Goldman Sachs Chief Urges Reforms in Corporations
Published on Thursday, June 6, 2002 by the New York Times
Goldman Sachs Chief Urges Reforms in Corporations
by Patrick McGeehan

WASHINGTON, June 5 In a rare public appearance, the chairman and chief executive of Goldman Sachs, Henry M. Paulson Jr., called for changes today in how public companies are run, audited and regulated to help restore investor confidence.

Mr. Paulson said faith in corporate executives was at a low and was forestalling a recovery in financial markets. He proposed several measures to rebuild trust, including restrictions on the ability of chief executives to sell shares of their own companies.

Tracing the crisis back to the collapse of the Enron Corporation last fall, Mr. Paulson said during a lunch meeting at the National Press Club here, "I cannot think of a time when business over all has been held in less repute."

In his speech, he was surprisingly critical of the corporate executives and directors who make up the client base of major investment banks like Goldman. Seldom does such a powerful Wall Street executive take on corporate America so directly.

"The business community has been given a black eye by the activities and behavior of some C.E.O.'s and other notable insiders who sold large numbers of shares just before dramatic declines in their companies' share prices," he said in his speech. He did not name any companies on that score.

Corporate directors should require executive officers to hold their company stock for "significant periods of time" and company insiders should have to give back any gains from sales of their companies' stock made less than a year before a bankruptcy filing, he said.

Wall Street firms have their own troubles, of course, and Mr. Paulson spent a few minutes discussing conflicts of interest at investment banks like Goldman. He said he felt compelled to speak out because the situation had become dire. Other than the two top executives of Merrill Lynch, which has been embroiled in an investigation into investment recommendations of its stock analysts, senior executives on Wall Street have kept low profiles in recent months.

"I think this speech is a month or two overdue," Mr. Paulson said.

Still, he devoted most of his speech to corporate governance and accounting reform. In the wake of several notable restatements of company earnings, investors have lost faith in the American accounting system, he said.

He cited two factors: the pressure chief executives feel to report bigger profits every quarter and the complexity of the "rules-based approach" that underlies the generally accepted accounting principles set by the Financial Accounting Standards Board. That system, he said, is "ripe for manipulation" and should be updated and simplified quickly, under the oversight of the Securities and Exchange Commission.

"If the outcome of all we have been through in the last six months, all the soul-searching and debate, is business as usual at the F.A.S.B., then we will have missed an enormous opportunity for improvement," Mr. Paulson said.

The accounting used by J. P. Morgan Chase and some of the huge banks that compete with Goldman has long been a pet peeve among their investment bank rivals. Mr. Paulson reiterated that complaint yesterday, saying that companies specializing in financial services should be forced to carry assets and liabilities on their books at their current market value, not at their historical cost as many do now.

To the certain consternation of many of Goldman's clients, Mr. Paulson predicted that companies eventually would have to treat the stock options they give executives and employees as an expense. Executives of technology companies, among others, have fiercely fought efforts to make companies count the value of options a big component of pay in certain industries as a cost of doing business.

"Ultimately, I think options will be expensed and the accountants will win out," he said. "But who knows?"

Mr. Paulson also said companies, to avoid the appearance of a conflict of interest, should not buy consulting services from the accounting firms that audit their financial reports. As for Goldman's own conflicts of interest in trying to serve corporations and investors who buy their stocks and bonds, investors should trust the firm to police itself, he said.

"For an integrated investment bank like Goldman Sachs, conflict management has always been a core competency," he said. But he added that, through the boom and bust of telecommunications and technology stocks, "we have not done as good a job as we might have of preserving and protecting the independence of our research analysts."

Goldman has made some changes in the organization of its stock research operation, installing an ombudsman and giving the audit committee of the firm's board oversight of research. But the firm, like Merrill and others, has clung to the view that analysts must play a role in helping to land investment banking assignments from the companies that they rate.

"The major part of our effort will be to continue to focus on doing better fundamental analysis," Mr. Paulson said. "The next time something looks too good to be true, we hope we have the wisdom to see it and the courage of our conviction to act accordingly."

Copyright 2002 The New York Times Company