Rebecca Byrne

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Goldman's Luster May Be Fading

Rebecca Byrne

Can Goldman Sachs(GS Quote) get its white shoes clean again?

For a long time, Goldman had largely escaped the criticism that Merrill Lynch(MER Quote), Citigroup's(C Quote) Salomon Smith Barney and Credit Suisse First Boston(CSR Quote) had received for their investment banking practices. Yes, New York state attorney general Eliot Spitzer included Goldman among the Wall Street firms he was investigating. But Goldman has been burnishing its image as "different" in the past few months -- a little cleaner than its rivals -- and the efforts had been successful.

Then came the revelation late Wednesday that Goldman doled out coveted IPO shares to executives at 21 companies and may have engaged in "spinning" -- allocating IPOs to top executives as an incentive to win investment banking business. Goldman denies the spinning allegation, and some analysts agree with the firm. The company's stock eased 4% to $62.90 -- not much damage in these scandal-phobic days.

However, the damage to Goldman's reputation may have long-term repercussions, denting the escutcheon of the 136-year-old firm and undermining its cachet as an underwriter and a stock.

"It's terrible public relations," noted Brad Hintz, an analyst at Bernstein.

Goldman's Stock

Still, Hintz, who has a "screaming" buy on Goldman but doesn't own the stock, said the news is "unlikely to lead to criminal investigations or even civil liability." Although things look bad now, the longer-term effects are probably negligible, he said.

David Trone, an analyst at Prudential Securities, says that nothing has emerged that would serve as evidence of quid pro quo. "As a result, while the headlines are big and the stock may be under pressure, this turn of events appears to have no real legal relevance."

But others aren't so sure that more serious damage hasn't been done to Goldman Sachs as a result of these new discoveries. One of the main reasons that the firm has proven so successful over the years has been because of its solid reputation.

"The idea that Goldman is somehow different doesn't work for me," said Tim Ghriskey, president of Ghriskey Capital. "Clearly they were involved in this as much as anybody."

Goldman's Mystique

Up until it became a public entity in 1999 -- after a rancorous internal debate among the rarefied ranks of Goldman partners -- much of the firm's dirty laundry was kept secret. Its role as lone "partnership" among publicly traded rivals added to the mystique around Goldman. With the company's flaws and inadequacies now in the public domain, along with its aggressive role in the Internet IPO boom, that mystique appears to be fading.

In recent months, Goldman had made an effort to distance itself from allegations of wrongdoing. Back in June, CEO Henry Paulson made a speech in which he called for reform within the financial system to restore public confidence in business principles and practices.

"Integrity is the cornerstone, if not the bedrock, upon which all financial markets are based. I am confident we can move beyond finger-pointing, to attain real progress on meaningful reform," he said.

Goldman also has claimed that because it caters to high net-worth individuals, not retail investors, it was never guilty of hurting the little guy during the Internet craze of the late 1990s. At the same time, however, the firm has appeased lawmakers by saying it would create a research ombudsman and a committee to review analyst compensation. It also simplified its stock-rating system.

Goldman helped underwrite dozens of Internet IPOs during the height of the bubble, many of which subsequently fell to pennies a share. Along with Morgan Stanley, Goldman executed the most Internet deals at the height of the Web IPO boom in 1998 and early 1999, according to CommScan. Meanwhile, the firm reaped hundreds of millions of dollars in fees.

Despite its protestations to the contrary, some argue that individual investors were seriously hurt by the firm's unscrupulous investment banking practices. A survey by analyst tracker Investars in May showed that average investors who followed the recommendations of Goldman's analysts would have lost 85% of their initial investment over the past year.

eToys Story

On Goldman Sachs' recommendation, the IPO was priced at $20 a share, which eToys said was substantially lower than market conditions warranted given the high demand for its shares.

The company alleges that Goldman deliberately underpriced the shares because it had entered into unlawful arrangements with its customers, who gave kickbacks to Goldman when the shares soared in the aftermarket.

Even up until this year, Goldman had engaged in some unpalatable dealings.

Consider Tesoro Petroleum(TSO Quote). Analyst Arjun Murti put the stock on the firm's recommend list on Jan. 8, just six weeks before Goldman would be named as a co-manager on a $245 million secondary stock offering for the Texas-based oil refiner.

At the time, the stock was trading for about $13 and Murti said it was "poised for a major breakout." It subsequently plunged in value, prompting Murti to reduce his rating to market outperformer. Tesoro now trades for about $2.