Securities and Exchange Commission

Litigation Release No. 18113 / April 28, 2003

Securities and Exchange Commission v. Goldman, Sachs & Co., 03 CV 2944 (WHP) (S.D.N.Y.)

SEC SUES GOLDMAN SACHS FOR RESEARCH ANALYST CONFLICTS OF INTEREST FIRM TO SETTLE WITH SEC, NASD, NYSE, NY ATTORNEY GENERAL, AND STATE REGULATORS

The Securities and Exchange Commission announced today that it has settled charges against Goldman, Sachs & Co., a New York-based investment bank and securities firm, arising from an investigation of research analyst conflicts of interest. This settlement, and settlements with nine other brokerage firms, are part of the global settlement the firms have reached with the Commission, NASD, Inc., the New York Stock Exchange, Inc. ("NYSE"), the New York Attorney General, and other state regulators. As part of the settlement, Goldman Sachs has agreed to pay $25 million as disgorgement and an additional $25 million in penalties. One-half of the total of these payments - $25 million - will be paid in connection with the SEC action and related proceedings by the NASD and NYSE and will be placed into a distribution fund for the benefit of customers of the firm. The remainder will be paid to resolve related proceedings by state regulators. In the SEC action, Goldman Sachs has agreed to a federal court order that will enjoin the firm from future violations of NASD and NYSE rules and require the firm to make changes in the operations of its equity research and investment banking divisions. In addition, Goldman Sachs will pay, over five years, $50 million to provide the firm's clients with independent research, and $10 million to be used for investor education.

In connection with this matter, the Commission today filed a Complaint against Goldman Sachs in the U.S. District Court for the Southern District of New York, alleging violations of NASD and NYSE rules. According to the Commission's Complaint, from at least July 1999 through June 2001, research analysts at Goldman Sachs were subject to inappropriate influence by investment banking at the firm. The Complaint also alleges that Goldman Sachs published exaggerated or unwarranted research and failed to maintain appropriate supervision over its research and investment banking operations.

Specifically, the Commission's Complaint alleges that:

• Goldman Sachs compensated its analysts based at least in part upon their participation in the firm's investment banking-related activities. Analysts were required to prepare business plans that discussed, among other things, what steps the analysts planned to take to assist investment banking efforts. In preparing these business plans, analysts were required to answer such questions as "How much of your time will be devoted to IBD [investment banking division]?" and "How can you work more effectively with IBD to exploit the opportunities available to the firm?" In response to the question "What are the three most important goals for you in 2000?" one analyst replied, "1. Get more investment banking revenue. 2. Get more investment banking revenue. 3. Get more investment banking revenue."

• Goldman Sachs "aligned" its research, equities, and investment banking divisions to work collaboratively in order to fully leverage its limited research resources. In 2000, Goldman Sachs concluded internally that "US Investment Research appears to be on the right track," noting that "research analysts, on 429 different occasions, solicited 328 transactions in the first 5½ months of [the year]" and that "[r]esearch was involved in 82% of all `won business' solicitations."

• Goldman Sachs analysts participated in investment banking marketing efforts, including working with investment bankers to prepare "pitch" materials and in some cases attending the pitch meetings. For example, in an April 2000 e-mail, an investment banker told an analyst that the company they were about to pitch to "strongly suggested that you guys come prepared to SELL." Some pitchbooks implicitly suggested that Goldman Sachs would provide favorable research coverage after the investment banking transaction.

• In several instances, these conflicts resulted in analysts publishing recommendations that were exaggerated or unwarranted. For example, in August 2000, the business unit leader for U.S. telecommunications research at the firm wrote to his counterpart in Europe: "The plan we have in place now is that in early September we are going to re-rate most of the CLECs [competitive local exchange carriers], which is where the problem is most egregious. The ratings were a residual from [a former analyst], and I never changed them, not wanting to disrupt things too much. But it's ridiculous. I've already met with the bankers, and plan to move most of the companies down to M[arket] O[utperformer], from RL [the highest rating]. For the other segments the situation is not as bad, and where there is a problem, investment banking considerations have prevented me from making a change (i.e. AT&T, WCOM). I don't think I would end up leaving only 7.5% as RL, but the present 68% is ridiculous...."

• Goldman Sachs failed to establish and maintain adequate policies, systems, and procedures reasonably designed to ensure the objectivity of its published research.

Goldman Sachs has agreed to settle the Commission's action and has consented, without admitting or denying the allegations of the Complaint, to the entry of a final judgment that, if approved by the court, permanently enjoins Goldman Sachs from violations of NASD and NYSE rules pertaining to just and equitable principles of trade (NASD Rule 2110; NYSE Rules 401 and 476), advertising (NASD Rule 2210; NYSE Rule 472), and supervisory procedures (NASD Rule 3010; NYSE Rule 342). The final judgment also orders the firm to make the payments described above, and provides for the appointment of a fund administrator who, subject to court approval, will formulate and administer a plan of distribution for those monies placed into the distribution fund.

In addition, the final judgment orders Goldman Sachs to implement structural reforms and provide enhanced disclosure to investors, including a broad range of changes relating to the operations of its equity research and investment banking operations. Goldman Sachs has agreed to sever the links between research and investment banking, such that: research and investment banking are physically separated with completely separate reporting lines; analysts' compensation cannot be based directly or indirectly upon investment banking revenues; investment bankers may no longer evaluate analysts; investment bankers will have no role in determining what companies are covered by the analysts; and research analysts will be prohibited from participating in efforts to solicit investment banking business, including pitches and roadshows. In addition, Goldman Sachs must disclose on the first page of each research report whether the firm does or seeks to do investment banking business with that issuer, and when Goldman Sachs decides to terminate coverage of an issuer, Goldman Sachs must issue a final research report discussing the reasons for the termination. Each quarter, Goldman Sachs also will publish on its website a chart showing its analysts' performance, including each analyst's name, ratings, price targets, and earnings per share forecasts for each covered company, as well as an explanation of the firm's rating system.

Goldman Sachs also has agreed as part of this settlement to retain, at its own expense, an Independent Monitor to conduct a review to provide reasonable assurance that the firm is complying with the structural reforms. This review will be conducted eighteen months after the date of the entry of the Final Judgment and the Independent Monitor will submit a written report of his or her findings to the SEC, NASD, and NYSE within six months after the review begins. Five years after the entry of the final judgment, Goldman Sachs must certify to the SEC and other regulators that it has complied in all material respects with the requirements and prohibitions of the structural reforms.

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The Commission acknowledges the assistance of NASD, NYSE, the Securities Division of the Utah Department of Commerce, and other state regulators in the investigation of this matter.

SEC Complaint in this matter
SEC Final Judgment in this matter
Final Judgment Appendix A
Final Judgment Appendix B
Consent