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Thursday, March 15, 2012 1:35 AM

Executive Director of Goldman Sachs Resigns Over Parasitic Behavior of Goldman to Its Clients; Reflections on Chasing Performance

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Greg Smith's op-ed in the New York Times "Why I Am Leaving Goldman Sachs" is precisely the catalyst that will eventually bring reform to the securities industry.

Denial Coming Up

Unfortunately, neither the Fed nor the SEC has any inclination to do anything about industry-wide fraud and corruption, therefore immediate results are not forthcoming.

Moreover, Goldman Sachs will deny the story every step of the way. Furthermore, it is safe to assume the SEC will turn a blind eye to these charges while preparing for the next headline case against another Martha Stewart on another meaningless charge.

With that backdrop, please consider these snips from Greg Smith, former Goldman Sachs executive director and head of the firm’s United States equity derivatives business in Europe, the Middle East and Africa.

TODAY is my last day at Goldman Sachs. After almost 12 years at the firm — first as a summer intern while at Stanford, then in New York for 10 years, and now in London — I believe I have worked here long enough to understand the trajectory of its culture, its people and its identity. And I can honestly say that the environment now is as toxic and destructive as I have ever seen it.

I was selected as one of 10 people (out of a firm of more than 30,000) to appear on our recruiting video, which is played on every college campus we visit around the world. In 2006 I managed the summer intern program in sales and trading in New York for the 80 college students who made the cut, out of the thousands who applied.

I knew it was time to leave when I realized I could no longer look students in the eye and tell them what a great place this was to work.

When the history books are written about Goldman Sachs, they may reflect that the current chief executive officer, Lloyd C. Blankfein, and the president, Gary D. Cohn, lost hold of the firm’s culture on their watch. I truly believe that this decline in the firm’s moral fiber represents the single most serious threat to its long-run survival.

What are three quick ways to become a leader? a) Execute on the firm’s “axes,” which is Goldman-speak for persuading your clients to invest in the stocks or other products that we are trying to get rid of because they are not seen as having a lot of potential profit. b) “Hunt Elephants.” In English: get your clients — some of whom are sophisticated, and some of whom aren’t — to trade whatever will bring the biggest profit to Goldman. Call me old-fashioned, but I don’t like selling my clients a product that is wrong for them. c) Find yourself sitting in a seat where your job is to trade any illiquid, opaque product with a three-letter acronym.

Today, many of these leaders display a Goldman Sachs culture quotient of exactly zero percent. I attend derivatives sales meetings where not one single minute is spent asking questions about how we can help clients. It’s purely about how we can make the most possible money off of them. If you were an alien from Mars and sat in on one of these meetings, you would believe that a client’s success or progress was not part of the thought process at all.

Brainwash and Promote

There is much more in the NY Times article, but that is the core of it, and clearly the core is rotten.

There is no fiduciary responsibility in the industry "in general". Of course, you can find a select few fund managers and subordinates that put their clients first but that is the exception, not the rule.

The fact remains, firms brainwash and promote from within those willing to tout the company line "you need to be 100% invested 100% of the time", in whatever garbage the firm wants to unload.

Over time, purposely brainwashed employees move higher and higher up the ranks. A trickle down effect ensures that subordinates believe they are serving clients' interests when they are in reality doing nothing of the sort.

I discussed this before, many times but the best example comes from  a conversation I had in January 2009.
Conflicts of Interest in "Stay the Course" Advice

In January of 2009 before the final 20% plunge in the stock market, an investment advisor from Wachovia Securities called me up and stated "Mish, I am sitting on millions because I see nothing I like".

I told the person I did not like much either and that Sitka Pacific was heavily in cash and or hedged. His response was "Well, I do not get paid anything if my clients are sitting in cash".

I called up a rep at Merrill Lynch and he said the same thing, that reps for Merrill Lynch do not get paid if their clients are sitting in cash.

Massive Conflict of Interest

Notice the massive conflict of interest possibilities. Reps for various broker dealers have a vested interest in keeping clients 100% invested 100% of the time, even if they know it is wrong. And so during every recession and every boom alike, bad advice permeates the airwaves and internet "Stay The Course".

By the way, that person at Wachovia mentioned above did the right thing. He did not see investment opportunities he liked, so he kept client funds in cash. Such action is not the norm.

Bullishness Sells

The fact that managers do not get paid if clients sit in cash accounts for a great deal of the long-term-buy-and-hold mentality you see. The rest of it comes from analysts who have a vested interest via relationships to broker-dealers to be optimistic.
The allegations of Greg Smith are far more damning. What Smith describes is more along the lines of perpetrated fraud by representatives of JP Morgan against citizens of Jefferson County Alabama.

Please see Jefferson County Alabama Hires Bankruptcy Firm; Record Municipal Bankruptcy Coming; Death Spiral Swaps and JPMorgan Fraud Revisited for details.

Asking Broker for Advice

Unless you have $10 million or more to invest (and perhaps even then), it is a huge mistake to ask a large brokerage firm for an opinion. They will likely sell you GM bonds, bank stocks, or whatever total garbage the firm wants to short or the firm's big clients want to dump.

I made a blanket statement to emphasize a point. However, there are honest dealers and honest advisors out there. You may have one of them. Then again, you may have an honest but "brainwashed" dealer. It is important yet not easy to recognize the difference.

Flat out, if your broker advised you to load up on GM bonds prior to the collapse, or if your broker kept you fully invested in 2008, that person is not someone you can trust.

However, no one is perfect. It is important to look at overall track records and it is equally important to find someone that actually invests according to what they say, and according to a style of investment you desire.

Portfolio fluctuations over months (even years for long-term investors)  are inevitable. However, 50% portfolio declines are not.

Question of Style

If you have an advisor, do you really believe what they are saying, and does their long-term track record pan out with what they say? Alternatively, if you are short-term or swing trader, are you getting the advice and picks you need?

Whatever you do, don't trade out of your style. If you a a long-term trader, do not get caught up in short-term noise. If you are a short-term trader, the big macro picture is useless.

Know Your Time Horizon

Know your time horizon, style and the strengths of your advisor. If they do not match up, then find a new one, but don't arbitrarily chase the latest and greatest returns.

John Paulson made a billion dollars betting against the housing bubble, then the Paulson Flagship Fund Lost 50% of Assets Under Management in 2011.

On February 15, Forbes reported John Paulson Dumps Biggest Banks, Doubles-Down on Gold.
Paulson & Co. founder John Paulson wants to put 2011 behind him, given the huge losses his hedge fund amassed. The billionaire investor is seeking to rebound from an atrocious performance with new investments in companies including Delphi Automotive (DLPH) and United Rentals (URI).

After earning a record $5 billion for a hedge fund manager with the help of gold and bank stocks, Paulson is now slashing some of those holdings to reduce exposure. His flagship Advantage Plus Fund plummeted 51% last year, according to several media reports that cite investors in the fund.

Paulson took part in some dramatic sales during the fourth quarter, unloading his entire position in stocks like Citigroup (C), Bank of America (BAC) and Hewlett-Packard (HPQ), among others.
Reflections on Chasing Performance

If you have a reason to change managers then please do so (management philosophy, long-term vs. short-term style is a potential reason).

However, if you are constantly chasing performance, the most probable result is you will perpetually be one step too late, forever chasing your tail.

Mike "Mish" Shedlock
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