software that enables us to monitor and analyzeour market and credit risks. This risk management software not only analyzesmarket risk on firmwide, divisional and trading desk levels, but also breaksdown our risk into its underlying exposures, permitting management to evaluateexposures on the basis of specific interest rate, currency rate, equity price orcommodity price changes. To assist further in the management of our creditexposures, data from many sources are aggregated daily into credit managementsystems that give senior management and professionals in the Credit andControllers Departments the ability to receive timely information with respectto credit exposures worldwide, including netting information, and the ability toanalyze complex risk situations effectively. Our software accesses these data,allows for quick analysis at the level of individual trades and interacts withother Goldman Sachs systems.
Technology has been a significant factor in improving the overallefficiency of many areas of Goldman Sachs. By automating many tradingprocedures, we have substantially increased our efficiency and accuracy.
We currently have projects under way to ensure that our technology isYear 2000 compliant. See "Risk Factors Our Computer Systems and Those ofThird Parties May Not Achieve Year 2000 Readiness Year 2000 ReadinessDisclosure" and "Management's Discussion and Analysis of Financial Condition andResults of Operations Risk Management Operational and Year 2000Risks Year 2000 Readiness Disclosure" for a further discussion of the riskswe face in achieving Year 2000 readiness and our progress to date.
Management believes that one of the strengths and principal reasons forthe success of Goldman Sachs is the quality and dedication of its people and theshared sense of being part of a team. Goldman Sachs was ranked number seven inFortune magazine's "The 100 Best Companies to Work for in America" inJanuary 1999 and was ranked number three in Fortune magazine's 1999 "TheTop 50 MBA Dream Companies", the highest ranking investment banking andsecurities firm in each case. We strive to maintain a work environment thatfosters professionalism, excellence, diversity and cooperation among ouremployees worldwide.
Instilling the Goldman Sachs culture in all employees is a continuousprocess, of which training is an essential part. We recently opened a 34,000square foot training center in New York City, near our world headquarters. Allemployees are offered the opportunity to participate in education and periodicseminars that we sponsor at various locations throughout the world. We alsosponsor off-site meetings for the various business units that are designed topromote collaboration among co-workers.
Another important part of instilling the Goldman Sachs culture in allemployees is our employee review process. Employees arereviewed by supervisors, co-workers and employees they supervise in a 360-degreereview process that is integral to our team approach. In 1998, over 140,000reviews were completed, evidencing the comprehensive nature of this process.
We also believe that good citizenship is an important part of being amember of the Goldman Sachs team. To that end, we established our CommunityTeamWorks initiative in 1997. As part of Community TeamWorks, all employees areoffered the opportunity to spend a day working at a charitable organization oftheir choice while continuing to receive their full salary for that day. In1998, approximately two-thirds of our employees participated in CommunityTeamWorks. The commitment of our partners to the community is also demonstratedby their having given over $90 million in each of the last two years tocharities, including private foundations.
As of February 1999, we had approximately 13,000 employees. Inaddition, The Archon Group, L.P. and Archon Group (France) S.C.A., subsidiariesof Goldman Sachs that provide real estate services for our real estateinvestment funds, had a total of approximately 1,260 employees as of February1999. Goldman Sachs is reimbursed for substantially all of the costs of theseemployees by these funds.
See "Management The Employee Initial Public Offering Awards" for adiscussion of the steps taken by Goldman Sachs to encourage the continuedservice of its employees after the offerings and see "Risk Factors OurConversion to Corporate Form May Adversely Affect Our Ability to Recruit, Retainand Motivate Key Employees" for a discussion of the factors that may have anadverse impact on the effectiveness of these efforts.
The financial services industry and all of our businesses areintensely competitive, and we expect them to remain so. Our competitors areother brokers and dealers, investment banking firms, insurance companies,investment advisors, mutual funds, hedge funds, commercial banks and merchantbanks. We compete with some of our competitors globally and with some others ona regional, product or niche basis. We compete on the basis of a number offactors, including transaction execution, our products and services, innovation,reputation and price.
Competition is also intense for the attraction and retention ofqualified employees. Our ability to continue to compete effectively in ourbusinesses will depend upon our ability to attract new employees and retain andmotivate our existing employees. See " Employees" for a discussion of ourefforts in this regard.
In recent years there has been substantial consolidation andconvergence among companies in the financial services industry. In particular, anumber of large commercial banks, insurance companies and other broad-basedfinancial services firms have established or acquired broker-dealers or havemerged with other financial institutions. Many of these firms have the abilityto offer a wide range of products, from loans, deposit-taking and insurance tobrokerage, asset management and investment banking services, which may enhancetheir competitive position. They also have the ability to support investmentbanking and securities products with commercial banking, insurance and otherfinancial services revenues in an effort to gain market share, which couldresult in pricing pressure in our businesses.
This trend toward consolidation and convergence has significantlyincreased the capital base and geographic reach of our competitors. This trendhas also hastened the globalization of the securities and other finan-cialservices markets. As a result, we have had to commit capital to support ourinternational operations and to execute large global transactions.
We believe that some of our most significant challenges andopportunities will arise outside the United States. See "Industry and EconomicOutlook" for a discussion of these challenges and opportunities. In order totake advantage of these opportunities, we will have to compete successfully withfinancial institutions based in important non-U.S. markets, particularly inEurope. Some of these institutions are larger, better capitalized and have astronger local presence and a longer operating history in these markets.
We have experienced intense price competition in some of our businessesin recent years. For example, equity and debt underwriting discounts have beenunder pressure for a number of years and the ability to execute tradeselectronically, through the Internet and other alternative trading systems mayincrease the pressure on trading commissions. It appears that this trend towardalternative trading systems will continue and perhaps accelerate. Similarly,underwriting spreads in Latin American and other privatizations have beensubject to considerable pressure in the last year. We believe that we mayexperience pricing pressures in these and other areas in the future as some ofour competitors seek to obtain market share by reducing prices.
See "Risk Factors The Financial Services Industry Is IntenselyCompetitive and Rapidly Consolidating" for a discussion of the competitive riskswe face in our businesses.
Goldman Sachs' business is, and the securities and commodity futuresand options industries generally are, subject to extensive regulation in theUnited States and elsewhere. As a matter of public policy, regulatory bodies inthe United States and the rest of the world are charged with safeguarding theintegrity of the securities and other financial markets and with protecting theinterests of customers participating in those markets, not with protecting theinterests of Goldman Sachs' shareholders or creditors. In the United States, theSEC is the federal agency responsible for the administration of the federalsecurities laws. Goldman, Sachs & Co. is registered as a broker-dealer and as aninvestment adviser with the SEC and as a broker-dealer in all 50 states and theDistrict of Columbia. Self-regulatory organizations, such as the NYSE, adoptrules and examine broker-dealers, such as Goldman, Sachs & Co. In addition,state securities and other regulators also have regulatory or oversightauthority over Goldman, Sachs & Co. Similarly, our businesses are also subjectto regulation by various non-U.S. governmental and regulatory bodies andself-regulatory authorities in virtually all countries where we haveoffices.
Broker-dealers are subject to regulations that cover all aspects of thesecurities business, including sales methods, trade practices amongbroker-dealers, use and safekeeping of customers' funds and securities, capitalstructure, record-keeping, the financing of customers' purchases and the conductof directors, officers and employees. Additional legislation, changes in rulespromulgated by self-regulatory organizations or changes in the interpretation orenforcement of existing laws and rules, either in the United States orelsewhere, may directly affect the mode of operation and profitability ofGoldman Sachs.
The U.S. and non-U.S. government agencies and self-regulatoryorganizations, as well as state securities commissions in the United States, areempowered to conduct administrative proceedings that can result in censure,fine, the issuance of cease-and-desist orders or the suspension or expulsion ofa broker-dealer or its directors, officers or employees. Occasionally, oursubsidiaries have been subject to investigations and proceedings, and sanctionshave been imposed for infractions of various regulations relating to ouractivities, none of which has had a material adverse effect on us or ourbusinesses.
The commodity futures and options industry in the United States issubject toregulation under the Commodity Exchange Act, as amended. The Commodity FuturesTrading Commission is the federal agency charged with the administration of theCommodity Exchange Act and the regulations thereunder. Goldman, Sachs & Co. isregistered with the Commodity Futures Trading Commission as a futures commissionmerchant, commodity pool operator and commodity trading advisor.
As a registered broker-dealer and member of various self-regulatoryorganizations, Goldman, Sachs & Co. is subject to the SEC's uniform net capitalrule, Rule 15c3-1. This rule specifies the minimum level of net capital abroker-dealer must maintain and also requires that at least a minimum part ofits assets be kept in relatively liquid form. Goldman, Sachs & Co. is alsosubject to the net capital requirements of the Commodity Futures TradingCommission and various securities and commodity exchanges. See Note 8 to theaudited consolidated financial statements and Note 5 to the unaudited condensedconsolidated financial statements for a discussion of our net capital.
The SEC and various self-regulatory organizations impose rules thatrequire notification when net capital falls below certain predefined criteria,dictate the ratio of subordinated debt to equity in the regulatory capitalcomposition of a broker-dealer and constrain the ability of a broker-dealer toexpand its business under certain circ*mstances. Additionally, the SEC's uniformnet capital rule imposes certain requirements that may have the effect ofprohibiting a broker-dealer from distributing or withdrawing capital andrequiring prior notice to the SEC for certain withdrawals of capital.
In January 1999, the SEC adopted revisions to its uniform net capitalrule and related regulations that permit the registration of over-the-counterderivatives dealers as broker-dealers. An over-the-counter derivatives dealercan, upon adoption of a risk management framework in accordance with the newrules, utilize a capital requirement based upon proprietary models forestimating market risk exposures. We have established Goldman Sachs FinancialMarkets, L.P. and are in the process of registering this company with the SEC asan over-the-counter derivatives dealer to conduct in a more capital efficientmanner certain over-the-counter derivative businesses now conducted in otheraffiliates.
Goldman Sachs is an active participant in the international fixedincome and equity markets. Many of our affiliates that participate in thosemarkets are subject to comprehensive regulations that include some form ofcapital adequacy rule and other customer protection rules. For example, GoldmanSachs provides investment services in and from the United Kingdom under aregulatory regime that is undergoing comprehensive restructuring aimed atimplementing the Financial Services Authority as the United Kingdom's unifiedregulator. The relevant Goldman Sachs entities in London are at presentregulated by the Securities and Futures Authority Limited in respect of theirinvestment banking, individual asset management, brokerage and principal tradingactivities, and the Investment Management Regulatory Organization in respect oftheir institutional asset management and fund management activities. Some ofthese Goldman Sachs entities are also regulated by the London Stock Exchange andother United Kingdom securities and commodities exchanges of which they aremembers. It is expected, however, that commencing in 2000 the responsibilitiesof the Securities and Futures Authority Limited and Investment ManagementRegulatory Organization will be taken over by the Financial Services Authority.The investment services that are subject to oversight by United Kingdomregulators are regulated in accordance with European Union directives requiring,among other things, compliance with certain capital adequacy standards, customerprotection requirements and conduct of business rules. These standards,requirements and rules are similarly implemented, under the same directives,throughout the European Union and are broadly comparable in scope and purpose totheregulatory capital and customer protection requirements imposed under the SECand Commodity Futures Trading Commission rules. European Union directives alsopermit local regulation in each jurisdiction, including those in which weoperate, to be more restrictive than the requirements of such directives andthese local requirements can result in certain competitive disadvantages toGoldman Sachs. In addition, the Japanese Ministry of Finance and the FinancialSupervisory Agency in Japan as well as German, French and Swiss bankingauthorities, among others, regulate various of our subsidiaries and also havecapital standards and other requirements comparable to the rules of the SEC.
Compliance with net capital requirements of these and other regulatorscould limit those operations of our subsidiaries that require the intensive useof capital, such as underwriting and trading activities and the financing ofcustomer account balances, and also could restrict our ability to withdrawcapital from our regulated subsidiaries, which in turn could limit our abilityto repay debt or pay dividends on our common stock.
We are involved in a number of judicial, regulatory and arbitrationproceedings (including those described below) concerning matters arising inconnection with the conduct of our businesses. We believe, based on currentlyavailable information, that the results of such proceedings, in the aggregate,will not have a material adverse effect on our financial condition, but might bematerial to our operating results for any particular period, depending, in part,upon the operating results for such period.
MobileMedia Securities Litigation
Goldman, Sachs & Co. has been named as a defendant in a purported classaction lawsuit commenced on December 6, 1996 and pending in the U.S. DistrictCourt for the District of New Jersey. This lawsuit was brought on behalf ofpurchasers of common stock of MobileMedia Corporation in an underwrittenoffering in 1995 and purchasers of senior subordinated notes of MobileMediaCommunications Inc. in a concurrent underwritten offering. Defendants areMobileMedia Corporation, certain of its officers and directors, and the leadunderwriters, including Goldman, Sachs & Co. MobileMedia Corporation iscurrently reorganizing in bankruptcy.
Goldman, Sachs & Co. underwrote 2,242,500 shares of common stock, for atotal price of approximately $53 million, and Goldman Sachs Internationalunderwrote 718,750 shares, for a total price of approximately $17 million.Goldman, Sachs & Co. underwrote approximately $38 million in principal amount ofthe senior subordinated notes.
The consolidated class action complaint alleges violations of thedisclosure requirements of the federal securities laws and seeks compensatoryand/or rescissory damages. In light of MobileMedia Corporation's bankruptcy, theaction against it has been stayed. Defendants' motion to dismiss was denied inOctober 1998.
Antitrust Matters Relating to Underwritings
Goldman, Sachs & Co. is one of numerous financial services companiesthat have been named as defendants in certain purported class actions brought inthe U.S. District Court for the Southern District of New York by purchasers ofsecurities in public offerings, who claim that the defendants engaged inconspiracies in violation of federal antitrust laws in connection with theseofferings. The plaintiffs in each instance seek treble damages as well asinjunctive relief. One of the actions, which was commenced on August 21, 1998,alleges that the defendants have conspired to discourage or restrict the resaleof securities for a period after the offerings, including by imposing "penaltybids". Defendants moved to dismiss the complaint in November 1998. Theplaintiffs amended their complaint in February 1999, modifying their claims invarious ways, including limiting the proposed class to retail purchasers ofpublic offerings. Several other actions were commenced, beginning onNovember 3, 1998, that allege that the defendants, many of whom are also namedin the other action discussed above, have conspired to fix at 7% the discountthat underwriting syndicates receive from issuers of shares in certainofferings.
Goldman, Sachs & Co. received a Civil Investigative Demand on April 29,1999 from the U.S. Department of Justice requesting information with respect toits investigation of an alleged conspiracy among securities underwriters to fixunderwriting fees.
Rockefeller Center Properties, Inc. Litigation
Several former shareholders of Rockefeller Center Properties, Inc.brought purported class actions in the U.S. District Court for the District ofDelaware and the Delaware Chancery Court arising from the acquisition ofRockefeller Center Properties, Inc. by an investor group in July 1996. Thedefendants in the actions include, among others, Goldman, Sachs & Co., WhitehallReal Estate Partnership V, a fund advised by Goldman, Sachs & Co., a Goldman,Sachs & Co. managing director and other members of the investor group. Thefederal court actions, which have since been consolidated, were filed beginningon November 15, 1996, and the state court action was filed on May 29, 1998.
The complaints generally allege that the proxy statement disseminatedto former Rockefeller Center Properties, Inc. stockholders in connection withthe transaction was deficient, in violation of the disclosure requirements ofthe federal securities laws. The plaintiffs are seeking, among other things,unspecified damages, rescission of the acquisition, and/or disgorgement.
In a series of decisions, the federal court has granted summaryjudgment dismissing all the claims in the federal action. The plaintiffs haveappealed those rulings.
The state action has been stayed pending disposition of the federalaction.
Reichhold Chemicals Litigation
Reichhold Chemicals, Inc. and Reichhold Norway ASA brought a claim inMarch 30, 1998 in the Commercial Court in London against Goldman SachsInternational in relation to the plaintiffs' 1997 purchase of the polymerdivision of one of Goldman Sachs International's Norwegian clients, Jotun A/S.The plaintiffs claim that they overpaid by $40 million based uponmisrepresentations concerning the financial performance of the polymerdivision.
In November 1998, the Commercial Court granted Goldman SachsInternational's application for a stay of the action pending the outcome ofarbitration proceedings between Reichhold Chemicals, Inc. and Reichhold NorwayASA, on the one hand, and Jotun A/S in Norway, on the other. The stay order iscurrently being reviewed by an appellate court.
Matters Relating to Municipal Securities
Goldman, Sachs & Co., together with a number of other firms active inthe municipal securities area, has received requests beginning in June 1995 forinformation from the SEC and certain other federal and state agencies andauthorities with respect to the pricing of escrow securities sold by Goldman,Sachs & Co. to certain municipal bond issuers in connection with the advancedrefunding of municipal securities. Goldman, Sachs & Co. understands that certainmunicipal bond issuers to which Goldman, Sachs & Co. sold escrow securities havealso received such inquiries.
There have been published reports that an action under the FederalFalse Claims Act was filed in February 1995 alleging unlawful and undisclosedovercharges in certain advance refunding transactions by a private plaintiff onbehalf of the United States and that Goldman, Sachs & Co., together with anumber of other firms, is a named defendant in that action. The complaint wasreportedly filed under seal while the government determines whether it willpursue the claims directly.
Goldman, Sachs & Co. is also one of many municipal underwriting firmsthat have been named as defendants in a purported class action brought onNovember 24, 1998 in the U.S. District Court for the Middle District of Floridaby the Clerk of Collier County, Florida on behalf of municipal issuers whichpurchased escrow securities since October 1986 in connection with advancerefundings. The amended complaint alleges that the securities were excessively"marked up" in violation of the Investment Advisers Act and Florida law, andseeks to recover the difference between the actual and alleged "fair" prices.The defendants moved to dismiss the complaint on April 30, 1999.
AMF Securities Litigation
The Goldman Sachs Group, L.P., Goldman, Sachs & Co. and a Goldman,Sachs & Co. managing director have been named as defendants in a purported classaction lawsuit commenced on April 27, 1999 in the U.S. District Court for theSouthern District of New York. This lawsuit was brought on behalf of purchasersof stock of AMF Bowling, Inc. in an underwritten initial public offering of15,525,000 shares of common stock in November 1997 at a price of $19.50 pershare. Defendants are AMF Bowling, Inc., certain officers and directors of AMFBowling, Inc. (including the Goldman, Sachs & Co. managing director), and thelead underwriters of the offering (including Goldman, Sachs & Co.). Thecomplaint alleges violations of the disclosure requirements of the federalsecurities laws and seeks compensatory damages and/or rescission. The complaintasserts that The Goldman Sachs Group, L.P. and the Goldman, Sachs & Co. managingdirector are liable as controlling persons under the federal securities lawsbecause certain funds managed by Goldman Sachs owned a majority of theoutstanding common stock of AMF Bowling, Inc. and the managing director servedas its chairman at the time of the offering.
Our principal executive offices are located at 85 Broad Street, NewYork, New York, and comprise approximately 969,000 square feet of leased space,pursuant to a lease agreement expiring in June 2008 (with an option to renew forup to 20 additional years). We also occupy over 500,000 square feet at each of 1New York Plaza and 10 Hanover Square in New York, New York, pursuant to leaseagreements expiring in September 2004 (with an option to renew for ten years)and June 2018, respectively. We also have a 15-year lease for approximately590,000 square feet at 180 Maiden Lane in New York, New York, that expires inMarch 2014. In total, we lease over 3.1 million square feet in the New Yorkarea, having more than doubled our space since November 1996. We have additionaloffices in the United States and elsewhere in the Americas. Together, theseoffices comprise approximately 650,000 square feet of leased space.
Consistent with Goldman Sachs' global approach to its business, we alsohave offices in Europe, Asia, Africa and Australia. In Europe, we have officesthat total approximately 790,000 square feet. Our largest presence in Europe isin London, where we lease approximately 639,000 square feet through variousleases, with the principal one, for Peterborough Court, expiring in 2016. Anadditional 396,000 square feet of leased space in London is expected to beoccupied during 2001.
In Asia, we have offices that total approximately 360,000 square feet.Our largest offices in these regions are in Tokyo and Hong Kong. In Tokyo, wecurrently lease approximately 175,000 square feet under leases that expirebetween November 1999 and June 2005. In Hong Kong, we currently leaseapproximately 103,000 square feet under a lease that expires in May 2000. Werecently entered into a new 12-year lease in Hong Kong for approximately 190,000square feet. There are also significant expansion efforts underway in Tokyo andSingapore.
Our space requirements have increased significantly over the lastseveral years. Currently, Goldman Sachs is at or near capacity at most of itslocations. As a result, we have been actively leasing additional space tosupport our anticipated growth. Based on our progress to date, we believe thatwe will be able to acquire additional space to meet our anticipated needs.
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