In 1954, after 25 years, the Dow Jones Industrial Average regained its previous all-time high set in August of 1929.  Coincidentally, that same year Harvard economist John Kenneth Galbraith published his landmark study of the debacle, The Great Crash: 1929.  Galbraith was no fan of unfettered capital markets, and blamed the crash on rampant speculation, among other things, fueled by what he saw as Wall Street’s pervasive greed.  Indeed, the third chapter of Galbraith’s book carries the infelicitous title “In Goldman Sachs We Trust,” so named for Wall Street’s then-leading investment bank more as a portent than a compliment.

One is led to recall Galbraith’s trenchant criticisms of Goldman, and indeed the pervasive culture of Wall Street, after the events of March 14, 2012 — a date that financial historians may one day recall as an inflection point.  For on that day, a young but rising executive director in Goldman Sachs’ London office, Greg Smith, emailed his superiors at 0640 AM in London to inform them of his immediate resignation from the firm.  What he did not tell them was that 15 minutes later, an op-ed essay penned by him to describe his resignation was published on the website of the New York Times, and in turn appeared on Page A27 as the lead guest editorial in the print edition of the Times later that morning.  Mr. Smith, an 11-year veteran of Goldman in New York and London, went very public with his reasons for leaving the firm, which became the talk of major national news outlets for the entire day and beyond.  By day’s end the Chairman of Goldman Sachs, Lloyd C. Blankfein, had issued a rebuttal to Mr. Smith’s charges, but on a day when the KBW benchmark index fund was up 1.1% and U.S. equities in general finished up slightly, Goldman’s shares (GS) tumbled 3.4%, for a decline of $2.15 billion in market capitalization.

Mr. Smith’s criticisms of Goldman Sachs contain a great lesson for all who are concerned with managing their financial affairs, and his words are worth considering at some length, in their precise form:

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.

To put the problem in the simplest terms, the interests of the client continue to be sidelined in the way the firm operates and thinks about making money…..  I can no longer in good conscience say that I identify with what it stands for……

When the history books are written about Goldman Sachs, they may reflect that [Goldman’s senior management] lost hold of the firm’s culture…. I truly believe that this decline in the firm’s moral fiber represents the single most serious threat to its long-run survival……I have always taken a lot of pride in advising my clients to do what I believe is right for them, even if it means less money for the firm. This view is becoming increasingly unpopular at Goldman Sachs….. Today, if you make enough money for the firm (and are not currently an ax murderer) you will be promoted into a position of influence…..

What are [some sure ways to career success at Goldman Sachs now]?  a) [P]ersuade 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) [G]et 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….. 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.

It makes me ill how callously people talk about ripping their clients off. Over the last 12 months I have seen five different managing directors refer to their own clients as “muppets,” sometimes over internal e-mail….. Integrity? It is eroding. I don’t know of any illegal behavior, but will people push the envelope and pitch lucrative and complicated products to clients even if they are not the simplest investments or the ones most directly aligned with the client’s goals? Absolutely. Every day, in fact.

It astounds me how little senior management gets a basic truth: If clients don’t trust you they will eventually stop doing business with you. It doesn’t matter how smart you are.

My proudest moments in life….. have all come through hard work, with no shortcuts. Goldman Sachs today has become too much about shortcuts and not enough about achievement. It just doesn’t feel right to me anymore.

I hope this can be a wake-up call to the board of directors. Make the client the focal point of your business again. Without clients you will not make money. In fact, you will not exist. Weed out the morally bankrupt people, no matter how much money they make for the firm. And get the culture right again, so people want to work here for the right reasons. People who care only about making money will not sustain this firm — or the trust of its clients — for very much longer.

In short, Mr. Smith describes a pervasive culture inside Goldman Sachs in which there are often divergences of interest between the firm and its clients wherein Goldman employees are encouraged to put the firm’s interests ahead of its clients.  These divergences are formally known as conflicts of interest between a “principal” and an “agent” whom the principal employs to act on his behalf, and there is a wide literature in economics on their ubiquity in modern finance.  The most common example of this is when a principal (or, client) hires an agent (such as Goldman Sachs) to act on his or her behalf in managing money, but the agent does not act in support of the client’s best interests first, instead favoring the interests of himself or his firm.

For example, a stock-broker who works on 100% commission is paid only when there are transactions with client portfolios.  What if the broker has financial pressures at a personal level — say, a spouse who does not work, three young children, and a mortgage to pay?  And, what if the client’s portfolio is currently diversified and performing well?  If the client owns shares of, say, IBM, a self-interested broker may initiate the sale of IBM and purchase of, say, Procter & Gamble, even if IBM were a solid holding or better for that client, merely to initiate a transaction that involves brokerage fees and commissions.  This has been called “account churning,” and it is so common in both retail and institutional investment management that it is often subconscious, and certainly unspoken.  Other examples of this phenomenon — from among dozens one could cite in everyday life — are an insurance agent selling more coverage than the client needs, selling hard-to-understand products to unsophisticated clients who do not need or cannot exploit the product’s complexity, or advising a client to pursue a transaction when unnecessary or even ill-timed.

Alhambra Partners was founded for the express purpose of avoiding these all-too-common conflicts of interest, and indeed, we only recruit employees who expressly insist on working under our fee-based registered advisor model.  We insist on full transparency and disclosure in every activity of the firm, and are publishing a series of works over time designed to educate and inform our clients — and a broader audience — about how the markets and the economy work, and indeed how our own business works.

To young Mr. Smith, the first-hand education he received about these pervasive conflicts of interest while at Goldman Sachs will serve him well over the balance of his career, in informing him how to act with honor and on behalf of clients’ bests interests at all times moving forward.  And we applaud him for walking away from Goldman’s lucre once he was mature enough to see how that firm has so often harmed its own clients — in ways the clients often will never understand.  The kinds of things Mr. Smith describes as part of Goldman’s culture now, including continual derision of the firm’s own clients, infuriates us all at Alhambra, because such activity reflects poorly on the profession of investment management as a whole.  Indeed this is a profession we in our firm, at least, regard as a noble line of work, in managing the net worth — and future dreams — of our clients.  On the other hand, we are convinced that both our passion for the business and integrity in doing what is best for Alhambra’s clients 100% of the time bodes well for us in the years ahead.  For of this we are certain: our commitment to excellence and integrity in all things assures our firm of a bright future, whereas an unchanging Goldman Sachs may well come to rue Mr. Smith’s warnings in the New York Times as the death knell for a corrupt and dying business model, in a better-informed world where transparency and fair dealing can still count for something sublime.

Joe Calhoun is Founder and Chief Executive of Alhambra Investment Partners, a Miami-based money management firm.  For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, Mr. Calhoun can be reached at jyc3@4kb.d43.myftpupload.com. 

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