Monday, December 05, 2005

Goldman Sachs Compensation Scheme

  
New York Magazine, Duff McDonald, 5 December 2005

It’s like buying a gift for the guy who has everything: What can you do to impress the boss for whom you’ve already been pulling all-nighters and all-weekenders? That’s the dilemma faced by thousands of investment bankers in New York every fall, when bonus season gets under way. Starting sometime after Labor Day and ending before Christmas, everybody in the financial industry is on their best, most obsequious behavior, hoping to curry the favor of those who divvy up the spoils. And what spoils there are this year—the 2005 bonus season looks to be Wall Street’s biggest haul in five years. Last year, the New York State Comptroller’s office estimated the average bonus on Wall Street to be a clean $100,600 (or $15.9 billion split among 158,000 employees). Early estimates of the 2005 bonus pool reach as high as $19 billion.

Typically, Goldman Sachs’s announcement of its third-quarter results kicks the bonus season into high gear. Long revered for being where the serious money gets made, the firm has had a blowout year even by its own standards. Announcing a record profit in the third quarter, Goldman also noted that it had set aside $9.25 billion, almost $420,000 per employee, in compensation. When fourth-quarter results are factored in, that total could swell to an $11 billion pool, or $500,000 per employee.

Naturally, money on Wall Street is not shared equally, not even close. Most Goldman employees will receive a good deal less than half a mil, while a few will make an ungodly amount more. It’s simply a matter of how much more. Is that guy on the commodities desk who bet right every time on the price of oil worth $20 million this year—or $25 million? Maybe it’s worth taking $5 million out of the pocket of that old-school investment banker who couldn’t close that simple snack-food takeover deal. Maybe it’s time he was sent a clear signal about the weight he’s been failing to pull.

Even in the land of seven-figure incomes—in fact, especially in the land of seven-figure incomes—bonus sensitivity runs high. “Most days, I think I’m one of the most overpaid people on earth,” a former Goldman employee told me. “But other days, I feel like I’m getting shafted. Everyone at Goldman is afraid of feeling that way.” The result of extensive interviews with both current and former Goldman employees, what follows is our best guess at how, exactly, that shafting takes place. That, and the names of a few people you’ve never heard of who make more money than A-Rod.

The standard portion of net revenue (total revenue minus interest expense) earmarked for compensation at Wall Street firms stands at an astonishing 50 percent. That’s because talent is the most precious commodity on Wall Street; it’s what they sell, so it’s also what they have to pay for.

“Wall Street is just a compensation scheme,” says Andy Kessler, a Wall Street veteran and the author of several books about its culture. “They literally exist to pay out half their revenue as compensation. And that’s what gets them into trouble every so often—it’s just a game of generating revenue, because the players know they will get half of it back.” Goldman Sachs is no exception to this lucrative rule. Through the first nine months of the year, the $9.25 billion that the company set aside for salaries and bonuses was precisely 50 percent of its net revenue.

Back in the late nineties, when Goldman Sachs’s partners were considering taking the company public, the resulting turmoil in their ranks led to the departure of Jon Corzine and the ascension of Henry Paulson Jr. to the position of sole chairman and CEO of the company. One of the primary questions Paulson faced was how Goldman could motivate its relatively underpaid junior staff if it couldn’t hold out the brass ring of Wall Street’s most coveted partnership as incentive. If the company was public, the partners couldn’t just split the profits among themselves as they always had. There would be other shareholders to think of.

As it turned out, however, not much actually changed when the company did go public. The partners still control the flow of money, and they still divert a disproportionate share of it to themselves. Although it’s no longer a partnership per se, the firm breaks down its executives into senior managing directors “PMDs” (for partner managing directors) and its junior ones “EMDs” (for executive managing directors) or “MD Lite.” Starting with the 50 percent of net revenue, the PMDs slice off a big chunk—a current EMD estimated it to be 15 percent of the total. If 2005 compensation comes in at $11 billion, as one analyst estimates, that’s $1.65 billion for the firm’s 250 or so PMDs to split among themselves. Each PMD has what are known as “points” in the partnership pool, and a quarter to a third of that 15 percent (stay with me here) is split according to those proportions. With all senior managers of Goldman taking home a $600,000 salary, an equal split of 30 percent of $1.65 billion would be worth almost $2 million, pushing their pay into the neighborhood of $2.6 million. But wait, there’s more.

The remaining $1.15 billion is then split among the PMDs according to the discretion of the top dogs, who evaluate each partner. “Having such a huge part of the partners’ pay package be discretionary is different from the way it used to be,” a former vice-president of the firm told me. “If there are partners they want to push out, they just fuck them on the discretionary part.”

For those in the highest standing, the estimated numbers run in the neighborhood of $20 million to $40 million. So massive are these sums that a secretary in the London office was able to steal £4.5 million from three of her bosses before they even noticed. In the meantime, she’d bought an Aston Martin, a villa in Cyprus, and £350,000 worth of Cartier jewelry.

Though the firm is very discreet about its discretionary bonuses, the requirements of being a public company have forced Goldman to reveal the compensation of its executive management team. They’re a well-paid lot, though not necessarily the best-paid at the firm. Last year, Paulson took home $29.8 million for his troubles, while Lloyd Blankfein, the firm’s president, made a shade less, $29.5 million. David Viniar, the chief financial officer, got $19 million, and vice-chairmen Robert Kaplan and Suzanne Nora Johnson scored $17.5 million apiece.

EMDs, for their part, might make anywhere from $1.75 million to $3 million, according to a knowledgeable employee at a rival firm. “Those guys are almost paying a fee to work at Goldman,” he says. “That’s one thing that hasn’t changed. Goldman is split between the haves—the PMDs—and the have-nots, which is everyone else.” That first point is only partly true, because when Goldman gave up the carrot of the partnership to motivate its employees, it received something in return: publicly traded stock. With an increasing part of its compensation coming in the form of stock grants that vest over time, EMDs still have a fancy set of golden handcuffs keeping them tethered to the firm. And though Goldman shares haven’t exactly rocketed to the moon since 1999, they have outpaced the Dow and the S&P 500.

So what of everyone else? Generally speaking, the remaining 35 percent of net revenue is split rationally at Goldman, based on a series of narrowing considerations: the performance of a particular division within the firm, the business unit within the division, the individuals themselves, and, increasingly, what you need to pay them to keep them from jumping ship. “You try to determine how much you have to pay to ensure their loyalty,” says a former EMD in Goldman’s fixed-income division who left the firm in early 2005. “Except at very senior levels, they’re almost always trying to find that point of indifference. Goldman is paying you $1.25 million and Lehman is dangling $1.5 million? After tax, what is that—150 grand or so? Is it worth switching? Without ever explicitly saying so, that’s precisely what Goldman tries to do—to find that number where someone says, ‘Screw it. It’s just not worth it to move.’ ”

Although the past five years have seen a huge amount of traffic from old-line investment banks to hedge funds, executive recruiters say that movement has slowed somewhat. The spate of hedge-fund scandals and spotty performance in 2005 will likely slow it even more. But that doesn’t mean Lehman Brothers and other investment banks aren’t chasing after Goldman’s top talent—and vice versa. “There’s a talent war out there in areas like derivatives, commodities, investment banking, and proprietary trading,” says Michael Karp, co-founder of executive-search firm Options Group.

So how do they keep their people from bolting when they find out the guy at the next desk got paid a little more? Trick No. 1: Demand secrecy. It’s not as difficult as it sounds; the employees themselves have an interest in not advertising their own bonuses. The only thing worse than getting shafted, after all, is having your colleagues know you’ve been shafted. “Everybody on Wall Street plays poker when it comes to compensation,” says that former EMD. “Even if you’re positively surprised, you hide it, because you want them to feel that was the least you expected.”

A current vice-president at the firm says that because everyone gets the news on the same day—“compensation day,” which is generally in the first half of December—the entire firm gets consumed in a frenzy of trying to read each other’s reactions. “All the offices have glass walls, so everyone is trying to read everyone else’s face, especially when they’re in there getting the news,” she says. “You wonder, Does she look happier than me?”

When I worked in Goldman Sachs’s investment-banking division in the early nineties, I knew of a group of more-senior employees who would sit together at the division’s annual party each year and throw their compensation numbers into a hat. A designated person would calculate the average and tell it to the table, just so all knew where they stood. But that was the extent of it—the actual numbers were not shared.

Trick No. 2: Tell people, unless it’s blatantly obvious otherwise, that they’re being paid “outside the top of the range.” This has a few beneficial effects. For starters, it makes the employees feel pretty good—at least temporarily. Second, it makes them even more reluctant to share their compensation around the water cooler. “Everyone was always telling me how great I was and that I was the only person in my division in my class being paid outside the top of the range,” says a former vice-president in Goldman’s equities division. “I ended up not wanting to ask people, because if it was true, and my number got around, it would be obvious it was me.”

As money-obsessed as Wall Street is, the taboo on discussing your own compensation remains very serious at firms like Goldman. At a conference several years ago that was being addressed by Jon Corzine—then head of the firm and now governor-elect of New Jersey—a vice-president I used to work for in corporate finance had too much to drink, stood up, and jokingly chanted something along the lines of “More pay! More pay!” He was met with looks of horror by the entire division and a withering stare from Corzine himself. That man, who by rights should have made partner at the firm given the revenue he brought in, never did get there. Everyone in the division remembers the incident. “A career-limiting move of epic proportions,” recalls an ex-colleague.

Trick No. 3: Because bonuses are based on everything from the performance of the firm down to the division and the individual, there’s always something else to blame when someone gets the shaft. “There was always an excuse about why you weren’t getting as much as you expected,” says the former equities VP. “If it wasn’t the division, it was your group; if not that, the firm itself.” Goldman’s problem this year: The firm seems to be hitting on all cylinders, so everyone expects a big payday.

Everyone, it should be noted, really means everyone. Goldman secretaries, I am told, now make anywhere from $50,000 to $75,000 a year—depending on whom they work for and their level of experience—and tend to earn anywhere from 10 to 25 percent more as bonus. The firm’s undergraduate hires, or “analysts”—which is what I was in the early nineties—now make $70,000 a year, with the potential bonus of $75,000, according to the career Website vault.com. Recent M.B.A. graduates, or “associates,” tend to make $95,000 or more and also have a shot at an equal amount as a bonus. Those numbers are pretty much Streetwide—like airlines, investment banks tend to move in lockstep when it comes to paying their grunts.

What doesn’t move in lockstep is the performance of the various businesses at Goldman, which are divided into four main groups: investment banking, asset management (known as GSAM), equities, and FICC (fixed income, currency, and commodities). All four divisions fight each year over that remaining 35 percent of net revenue, and the money tends to go to those divisions—and the business units within them—that are outperforming at the time.

The Goldman of today is a very different place than when its investment-banking franchise—still the envy of Wall Street—was the company’s crown jewel. As evidenced by the ascension of trading veteran Lloyd Blankfein to president, the banking division has been thoroughly eclipsed by the company’s traders, so much so that Goldman is now jokingly referred to as a hedge fund with an investment-banking arm stapled onto it.

In the third quarter of this year, the company’s trading and principal investments (both equities and FICC) pulled in $5.1 billion in revenue, 69.5 percent of the firm’s total; asset management and securities services, $1.2 billion (16.6 percent); and investment banking, $1.02 billion (13.9 percent). Although it’s the first time the investment-banking division has topped $1 billion in quarterly revenue since the third quarter of 2001, it’s quite clear where the bulk of the money’s going to go: to the company’s traders, particularly those who make massive bets with the firm’s own capital.

Ultimately, it’s those traders who are the toughest to replace. Depending on which “desk” they sit at—risk arbitrage, credit swaps, equities, and many others—these people operate almost like free agents within the firm, their market bets bankrolled to the tune of hundreds of millions of dollars. Although investment bankers can be—and often are—replaced, a talented trader is an asset worth paying to keep. And that goes for their off years as well. “Traders go hot and cold,” says Kessler. “But you’ve still got to pay them enough in the cold years if you want them to be around for the hot ones.”

The names that follow are notable for the quality they all share: Most people will have never heard of a single one of them, despite their place among New York’s and London’s wealthiest. It says a lot that the most famous Goldman veteran—even more so than Jon Corzine and former co-chairman Bob Rubin, who went on to become Secretary of the Treasury—is Kwame Jackson, from the first year of Donald Trump’s The Apprentice. Jackson reportedly asked for a leave of absence to participate in The Apprentice but was told it was “too much of a reputational risk.” So he quit.

Rumor has it that the man in line for one of the biggest paydays in the New York office in 2005 is Mark McGoldrick, co-head of global proprietary investment for Goldman. In English, that means McGoldrick is the co-chief of the division that makes bets with the firm’s own capital. One New York recruiter told me the word on the street was that McGoldrick’s group had delivered more than $2 billion in profits for the firm this year. That should put him in line for a payday in the realm of $40 million or more. Proprietary traders are the golden boys (and girls) of Goldman these days, and payouts of $15 million to $20 million will not be unusual for top performers.

Jeffrey Frase, head of crude-oil trading for the firm, made an estimated $20 million to $25 million last year, according to Trader Monthly magazine, and given the volatility of those same markets this year, he could be up for even more in 2005. Likewise, Robert Cignarella, a debt trader in the firm’s asset-management division, took home an estimated $25 million to $30 million last year and could do so again. Others who stand to make a substantial amount, given the strength of their divisions: Phil Hylander, co-head of global equity trading, Richard Ruzika, co-chief executive of global commodities, and Philippe Khuong-Huu from the fixed-income division.

Gene Sykes and Jack Levy, who run the firm’s mergers-and-acquisitions business, are also undoubtedly up for a substantial payday, given the recent tear of that division. The firm advised on huge deals like Ford’s sale of Hertz for $5.6 billion.

Across the pond in London, Goldman’s other center of power, the list of high earners is extensive, thanks to the intrusive capabilities of the British press. Michael Sherwood, co-chief of Goldman Sachs International and a protégé of Blankfein’s, is said to be in line for a bonus of $20 million or so. According to Trader Monthly, Driss Ben-Brahim, head of the exotics-and-derivatives desk in London, made anywhere from $25 million to $30 million last year, and he’s rumored to be in line for a similar payout in 2005. Likewise, John Bertuzzi, a top energy trader in London, is said to have made $20 million to $25 million last year and could be up for a similar amount once again.

Goldman also pays its supporting cast handsomely. Bankers whose jobs consist merely of pitching the capabilities of other people at the firm can make as much as your average NFL starter. “The amazing thing about Goldman,” says a hedge-fund executive who does business with the firm, “is not that a few talented people make $20 million—it’s all the mediocre talents that make over $1 million.”

What does the future hold for Goldman in the way it pays its people? It’s going to get messier. With the rise of the hedge-fund industry, more and more people are bolting every Wall Street institution to start their own shops, in pursuit of “2 and 20”—shorthand for customary hedge-fund fees of 2 percent of assets under management and 20 percent of any upside. Goldman recently lost one of its legendary “quants”—so-called for their quantitative trading skills—Eric Mindich, who founded his own hedge fund, Eton Park, last year with $3.5 billion from investors. In 1994, Mindich became the youngest partner in the firm’s history, although rumors swirl that he had fallen out of favor owing to the problematic acquisition of New York Stock Exchange specialist firm Spear, Leeds & Kellogg for $6.5 billion in 2000. Forbes magazine called the purchase a “billion-dollar blunder” in 2003.

In any case, Mindich is only the latest in a long list of Goldman defectors lured away by the possibility of making substantially more money on their own. It was recently suggested that 10 percent of all money in hedge funds had ex–Goldman people involved in managing it—some $100 billion in total assets. That number is probably overblown, but the anecdotal evidence is impressive: Top Goldman players who have left in recent years include Edward Misrahi and Scott Prince, who joined Mindich; super-trader Christian Siva-Jothy in London, who joined Fulcrum Asset Management; and Geoffrey Grant and Ron Beller, who formed Peloton Partners. Why? Shockingly, Goldman couldn’t pay them enough. On the other hand, Goldman is, in a sense, still paying them—the firm is rumored to be a seed investor in many of these funds. So these top traders get the 2 and 20 they want and still remain part of the extended Goldman family.

Because of its reputation and the incredible riches that came with making partner, Goldman used to enforce tight discipline in compensation. But the industry is more competitive now, and the firm has to fight along with everyone else to keep its top producers. One current EMD told me that Goldman is now prepared to pay its top traders 10 to 15 percent of the profits they make for the firm, a stark reversal of long-standing policy and a direct counter to the siren song of hedge funds. “There was always an implicit understanding that if you made $100 million for the firm, the last $50 million of it was a waste of your time—they were never going to pay you more than a certain amount,” says one former trader for the firm. “But that’s all changed now.”

In Goldman’s offices around the globe, but especially inside the gilded walls of 85 Broad Street, the annual bonus dance is about to reach its climax. On the day they’re told their numbers, those who are richly rewarded will do their best to contain the feeling that comes along with being $2 million, $10 million, or even $40 million richer. And what of those who get the shaft? “They try to be professional,” says the former EMD. “Although you can see from their trembling lips or the intensity of their stare that they’re disappointed. They’ll go out to their station, slam a few things down, grab their coat, and walk out. Some of them won’t come back for several days.” At which point, it will nearly be 2006, with the meter running on next year’s bonus.


The Goldman Sachs Diet

If the firm split its potential $11 billion pie equally among all 22,000 employees worldwide, they’d each get $500,000. But that’s not how it works.

The Big Piece

There are 250 or so partner managing directors, each of whom would receive an average bonus of $2 million right off the top. The rest depends on the success of their part of the business, and it can be massive. Top income-producers like Mark McGoldrick, co-head of global proprietary investment, can make upward of $40 million.

The “Tide You Over Until You’re a Somebody” Piece

Executive managing directors, also known as “MD Lites,” can make up to $3 million.

The Table Scraps

Just-out-of-college analysts make $70,000 and hope to match that in bonus. Associates, with M.B.A.’s, hope to match their $95,000 salaries with a bonus, too. Secretaries who make as much as $75,000 have their sights set on bonuses of roughly $15,000.
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