Resignation letter just the latest blow to Goldman's integrity

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Banker Greg Smith's resignation from Goldman Sachs Group Inc. laid bare a culture he called "toxic" at a firm that he said sold out clients for fees. Yet as shocking as it is, it's only the second-most damning indictment of the bank's behaviour in recent days.

Mr. Smith wrote the resignation letter seemingly read round the world – quitting by way of an opinion piece in Wednesday's New York Times – in which he said Goldman's clients were viewed as "muppets" to be taken advantage of.

One way to ensure quick promotion, he wrote, was to "get your clients – some of whom are sophisticated, and some of whom aren't – to trade whatever will bring the biggest profit to Goldman. Call me old-fashioned, but I don't like selling my clients a product that is wrong for them."

Links to the letter flew around the world on Twitter, blogs and websites, and had daytime talk radio buzzing.

Goldman, of course, disputes Mr. Smith's assertions, saying in a statement that they don't "reflect the way we run our business. In our view, we will only be successful if our clients are successful. This fundamental truth lies at the heart of how we conduct ourselves."

In addition, there are plenty of questions about Mr. Smith and his motives. Why was he billed as an executive director in the Times, when Goldman says he was just one of 12,000 company vice-presidents, a more junior rank? Is he just frustrated, given that he has been at the firm a decade and is still so low on the organization chart?

The problem for Goldman is that it's hard to question the motives of Leo Strine, the lead judge on the Delaware Court of Chancery and perhaps the most revered judge in the United States when it comes to corporate law. In a Feb. 29 ruling, he said much the same thing about Goldman as Mr. Smith does.

Mr. Smith wrote that advising clients to make moves that didn't maximize profits for Goldman, even if they were the right moves for the client, "is becoming increasingly unpopular at Goldman Sachs." In his ruling, Judge Strine found evidence of exactly that in how Goldman conducted itself in the takeover of energy and pipeline company El Paso by rival Kinder Morgan Inc.

Deal geeks read Judge Strine's decision, but it didn't get the kind of wide distribution that Mr. Smith's missive garnered. Maybe now it will, because it offers a very revealing peak inside Goldman as the firm played all sides of a transaction.

A group of El Paso's shareholders sought an injunction from Judge Strine stopping the sale to Kinder Morgan because the sale process was tainted by conflicts of interest, including one at Goldman Sachs.

El Paso used Goldman as a financial adviser as it looked at whether to go ahead with a plan to split into two separate companies, or whether to sell to Kinder Morgan, which had quietly expressed interest in a deal. El Paso hired Goldman as an adviser even though Goldman owned almost 20 per cent of Kinder, and had two seats on its board.

Given that, El Paso never should have hired Goldman. And when it did, Goldman should have seen the conflict and turned the work down.

Because of Goldman's big stake in Kinder, worth about $4-billion (U.S.), the firm had more to gain by Kinder getting El Paso on the cheap than from driving the best deal for El Paso by forcing Kinder to pay top dollar. And Judge Strine found Goldman's attempts to persuade him otherwise unconvincing.

"The court is not swayed by Goldman's assertions that it was not influenced by its own economic incentives to maximize its $4-billion investment in Kinder Morgan by steering El Paso toward a deal with Kinder Morgan at a suboptimal price," the judge wrote.

Goldman's conflict wasn't a secret, and El Paso tried to deal with it. However, the result was "inadequate," Judge Strine ruled. For example, El Paso hired Morgan Stanley as a second bank to advise on the deal, but the fees were structured so that Morgan Stanley would be paid only if the outcome was the one that most favoured Goldman as a shareholder of Kinder Morgan.

Oh, and to top it off, the Goldman banker who was the point person on advising El Paso did not disclose he owned $340,000 of Kinder Morgan stock. So he, too, had an interest in Kinder getting a good deal.

Without Judge Strine's findings, Mr. Smith's letter could be read as just one angry banker venting. Together, they paint a disturbing picture that Goldman will have a very hard time erasing.