Goldman Sachs Case

CASE SYNOPSIS
On August 21, 2007, David Viniar, Chief Financial Officer of Goldman Sachs, received an e-mail from a
trader in Goldman’s Mortgage Department. In the e-mail, addressed also to Goldman co-presidents Gary
Cohn and Jon Winkelreid, Joshua Birnbaum outlined a proposal for the firm to move from a net short
position in subprime mortgage securities and derivatives to a net long position. Birnbaum claimed that the
net long position would not only be profitable but also reduce Mortgage Department and firm-wide risk.
This proposal came at a critical time for the subprime mortgage markets in the U.S. and around the world.
Subprime mortgage originators such as New Century had filed for bankruptcy. Two Bear Sterns hedge
funds that traded subprime mortgages had collapsed. The turmoil had also spread to global markets.
Goldman Sachs, unique among New York investment banks, had anticipated the downturn in the
subprime mortgage markets and had positioned itself to profit from the meltdown. Now, at a critical
juncture, traders on the front lines of the subprime mortgage markets wanted to reverse Goldman’s net
short position and go net long. David Viniar knew that the decision to go long could not be taken lightly
and would have major implications for the firm, the firm’s overall levels of risk, and possibly th e firm’s
survival. Goldman’s board of directors and key board members had been monitoring the firm’s subprime
exposure and would likely want to be consulted regarding such a consequential decision.

COURSES AND LEVELS

This case was designed for graduate and executive education level courses in Corporate Finance,
Banking, and Risk Management. The case may also be useful for courses in Ethics, Business and Society,
and Financial Derivatives. The complexity of the case and the issues raised may require signif icant
preparation by the instructor in order to make the case suitable for undergraduates. I taught the case in my
MBA capstone course as an introduction to the global financial crisis of 2008.

TEACHING AND LEARNING OBJECTIVES

After studying and discussing this case, students should be able to:
 Evaluate the financial condition and risk levels of Goldman Sachs and draw conclusions about the
effectiveness of its subprime mortgage strategy.
 Consider Goldman Sachs’ risk management culture, practices, and procedures and draw conclusions
regarding its effectiveness during the subprime mortgage crisis.
 Outline several ethical frameworks for evaluating Goldman Sachs’ possible conflict of interest
during the subprime mortgage crisis and contrast the conclusions drawn from these various
theoretical frameworks.

 Summarize the options available to David Viniar as he appraises Joshua Birnbaum’s e -mail and
make a cogent argument regarding what David Viniar, the board of directors and the firm should
do next.
RESEARCH METHODOLOGY
The case is based primarily on two sources. The first is the United States Senate Permanent
Subcommittee on Investigations April 2011 report titled, “Wall Street and the Financial Crisis: Anatomy
of a Financial Collapse.” The report and exhibits total over 6,400 pages, many of them internal documents
from Goldman Sachs during the 2006–2007 time period. The second main source is William Cohan’s
2011 book, Money and Power: How Goldman Sachs came to Rule the World. Cohan reports numerous
interviews with key Goldman Sachs personnel, including David Viniar and Joshua Birnbaum. Some
details regarding Birnbaum’s meeting with John Paulson came from Gregory Zuckerman’s 2010 book
titled, The Greatest Trade Ever: The Behind the Scenes Story of How John Paulson Defied Wall Street
and Made Wall Street History. Two additional resources that may be helpful to future researchers of this
era include Greg Smith’s 2012 book, Why I left Goldman Sachs, and Michael Lewis’ book, The Big Short.
Additional material came from various academic studies and articles in the mainstream financial press.
Full references are provided in the case as well as the bibliography to this instructor's manual.
It is worth noting that, while 2006 and 2007 are several years in the past, the research sources for this case
at the time it was written were very newly available. Many research sources regarding the 2006 –2008
time period faced considerable delay before publication. It is also worth noting that lawyers working on
the Permanent Subcommittee report were quite effective in redacting key documents from the report’s
exhibits. Primary documents such as the meeting minutes of Goldman’s Board of Directors and Firm-
Wide Risk Committee during this time period did not make it into the report exhibits.

LINKS TO THEORETICAL AND APPLIED FRAMEWORKS

This instructor’s manual touches on several theoretical and applied topics related to Corporate Finance,
Banking and Risk Management, and the opportunities presented by these topics for class discussion with
respect to the Goldman Sachs case are summarized below.

(1) Risk Management and Oversight

Framework: Risk and Compliance Oversight
Importance: The Board of Directors should have processes in place to regularly monitor, assess, and
oversee the firm’s overall risk. The board should receive regular reports that identify and evaluate the
financial, industry, and other business risks that the firm encounters in its normal business activities. This
oversight function is particularly acute in financial firms, where the management of risk becomes a matter
of firm survival. Some boards, particularly in the financial industry, have committees dev oted exclusively
to the oversight of firm risk.
Key concepts/topics for discussion/analysis: Did the Goldman Sachs Board of Directors demonstrate
effective oversight of the firm’s risks during the 2006–2007 time periods? Why or why not? Was this
oversight effectively integrated with Goldman’s firm wide risk management? Does Goldman Sachs as a
firm manage risk effectively? What aspects of Goldman’s culture, policies, and procedures appear to
aid/hinder the overall management of the firm’s risks? Did the Mortgage Department at Goldman Sachs
effectively manage its risk posture during 2006–2007?
Opportunities for discussion/analysis: What are the implications of the August 21, 2007 Mortgage
Department proposal for the risk profile of Goldman Sachs? Does the proposal add or subtract from the
risk that Goldman Sachs was taking in the subprime mortgage market? Why? What should be the board’s
response to the Mortgage Department’s proposal?
Specific texts and articles:
American Bar Association (2011). Corporate Director’s Guidebook, 6th Edition. Chicago, IL: ABA
Publishing. Section 4–Risk Management, Compliance and Oversight.
Clarke, T. (2007). International Corporate Governance: A Comparative Approach. New York, NY:
Routledge. Chapter 2–Boards and Directors: The Political Mechanisms of Corporate Governance.
Colley, J., et. al. (2005). What is Corporate Governance? New York, NY: McGraw Hill/Irwin. Chapter 7–
The Board’s Role in Management.
De Kluyver, C. (2009). A Primer on Corporate Governance. New York, NY: Business Expert Press.
Chapter 6–Oversight, Compliance and Risk Management.

(2) Business Ethics

Framework: Ethics and Ethical Reasoning
Importance: The effective management of conflicts of interest is a critical function for businesses that
operate in a complex legal and regulatory environment. The ineffective management of conflicts of
interest may also be damaging to a firm’s business reputation and could impair a firm’s ability to
effectively conduct its business over the longer term.
Key concepts/topics for discussion/analysis: Did Goldman Sachs’ sale of subprime mortgage-backed
securities during 2006 and 2007 represent a conflict of interest? Why or why not? What frameworks for
ethical decision-making can you apply to this situation to support and substantiate your answer? How
could Goldman Sachs more effectively handle potential conflicts of interest such as the one described in
the case?
Opportunities for discussion/analysis: Apply three or four ethical frameworks to the events described in
the Goldman Sachs case. What do each of these ethical frameworks provide in the way of insight regarding
how Goldman Sachs handled its potential conflict of interest? Do you have any other perspectives on how
Goldman could have handled this conflict? Did Goldman not have a conflict? If so, why?
Specific text chapters, articles, etc.:
Lawrence and Weber (2011). Business and Society: Stakeholders, Ethics, Public Policy, 13th Edition.
New York, NY: McGraw Hill Irwin. Chapter 4–Ethics and Ethical Reasoning.
Steiner, G. and Steiner, J. (2012). Business, Government and Society, 13th Edition. New York, NY:
McGraw Hill/Irwin. Chapter 7–Business Ethics.

(3) Value at Risk

Framework: Value at Risk
Importance: Value at Risk was the primary standard for evaluating both unit and overall firm risk at
Goldman Sachs during the 2006–2007 time period described by this case. The management of the firm
was acutely sensitive to the daily reports on this metric, and the firm’s risk management functio ns made
this daily reported number the primary basis for firm risk decision making.
Key concepts/topics for discussion/analysis: What is Value at Risk? How is it measured? Why is this
metric used? How does the overall level of the number change, based on various market conditions? What
is good about this measure? Do you see any potential flaws? What is your assessment of its usage during
the events described in the case?
Opportunities for discussion/analysis: One of the bases for the Mortgage Department’s proposal was
that moving to a net long position in subprime mortgage securities and derivatives would lower the
overall Value at Risk for not only the unit, but the firm as well. What is the basis for this argument? Is
this a sound argument? What are some potential shortcomings of this strategy, in light of overall market
conditions? What arguments can you make to support this approach? How does the addition of subprime
mortgage securities to the Goldman Sachs balance sheet improve the risk profile of the mortgage
department and the firm?
Specific texts:
Jorion, P. (2007). Value at Risk: The New Benchmark for Managing Financial Risk. New York, NY:
McGraw Hill.
Taleb, N. (2010). The Black Swan: The Impact of the Highly Improbable. New York, NY: Random House.
Mandelbrot, B. and Hudson, R. (2004). The (Mis)behavior of Markets: A Fractal View of Risk, Ruin and
Reward. New York, NY: Perseus Books.

SUGGESTED TEACHING APPROACHES AND SUPPLEMENTARY MATERIALS

If time permits, some background discussion on the U.S. housing market circa 2001–2006 may be
helpful. In addition, a brief overview of the subprime mortgage market and how mortgage debt is
securitized may also be helpful. In particular, the instructor may want to give an overview of the various
“tranches” of securitized debt and how these tranches allow investors to customize their particular risk
profile and cash flow needs. (Also, see supplementary teaching materials below.) Graduate students are
likely to be familiar with the broad scope of the subprime mortgage crisis and its causal link to the global
financial crisis of 2008. Student familiarity with the events described in this case will likely weaken as
time passes.
Further, graduate students are likely to have some knowledge of the role and functioning of the board of
directors; some preparatory material along these lines may also be necessary or helpful. Executive
Education programs will undoubtedly want to have a deeper discussion regarding the specifics of the
legal/fiduciary obligations of the board in addition to the discussion on risk management presented below.
Corporate Finance courses may want to focus on the financial instruments discussed in the case in more
detail, particularly the various tranches of the ABX index and their specific risk characteristics.
Undergraduates will require a major preliminary discussion and/or assigned readings in order to master
the material in this case. Instruction or background on the fundamentals of the banking system and
corporate finance will probably be necessary. Students with a working knowledge or coursework in
derivatives will undoubtedly better grasp the mechanics of this case.
With adequate preparation, the case can be taught in a 90-minute class period. Some instructors may want
to only focus on selected topics in the case, such as the firm’s potential conflict of interest, in a shorter
class period.

TEACHING TIP: VIDEOS

Here are three videos that may be helpful when teaching this case. They are all available in either DVD
format or may be streamed directly from the internet. I would recommend a class discussion of the case,
followed by a viewing of a video if the instructor wishes to explore issues related to the case in more
detail. For example, the Charlie Rose interview would be helpful in examining firm conflicts of interest,
while the Frontline videos explore the roots of the global financial crisis of 2008.
“Charlie Rose–Lloyd Blankfein,” Charlie Rose, first aired April 30, 2010. (57 minutes). This DVD
shows the broadcast interview of Goldman Sachs Chairman and Chief Executive Officer Lloyd Blankfein
by Charlie Rose in April 2010. The interview covers a discussion of the events described in the case as
well as the 2008 financial crisis, plus the resulting backlash on Capitol Hill. Blankfein outlines in this
wide-ranging interview the firm’s thinking on a number of issues raised in the case, and in particular on
the allegations that the firm faced a conflict of interest when dealing with customers who purchased
mortgage-backed securities. This video can be used as an introduction to the culture and leadership of
Goldman Sachs. Available for purchase in DVD format at: http://www.amazon.com/gp/product/
B003ES5GLS/?tag=charlierose-20 ($24.95). Also available in streaming video at: http://www.charlierose.com/
view/interview/10989.
“Money, Power and Wall Street,” Frontline, first aired 2012 (240 minutes). In a special four-hour
investigation, FRONTLINE tells the inside story of the origins of the financial meltdown and the battle to
save the global economy. The film explores key decisions, missed opportunities, and the unprecedented
moves by the government and banking leaders that have affected the fortunes of millions of people. This
video can be used to teach a detailed overview of the global financial crisis and its roots in the subprime
mortgage market. Available for purchase in DVD format at: http://www.shoppbs.org ($29.99). Also
available in streaming video at: http://www.pbs.org/wgbh/pages/frontline/money-power-wall-street/#a.
“The Warning,” Frontline, first aired 2009 (60 minutes). This DVD examines the roots of the 2008
global financial crisis, and traces many of these elements to decisions made during the Clinton
presidency. The DVD also explores the role of financial derivatives in amplifying the effects of the crisis,
and attributes the lack of financial regulation of these “weapons of mass destruction” to many of the most
devastating consequences of the crisis. This video can be used as a basis for the discussion of the potential
causes of the 2008 global financial crisis. Available in DVD format at: http://shopPBS.org ($24.99).
Also available in streaming video at: http://www.pbs.org/wgbh/pages/frontline/warning/view/.

SUMMARY OF DISCUSSION QUESTIONS

(1) What is the financial condition of Goldman Sachs as of the third quarter of 2007? Which areas
of the company are doing well? Which areas of the company are doing poorly? How heavily is
the firm leveraged? What do you observe about the firm’s average levels of risk, as measured
by VaR? What are your conclusions about the firm’s overall financial condition?
(2) On August 21, Josh Birnbaum e-mailed key executives at Goldman Sachs to propose that the
mortgage department go net long the subprime mortgage market. Did Birnbaum violate the
firm’s chain of command? Why or why not?
(3) Consider the risk management culture, practices and procedures of Goldman Sachs. What is
your assessment of the effectiveness of the firm’s risk management practices during the 2006–
2007 time period?
(4) Examine the various investment-banking roles played by Goldman Sachs during the events
described in the case. Did these roles conflict? Explain.
(5) Did Goldman Sachs have a conflict of interest when it sold subprime mortgage-based financial
products to its customers while, at the same time, it sold subprime mortgage securities and
shorted the subprime market? What do various ethical frameworks and points of view help
you conclude about this possible conflict of interest?
(6) Consider David Viniar’s options as he reviews the e-mail from Joshua Birnbaum. Should
Viniar support, reject, or defer judgment on the proposed strategy to go long in subprime
mortgages? What would be the proper level of review for such a decision?

DISCUSSION QUESTIONS AND ANSWERS

(1) What is the financial condition of Goldman Sachs as of the third quarter of 2007? Which areas
of the company are doing well? Which areas of the company are doing poorly? How heavily is
the firm leveraged? What do you observe about the firm’s average levels of risk, as measured
by VaR? What are your conclusions about the firm’s overall financial condition?
Goldman Sachs appeared to be in excellent financial condition at the end of the third quarter of 2007. The
August 31, 2007 quarterly statement reflected a 21.14 percent growth in revenues from the previous
quarter; overall, revenues to the firm had risen by 19.34 percent over the six quarters covered by the
financial exhibits in the case. (See Exhibit IM-1 for a financial analysis of Goldman Sachs from February
24, 2006 to August 31, 2007.)
One unit, the Fixed Income, Currencies, and Commodities (FICC) Group, was growing faster than any
other area of Goldman’s business. The FICC group contained the Mortgage Department, so it is likely
that the Mortgage Department accounted for a great deal of the FICC Group’s contribution to revenue
growth. FICC group revenues grew 45. 16 percent from 2Q2007 to 3Q2007, and had grown 30.72 percent
over the previous six quarters. Overall revenues for Goldman Sachs grew 19.34 percent from the first
quarter of 2006 to the third quarter of 2007.
Compensation and Benefits grew dramatically in the fourth quarter of 2006, likely reflecting the issuance
of year-end bonuses. Otherwise, growth in compensation and benefits, as well as overall operating
expenses, closely matched the firm’s growth (or decline) in net revenues.
Net Earnings for the firm grew from $2.4 billion in first quarter 2006 to $2.8 billion in third quarter 2007,
a 15.13 percent increase. Diluted EPS climbed from $5.08/share in 1Q2007 to $6.13/share in 3Q20 07.
Earnings for the firm were particularly strong in 4Q2006 and 1Q2007.
Total assets under management (AUM) for the firm increased from $571 billion in 1Q2006 to a whopping
$796 billion in 3Q2007. This represented an overall growth in AUM of 39.40 percent . Tangible common
shareholder’s equity also increased from $22.3 billion to $30.6 billion in 3Q2007. Despite the large
growth in AUM, leverage and net leverage for the firm remained quite stable. Net leverage increased
slightly from 25.62x to 25.98x over six quarters, while the overall leverage ratio increased slightly from
19.88x to 20.35x from 1Q2006 to 3Q2007. Goldman Sachs did not increase overall leverage levels while
AUM levels grew sharply. This likely reflects considerable restraint on the part of management to balance
strong growth with acceptable levels of firm leverage.
EXHIBIT IM-1: GOLDMAN SACHS FINANCIAL ANALYSIS (UNAUDITED)
February 24, 2006 to August 31, 2007
(Dollars in Millions, except per share data and employees)

At or for the Quarter Ended

02/24/2006 05/26/2006 08/25/2006 11/24/2006 02/23/2007 05/25/2007 08/31/2007
Revenues
Δ Investment Banking – 3.73% (15.60%) 4.35% 27.68% 0.29% 24.64%
Δ Asset Mgmt. and Securities – (18.69%) (9.63%) (1.79%) 11.76% 13.46% 8.17%
Trading and Prin. Inv.
Δ FICC – 15.40% (36.54%) 13.33% 48.32% (26.85%) 45.16%
Δ Equities – (3.96%) (34.06%) 37.40% 44.86% (19.11%) 25.31%
Δ Principal Inv. – (57.84%) 46.76% 225.35% 23.37% (54.58%) (73.09%)
Δ Total Trading and Principal – 12.13% (32.19%) 40.55% 41.95% (29.39%) 23.76%
Investments
Δ Interest Income – 13.39% 9.45% 4.33% 6.17% 8.92% 13.54%
Total Revenues $17,246 $18,002 $15,979 $18,126 $22,280 $20,351 $23,803
Δ Total Revenues – 4.38% (11.24%) 13.44% 22.92% (8.66%) 16.96%
Δ Interest Expense – 13.91% 8.17% 3.86% 9.53% 6.48% 12.78%
Net Revenues $10,335 $10,097 $7,463 $9,407 $12,730 $10,182 $12,334
Δ Net Revenues – (2.30%) (26.09%) 26.05% 35.32% (20.01%) 21.14%

Operating Expenses
Δ Compensation and Benefits – (4.06%) (30.99%) (28.63%) 143.95% (20.03%) 21.14%
Total Operating Expenses $6,646 $6,573 $5,101 $4,422 $7,871 $6,751 $8,075
Δ Total Operating Expenses – (1.10%) (22.39%) (13.31%) 78.00% (14.23%) 19.61%

Net Earnings $2,479 $2,286 $1,594 $3,152 $3,197 $2,333 $2,854

Δ Net Earnings – (7.79%) (30.27%) 97.74% 1.43% 27.03% 22.33%
Tangible Common $22,287 $23,425 $28,876 $24,845 $28,156 $29,336 $30,641
Shareholders’ Equity
Shareholders’ Equity $28,724 $30,082 $32,618 $33,034 $36,900 $38,459 $39,118
Long Term Borrowings $114,650 $125,590 $129,330 $122,840 $132,730 $141,480 $151,070
Total Capital $143,570 $157,390 $162,820 $158,630 $169,630 $179,940 $190,190

Total Assets Under $571,000 $593,000 $629,000 $676,000 $719,000 $758,000 $796,000
Management

7
Net Leverage 25.62x 25.31x 21.78x 27.21x 25.54x 25.84x 25.98x
Leverage 19.88x 19.71x 19.28x 20.46x 19.48x 19.71x 20.35x

Average Daily Value at $92 $112 $92 $106 $127 $133 $139
Risk
Δ Average Daily Value at – 21.74% (17.86%) 15.22% 19.81% 4.72% 4.51%
Risk

# of Employees at Period 23,641 24,013 25,647 26,467 26,959 28,012 29,905

End
Δ # of Employees at Period – 1.57% 6.80% 3.20% 1.86% 3.91% 6.76%
End

Source: Goldman Sachs Quarterly Press Releases

Note: Numbers are unaudited.

8
Risk levels for the firm, as measured by Average Value at Risk (VaR), had risen from $92 million in
1Q2006 to $139 million in 3Q2007, a 51.09 percent increase over the six-quarter time period. VaR levels
had risen sharply in both 4Q2006 and 1Q2007, the time period when the Mortgage Department had first
positioned net short in the subprime mortgage market. Overall firm levels of risk had remained elevated
since this time, though growth in these levels had tapered off. This elevation in firm wide VaR is
consistent with the case’s description of the increased concern within Goldman Sachs regarding the
perceived risks that were being undertaken by the Mortgage Department.
Employees of the firm increased from 23,641 in 1Q2006 to 29,905 in 3Q2007, a 26.60 percent increase.
With overall firm revenues increasing 19.34 percent during the same time period, the rate of growth in
new employees was slightly higher than the overall rate of revenue growth. The rate of employee growth
also likely reflects considerable discipline on the part of management to keep firm growth in line with
revenue growth.

Summary
The financial condition of Goldman Sachs was excellent. There was strong revenue and earnings growth
during the time period covered in the case. This revenue and earnings strength is particularly remarkable
given the distress experienced by other financial firms during the 2006–2007 time periods. Leverage, both
overall and net, was stable, with no evidence of the debt-fueled growth that was symptomatic of other
New York investment banks during the U.S. housing boom (bubble?). Expenses, most notably
compensation, were closely in line with firm growth.
The only area of concern in the financial statements was a notable increase in the average daily VaR
measure. This increase likely reflected the heavy net short positions taken by the Mortgage Department.
Senior management was quite concerned about these elevated levels in the case, and was actively
pursuing strategies to manage the overall levels of firm risk.
(2) On August 21, Josh Birnbaum e-mailed key executives at Goldman Sachs to propose that the
mortgage department go net long the subprime mortgage market. Did Birnbaum violate the
firm’s chain of command? Why or why not?
This question refers to an e-mail exchange between Joshua Birnbaum, Daniel Sparks, Thomas Montag,
Donald Mullen, David Vinair and Gary Cohn on August 21st, 2007, proposing that Goldman go long the
subprime mortgage market. Following that e-mail and some additional discussion, Donald Mullen, head
of U.S. Credit Sales and Trading, e-mailed Goldman Sachs co-presidents Gary Cohn and John
Winkelreid, on or around the same day:
Mullen wrote to Cohn and Winkelreid, “It would help to manage these guys if you would not answer these
guys and keep bouncing them back to Tom (Montag) and I,” Mullen wrote. 1
Cohn replied, “Got that and am not answering. I do like the idea but your call.” 2
Daniel Sparks, head of the Mortgage unit at Goldman, had also directly e-mailed the co-presidents the day
before, and had proposed essentially the same thing. Co-president Winkelreid had directly replied to
Sparks on that e-mail.
It may be helpful at this point in a class discussion to sketch out a small diagram of the key players in this
exchange, and to classify them into various management ranks. A rough diagram of the individuals and
the managerial hierarchy should look like this:
 Name Title Rank
Josh Birnbaum Managing Director Front Line
Daniel Sparks Principal Managing Director Front Line Management
Donald Mullen Head, U.S. Credit Sales Mid-Management
Thomas Montag Co-Head, Global Securities Mid-Management
David Viniar Chief Financial Officer Top Management
Gary Cohn Co-President Top Management
Jon Winkelreid Co-President Top Management

The Argument For a Violation of the Chain of Command

The strongest evidence that Birnbaum may have violated the chain of command at Goldman is the
dialogue between Donald Mullen, Head of U.S. Credit Sales and Gary Cohn, Goldman Sachs Co -
President. In their exchange, Mullen asks Cohn to not directly engage in a dialogue with Birnbaum, and
also presumably Sparks (head of the Mortgage unit), and to allow Montag and Mullen to deal with the
matter. Cohn replies in agreement to this request, and also affirms that the matter is Mullen’s “call.”
The dialogue strongly suggests that Goldman Sachs had a formal chain of command. Mullen’s
conversation with Cohn strongly suggests that he, along with Montag, had oversight responsibility for the
firm’s mortgage unit, and that Goldman had a formal process for how information was communicated up
and down the formal chain of command within the organization. In other words, Birnbaum could have
overstepped Mullen (and possibly Montag) by e-mailing co-president Cohn and CFO Viniar directly.

The Argument Against a Violation of the Chain of Command

“A” students, however, should be quick to point out that there was considerable evidence in the case to
suggest that Goldman Sachs did not strictly adhere to the formal chain of command when discussing
information or making decisions. This theme is prevalent throughout the case, and strongly suggests that
even front line traders like Birnbaum felt no hesitation about e-mailing even a co-president of the firm.
For example, CFO Viniar regularly communicated with numerous individuals throughout the firm on a
daily basis:
While the Committee met weekly, Viniar reviewed the profit and loss statements on all of the firm’s
business units on a daily basis. He also talked widely on a daily basis with key players in the company. “I
can give you one hundred risk management rules,” Viniar said, “but that’s a good early warning sign —just,
“How are they doing?”3
Goldman’s risk management culture appeared to give everyone a voice in an ongoing dialogue regarding
decisions that were consequential to the firm. Viniar appeared to be in constant contact with every part of
the firm. The case also states that CEO Blankfein and co-president Cohn were also deeply involved with
the firm’s risk management and consulted widely on a daily basis.
The firm’s risk management team also shared this transparent approach to information flow:
I call it both seamless horizontal and vertical communication, and not just on the business side, but on the
control side as well. We have a lot of checks and balances in place in both the business side and the control
side and information sharing . . . and the collegial atmosphere in terms of the sharing of that information —
you know, businesses aren’t siloed, risk isn’t siloed here. 4
This was also not the first time that Birnbaum had communicated directly with top management. For
example, in February 2007, Birnbaum had discussed the plan to get short with upper management:

3
Cohan, W. (2011). 499.
4
Ibid., 498.
 When we were socializing our plan to get short in the beginning of the year, I put together a tool . . .
quantifying our position risk and p&l [profit and loss] under various market scenarios. I believe this was key
for senior management to gain confidence that we were taking controlled and quantifiable risk that was well
understood.5
There are also other examples throughout the case that information flowed freely between the various levels
of the firm, with e-mails finding their way to Viniar, Cohn and others and with top management frequently
replying. In other words, it is arguable on the basis of dialogue in the case that Goldman Sachs did not
strictly adhere to a formal chain of command with regard to either information flow or decision-making.

An Alternate Argument
So why did Donald Mullen, head of U.S. Credit Sales and Trading, ask co-president Gary Cohn to not
respond to Birnbaum, and presumably Sparks? Again, it may be helpful for a class discussion to sketch
out a rough diagram of the key players in this exchange, and add in their respective positions (inferred
from their dialogue in the case) regarding the proposed course of action to go long subprime:
Name Rank Position on Decision
Josh Birnbaum Front Line Go Long
Daniel Sparks Front Line Management Go Long
Donald Mullen Mid-Management Possibly Against?
Thomas Montag Mid-Management Opposed
David Viniar Top Management No Position Stated
Gary Cohn Top Management Likes the Idea
Jon Winkelreid Top Management Cautious about Proposal

After some class discussion, what should emerge is a possible alternative explanation regarding the
“chain of command” e-mail exchange: that Montag, and most likely Mullen, were opposed to the idea to
go long in the subprime market and were invoking the firm’s chain of command in order to delay or
possibly block a decision by top management to switch trading positions in the subprime mortgage
markets and get net long.

Summary
Josh Birnbaum e-mailed all of the key players in a possible decision to reverse the firm’s trading posture.
While the mortgage department wanted to go long, mid-managers appeared to be opposed to the idea,
with top management cautious or mildly positive regarding the possible shift in trading posture. Birnbaum
may have violated the firm’s formal chain of command, but “A” students should recognize that this type
of communication appeared to be commonplace, or perhaps even to be expected from a firm wide risk
management perspective.

Teaching Tip: Diffusion of Responsibility

One dynamic at work during the discussion between Josh Birnbaum and key decision makers may have
been diffusion of responsibility. Is it possible that with “everyone” responsible for risk management that
it was too easy for individuals to assume that someone else should worry about the decision to go long, or
make the call, rather than fully consider the ethical and risk implications of their own behavior? In order
for people to see a connection between what they think is right and what they do, they must feel
responsible for the consequences of their actions. See Treviño and Nelson (2011), Chapter 7, for
background material on this teaching point.

5
Staff Report, p. 413.
(3) Consider the risk management culture, practices and procedures of Goldman Sachs. What is
your assessment of the effectiveness of the firm’s risk management practices during the 2006–
2007 time periods?

Suggested Readings for a Broad Overview

 American Bar Association (2011). Corporate Director’s Guidebook, 6th Edition. Chicago, IL:
ABA Publishing. Section 4–Risk Management, Compliance and Oversight.
 Clarke, T. (2007). International Corporate Governance: A Comparative Approach. New York,
NY: Routledge. Chapter 2–Boards and Directors: Political Mechanisms
 Colley, J., Doyle, J. and Stettinius, W. (2005). What is Corporate Governance? New York, NY:
McGraw Hill/Irwin. Chapter 7–The Board’s Role in Management.
 De Kluyver, C. (2009). A Primer on Corporate Governance. New York, NY: Business Expert
Press. Chapter 3–The Board of Directors.

Teaching Tip: Board Work

Students can be provided Exhibit IM-2 before class. They can then be asked to compare the principles of
risk oversight with the evidence provided by the case. If desired, the instructor can make this part of a
written assignment to be prepared prior to class discussion. In the class discussion, the instructor may
wish to develop two columns on the board, the first listing the principles of risk oversight, and the second
showing whether or not Goldman Sachs’ board was consistent with these principles. A sample of this
board work is shown in Exhibit IM-3 below.
“A” students should be able to quickly take the attached Exhibit IM-2 and analyze Goldman Sachs’ risk
management practices. In general, they should also be able to quickly identify the specific sections of the
case that align with the Principles for Risk Oversight. When prompted, they should also be able to
reasonably conclude that Goldman’s risk management practices appear to be exemplary.
For example, students should be able to quickly point to Goldman Board Meetings where the firm’s risk
management was discussed, and observe that they were clearly informed regarding the firm’s subprime
exposure and risks at their March 26, 2007 meeting. Also, because of the March 26th meeting, “A”
students should also quickly point out the Board clearly oversees the firm’s risk management process.
One possible area for discussion regards the firm’s Chief Risk Officer. While Goldman had a Chief Risk
Officer, dialogue in the case strongly suggested that it was David Viniar, the CFO, and not Craig Broderick,
the nominal Chief Risk Officer, who was ultimately in charge of the firm’s day-to-day risk management.
For example, it was Viniar who chaired the firm-wide risk management committee and not Broderick.
Another area of discussion regards the Board’s lack of a risk management committee. Rather than have a
committee of the Board that was exclusively focused on risk, it appeared that risk management was
discussed by the full board.
Finally, another relevant concept here might be the “illusion of superiority,” a cognitive bias where
people do not view their behavior objectively because they believe they are superior. They will
unconsciously filter and distort information in order to maintain a positive self-image. That is, what we
propose must be right, because we are right more than others. Stated another way, Goldman Sachs may
have believed that they had superior risk management because they were Goldman Sachs. See Treviño
and Nelson (2011), Chapter 3, for additional discussion on this point.
Summary
Risk management at Goldman Sachs appeared to be more than adequate, even under the most extreme of
market conditions. The only potential criticism of Goldman’s procedures in 2006–2007 was that they did
not have an exclusive committee of the board devoted solely to risk oversight and assessment. It is also
intriguing to note the extremely collaborative nature of information flow and decision making in the
Goldman Sachs organization. Even front line traders appeared to have unfettered access to the co-
presidents and the CEO, and thus the Board.

EXHIBIT IM-2: PRINCIPLES OF RISK OVERSIGHT (UNDERLINES ADDED BY AUTHOR)

General Principle of Risk Oversight
Although the management of a company is ultimately responsible for a company’s risk management, the
Board of Directors must understand the risks facing the company and oversee the risk management process.
De Kluyver, C. (2009)
Overview of Risk Management
The board, or an appropriate committee, should receive periodic reports describing and assessing the
corporation’s programs for identifying financial, industry, and other business risks and for managing such
risks to protect corporate assets and reputation. A full understanding of the controls and infrastructure for
the prevention, mitigation, and remediation of risks allows a corporation to determine its risk/reward
appetite and risk tolerance in various business areas and to manage those risks more effectively, thus
enabling informed risk taking. Some corporations have designated a Chief Risk Officer and/or created a
high-level committee on risk, which reports regularly to the board. Some corporations, especially those in
the financial services sector, have board committees focused exclusively on risk. Crisis management,
information technology security, insurance arrangements, compliance programs, plant security, protection
of confidential information, and intellectual property are typical of risk management programs.
American Bar Association (2007)
Five Questions about Hedging, Derivatives, and Trading Risks
(1) Where are the hedging, derivative, and trading risks embedded in the company, and who in the
company is responsible for these activities?
(2) Does the Board of Directors understand the nature and purposes of the risk positions being taken?
(3) Are these risk limitations in place, and if so, what are they and how effectively are they implemented?
(4) What is the risk to reward ratio that fits into the company’s strategic plan?
(5) Does the Board of Directors have a glossary to translate the explanations that it is likely to receive?
De Kluyver, C. (2009)
EXHIBIT IM-3: SAMPLE ASSESSMENT OF GOLDMAN SACHS’ RISK OVERSIGHT
Principle Principle Comments
Met?

Board Understands the Risks Yes Board was clearly informed regarding subprime exposure
and risks at March 26, 2007 meeting of the Board.

Board Oversees Risk Management Yes Board was given complete report regarding subprime
Process mortgage market and Goldman exposure during March 26,
2007 Board meeting.

Periodic Reports to Board or Board Yes Board was given complete report regarding subprime
Committee mortgage market and Goldman exposure during March 26,
2007 Board meeting.

Firm Able to Determine Yes Case clearly indicated a strong focus by the firm on firm-
Risk/Reward Appetite and Risk wide risk management, often to the consternation of traders.
Tolerance VaR numbers calculated and discussed on a daily basis.

Chief Risk Officer Yes Not clear from the case whether the Chief Risk Officer had
the final say on risk positions. Decision-making appeared to
be consensus based at the highest levels of the organization.

High-Level Committee on Risk Yes Firm-Wide Risk Committee met on regular basis and
assessed both unit and firm level risk levels.

Board Committee Focused No Risk management appeared to be discussed by the full

Exclusively on Risk board. No evidence that the Audit Committee of the Board
exclusively handled risk management.

(4) Examine the various investment banking roles played by Goldman Sachs during the events
described in the case. Did these roles conflict? Explain.

Teaching Tip: Advance Preparation

Students can be provided Exhibit IM-4 before class. They can then be asked to evaluate the various
generic investment banking roles against the events described in the case. If desired, the instructor can
make this part of a written assignment to be prepared prior to class discussion. Classes on investment
banking may find this exercise particularly useful. In the class discussion, the instructor may wish to
develop three columns on the board, the first listing the generic investment banking roles, the second
whether this role occurred in the case, and then the third analyzing the nature of the conflict created. This
exercise may also serve as a vehicle for discussion of the legal environment of investment banking,
particularly the Glass-Steagall Act and its history as well as Dodd-Frank and the so-called Volcker Rule.
A sample of this board work is shown in Exhibit IM-5 below.
The Financial Crisis Staff Report details a number of concerns regarding Goldman’s actions during the events
of 2006–2008. Among them, the report discusses the following points that are relevant to this case study:
 (1) Shorting its own securities.
(2) Failing to disclose key information to investors.
(3) Misrepresenting the source for the securities that were bundled and sold to investors.
(4) Selling securities designed to fail.
(5) Misrepresenting assets.
(6) Using poor quality loans in securitizations.
(7) Concealing Goldman’s net short position.6
Although a complete discussion of these points is beyond the scope of this instructor’s manual, the case
study and Exhibit IM-4 should provide ample opportunity for discussion and analysis of the role conflicts
that Goldman Sachs faced as it worked to offload its subprime mortgage-backed securities and then
position itself to profit, or hedge related losses, from the collapse of the subprime mortgage markets in
2006 and 2007.

Summary
When did customers become counterparties in the investment banking world? Numerous conflicts of
interest are apparent from the case study and the analysis of the generic roles played by investment
banking firms. One of the most serious of these conflicts appears to be the breakdown of the firewall
between making markets for customers and proprietary trading by the firm. The case clearly documents
Joshua Birnbaum making markets in the ABX index, and then taking increasingly aggressive positions for
the Goldman account to short this index. The other area that was (in hindsight) more directly damaging to
Goldman customers was the sale of securities backed by subprime mortgage loans that would later lose
most or all of their value during the mortgage crisis.

6
Staff Report, p. 602–603.
EXHIBIT IM-4: ROLES AND DUTIES OF AN INVESTMENT BANK
Role Description
Market Maker Market makers are typically a dealer
in financial instruments that stand
ready to buy or sell for their own
account at a publicly quoted price.
Underwriter Securities underwriters purchase
securities from the issuer, hold them
on their books, conduct the public
offering and bear the financial risk for
the issuance.
Placement Agent Placement agents perform
intermediary services between those
seeking to raise money and investors.
They help design the securities,
produce the offering materials, and
market the new securities to investors.
Broker-Dealer Broker-Dealers buy and sell securities
on behalf of their clients.
Investment Advisor A firm qualifies as an investment
advisor if it provides advice regarding
securities, is in the business of
providing such advice, and provides
that advice for compensation.
Proprietary Trader Proprietary trading, or “prop trading,”
occurs when a firm trades securities
with the firm’s own money in order to
make a profit for itself.
Source: Adapted from the Staff Report, Wikipedia.
Legal Standard for Conduct
Provide fair and accurate information related to
the execution of a particular trade. Prohibited
against fraud and market manipulation. Must use
best execution efforts when placing a client’s
buy or sell order.
Underwriters are liable for any material
misrepresentation or omission of a material fact
made in connection with a solicitation or sale of
a security. The relationship between an
underwriter and a customer involves an implicit
recommendation of the security.
Placement agents are liable for any material
misrepresentation or omission of a material fact
made in connection with a solicitation or sale of
a security. The relationship between a placement
agent and a customer involves an implicit
recommendation of the security.
When a broker-dealer recommends a security to
a customer, it must avoid material misstatements
of fact and must also disclose material adverse
facts that it is aware of. This disclosure must
include adverse interests such as economic self-
interest that could have influenced its
recommendation.
When acting as an investment advisor, the
investment bank has a fiduciary obligation to act
in the best interests of its clients.
Proprietary trading must be kept separate from
other investment banking operations in order to
separate (through a “firewall”) knowledge
regarding customer order flow between units.
EXHIBIT IM-5: SAMPLE ASSESSMENT OF GOLDMAN’S ROLES AND DUTIES CONFLICTS

Role Goldman Conflict? Discussion

Performed
this Role?

Market Maker Yes Yes Joshua Birnbaum began trading the ABX index as a market
maker for his clients. It is unclear from the case at exactly what
point he began taking positions for Goldman on the ABX, but
the big short was clearly a proprietary trade.

Underwriter Yes Yes Goldman Sachs underwrote RMBS and CDO securities during
the events described in the case. Did Goldman Sachs
misrepresent or omit information that was material to its
customers? Did the sale imply a “buy” recommendation on
these securities? Clearly Goldman Sachs had conviction on the
direction of the Mortgage market while these sales occurred.

Placement Agent No No While Goldman Sachs may act as a placement agent for
customers, there is no discussion of Goldman taking this role in
this case study.

Broker-Dealer Yes Yes Goldman Sachs sold and shorted large quantities of mortgage-
backed securities to customers during the events described in
this case. At the same time, Goldman Sachs had an economic
self-interest in these trades, both as a proprietary trader and also
due to its conviction on the direction of the mortgage market.

Investment Advisor No No While Goldman Sachs may act as an investment advisor for
customers, there is no discussion or evidence that it acted as an
investment advisor in this case study.

Proprietary Trader Yes Yes The big short was clearly a proprietary trade for Goldman Sachs.
Birnbaum also clearly mentions that he started trading the ABX as
a market maker. Aren’t these two functions supposed to be clearly
separated by a firewall? Did Birnbaum’s role as an ABX index
market maker conflict with his fiduciary obligation as a neutral
market maker?
(5) Did Goldman Sachs have a conflict of interest when it sold subprime mortgage-based financial
products to its customers while, at the same time, it sold subprime mortgage securities and
shorted the subprime market? What do various ethical frameworks and points of view help
you conclude about this possible conflict of interest?

Suggested Readings for a Broad Overview

 Lawrence, A., and Weber, J. (2011). Business and Society: Stakeholders, Ethics, Public Policy,
13th Edition. New York, NY: McGraw Hill/Irwin. Chapter 4–Ethics and Ethical Reasoning.
 Steiner, G., and Steiner, J. (2012). Business, Government and Society, 13th Edition. New York,
NY: McGraw Hill/Irwin. Chapter 7–Business Ethics.
 Treviño, L., and Nelson, K. (2011). Managing Business Ethics: Straight Talk about How to Do It
Right, 5th Edition. Hoboken, NJ: John Wiley and Sons. Chapter 7–Managing for Ethical
Conduct.

Advanced Reading
 Friedman, M. (1962). Capitalism and Freedom. Chicago, IL: The University of Chicago Press.
Definition
A conflict of interest occurs when an individual’s self-interest conflicts with acting in the best interest of
another, when the individual has an obligation to do so. A conflict of interest for an organization occurs
when an organization’s self-interest conflicts with acting in the best interest of a stakeholder, such as a
customer, when the organization has an obligation to do so.
Adapted from Lawrence and Weber (2011), p. 80.

Teaching Tip: Board Work

Students can be provided Exhibit IM-6 before class. They can then be asked to compare the ethical
principles and perspectives with the evidence provided by the case. If desired, the instructor can make this
part of a written assignment to be prepared prior to class discussion. In the class discussion, the instructor
may wish to develop two columns on the board, the first listing the ethical principles and perspectives,
and the second analyzing whether or not Goldman Sachs was consistent with these principles. A sample
of this board work is shown in Exhibit IM-7 below.

Teaching Tip: Theory of the Firm

The resolution of the question regarding Goldman’s ethical performance ultimately resides with the much
broader question regarding what the purpose of the corporation is or should be. Fundamentally, the
conflict revolves around a very old and very basic question: Whose interests should the corporation
serve? “Whether it is in the public interest for widely held corporations to be run exclusively for
shareholders is an old question.” (Blair, 1995). It is also an unresolved question.
So, did Goldman Sachs act unethically when it sold subprime mortgage-based financial products to its
counterparts while, at the same time, it sold subprime mortgage securities and shorted the subprime
market? It is unclear from the case whether the individuals who were engaged in the various subprime
markets were aware of the actions of their counterparts throughout the firm, although in the meetings
where these decisions were made, management clearly understood the mandate to lighten up on subprime
securities and derivatives. Also, Goldman had clearly gotten “bearish” on the subprime markets and
directed the firm’s strategy to reflect that conviction. There is also clear evidence to suggest that there was
disagreement regarding that strategy, both within and outside the firm.
Milton Friedman (1962) argued that the only responsibility of a firm is to increase its profits for the
benefit of shareholders, provided that the firm breaks no laws in doing so:
The view has been gaining widespread acceptance that corporate officials and labor leaders have a “social
responsibility” that goes beyond serving the interest of their stockholders or their members. This view
shows a characteristic misconception of the character and nature of a free economy. In such an economy,
there is one and only one social responsibility of business—to use its resources and engage in activities
designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in
open and free competition, without deception or fraud . . . Few trends could so thoroughly undermine the
very foundations of our free society as the acceptance by corporate officials of a social responsibility other
than to make as much money for their stockholders as possible. This is a fundament ally subversive
doctrine. If businessmen do have a social responsibility other than making maximum profits for
stockholders, how are they to know what it is? (Friedman, 1962, p. 133.)

From this perspective, assuming that no laws were broken or that Goldman did not engage in any type of
deception, sparing Goldman shareholders from the worst impact of the subprime mortgage crisis was
clearly a good thing. Given that the firm is primarily beholden to the residual owners of t he firm, then
anything that furthers the shareholder interest is clearly a good thing, and Goldman is to be commended
for doing so. On the other hand, if laws were broken, or the firm engaged in deception, then Goldman’s
conduct would fall outside what Friedman (1962) conceived.
In contrast, a recent business ethics text argues a much broader scope of conduct and responsibility for the
business organization:
Organizations also have a clear ethical obligation to shareholders and other “owners.” This ethical
obligation includes serving the interests of owners and trying to perform well in the short term as well as
the long term. It also means not engaging in activities that could put the organization out of business and
not making short-term decisions that might jeopardize the company’s health in the future . . . These are all
ethical issues because they involve obligations to primary or key stakeholder groups. Consumers,
shareholders, employees, and the community are probably the major constituencies of any organization that
is not operating in a vacuum. (Treviño and Nelson, 2011, p. 381–389.)
According to Treviño and Nelson (2011), the firm has a much broader scope of responsibility than their
shareholders. While shareholders are a stakeholder to the firm, customers, employees, and the broader
community also have a stake in the outcomes of the firm. An open question then is: what is the nature and
scope of the responsibility that the firm has to these other stakeholder groups? Is there a rank order to
these various stakeholder groups, and how should management assign priority? What should management
do when these stakeholder groups are in conflict?
For example, what about Goldman’s customers? What about the purchasers of Goldman securities,
derivatives, and financial products that were wiped out in the subprime implosion? Peter Drucker (1981)
argued that the primary responsibility of a firm’s management is to do no harm. What is meant by harm,
and to whom? Clearly, the financial interests of the owners of these financial products were harmed, but
isn’t that the risk that all sophisticated market participants take when they trade with one another? Or does
Goldman Sachs have a responsibility to its customers that goes beyond this, as suggested by Treviño and
Nelson (2011) and Smith (2012)? Also, does Goldman Sachs have asymmetric information with respect
to the firms with which it does business, and thus have some type of fiduciary obligation to them when it
trades? If so, how could Goldman have handled the crisis differently? If not, what does the resulting loss
of confidence amongst all market participants do to the open marketplace? What role should the
regulatory apparatus play as intermediary?
Other theoretical perspectives are mixed on the question of Goldman’s ethical conduct. From a virtues
perspective, it is likely that Goldman’s conduct of selling subprime securities when it had become bearish
on the subprime market does not align with good character and honorable behavior on the part of the firm.
A rights and duties perspective would also question whether the basic human rights of the customers of
the firm were violated when sold securities and derivatives by Goldman.
A utilitarian analysis of Goldman’s conduct is indeterminate. On the one hand, from a simple cost
perspective, the cost to Goldman of doing nothing in light of Goldman’s strong market conviction could
potentially have been catastrophic. On the other hand, did the benefit to Goldman exceed the broader cost to
society, or did the cost to society greatly exceed any short-term advantage that was gained by Goldman?
How would/should the cost to society be fully evaluated? From Goldman’s perspective, then, the cost of
doing something was likely much smaller than any potential delay, especially in light of the failure/sale of
other investment banks in the wake of the crisis, but the potential costs to the broader society were arguably
quite extensive. Evaluating the cost to society, unfortunately, is likely to be hotly debatable.
From a justice perspective, the results are also mixed. Goldman Sachs operated according to the
commonly accepted rules for transactions with other sophisticated Wall Street banks and investors. On
the other hand, Goldman Sachs arguably did not operate according to basic standards of human fairness.
By extension, then, we might observe that commonly accepted rules for transactions amongst
sophisticated Wall Street banks and investors apparently do not conform to basic standards for human
fairness.

Summary
The question about Goldman’s conduct during the subprime mortgage meltdown is likely to provoke a
lively classroom conversation. Applying various ethical approaches and perspectives does not result in a
consistent conclusion regarding what to do in Goldman’s particular situation.
EXHIBIT IM-6: PERSPECTIVES ON ETHICAL DECISION-MAKING FOR ORGANIZATIONS
Method/Proponent Principle/Perspective An Action is Ethical When . . .

Milton Friedman Provided they stay within the law, corporate executives Corporate executives engage in open and free competition without
should make as much money for shareholders as possible. deception or fraud.

Peter Drucker The ultimate responsibility of company directors is not to No harm comes to a participant in the firm’s business activities.
do harm.

Virtues Values and Character The action aligns with good character. Is the action something of which all
participants can be proud?

Utilitarian Comparing Benefits and Costs Net benefits of the action exceed the costs incurred by society. If the
benefits to society outweigh the costs, then it is ethical.

Rights and Duties Respecting Entitlements and Fulfilling Responsibilities Basic human rights are respected. Respecting others is the essence of
human rights, provided that others do the same for us. Duties accrue to
particular positions, especially with regard to the notion of fiduciary
responsibility.

Justice Distributing Fair Shares Benefits and costs of the action are fairly distributed according to accepted
rules or practice. Is the action fair or just?

Source: Adapted from Lawrence and Weber, 2011.

21
EXHIBIT IM-7: SAMPLE ASSESSMENT OF GOLDMAN SACHS’ ETHICAL DECISION MAKING
Principle/Proponent Principle Met? Comments

Milton Friedman Yes Shareholders were positively affected by the actions of

Goldman executives. The sale of subprime mortgage
securities prevented possibly catastrophic losses for
shareholders.

Peter Drucker No Customers of Goldman Sachs were harmed by the sale of

Goldman securities that later became worthless.

Virtues No Selling subprime securities when Goldman had become

bearish on the subprime market does not align with good
character and honorable behavior.

Utilitarian Yes/No The monetary benefits to Goldman Sachs far outweighed any
costs that Goldman may have incurred in the wake of the
subprime mortgage market meltdown. However, did the
benefits to Goldman Sachs exceed the costs to society?

Rights and Duties No Being informed is a basic human right, and by obscuring
Goldman’s knowledge of the subprime mortgage market,
Goldman did not respect the basic human rights of customers
of the firm, and possibly violated its fiduciary duties.

Justice Yes/No Yes, Goldman Sachs operated according to commonly

accepted rules for transactions with other sophisticated Wall
Street banks and investors.
No, Goldman Sachs did not operate according to basic human
standards of fairness.
(6) Consider David Viniar’s options as he reviews the e-mail from Joshua Birnbaum. Should
Viniar support, reject, or defer judgment on the proposed strategy to go long in subprime
mortgages? What would be the proper level of review for such a decision?

Teaching Tip: Type I Errors and Career Management

Instructors wishing to take a more rigorous approach to a discussion of Viniar’s decision may want to
discuss Type I and Type II errors in decision making. It could be argued that executives will probably not
get fired or punished for committing a Type II error—leaving money on the table, while avoiding a big
loss. Type I errors, on the other hand, directly put executives at risk for their job and negatively affe ct the
company’s stock price. A leading question for students could be: so how would this framework apply
here? If Viniar is interested in avoiding a Type I error in this case, then his bias is likely to be to either
defer a decision to others in the organization or to reject the Mortgage Department’s proposal. Given that
the current positioning of the Mortgage Department is neutral, rejecting or deferring the Mortgage
Department’s proposal would minimize the likelihood of Type I error for Viniar, and hence losses to the
firm, but would also increase the likelihood of Type II error for this decision.
David Vinair was considering the following three options on August 21, 2007:
a) Approve the Mortgage Department proposal,
b) Reject the Mortgage Department proposal, or
c) Defer a decision to others in the organization.
Each of the three options Viniar was considering carried a great deal of uncertainty regarding potential
future outcomes. The fundamental dilemma underneath each option under consideration was the future
state of the subprime housing market and the corresponding financial instruments that were either
composed of subprime securities or referenced subprime securities. Approving the Mortgage Department
proposal would require a careful analysis of the potential outcomes for the securities that the Mortgage
Department had targeted, as well as analysis from the Risk Management unit regarding its potential effect
on unit and firm-wide VaR.
Rejection of the Mortgage Department proposal would likely require an explanation of some type for the
Management Committee and ultimately, the Board. On the surface, this option appeared to be the most
intuitive. Buy subprime securities? In 2007? Considering the panic in the financial markets in August
2007, it appeared likely that Viniar would not receive a great deal of criticism for rejecting the proposal,
considering the state of the markets. Rejection of the proposal could also be potentially attached to a
mandate to “get closer to home,” that is, to go neutral with respect to the subprime market, and allow the
storm to pass. Going neutral, however, also meant bypassing potentially lucrative positions in the
mortgage markets. The Mortgage Department’s performance prior and subsequent to the onset of the
crisis was a powerful validator to not reject the proposal out of hand.
What about a deferral? This move would depend greatly on the timeliness of the decision, and whether
delay would forego taking the position argued for by the Mortgage Department. Also, Viniar would not
likely be the only person involved in the decision, regardless of the outcome. The case clearly articulates
a consensus decision-making model for the organization, and Viniar would almost certainly have to
review (“socialize”) the proposed move in the Firm-Wide Risk Committee, and the Management
Committee, at a minimum. Ultimately, the decision would have to be reviewed by the Board of Directors
and possibly the Audit Committee as well. While it is not explicitly discussed in the case, the
compensation system at Goldman Sachs would also likely affect the outcome of the decision, with each of
the actors in the decision taking actions that they perceived would be in their financial best interest.
EPILOGUE
Birnbaum and Sparks again won the internal debate at Goldman Sachs. The Mortgage Department was
given approval to go net long:
In the end, Sparks and Birnbaum got the green light to “opportunistically . . . buy assets” at the same time
that the mortgage department trading group was “significant(ly) covering (its) short positions,” according
to a presentation given to Goldman’s board of directors in September 2007.
Cohan, W. (2010). p. 563.
For the third quarter of 2007, the Mortgage Department, and Goldman Sachs, booked record profits.
According to one internal Goldman report, the Mortgage Department made $3.738 billion for fiscal 2007.7
The Mortgage Department’s risk levels also came down as a result of this shift in strategy. The Mortgage
Department’s Value at Risk fell from the August 2007 peak to approximately $80 million by the end of
December 2007.
Both Sparks and Birnbaum left Goldman Sachs in 2008. Sparks went on to become the chairman of Archon
Mortgage LLC, a real estate management company in Irving, Texas. Birnbaum became the founder and
Chief Investment Officer of Tilden Park Capital Management, a New York based hedge fund.
On April 25, 2010, the U.S. Securities and Exchange Commission filed a complaint against Goldman
Sachs and one of the lead salesmen for the Abacus CDO, alleging that they had failed to disclose material
adverse information to investors and committed securities fraud in violation of Section 17(a) of the
Securities Act and Section 10(b) and Rule 10b-5 for the Securities Exchange Act of 1934.
Goldman settled with the SEC on July 14, 2010, and agreed to pay a $550 million fine. As part of the
settlement, Goldman Sachs made the following acknowledgement:
Goldman acknowledges that the marketing materials for the ABACUS 2007-AC1 transaction contained
incomplete information. In particular, it was a mistake for the Goldman marketing materials to state that the
reference portfolio was “selected by” ACA Management LLC without disclosing the role of Paulson & Co.
Inc. in the portfolio selection process and that Paulson’s economic interests were adverse to CDO investors.
Goldman regrets that the marketing materials did not contain that disclosure. 8
“Half a billion dollars is the largest penalty ever assessed against a financial services firm in the history of
the SEC,” said Robert Khuzami, Director of the SEC’s Division of Enforcement. “This settlement is a
stark lesson to Wall Street that no product is too complex, and no investor too sophi sticated, to avoid a
heavy price if a firm violates the fundamental principles of honest treatment and fair dealing.” 9
In the wake of the Financial Crisis of 2008 and subsequent SEC actions and congressional investigations, a
number of reforms were enacted. Chief among these was the passage of the Dodd-Frank Wall Street Reform
and Consumer Protection Act, signed into law by President Barack Obama on July 21, 2010. Among other
provisions, the Dodd-Frank Act prohibits banking entities from engaging in proprietary trading, subject to
certain provisions allowing them to continue to serve clients and reduce risks. 10 The Dodd-Frank Act also
contains a provision that prohibits firms that underwrite securities from engaging in a transaction that would
involve or result in any material conflict of interest with an investor in that security.11

7
Cohan, W. (2011). p. 591.
8
Securities and Exchange Commission (July 15, 2010). Press Release: Goldman Sachs to pay record $550 million to settle SEC
charges related to Subprime Mortgage CDO. Retrieved at www.sec.gov.
9
Ibid.
10
Staff Report. p. 636.
11
Ibid.
BIBLIOGRAPHY
American Bar Association (2011). Corporate Director’s Guidebook, 6th Edition. Chicago, IL: ABA
Publishing.
Blair, M. (1995). Ownership and Control: Rethinking Corporate Governance for the Twenty-First
Century. New York, NY: The Brookings Institution.
Clarke, T. (2007). International Corporate Governance: A Comparative Approach. New York, NY:
Routledge.
Cohan, W. (2011). Money and Power: How Goldman Sachs Came to Rule the World. New York, NY:
Random House.
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