1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 24, 1998
REGISTRATION NO. 333-
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
------------------------
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
THE GOLDMAN SACHS GROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 6211 13-4019460
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
------------------------
85 BROAD STREET
NEW YORK, NEW YORK 10004
(212) 902-1000
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
ROBERT J. KATZ
GREGORY K. PALM
GOLDMAN, SACHS & CO.
85 BROAD STREET
NEW YORK, NEW YORK 10004
(212) 902-1000
(NAMES, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENTS FOR SERVICE)
------------------------
COPIES TO:
RICARDO A. MESTRES, JR. ALAN L. BELLER
JOHN P. MEAD CHRISTOPHER E. AUSTIN
DAVID B. HARMS CLEARY, GOTTLIEB, STEEN & HAMILTON
ROBERT W. REEDER III ONE LIBERTY PLAZA
SULLIVAN & CROMWELL NEW YORK, NEW YORK 10006
125 BROAD STREET (212) 225-2000
NEW YORK, NEW YORK 10004
(212) 558-4000
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after the effective date of this Registration Statement.
------------------------
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If the delivery of the prospectus is expected to be made pursuant to Rule
434 under the Securities Act, check the following box. [ ]
------------------------
CALCULATION OF REGISTRATION FEE
- ---------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------
PROPOSED MAXIMUM
TITLE OF EACH CLASS AGGREGATE AMOUNT OF
OF SECURITIES TO BE REGISTERED OFFERING PRICE(1)(2) REGISTRATION FEE
- ---------------------------------------------------------------------------------------------------------------------------
Common Stock, par value $.01 per share
Rights(3).................................................. $10,000,000 $2,950
- ---------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------
(1) A portion of the shares to be registered represents shares that are to be
offered outside of the United States but that may be resold from time to
time in the United States. Such shares are not being registered for the
purpose of sales outside the United States.
(2) Estimated solely for the purpose of calculating the registration fee in
accordance with Rule 457(o) under the Securities Act of 1933.
(3) Each share of Common Stock includes one Shareholder Protection Right as
described under "Description of Capital Stock".
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
2
THE INFORMATION IN THIS PRELIMINARY PROSPECTUS IS NOT COMPLETE AND MAY BE
CHANGED. THESE SECURITIES MAY NOT BE SOLD UNTIL THE REGISTRATION STATEMENT FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PRELIMINARY
PROSPECTUS IS NOT AN OFFER TO SELL NOR DOES IT SEEK AN OFFER TO BUY THESE
SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR SALE IS NOT PERMITTED.
SUBJECT TO COMPLETION. DATED AUGUST 24, 1998.
Shares
THE GOLDMAN SACHS GROUP, INC.
[GOLDMAN SACHS LOGO]
Common Stock
------------------------
This is an initial public offering of shares of Common Stock of The Goldman
Sachs Group, Inc. This prospectus relates to an offering of
shares in the United States. In addition, shares are being
offered outside the United States and the Asia/Pacific region and
shares are being offered in the Asia/Pacific region.
Goldman Sachs is offering of the shares to be sold in the
offerings. The selling shareholders identified in this prospectus are offering
an additional shares. Goldman Sachs will not receive any of the
proceeds from the sale of the shares being sold by the selling shareholders.
The underwriters intend to make available up to shares for
sale at the initial public offering price to Goldman Sachs employees and certain
other purchasers.
Prior to this offering, there has been no public market for the Common
Stock. It is currently estimated that the initial public offering price per
share will be between $ and $ . Goldman Sachs intends to list
the Common Stock on the New York Stock Exchange under the symbol "GS".
See "Risk Factors" beginning on page 14 to read about certain factors you
should consider before buying shares of the Common Stock.
------------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY
BODY HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ADEQUACY
OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
------------------------
Per Share Total
--------- -----
Initial public offering price............................... $ $
Underwriting discount....................................... $ $
Proceeds, before expenses, to Goldman Sachs................. $ $
Proceeds, before expenses, to the selling shareholders...... $ $
The underwriters may, under certain circumstances, purchase up to an
additional shares from Goldman Sachs at the initial public
offering price less the underwriting discount. The international underwriters
and the Asia/Pacific underwriters may similarly purchase up to an aggregate of
an additional shares.
------------------------
The underwriters are severally underwriting the shares being offered. The
underwriters expect to deliver the shares against payment in New York, New York
on , 1998.
GOLDMAN, SACHS & CO.
------------------------
Prospectus dated , 1998.
3
Description of photograph(s) will be provided.
2
4
OUR BUSINESS PRINCIPLES
1. Our clients' interests always come first. Our experience shows that if we
serve our clients well, our own success will follow.
2. Our assets are our people, capital and reputation. If any of these is ever
diminished, the last is the most difficult to restore. We are dedicated to
complying fully with the letter and spirit of the laws, rules and ethical
principles that govern us. Our continued success depends upon unswerving
adherence to this standard.
3. Our goal is to provide superior returns to our shareholders. Profitability
is critical to achieving superior returns, building our capital and attracting
and keeping our best people. Significant employee stock ownership aligns the
interests of our employees and our shareholders.
4. We take great pride in the professional quality of our work. We have an
uncompromising determination to achieve excellence in everything we undertake.
Though we may be involved in a wide variety and heavy volume of activity, we
would, if it came to a choice, rather be best than biggest.
5. We stress creativity and imagination in everything we do. While recognizing
that the old way may still be the best way, we constantly strive to find a
better solution to a client's problems. We pride ourselves on having pioneered
many of the practices and techniques that have become standard in the industry.
6. We make an unusual effort to identify and recruit the very best person for
every job. Although our activities are measured in billions of dollars, we
select our people one by one. In a service business, we know that without the
best people, we cannot be the best firm.
7. We offer our people the opportunity to move ahead more rapidly than is
possible at most other places. We have yet to find the limits to the
responsibility that our best people are able to assume. Advancement depends
solely on ability, performance and contribution to the Firm's success, without
regard to race, color, religion, sex, age, national origin, disability, sexual
orientation, or any other impermissible criterion or circumstance.
8. We stress teamwork in everything we do. While individual creativity is
always encouraged, we have found that team effort often produces the best
results. We have no room for those who put their personal interests ahead of the
interests of the Firm and its clients.
9. The dedication of our people to the Firm and the intense effort they give
their jobs are greater than one finds in most other organizations. We think that
this is an important part of our success.
10. We consider our size an asset that we try hard to preserve. We want to be
big enough to undertake the largest project that any of our clients could
contemplate, yet small enough to maintain the loyalty, the intimacy and the
esprit de corps that we all treasure and that contribute greatly to our success.
11. We constantly strive to anticipate the rapidly changing needs of our
clients and to develop new services to meet those needs. We know that the world
of finance will not stand still and that complacency can lead to extinction.
12. We regularly receive confidential information as part of our normal client
relationships. To breach a confidence or to use confidential information
improperly or carelessly would be unthinkable.
13. Our business is highly competitive, and we aggressively seek to expand our
client relationships. However, we must always be fair competitors and must never
denigrate other firms.
14. Integrity and honesty are at the heart of our business. We expect our
people to maintain high ethical standards in everything they do, both in their
work for the Firm and in their personal lives.
3
5
CERTAIN INTRODUCTORY MATTERS
CERTAIN DEFINITIONS
Unless otherwise stated herein, the "Company", the "Firm", "Goldman Sachs",
"we" and "our" mean (a) prior to the completion of the Incorporation
Transactions, The Goldman Sachs Group, L.P., a Delaware limited partnership
("Group L.P."), and its consolidated subsidiaries and, prior to the formation of
Group L.P. in 1989, Goldman, Sachs & Co. ("GS&Co.") and its consolidated
subsidiaries; and (b) after the completion of the Incorporation Transactions,
The Goldman Sachs Group, Inc., a Delaware corporation ("GS Inc."), and its
consolidated subsidiaries.
"PLPs" means the Managing Directors who are also Schedule II limited
partners of Group L.P. (they participate in the profits of the Firm). "RLPs"
means the Schedule I limited partners (the retired limited partners) of Group
L.P.
SHARE AMOUNTS
Unless otherwise stated herein, all information contained in this
Prospectus assumes no exercise of the options to purchase additional shares
granted to the underwriters. GS Inc.'s common stock, par value $.01 per share
(the "Common Stock"), and GS Inc.'s nonvoting common stock, par value $.01 per
share (the "Nonvoting Common Stock"), are collectively referred to as the
"Common Shares".
REFERENCES TO DATES
Unless otherwise stated herein, all references to 1993, 1994, 1995, 1996
and 1997 refer to the Firm's fiscal year ended, or the date, as the context
requires, November 26, 1993, November 25, 1994, November 24, 1995, November 29,
1996 and November 28, 1997, respectively, and all references to May 1997 and May
1998 refer to the Firm's six-month fiscal period ended, or the date, as the
context requires, May 30, 1997 and May 29, 1998, respectively.
MARKET SHARE DATA
Except as otherwise indicated, all amounts with respect to the volume,
number and market share of mergers and acquisitions and underwriting
transactions and related ranking information have been derived from information
compiled and classified by Securities Data Company ("SDC"). SDC obtains and
gathers its information from sources it considers to be reliable, but SDC does
not guarantee the accuracy or completeness of the information. In the case of
mergers and acquisitions, data are based upon the dollar value of announced
transactions for the period indicated, taken as a whole. In the case of
underwritings, data are based upon the dollar value of total proceeds raised
(exclusive of any option to purchase additional shares) with equal credit to
each bookrunner for the period indicated, taken as a whole.
FINANCIAL DATA
The Firm's compensation and benefits expense does not reflect any payments
for services rendered by its partners and therefore understates the expected
operating costs to be incurred by the Firm after the offerings. In addition, the
Firm, as a partnership, generally was not subject to U.S. federal or state
income taxes.
Net revenues is total revenues, net of interest expense. Interest expense
is allocated to specific securities, commodities and other positions in relation
to the level of financing incurred by each position.
In Trading and Principal Investments, net revenues from the Firm's
investments in its merchant banking funds do not include management fees and
overrides. These management fees and overrides are included in Asset Management
and Securities Services.
The Firm's assets under supervision are comprised of assets under
management and other client assets. Assets under management typically generate
fees based on a percentage of their value and include the Firm's mutual funds,
separate accounts managed for institutional and individual investors, merchant
banking funds and other alternative investment funds. Other client assets are
comprised of assets in brokerage accounts of high net worth individuals on which
the Firm earns primarily commissions.
4
6
PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this Prospectus.
This summary is not complete and does not contain all of the information that
you should consider before investing in the Common Stock. You should read the
entire Prospectus carefully, especially the risks of investing in the Common
Stock discussed under "Risk Factors".
THE GOLDMAN SACHS GROUP, INC.
Our mission is to be the preeminent global investment banking and
securities firm -- the advisor of choice for our clients and a leading
participant in global financial flows. We are a market leader in each of our
three principal business lines: (i) Investment Banking, (ii) Trading and
Principal Investments and (iii) Asset Management and Securities Services. We
provide services worldwide to a substantial and diversified client base, which
includes corporations, financial institutions, governments and high net worth
individuals. Our net revenues and pre-tax earnings for 1997 were $7.4 billion
and $3.0 billion, respectively, and for the six months ended May 1998 were $5.5
billion and $2.1 billion, respectively. As of May 1998, our total assets were
$241.9 billion and our partners' capital was $6.6 billion.
We have produced strong earnings growth and attractive returns on partners'
capital through various economic cycles and market conditions. Over the last 15
years, our pre-tax earnings have grown from $364 million in 1982 to $3.0 billion
in 1997, representing a compound annual growth rate of 15%. We have achieved
this growth, which has been almost exclusively organically generated, by
maintaining an intense commitment to our clients, focusing on our core
businesses and key opportunities and operating as a highly integrated, global
franchise.
Because we believe that the needs of our clients are global and that
international markets have high growth potential, we have aggressively leveraged
our U.S. market leadership into leading positions in other parts of the world.
Today, the Firm has a strong global presence as evidenced by the geographic
breadth of our transactions, leadership in our core products and the scale of
our international operations. As of May 1998, we operated offices in 22
countries and had over 4,100 employees (representing 36% of total employees)
based outside the United States.
We are committed to a distinctive culture and set of core values. Our core
values are reflected in our Business Principles, which emphasize (i) placing our
clients' interests first, (ii) integrity, (iii) commitment to excellence and
innovation and (iv) teamwork.
The Firm is managed by its principal owners. Simultaneously with the
Offerings, we will make equity-based awards that will total over $ in
aggregate value, to substantially all of our employees. Following the Offerings,
our employees will own approximately % of the Company on a fully diluted
basis. None of our employees are selling shares in the Offerings.
WHY WE ARE GOING PUBLIC
We have chosen to become a public company in order to better match the
Firm's capital structure to our mission of being the preeminent global
investment banking and securities firm. As a public company, we will have
greater financial strength, greater strategic flexibility and broader alignment
of employee interests with the interests of our shareholders. From a financial
perspective, public ownership will give us a more stable capital base, broaden
our sources of capital and lower our funding costs. From a strategic
perspective, while we expect most of our growth will continue to be organic,
public ownership will give us a currency with which we may choose to pursue
strategic acquisitions. From an employee perspective, public ownership will help
us meet a fundamental objective -- to share ownership broadly among the Firm's
employees.
5
7
SUMMARY FINANCIAL DATA
($ in millions)
AS OF OR FOR
AS OF OR FOR SIX MONTHS
YEAR ENDED NOVEMBER ENDED MAY
------------------------------ CAGR(3) ------------------- INCREASE
1995 1996 1997 '95-'97 1997 1998 '97-'98
---- ---- ---- ------- ---- ---- --------
Net revenues:
Investment Banking........ $ 1,595 $ 2,113 $ 2,587 27% $ 1,094 $ 1,587 45%
Trading and Principal
Investments............. 1,744 2,693 2,926 30 1,660 2,578 55
Asset Management and
Securities Services..... 1,144 1,323 1,934 30 877 1,296 48
-------- -------- -------- -------- --------
Total net revenues.......... $ 4,483 $ 6,129 $ 7,447 29 $ 3,631 $ 5,461 50
======== ======== ======== ======== ========
Pre-tax earnings(1)......... $ 1,368 $ 2,606 $ 3,014 48 $ 1,515 $ 2,059 36
Total assets................ 100,066 152,046 178,401 34 169,200 241,852 43
Adjusted assets(2).......... 73,552 93,279 119,883 28 102,989 153,355 49
Partners' capital........... 4,905 5,309 6,107 12 5,609 6,638 18
Pre-tax return on average
partners' capital(1)...... 28% 51% 53% 56%(4) 65%(4)
- ---------------
The table above should be read in conjunction with the footnotes to "Selected
Consolidated Financial Data" as well as the following footnotes:
(1) The Firm's pre-tax earnings and compensation and benefits expense do not
reflect any payments for services rendered by its partners. Accordingly,
pre-tax earnings understate the expected operating costs to be incurred by
the Firm after the Offerings. See "Pro Forma Consolidated Financial
Information".
(2) Adjusted assets represent total assets less (i) securities purchased under
agreements to resell, (ii) certain securities borrowed transactions and
(iii) with respect to May 1998, the increase of $17 billion in total assets
related to the adoption of the provisions of Statement of Financial
Accounting Standards ("SFAS") No. 125 that were deferred by SFAS No. 127.
(3) Compound annual growth rate.
(4) The pre-tax returns on average partners' capital for May 1997 and May 1998
have been annualized. Interim results may not be indicative of results for a
full year. See "Risk Factors".
------------------------
PRINCIPAL BUSINESS LINES
INVESTMENT BANKING
Investment Banking represented 35% of 1997 net revenues. We are a market
leader in both our financial advisory and underwriting businesses, serving over
3,000 clients worldwide. For the period January 1, 1993 to June 30, 1998, in
worldwide mergers and acquisitions advisory services, we had the
industry-leading market share of 23.8%, having advised on over $1.4 trillion of
transactions. Over the same period, we also achieved the number one market share
in underwriting worldwide initial public offerings and all common stock issues
with market shares of 15.2% and 14.1%, respectively.
TRADING AND PRINCIPAL INVESTMENTS
Trading and Principal Investments represented 39% of 1997 net revenues. We
make markets in equity and fixed income products, currencies and commodities;
enter into swaps and other derivative transactions; engage in proprietary
trading and arbitrage; and make principal investments. In trading, we focus on
building lasting relationships with our most active clients while maintaining
leadership positions in our key markets. We believe our value-added research,
market-making roles and proprietary activities enhance our understanding of
markets and ability to serve our clients. Principal investments includes the net
revenues from the Firm's investments in its merchant banking funds.
ASSET MANAGEMENT AND SECURITIES SERVICES
Asset Management and Securities Services represented 26% of 1997 net
revenues. We provide global investment management and advisory services; earn
commissions on agency transactions; earn management fees
6
8
and derive overrides from our merchant banking funds; and provide prime
brokerage, securities lending and financing services. As of May 1998, the Firm
had approximately $305 billion of assets under supervision, of which $165
billion represented assets under management. Our asset management business is
rapidly growing, with current net asset inflows averaging over $115 million per
business day. We manage one of the largest private equity pools for corporate
and real estate investments, having raised over $13.2 billion of committed
equity capital as of June 1998.
INDUSTRY AND ECONOMIC OUTLOOK
We believe that significant growth and profit opportunities exist for
financial intermediaries worldwide. These opportunities derive from important
long-term trends, including (i) financial market deregulation, (ii) the
globalization of the world economy, (iii) the increasing focus of companies on
shareholder value, (iv) consolidations in various industries, (v) increases in
investable funds due in part to changing demographics and (vi) accelerating
technology and financial product innovation. As the table below demonstrates,
over the last 15 years these trends have contributed to a substantially higher
rate of growth in activity in the financial services industry than the growth in
overall economic activity. We believe that these long-term trends will continue
to affect growth in the financial services industry positively.
We believe scale, global resources and leading market positions are
important competitive advantages for financial intermediaries in this
environment. As a result, we believe the Firm is well positioned to capitalize
on the worldwide opportunities created by these long-term trends.
The following table sets forth selected key industry indicators:
KEY INDUSTRY INDICATORS
($ in billions, except GDP)
(volume in millions of shares)
AS OF OR FOR
YEAR ENDED DECEMBER 31,
----------------------------------- CAGR
1982 1987 1992 1997 '82-'97
---- ---- ---- ---- -------
Worldwide GDP ($ in trillions)(1)........... $ 11 $ 16 $ 23 $ 29 7%
Worldwide mergers and acquisitions.......... 56 327 353 1,579 25
Worldwide equity issued..................... 22 89 131 285 19
Worldwide debt issued....................... 73 492 1,165 2,086 25
Worldwide equity market capitalization(2)... 2,737 7,896 10,922 23,541 15
NYSE average daily volume................... 65 189 202 527 15
Worldwide pension assets(3)................. $1,175 $3,407 $ 5,956 $ 9,694 15
U.S. mutual fund assets(4).................. 297 770 1,646 4,490 20
- ---------------
(1) Gross domestic product. Source: The Economist Intelligence Unit, 1998.
(2) Source: Emerging Stock Markets Factbook, International Finance Corporation.
(3) Source: InterSec Research Corp.
(4) Source: Mutual Fund Factbook, Investment Company Institute.
------------------------
COMPETITIVE STRENGTHS
STRONG CLIENT RELATIONSHIPS
We endeavor to treat each client relationship as a valued asset that we
develop over time. In 1997, over 75% of our Investment Banking revenues
represented business from existing clients of the Firm. We also aggressively
pursue new client relationships as evidenced by the over 400 investment banking
transactions we completed for first-time clients in 1997. In our trading
businesses, we focus on building lasting relationships with our clients, for
whom we structure and exe-
7
9
cute transactions across a wide array of markets and countries. In our asset
management businesses, we manage assets for three of the five largest pension
pools in the United States as ranked by Pensions and Investments, have 14
clients for which we manage at least $1 billion each and maintain accounts for
over 40% of the Forbes "Four Hundred".
DISTINCTIVE PEOPLE AND CULTURE
Our most important asset is our people. We seek to reinforce our employees'
commitment to our culture and values through recruiting, training, a
comprehensive 360-degree review system and a compensation philosophy that
rewards teamwork. We were ranked number 12 in Fortune magazine's 1998 "The 100
Best Companies to Work for in America" and were ranked number two in Fortune
magazine's 1998 "The Top 50 MBA Dream Companies", the highest-ranked investment
banking and securities firm in each case.
GLOBAL REACH
Over the past decade, we have made a significant commitment to building a
worldwide franchise. We have achieved leading positions in major international
markets by capitalizing on our product knowledge and global research, as well as
by building a local presence where appropriate. In doing so, we have become one
of the few truly global investment banking and securities firms with the ability
to execute large and complex cross-border financial advisory and underwriting
assignments. We had the number one market share of 22.1% in cross-border mergers
and acquisitions for the period January 1, 1993 to June 30, 1998. More recently,
in the first six calendar months of 1998, we had the leading market share in the
newly developing European non-dollar high-yield debt underwriting market,
according to MCM
CorporateWatch Data Services. Furthermore, as of July 31, 1998, we were the
largest non-Japanese mutual fund manager in Japan, according to the Investment
Trust Association.
ABILITY TO MANAGE AND BENEFIT FROM RISK
We assume diversified risks in our business and devote substantial
resources to identify, analyze and benefit from these exposures. We believe our
willingness and ability to take risk distinguishes us and substantially enhances
our client relationships. By combining our strong fundamental research, access
to information, analytic capabilities, experience, judgment and risk
diversification skills, we have generated attractive returns through various
economic cycles and market conditions.
STRATEGY
LEVERAGE THE FRANCHISE
We believe our various businesses are generally stronger and more
successful because they are part of the Goldman Sachs franchise. Our culture of
teamwork fosters cooperation among our businesses, which allows us to leverage
our broad-based capabilities to provide our clients with an integrated,
full-service product. We also create multiple points of contact with our clients
to further enhance our relationships. For example, our merchant banking area
sources investment opportunities from our global network of client
relationships. Moreover, major selling shareholders of our investment banking
clients often become substantial asset management clients.
EXPAND LEADERSHIP POSITION IN HIGH GROWTH, HIGH VALUE-ADDED BUSINESSES
We focus our human and capital resources to better serve our clients
through high value-added activities. Our growth strategy is based on leveraging
our leadership positions to pursue growth opportunities in both existing and new
markets where we believe we can earn high returns. For example, we have
substantially increased our headcount in Investment Banking in order to better
execute mergers and acquisitions, initial public offerings and high-yield
financings. Similarly, in trading, we have strategically deployed professionals
and capital to the areas of greatest opportunity and importance to our clients.
In asset management, we have demonstrated our ability to build a leading
business rapidly and have grown assets
8
10
under supervision from $87 billion as of November 1993 to $305 billion as of May
1998, representing a CAGR of 32%.
PURSUE INTERNATIONAL OPPORTUNITIES
We believe that our global reach will allow us to take advantage of growth
in international markets. In Europe, the establishment of the Economic and
Monetary Union ("EMU") in 1999 will create, over time, a large pan-European
market rivaling the U.S. capital markets in size and liquidity. This is expected
to generate increased activity across our principal business lines. In Asia, we
expect increased trading opportunities as we meet the liquidity needs of our
clients and increased mergers and acquisitions advisory opportunities as a
result of corporate restructurings. In the longer term, we anticipate additional
opportunities in these markets for merchant banking as well as increases in
asset management activities due to an expected shift towards privatization of
pension systems and changing demographics.
OUR HEADQUARTERS
Our principal executive offices are located at 85 Broad Street, New York,
New York 10004, telephone (212) 902-1000.
9
11
THE OFFERINGS
Common Stock:
Offered by the Company............................. shares
Offered by the Selling Shareholders................ shares
-------------
Total........................................... shares
=============
U.S. Offering...................................... shares
International Offering............................. shares
Asia/Pacific Offering.............................. shares
-------------
Total(1)........................................ shares
=============
Common Shares to be outstanding after the
Offerings(2)....................................... shares
- ---------------
(1) The offerings of Common Stock are collectively referred to as the
"Offerings".
(2) Excludes shares issuable upon exercise of the underwriters'
options to purchase additional shares, which are described under
"Underwriting". Includes shares of Common Stock deliverable pursuant to
the Formula RSUs and shares of Common Stock irrevocably contributed to a
nonqualified defined contribution plan and shares of Nonvoting
Common Stock that upon transfer automatically convert into shares of Common
Stock on a one-for-one basis. See "Description of Capital Stock -- Nonvoting
Common Stock". Excludes shares of Common Stock deliverable pursuant to
the Discretionary RSUs and Discretionary Options. The Formula RSUs, the
Discretionary RSUs, the nonqualified defined contribution plan and the
Discretionary Options are defined and described under "Management -- The
Employee IPO Awards".
------------------------
Voting Rights................. Holders of Common Stock will have one vote per
share.
Dividend Policy............... The holders of Common Stock (as well as the
Nonvoting Common Stock) will share ratably on a
per share basis in all dividends and other
distributions declared by our Board of
Directors. Our Board of Directors currently
intends to declare quarterly dividends on all
Common Shares and expects that the first
quarterly dividend will be $ per share,
and that it will be declared during the first
fiscal quarter of 1999. For a discussion of the
factors that affect the determination by the
Board of Directors to declare dividends, as
well as certain other matters concerning our
dividend policy, see "Dividend Policy" and
"Business -- Regulation".
Use of Proceeds............... The Firm will receive net proceeds from sales
of Common Stock by it in the Offerings of
approximately $ . We expect to use the
net proceeds for general corporate purposes.
The Firm will not receive any of the proceeds
from sales of Common Stock by the Selling
Shareholders in the Offerings.
Risk Factors.................. For a discussion of certain factors you should
consider before buying shares of Common Stock,
see "Risk Factors".
Proposed New York Stock
Exchange Symbol............. GS
10
12
INCORPORATION AND RELATED TRANSACTIONS
Simultaneously with the consummation of the Offerings, we will complete a
number of transactions in order to convert from partnership to corporate form.
We will also make substantial equity-based awards to our employees. For a more
detailed description of these transactions, see "Certain Relationships and
Related Transactions -- Incorporation and Related Transactions",
"Management -- The Employee IPO Awards" and "Pro Forma Consolidated Financial
Information".
The principal incorporation transactions (the "Incorporation Transactions")
and the related transactions (the "Related Transactions") are summarized below:
INCORPORATION TRANSACTIONS
- - The PLPs will exchange their interests in Group L.P. for shares of
Common Stock;
- - The RLPs will exchange their interests in Group L.P. for an aggregate of
approximately $ in cash, $ in principal amount of 12% junior
subordinated debentures of GS Inc. (the "Junior Subordinated Debentures") and
shares of Common Stock;
- - Sumitomo Bank Capital Markets, Inc. ("SBCM") will exchange its interests in
Group L.P. for shares of Common Stock and shares of Nonvoting Common
Stock; and
- - Kamehameha Activities Association ("KAA") will exchange its interest in Group
L.P. for shares of Common Stock.
RELATED TRANSACTIONS
- - Equity awards will be granted to employees other than PLPs in the form of (i)
restricted stock units (the "Formula RSUs") with a value of
$ , (ii) an initial irrevocable contribution of up to
shares of Common Stock with a value of $ to a nonqualified defined
contribution plan (the "DCP"), (iii) restricted stock units (the
"Discretionary RSUs") with a value of $ and (iv) options to purchase
shares of Common Stock at the initial public offering price for the
Offerings (the "Discretionary Options"). The indicated values of these awards
are based on the midpoint of the range of initial public offering prices set
forth on the cover page of this Prospectus;
- - After the closing of the Offerings, we will make a $ contribution to
a Goldman Sachs charitable foundation (the "Charitable Contribution"); and
- - In addition to the Offerings, we plan to raise capital through an offering of
mandatorily redeemable preferred securities ("QUIPS"(SM)*). At or about the
time of the Offerings, we plan to issue through a special purpose trust up to
$ of QUIPS in an underwritten public offering (the "QUIPS Offering").
The proceeds from the QUIPS Offering will be used for general corporate
purposes. The closing of the Offerings is not conditioned on the closing of
the QUIPS Offering, and we can give no assurance that the QUIPS Offering will
be completed or, if completed, as to the amount or final terms of the QUIPS
that will be sold. See "Description of Capital Securities".
PARTNERSHIP CAPITAL ADJUSTMENTS
Prior to our conversion to corporate form, we will adjust our partners'
capital (the "Partnership Capital Adjustments") by, among other things, making a
cash distribution of $ . This distribution is not conditioned on the
incorporation of the Firm or the completion of the Offerings.
- ---------------
* QUIPS is a registered servicemark of GS&Co.
11
13
SUMMARY CONSOLIDATED FINANCIAL DATA
The summary historical consolidated income statement and balance sheet data
set forth below have been derived from the Firm's consolidated financial
statements and the notes thereto. The Firm's consolidated financial statements
have been audited by PricewaterhouseCoopers LLP, independent public accountants,
as of November 1996 and November 1997 and for the years ended 1995, 1996 and
1997, and as of and for the six months ended May 1998. These financial
statements are included elsewhere in this Prospectus, together with the report
thereon of PricewaterhouseCoopers LLP.
The summary historical consolidated income statement and balance sheet data
set forth below as of November 1993, November 1994 and November 1995 and for the
years ended 1993 and 1994 have been derived from audited consolidated financial
statements of the Firm not included in this Prospectus.
The summary historical consolidated income statement and balance sheet data
set forth below as of and for the six months ended May 1997 have been derived
from the Firm's unaudited interim consolidated financial statements and, in the
opinion of management, include all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation. The interim results
set forth below for the six-month period ended May 1998 may not be indicative
of the results for the full year.
The pro forma data set forth below for the year ended November 1997 and as
of and for the six months ended May 1998 have been derived from the pro forma
data set forth in "Pro Forma Consolidated Financial Information".
The summary consolidated financial data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", "Pro Forma Consolidated Financial Information" and the consolidated
financial statements and the notes thereto.
AS OF OR FOR
SIX MONTHS
AS OF OR FOR YEAR ENDED NOVEMBER ENDED MAY
--------------------------------------------------- ----------------------
1993 1994(8) 1995 1996 1997 1997 1998
---- ------- ---- ---- ---- ---- ----
(unaudited)
($ in millions, except share and per share amounts)
INCOME STATEMENT DATA:
Net revenues............................... $ 5,764 $3,537 $ 4,483 $ 6,129 $ 7,447 $ 3,631 $ 5,461
Compensation and benefits expense(1)....... 2,126 1,789 2,005 2,421 3,097 1,528 2,589
Other operating expenses................... 980 1,240 1,110 1,102 1,336 588 813
-------- ------- -------- -------- -------- -------- --------
Pre-tax earnings(1)........................ $ 2,658 $ 508 $ 1,368 $ 2,606 $ 3,014 $ 1,515 $ 2,059
======== ======= ======== ======== ======== ======== ========
BALANCE SHEET DATA:
Total assets(2)............................ $115,900 $95,296 $100,066 $152,046 $178,401 $169,200 $241,852
Adjusted assets (unaudited)(3)............. 84,569 75,772 73,552 93,279 119,883 102,989 153,355
Long-term borrowings....................... 10,241 14,418 13,358 12,376 15,667 12,782 20,275
Total liabilities(2)....................... 110,073 89,981 94,686 145,753 171,864 163,045 234,648
Partners' capital.......................... 5,008 4,771 4,905 5,309 6,107 5,609 6,638
PRO FORMA DATA:
Pro forma net earnings(4).................. -- -- -- -- --
Pro forma net earnings per share(4)(5)..... -- -- -- -- --
Pro forma net earnings per share as
adjusted for the Offerings(4)(6)......... -- -- -- -- --
Pro forma Common Shares as adjusted for the
Offerings(6)............................. -- -- -- -- --
Pro forma stockholders' equity as adjusted
for the Offerings(4)..................... -- -- -- -- -- --
Pro forma book value per share as adjusted
for the Offerings(6)..................... -- -- -- -- -- --
12
14
AS OF OR FOR
SIX MONTHS
AS OF OR FOR YEAR ENDED NOVEMBER ENDED MAY
-------------------------------------------------- -------------------
1993 1994(8) 1995 1996 1997 1997 1998
---- ------- ---- ---- ---- ---- ----
($ in millions)
SELECTED DATA AND RATIOS (UNAUDITED):
Pre-tax return on average partners'
capital(1).......................... 61% 10% 28% 51% 53% 56%(9) 65%(9)
Ratio of compensation and benefits
expense to net revenues(1).......... 37% 51% 45% 40% 42% 42% 47%
Employees:
United States....................... 5,528 5,822 5,356 5,818 6,879 6,027 7,331
International....................... 2,575 3,176 2,803 3,159 3,743 3,263 4,109
------- ------- -------- -------- -------- -------- --------
Total employees(7).................... 8,103 8,998 8,159 8,977 10,622 9,290 11,440
======= ======= ======== ======== ======== ======== ========
Assets under supervision:
Assets under management............. $41,710 $43,671 $ 52,358 $ 94,599 $135,929 $116,714 $165,226
Other client assets................. 45,663 52,783 62,820 83,362 110,441 94,750 139,689
------- ------- -------- -------- -------- -------- --------
Total assets under supervision........ $87,373 $96,454 $115,178 $177,961 $246,370 $211,464 $304,915
======= ======= ======== ======== ======== ======== ========
- ---------------
(1) The Firm's pre-tax earnings and compensation and benefits expense do not
reflect any payments for services rendered by its partners. Accordingly,
pre-tax earnings understate the expected operating costs to be incurred by
the Firm after the Offerings. See "Pro Forma Consolidated Financial
Information".
(2) Total assets and liabilities as of May 1998 were increased by $17 billion
due to the adoption of the provisions of SFAS No. 125 that were deferred by
SFAS No. 127. See "Accounting Developments" in Note 2 to the consolidated
financial statements.
(3) Adjusted assets represent total assets less (i) securities purchased under
agreements to resell, (ii) certain securities borrowed transactions and
(iii) with respect to May 1998, the increase of $17 billion in total assets
related to the adoption of the provisions of SFAS No. 125 that were
deferred by SFAS No. 127.
(4) Reflects such adjustments as are necessary, in the opinion of management,
for a fair presentation of the results of operations and stockholders'
equity of the Firm on a pro forma basis. See "Pro Forma Consolidated
Financial Information".
(5) Calculated based on Common Shares outstanding after giving effect
to the Pro Forma Adjustments. Common Shares outstanding does not include
shares of Common Stock deliverable pursuant to the Discretionary
RSUs and Discretionary Options. See "Pro Forma Consolidated Financial
Information".
(6) Calculated based on Common Shares outstanding after giving effect
to the Pro Forma Adjustments, as adjusted to reflect the issuance of
shares of Common Stock offered by the Firm at the midpoint of the
range of initial public offering prices set forth on the cover page of this
Prospectus, after deduction of underwriting discounts and estimated
expenses to be paid by the Firm. Common Shares outstanding does not include
shares of Common Stock deliverable pursuant to the Discretionary
RSUs and Discretionary Options. See "Pro Forma Consolidated Financial
Information".
(7) Excludes employees of the Firm's two property management subsidiaries,
Archon Group, L.P. ("Archon") and Gestion d'Actifs Haussmann SCA ("GAH").
Substantially all of the costs of these employees are reimbursed to the
Firm by the real estate investment funds to which the two companies provide
property management services. In addition, as of May 1998, we had
approximately 2,900 temporary staff and consultants. See
"Business -- Employees" and "-- Temporary Staff and Consultants".
(8) See "Business -- Trading and Principal Investments -- Trading Risk
Management -- 1994" for a discussion of the decrease in net revenues in
1994 compared to 1993.
(9) The pre-tax returns on average partners' capital for May 1997 and May 1998
have been annualized. Interim results may not be indicative of the results
for a full year. See "Risk Factors".
13
15
RISK FACTORS
An investment in the Common Stock involves a number of risks, some of
which, including market, liquidity, credit, operational, legal and regulatory
risks, could be substantial and are inherent in the business of the Firm. You
should carefully consider the following information about these risks, together
with the other information in this Prospectus, before buying shares of Common
Stock.
MARKET RISK COULD ADVERSELY AFFECT OUR
BUSINESSES IN MANY WAYS
As an investment banking and securities firm, our businesses are dependent
on conditions in the financial markets and on economic conditions generally,
both in the United States and elsewhere around the world. Over the past several
years, the equity and debt markets in the United States and elsewhere have
achieved record or near record levels, and this favorable business environment
will not continue indefinitely. In the event of a market downturn, our
businesses could be adversely affected in many ways, including those described
below. Our revenues are likely to decline in such circumstances and, if we were
unable to reduce expenses at the same pace, our profit margins would erode. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Results of Operations -- Operating Expenses" for a description of
our cost structure. Even in the absence of a market downturn, the Firm is
exposed to substantial risk of loss due to market volatility.
LOWER REVENUES FROM INVESTMENT BANKING ACTIVITY
Unfavorable financial or economic conditions would likely reduce the number
and size of transactions in which we provide underwriting, mergers and
acquisitions advisory and other services. Our Investment Banking revenues, in
the form of underwriting discounts and financial advisory fees, are directly
related to the number and value of the transactions in which we participate and
would therefore be adversely affected by a market downturn.
LOSSES FROM TRADING AND INVESTMENT ACTIVITY
The Firm generally maintains large trading and investment positions in the
fixed income, currency, commodity and equity markets. To the extent that the
Firm has long positions (i.e., owns assets) in any of those markets, a downturn
in those markets could result in a decline in the value of those long positions,
resulting in losses and reduced asset values for the Firm. Conversely, to the
extent that the Firm has short positions (i.e., has sold assets it does not own)
in any of those markets, an upturn in those markets could expose the Firm to
potentially unlimited losses as it attempts to cover its short positions by
acquiring assets in a rising market. Often the Firm carries paired long and
short positions whose relative values may change substantially. In addition, the
Firm maintains substantial trading positions that can be adversely affected by
the level of volatility (i.e., the degree to which trading prices fluctuate over
a particular period) in a particular market, regardless of market levels.
LOWER REVENUES FROM COMMISSIONS AND MANAGEMENT FEES
A market downturn is likely to lead to a decline in the volume of trading
transactions that we effect for our customers and, therefore, to a decline in
the revenues we receive from commissions and spreads. In addition, because the
fees that we charge for managing securities and other financial asset portfolios
for our clients are in many cases based on the value of those portfolios, a
market downturn that reduces the value of our clients' portfolios or increases
the amount of withdrawals would reduce the revenue we receive from our asset
management business.
CONCENTRATION OF MARKET RISK
The Firm has committed substantial amounts of capital to its arbitrage,
market-making, block trading, underwriting and lending businesses. These
activities often require the Firm to take large positions in the securities of a
particular issuer, or issuers in a particular industry, country or region. In
the past, concentration of risk has increased the
14
16
losses that we have incurred in these activities. See "Business -- Trading and
Principal Investments -- Trading Risk Management -- 1994". Moreover, the trend
in all major capital markets, for competitive and other reasons, is towards
larger commitments of capital in these activities.
OTHER RISKS INCREASED BY MARKET RISK
In addition to having the potentially adverse effects on our businesses
described above, market risk could exacerbate other risks that we face. For
example, if we incur substantial trading losses, our need for liquidity could
rise sharply while our access to liquidity could be impaired. In addition, in
conjunction with a market downturn, our customers and counterparties could incur
substantial losses of their own, thereby weakening their financial condition and
increasing our credit risk to them. Our liquidity risk and credit risk are
described below.
LIQUIDITY RISK COULD IMPAIR OUR ABILITY TO FUND
OPERATIONS AND JEOPARDIZE OUR
FINANCIAL CONDITION
Liquidity (i.e., ready access to funds) is essential to our business. In
addition to maintaining a cash position, we rely on three principal sources of
liquidity: borrowing in the debt markets, access to certain other funding
sources, such as the repurchase and securities lending markets, and selling
securities and other assets. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Liquidity".
CONTINUOUS BORROWING NEEDS
We depend on continuous access to the debt capital markets to finance our
day-to-day operations. An inability to raise money in the long-term or
short-term debt markets, or to engage in certain other financing activities,
could have a substantial negative effect on our liquidity. Our access to debt in
amounts adequate to finance our activities could be impaired by many factors,
some of which may be specific to the Firm. For example, lenders could develop a
negative perception of our long-term or short-term financial prospects if we
incurred large trading losses, if the level of our business activity decreased
due to a market downturn, if regulatory authorities took significant action
against the Firm, or if we discovered that one of our employees had engaged in
serious unauthorized or illegal activity. Our ability to borrow in the debt
markets also could be impaired by factors that are not specific to the Firm,
such as a severe disruption of the financial markets or negative views about the
prospects for the investment banking, securities or financial services
industries generally.
DEPENDENCE ON ACCESS TO SHORT-TERM DEBT MARKETS
The Firm depends on the issuance of commercial paper and promissory notes
as a principal source of unsecured short-term funding for its operations. As of
May 1998, the Firm had approximately $16.7 billion of outstanding commercial
paper and promissory notes with a weighted average maturity of approximately 100
days. The Firm's liquidity depends to an important degree on its ability to
refinance these borrowings on a continuous basis. Investors who hold the Firm's
outstanding commercial paper and promissory notes have no obligation to purchase
new instruments when the outstanding instruments mature.
DEPENDENCE ON ABILITY TO SELL ASSETS
If we were unable to borrow in the debt capital markets, we would need to
liquidate assets in order to meet our maturing liabilities. In certain market
environments, overall market liquidity may decline. In a time of liquidity
stress we may be unable to sell certain assets, or we may have to sell assets at
depressed prices, which could weaken our financial condition.
DEPENDENCE ON CREDIT RATINGS
Our cost of funds and our access to the debt capital markets depend
significantly on our credit ratings. These ratings are assigned by recognized
rating agencies, which may reduce or withdraw their ratings or place the Firm on
"credit watch" with negative implications at any time. See "Management's
Discussion and Analysis of Financial Condition
15
17
and Results of Operations -- Liquidity -- Credit Ratings".
CREDIT RISK EXPOSES US TO LOSSES CAUSED
BY FINANCIAL OR OTHER PROBLEMS
EXPERIENCED BY THIRD PARTIES
We are exposed to the risk that third parties that owe us money or have
other obligations to us will not perform. These parties include our trading
counterparties, customers, clearing agents, exchanges, clearing houses and other
financial intermediaries as well as issuers whose securities we hold. These
parties may default on their obligations to us due to bankruptcy, lack of
liquidity, operational failure or other reasons. This risk may arise, for
example, from holding securities of third parties; entering into swap or other
derivative contracts under which counterparties have long-term obligations to
make payments to us; effecting securities, futures, currency or commodity trades
that fail to settle at the required time due to non-delivery by the counterparty
or systems failure by clearing agents, exchanges, clearing houses or other
financial intermediaries; and extending credit to our clients through bridge or
margin loans or other arrangements. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Risk Management -- Credit
Risk".
INCREASED EXPOSURE IN RECENT YEARS
In recent years, we have significantly expanded our swaps and other
derivatives businesses and placed a greater emphasis on providing credit and
liquidity to our clients. As a result, our credit risks have increased and have
become longer in duration. Further, we have experienced pressure to assume
longer-term credit risk, extend credit against less liquid collateral and price
more aggressively the credit risks that we take.
COUNTRY RISK
Country, regional and political risks are components of credit risk, as
well as market risk. Economic or political pressures in a country or region,
including those arising from local market disruptions or strains on local
currency, may adversely affect the ability of clients or counterparties located
in that country or region to obtain foreign exchange or credit and, therefore,
to perform their obligations to us. See "-- We Are Exposed to Risks in Emerging
and Other Markets".
SYSTEMIC RISK
Credit risk may also arise through a default by one of several large
institutions that are dependent on one another to meet their liquidity or
operational needs, so that a default by one institution causes a series of
defaults by the other institutions. This is sometimes referred to as "systemic
risk" and may adversely affect financial intermediaries, such as clearing
agencies, clearing houses, banks, securities firms and exchanges, with which we
interact on a daily basis.
UNCERTAINTY IN MANAGING CREDIT RISK
Although we regularly review our credit exposure to specific clients and
counterparties and to specific industries, countries and regions that we believe
may present credit concerns, default risk may arise from factors that are not
readily ascertainable, including fraud. In addition, in cases of secured
financing, we may find that we are undersecured, for example, as a result of
sudden declines in market values that reduce the value of collateral.
FIRM AND THIRD-PARTY COMPUTER SYSTEMS
MAY NOT ACHIEVE YEAR 2000 OR
EMU READINESS
YEAR 2000
With the new millennium approaching, many institutions around the world are
reviewing and modifying their computer systems to ensure that they are Year 2000
compliant. The issue, in general terms, is that many existing computer systems
and microprocessors with data functions (including those in non-information
technology equipment and systems) use only two digits to identify a year in the
date field with the assumption that the first two digits of the year are always
"19". Consequently, on January 1, 2000, computers that are not Year 2000
compliant may read the year as 1900. Systems that
16
18
calculate, compare or sort using the incorrect date may malfunction.
Because the Firm is dependent, to a very substantial degree, upon the
proper functioning of its computer systems, a failure of its systems to be Year
2000 compliant could have a material adverse effect on the Firm. Failure of this
kind could, for example, cause settlement of trades to fail, lead to incomplete
or inaccurate accounting, recording or processing of trades in securities,
currencies, commodities and other assets, result in generation of erroneous
results or give rise to uncertainty about our exposure to trading risks and our
need for liquidity. If not remedied, potential risks include business
interruption or shutdown, financial loss, regulatory actions, reputational harm
and legal liability.
In addition, the Firm depends upon the proper functioning of third-party
computer and non-information technology systems. These parties include trading
counterparties, financial intermediaries such as stock and commodities
exchanges, depositories, clearing agencies, clearing houses and commercial banks
and vendors such as providers of telecommunication services and other utilities.
We have initiated communications with counterparties, intermediaries and vendors
with whom we have important financial or operational relationships to determine
the extent to which they are vulnerable to the Year 2000 issue. We have not yet
received sufficient information from all parties about their remediation plans
to predict the outcome of their efforts. In particular, in some international
markets in which we do business, the level of awareness and remediation efforts
relating to the Year 2000 issue is thought to be less advanced than in the
United States.
If third parties with whom we interact have Year 2000 problems that are not
remedied, the following problems could result: (i) in the case of vendors, in
disruption of important services upon which the Firm depends, such as
telecommunications and electrical power; (ii) in the case of third-party data
providers, in the receipt of inaccurate or out-of-date information that would
impair our ability to perform critical data functions, such as pricing our
securities or other assets; (iii) in the case of financial intermediaries such
as exchanges and clearing agents, in failed trade settlements, an inability to
trade in certain markets and disruption of funding flows; (iv) in the case of
banks and other lenders, in the disruption of capital flows potentially
resulting in liquidity stress; and (v) in the case of counterparties and
customers, in financial and accounting difficulties for those parties that
expose the Firm to increased credit risk and lost business. Disruption or
suspension of activity in the world's financial markets is also possible. In
addition, uncertainty about the success of remediation efforts generally may
cause many market participants to reduce the level of their market activities
temporarily as they assess the effectiveness of these efforts during a "phase-
in" period beginning in late 1999. This in turn could result in a general
reduction in trading and other market activities (and lost revenues) as well as
reduced funding availability in late 1999 and early 2000. We cannot predict the
impact that such reduction would have on our business.
The Firm is implementing a worldwide plan to prepare its computer systems
to be Year 2000 compliant and expects to complete this process with respect to
its mission-critical systems in advance of an industry-wide systems test to be
sponsored by the Securities Industry Association in the first half of 1999. We
currently estimate that the total cost of implementing our Year 2000 program
will be between $120 million and $150 million. We can give no assurance that the
Firm's Year 2000 program will be effective or that our estimates about the
timing and cost of completing our program will be accurate. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -- Risk
Management -- Operational, Year 2000 and EMU Risks -- Year 2000".
EMU
Commencing on January 1, 1999, 11 European countries will enter into the
EMU and replace their local currencies with a single currency, the Euro. During
a three-year
17
19
transition period, the national currencies will continue to circulate but only
as fixed denominations of the Euro. Commencing on January 1, 1999, the Euro will
be the predominant currency to settle wholesale (non-cash) transactions
previously denominated in the participating national currencies.
The Firm is implementing a worldwide EMU conversion and testing plan. The
Euro conversion presents systems issues that are unprecedented in three
respects. First, we will need to convert an exceptionally large amount of the
data in our systems. Second, we have had to make system changes based on
numerous technical decisions that were made by the participating countries only
recently, thus making advanced planning difficult. Moreover, the participating
countries were under no obligation to reach a consensus on how these technical
issues were to be resolved and the protocols they adopted differ. Third, unlike
the systems changes that will be required by the Year 2000 issue, those required
by the adoption of the Euro must all be implemented successfully over a single
weekend, beginning when markets close on December 31, 1998.
The changes to our data and computer systems will affect our clearance,
settlement and financial reporting activities, among other key operations of the
Firm. If not properly implemented, these changes could lead to failed trade
settlements, inability to reconcile trading positions and funding disruptions.
These changes could also lead to erroneous entries in our books and records.
These events could result in misstatement of our financial condition and results
of operations, impair our ability to manage our risks and result in a material
loss, regulatory actions, reputational harm and legal liability.
The Firm is also dependent for proper transaction clearance and reporting
on many third parties, including counterparties, clearing agents, banks,
exchanges, clearing houses and providers of information. If these third parties'
systems do not appropriately reflect the introduction of the Euro, the Firm's
clearance, settlement and reporting activities could be adversely affected in
the manner described above.
We can give no assurance that the Firm or third parties on whom we depend
will have in place in a timely manner the systems necessary to process
Euro-denominated transactions. Moreover, disruption of activity in European
markets because of the conversion to the Euro could hurt our businesses in those
markets, resulting in lost revenues.
OTHER OPERATIONAL RISKS MAY DISRUPT OUR
BUSINESS, RESULT IN REGULATORY ACTION
AGAINST US OR LIMIT OUR GROWTH
We face operational risk arising from mistakes made in the confirmation or
settlement of transactions or from transactions not being properly booked,
evaluated or accounted for. Our business is highly dependent on our ability to
process, on a daily basis, a large number of transactions across numerous and
diverse markets in many currencies, and the transactions we process have become
increasingly complex. Consequently, we rely heavily on our financial, accounting
and other data processing systems. If any of these systems do not operate
properly or are unavailable due to problems with our physical infrastructure, we
could suffer financial loss, a disruption of our business, liability to clients,
regulatory intervention or reputational damage. The inability of our systems to
accommodate an increasing volume of transactions could also constrain our
ability to expand our businesses. In recent years, we have substantially
upgraded and expanded the capabilities of our data systems and other operating
technology, and we expect that we will need to continue to upgrade and expand in
the future to avoid disruption of or constraints on our operations.
LEGAL AND REGULATORY RISKS ARE INHERENT AND
SUBSTANTIAL IN OUR BUSINESSES
Substantial legal liability or a significant regulatory action against the
Firm could have a material financial effect on the Firm. Perhaps of equal
importance, such a development could also cause significant reputational harm to
the Firm, which in turn could seriously harm our business prospects.
18
20
EXPOSURE TO LEGAL LIABILITY; RISING LITIGATION COSTS
We face significant legal risk in our business, and the volume and amount
of damages claimed in litigation against financial intermediaries are
increasing. These risks include potential liability under securities or other
laws for materially false or misleading statements made in connection with
securities and other transactions, potential liability for the "fairness
opinions" and other advice we provide to participants in corporate transactions
and disputes over the terms and conditions of complex trading arrangements. We
also face the possibility that counterparties in complex or risky trading
transactions will claim that we improperly failed to apprise them of the risks
or that they were not authorized or permitted under applicable corporate or
regulatory requirements to enter into these transactions with us and that their
obligations to the Firm are not enforceable. Particularly in our rapidly growing
business focused on high net worth individuals, we are increasingly exposed to
potential liability for violations of customer suitability requirements and
anti-churning rules and for the exercise of unauthorized trading discretion. We
are also subject to potential liability arising from disputes with employees for
alleged discrimination or harassment, among other things. These risks often may
be difficult to assess or quantify and their existence and magnitude often
remain unknown for substantial periods of time. We incur significant legal
expenses every year in defending against litigation, and we expect to continue
to do so in the future. See "Business -- Legal Matters".
EXTENSIVE REGULATION OF THE FIRM
The financial services industry is subject to extensive regulation. In the
United States alone, our business is regulated by the Securities and Exchange
Commission ("SEC"), the Commodity Futures Trading Commission ("CFTC") and
various other federal and state governmental authorities. In addition, the Firm
is subject to regulation by various self-regulatory organizations such as the
National Association of Securities Dealers, Inc. ("NASD"), the New York Stock
Exchange, Inc. ("NYSE") and other exchanges. The Firm is also subject to
regulation by governmental and self-regulatory organizations in virtually all
other jurisdictions in which it operates around the world.
These regulatory regimes are designed to ensure the integrity of the
financial markets and to protect customers and other third parties who deal with
the Firm and are not designed to protect shareholders of the Firm. Consequently,
these regulations often serve to limit the Firm's activities, including through
net capital, customer protection and market conduct requirements. We face the
risk of significant intervention by regulatory authorities, including extended
investigation and surveillance activity, adoption of costly or restrictive new
regulations and judicial or administrative proceedings that may result in
substantial penalties to the Firm. Among other things, the Firm could be fined
or enjoined from engaging in certain business activities and could have its
registration as a broker-dealer, investment advisor or other regulated entity
suspended or terminated. See "Business -- Regulation".
LEGAL RESTRICTIONS ON OUR CLIENTS
New laws or regulations or changes in enforcement of existing laws or
regulations applicable to the Firm's clients may also adversely affect our
business. For example, changes in antitrust enforcement could affect the level
of mergers and acquisitions activity and changes in the regulation of certain
industries could restrict the activities of the Firm's clients engaged in those
industries and, therefore, the Firm's services on their behalf.
EMPLOYEE MISCONDUCT COULD HARM THE FIRM
AND IS DIFFICULT TO DETECT AND DETER
There have been a number of highly publicized cases involving fraud or
other misconduct by employees in the financial services industry in recent
years, and we run the risk that employee misconduct could occur. Misconduct by
employees could include binding the Firm to transactions that exceed authorized
limits or present unacceptable risks, or hiding from the Firm unauthorized or
unsuccessful activities, which, in either case,
19
21
may result in unknown and unmanaged risks or losses. Employee misconduct could
also involve the improper use of confidential information, which could result in
regulatory sanctions and serious reputational harm. It is not always possible to
deter employee misconduct and the precautions we take to prevent and detect this
activity may not be effective in all cases.
OUR RISK MANAGEMENT POLICIES AND
PROCEDURES MAY LEAVE US EXPOSED TO
UNIDENTIFIED OR UNANTICIPATED RISK
We have devoted significant resources to developing our risk management
policies and procedures and expect to continue to do so in the future.
Nonetheless, our policies and procedures to identify, monitor and manage our
risks may not be fully effective. Certain of our methods to manage risk are
based on historical measures of market behavior or stress and are not
necessarily predictive of future risk exposures, which could be greater than the
historical measures and correlations indicate. Other risk management methods
depend upon evaluation of information regarding markets, clients or other
matters that is publicly available or otherwise accessible by the Firm. Such
information may not in all cases be accurate, complete, up-to-date or properly
evaluated. Management of operational, legal and regulatory risk requires, among
other things, policies and procedures to record properly and verify a large
number of transactions and events, and we can give no assurance that those
policies and procedures will be fully effective.
THE FINANCIAL SERVICES INDUSTRY IS INTENSELY
COMPETITIVE AND RAPIDLY CONSOLIDATING
The financial services industry -- and all of our businesses -- are
intensely competitive, and we expect them to remain so. We compete on the basis
of a number of factors, including execution, depth of product and service
offerings, innovation, reputation and price. We have experienced intense price
competition in certain areas of our business in recent years and believe we may
experience pricing pressures in these and other areas in the future as some of
our competitors seek to obtain market share by reducing fees or spreads.
TREND TOWARD CONSOLIDATION AND INCREASING COMPETITION
In recent years, there has been substantial consolidation and convergence
among participants in the financial services industry. In particular, a number
of large commercial banks, insurance companies and other broad-based financial
services firms have established or acquired broker-dealer affiliates. These
firms have the ability to offer a wide range of products, from loans,
deposit-taking and insurance to brokerage, asset management and investment
banking services, which may enhance their competitive position. They also have
the ability to support investment banking and securities products with
commercial banking, insurance and other financial services product revenues in
an effort to gain market share, which could result in pricing pressure in our
businesses.
INCREASED NEED FOR CAPITAL
This trend toward consolidation and convergence has significantly increased
the capital base and geographic reach of our competitors. This trend has also
hastened the globalization of the securities and other financial services
markets. As a result, our businesses now require increased amounts of capital.
COMPETITION IN NON-U.S. MARKETS
We believe that some of our most significant opportunities for growth will
arise outside the United States. See "Industry and Economic Outlook". In order
to take advantage of these opportunities, we will have to compete successfully
with financial institutions based in important non-U.S. markets, particularly in
Europe. Certain of these institutions are larger, better capitalized and have a
stronger local presence and a longer operating history in these markets.
COMPETITION FROM ALTERNATIVE TRADING SYSTEMS
Securities and futures transactions are now being conducted through the
Internet and
20
22
other alternative, non-traditional trading systems, and it appears that the
trend toward alternative trading systems will continue and perhaps accelerate. A
dramatic increase in computer-based trading may adversely affect the Firm's
commission and trading revenues, reduce the Firm's participation in the trading
markets and associated access to market information and lead to the creation of
new competitors.
WE ARE EXPOSED TO RISKS IN
EMERGING AND OTHER MARKETS
We conduct business in major markets around the world, including many
developing markets in Asia, Latin America and Eastern Europe. Our non-U.S.
operations are subject to political, economic, legal, operational and other
risks that are inherent in operating in these countries and range from
difficulties in settling transactions in emerging markets to possible
nationalization, expropriation, price controls and other restrictive
governmental actions. We also face the risk that exchange controls or similar
restrictions imposed by foreign governmental authorities may restrict our
ability to convert local currency received or held by us in their countries into
U.S. dollars or other currencies, or to take those dollars or other currencies
out of those countries.
In the last several years, various emerging market countries, including
most recently those in Asia and Eastern Europe, have experienced severe economic
and financial disruptions, including significant devaluations of their
currencies and low or negative growth rates in their economies. The possible
effects of these conditions include an adverse impact on multinational companies
and increased volatility in financial markets generally. Moreover, economic
problems in a single emerging market country are increasingly having contagion
effects in other economies and affecting emerging and other markets generally. A
continuation of these situations could adversely affect global economic
conditions and world markets and, in turn, could adversely affect the Firm's
business. Among the risks are regional or global market downturns and, as noted
above, increasing liquidity and credit risks, particularly in Japan where the
economy continues to be weak and we have significant exposure.
Moreover, in many developing countries, the laws and regulations applicable
to the securities and financial services industries are uncertain and evolving,
and it may be difficult for us to determine the exact requirements of local laws
in every market. Our inability to remain in compliance with local laws in a
particular foreign market could have a significant and negative effect not only
on our business in that market but also on the Firm's reputation generally.
These uncertainties may also make it difficult for us to structure our
transactions in such a way that the results we expect to achieve are legally
enforceable in all cases. See "-- Legal and Regulatory Risks Are Inherent and
Substantial in Our Businesses -- Exposure to Legal Liability; Rising Litigation
Costs" and "Business -- Regulation".
OUR CONVERSION TO CORPORATE FORM
MAY ADVERSELY AFFECT OUR ABILITY TO RECRUIT,
RETAIN AND MOTIVATE KEY EMPLOYEES
The Firm's performance is largely dependent on the talents and efforts of
highly skilled individuals. Competition in the financial services industry for
qualified employees is intense. Our continued ability to compete effectively in
our businesses depends on our ability to attract new employees and to retain and
motivate our existing employees.
In connection with the Offerings and the Firm's conversion from partnership
to corporate form, the PLPs will receive substantial amounts of Common Stock in
exchange for their interests in the Firm. Upon the closing of the Offerings,
this stock will be owned outright and these individuals will be permitted to
sell their shares beginning after the third anniversary of the Offerings or
earlier if the transfer restrictions are waived. See "Certain Relationships and
Related Transactions -- Shareholders' Agreement -- Transfer Restrictions". We
can give no assurance that steps taken by the Firm to encourage the continued
service of these individuals in the Firm's businesses after the Offerings will
be effective. See "Management -- The Employee IPO Awards -- The Partner Pool"
and "Certain
21
23
Relationships and Related Transactions -- Incorporation and Related
Transactions".
In connection with the Offerings and the Firm's conversion from partnership
to corporate form, employees other than the PLPs will receive equity-based
awards. We can give no assurance that the incentives to attract, retain and
motivate employees provided by these awards, or that future arrangements,
including equity-based arrangements, will be as effective as those that existed
prior to conversion. See "Management -- The Employee IPO Awards".
THE FIRM WILL BE CONTROLLED BY ITS PRINCIPAL SHAREHOLDERS AND WILL BE SUBJECT TO
ANTI-TAKEOVER PROVISIONS
Upon consummation of the Offerings, the PLPs and other Managing Directors
will collectively own approximately shares of Common Stock. These shares
will be subject to the Shareholders' Agreement, which will provide for
coordinated voting by the parties. See "Certain Relationships and Related
Transactions -- Shareholders' Agreement".
As a result of the arrangement described above, the Managing Directors will
be able to elect the entire Board of Directors, control the management and
policies of the Company and, in general, determine (without the consent of the
Company's other shareholders) the outcome of any corporate transaction or other
matter submitted to the shareholders for approval, including mergers,
consolidations and the sale of all or substantially all of the Company's assets.
The Managing Directors will be able to prevent or cause a change in control of
the Company.
In addition, our Amended and Restated Certificate of Incorporation and
By-Laws contain provisions, and our Board of Directors has adopted a "poison
pill" rights plan, that will prevent or impede the removal of directors and may
discourage a third party from making a proposal to acquire us. See "Description
of Capital Stock -- Certain Anti-Takeover Matters".
OUR SHARE PRICE MAY DECLINE DUE TO SHARES
ELIGIBLE FOR FUTURE SALE
Upon completion of the Offerings, there will be Common Shares
outstanding. Of these shares, the shares of Common Stock expected to
be sold in the Offerings (excluding the Directed Offering described below) will
be freely transferable without restriction or further registration under the
Securities Act of 1933, as amended (the "Securities Act"), except for shares
purchased by "affiliates" of the Company, as that term is defined in Rule 144
under the Securities Act ("Rule 144").
Of the remaining Common Shares outstanding, up to
shares of Common Stock will be sold in the Offerings to the Firm's employees and
certain other purchasers (the "Directed Offering").
RLPs will hold shares, which, subject to the 180-day lockup
described below, will be freely transferable commencing December 1, 1998. PLPs
will hold restricted shares, which will not be transferable until
after the third anniversary of the date of this Prospectus, unless these
restrictions are waived. See "Certain Relationships and Related
Transactions -- Shareholders' Agreement".
These shares held by RLPs and PLPs, as well as the shares sold in the
Directed Offering, will be subject to the 180-day Underwriters' lockup described
under "Underwriting".
Shares underlying Formula RSUs are deliverable beginning on the first
anniversary of the date of grant; shares underlying the Discretionary RSUs or
held by the DCP will be deliverable beginning on the third anniversary of the
date of grant; and Discretionary Options will be exercisable beginning on the
third anniversary of the date of grant, in each case if relevant conditions are
satisfied. See "Management -- The Employee IPO Awards".
Sales of substantial amounts of Common Stock, or the possibility of such
sales, pursuant to Rule 144 or otherwise, may adversely affect the price of the
Common Stock and
22
24
impede the Firm's ability to raise capital through the issuance of equity
securities. See "Certain Relationships and Related Transactions" and "Shares
Eligible for Future Sale".
THERE HAS BEEN NO PRIOR MARKET FOR THE
COMMON STOCK AND THE MARKET PRICE OF
THE SHARES WILL FLUCTUATE
Prior to the Offerings, there has been no market for the Common Stock. The
initial public offering price of the Common Stock will be determined by
negotiations among the Company and the representatives of the Underwriters.
Because of the relationship between GS&Co. and the issuer of the Common Stock,
the NASD requires that a third party or "qualified independent underwriter"
determine that the initial public offering price is not too high. are
acting as these third-party underwriters. See "Underwriting".
The price of the Common Stock after the Offerings may fluctuate widely,
depending upon many factors, including the perceived prospects of the Firm and
the securities or financial services industries in general, differences between
our actual financial and operating results and those expected by investors and
analysts, changes in analysts' recommendations or projections, changes in
general economic or market conditions and broad market fluctuations. The Common
Stock may trade at prices significantly below the initial public offering price.
We will apply to list the Common Stock on the NYSE. The NYSE listing does
not, however, guarantee that a trading market for the Common Stock will develop
or, if a market does develop, the depth of the trading market for the Common
Stock.
After the Offerings, because GS&Co. is a member of the NYSE and because of
GS&Co.'s relationship to the Firm, it will not be permitted under the rules of
the NYSE to make markets in, or recommendations regarding the purchase or sale
of, the Common Stock. This may adversely affect the trading market for the
Common Stock.
INVESTORS IN THE OFFERINGS WILL EXPERIENCE
IMMEDIATE AND SUBSTANTIAL DILUTION
Investors in the Offerings will experience immediate and substantial
dilution in the net tangible book value of $ per share based on an assumed
initial public offering price of $ (the midpoint of the range of initial
public offering prices set forth on the cover page of this Prospectus). See
"Dilution".
23
25
USE OF PROCEEDS
Based upon an initial public offering price of $ per share (the
midpoint of the range of initial public offering prices set forth on the cover
page of this Prospectus), the Company estimates that it will receive net
proceeds from the Offerings of $ (or $ if the underwriters'
options to purchase additional shares are exercised in full), after deducting
the underwriting discounts and estimated expenses that are payable by the
Company in the Offerings. The above amounts do not give effect to underwriting
discounts that will be realized by GS&Co., Goldman Sachs International ("GSI")
and Goldman Sachs (Asia) L.L.C. as underwriters in the Offerings. The Company
intends to use the net proceeds from the Offerings for general corporate
purposes.
The Company will not receive any of the proceeds from the sale of shares of
Common Stock by the Selling Shareholders.
We plan to complete the QUIPS Offering at or about the time of the
Offerings. We estimate that the net proceeds from the QUIPS Offering will be
approximately $ and we will use those proceeds for general corporate
purposes. The closing of the Offerings is not conditioned on the closing of the
QUIPS Offering, and we can give no assurance that the QUIPS Offering will be
completed or, if completed, as to the amount or final terms of QUIPS that will
be sold. See "Description of Capital Securities".
DIVIDEND POLICY
The holders of Common Shares will share ratably on a per share basis in all
dividends and other distributions declared by our Board of Directors. Our Board
of Directors currently intends to declare quarterly dividends on all Common
Shares and expects that the first quarterly dividend will be $ per share, and
that it will be declared during the first fiscal quarter of 1999.
The declaration of dividends by the Company is subject to the discretion of
the Board of Directors. The Board of Directors will take into account such
matters as general business conditions, the Firm's financial results, capital
requirements, contractual, legal and regulatory restrictions on the payment of
dividends by the Company to its shareholders or by the Company's subsidiaries to
the Company, the effect on debt ratings of the Company and such other factors as
the Board of Directors may deem relevant. See "Business -- Regulation" and
"Description of Capital Securities".
24
26
DILUTION
As of August 1998, the pro forma net tangible book value of the Firm (after
giving effect to the Pro Forma Adjustments that are defined and described under
Pro Forma Consolidated Financial Information) was approximately $ , or
approximately $ per Common Share (which includes Common Stock and Nonvoting
Common Stock). "Pro forma net tangible book value" per Common Share represents
the amount of the Company's total consolidated tangible assets minus total
consolidated liabilities, divided by the Common Shares outstanding on a pro
forma basis after giving effect to the Pro Forma Adjustments. After giving
effect to the sale by the Company of shares of Common Stock in the
Offerings at an assumed initial public offering price of $ per share (the
midpoint of the range of initial public offering prices set forth on the cover
page of this Prospectus) and after deducting the underwriting discounts and
estimated expenses payable by the Company in the Offerings, the pro forma net
tangible book value of the Company as of August 1998 would have been
approximately $ , or approximately $ per Common Share. This represents
an immediate increase in net tangible book value of $ per Common Share to
existing shareholders and an immediate dilution in net tangible book value of
$ per share to new investors purchasing shares of Common Stock at the
assumed initial public offering price.
The following table illustrates this dilution on a per share basis:
Assumed initial public offering price per share of
Common Stock.............................................. $
--------
Pro forma net tangible book value per Common Share before
giving effect to the Offerings(1)...................... $
--------
Increase in net tangible book value per Common Share
attributable to the sale of Common Stock in the
Offerings(2)........................................... $
--------
Pro forma net tangible book value per Common Share after
giving effect to the Offerings............................ $
--------
Dilution in net tangible book value per Common Share to new
investors(3).............................................. $
--------
- ---------------
(1) The Firm's intangible assets as of August 1998 were $ , comprised
primarily of goodwill, equivalent to $ per Common Share (after giving
effect to the Pro Forma Adjustments).
(2) After deducting the underwriting discounts and estimated expenses payable by
the Company in the Offerings.
(3) Dilution is determined by subtracting pro forma net tangible book value per
share after giving effect to the Offerings from the assumed initial public
offering price paid by a new investor.
------------------------
The foregoing table does not assume the exercise of the underwriters'
options to purchase additional shares that are described under "Underwriting".
Common Shares outstanding includes shares of Common Stock deliverable
pursuant to the Formula RSUs and shares of Common Stock contributed to the
DCP. Common Shares outstanding does not include shares of Common Stock
deliverable pursuant to the Discretionary RSUs and Discretionary Options. See
"Management -- The Employee IPO Awards".
25
27
CAPITALIZATION
The following table sets forth the consolidated capitalization of the Firm
as of August 1998: (i) on a pro forma basis after giving effect to the Pro Forma
Adjustments and (ii) as adjusted for the sale of shares of Common
Stock by the Company in the Offerings at an assumed initial public offering
price of $ per share (the midpoint of the range of the initial public
offering prices set forth on the cover page of this Prospectus) and after
deduction of the underwriting discounts and estimated expenses payable by the
Company in the Offerings.
This table should be read in conjunction with the consolidated financial
statements and the notes thereto.
AS OF AUGUST 1998
----------------------------
PRO FORMA
AS ADJUSTED
PRO FORMA(5) FOR OFFERINGS
------------ -------------
(in millions)
Short-term borrowings (including commercial paper)(1)....... $ $
====== ======
Long-term borrowings(2):
Senior debt(3)............................................ $ $
Junior Subordinated Debentures(4).........................
------ ------
Total long-term borrowings........................ $ $
Mandatorily redeemable preferred securities (QUIPS).........
Stockholders' equity:
Preferred Stock, par value $.01 per share;
shares authorized, no shares issued and outstanding....
Common Stock, par value $.01 per share; shares
authorized, shares issued and outstanding
( shares issued and outstanding as
adjusted(5))...........................................
Nonvoting Common Stock, par value $.01 per share;
shares authorized and shares issued and
outstanding............................................
Additional paid-in capital................................
Retained earnings.........................................
------ ------
Total stockholders' equity........................ $ $
------ ------
Total capitalization............................ $ $
====== ======
- ---------------
(1) Includes current portion of long-term borrowings of $ .
(2) See Note 5 to the consolidated financial statements. The Company anticipates
that shortly after the Offerings it may effect one or more offerings of
long-term debt securities.
(3) Includes subordinated debt of GS&Co. of $ .
(4) Consists of the Junior Subordinated Debentures issued to the RLPs. See
"Certain Relationships and Related Transactions -- Incorporation and Related
Transactions".
(5) The foregoing table does not assume the exercise of the underwriters'
options to purchase additional shares that are described under
"Underwriting". Common Stock outstanding includes shares of Common
Stock deliverable pursuant to the Formula RSUs and shares of
Common Stock contributed to the DCP. Common Stock outstanding does not
include shares of Common Stock deliverable pursuant to the
Discretionary RSUs and Discretionary Options. See "Management -- The
Employee IPO Awards".
26
28
PRO FORMA CONSOLIDATED FINANCIAL INFORMATION
The following Pro Forma Consolidated Financial Information is based upon
the historical consolidated financial statements of the Firm and reflects the
pro forma effects of (i) the Partnership Capital Adjustments, the Incorporation
Transactions and the Related Transactions; (ii) compensation to Managing
Directors who were former PLPs; (iii) equity-based compensation; (iv) the
provision for corporate income taxes; and (v) the effect of recognition of net
deferred tax assets as a result of the conversion of Group L.P. to corporate
form (collectively, the "Pro Forma Adjustments").
The Pro Forma Consolidated Income Statement Information does not give
effect to certain items because of their non-recurring nature. These are (i) the
award of the Formula RSUs; (ii) the initial irrevocable contribution of shares
of Common Stock to the DCP; (iii) the effect of recognition of net deferred tax
assets as a result of the conversion of Group L.P. to corporate form; and (iv)
the Charitable Contribution. The Pro Forma Consolidated Balance Sheet
Information, however, does give effect to these items.
The Pro Forma Adjustments are based upon available information and certain
assumptions that management believes are reasonable. The Pro Forma Consolidated
Financial Information and accompanying notes should be read in conjunction with
the consolidated financial statements and notes thereto.
THE PRO FORMA CONSOLIDATED FINANCIAL INFORMATION PRESENTED IS NOT
NECESSARILY INDICATIVE OF THE RESULTS OF OPERATIONS OR FINANCIAL POSITION THAT
MIGHT HAVE OCCURRED HAD THE PRO FORMA ADJUSTMENTS ACTUALLY TAKEN PLACE AT THE
DATES SPECIFIED, OR THAT MAY BE EXPECTED TO OCCUR IN THE FUTURE.
27
29
PRO FORMA CONSOLIDATED INCOME STATEMENT INFORMATION
($ in millions, except share and per share data)
YEAR ENDED NOVEMBER 1997
-----------------------------------------------------------------------
PRO FORMA
PRO FORMA ADJUSTMENT AS ADJUSTED
HISTORICAL ADJUSTMENTS PRO FORMA FOR OFFERINGS FOR OFFERINGS
---------- ----------- ------------ ------------- -------------
Total revenues......................
Interest expense, principally on
short-term funding................ (a)(b)
----- ----- ----- ----- -----
Revenues, net of interest expense...
Compensation and benefits, excluding
Employee IPO Awards............... (c)
Employee IPO Awards................. (d)
Other operating expenses............
----- ----- ----- ----- -----
Total operating expenses............
Pre-tax earnings....................
Provision for taxes................. (e)
----- ----- ----- ----- -----
Net earnings........................
===== ===== ===== ===== =====
Common Shares outstanding........... (f) (f) (g) (g)
Earnings per share..................
NINE MONTHS ENDED AUGUST 1998
-----------------------------------------------------------------------
PRO FORMA
PRO FORMA ADJUSTMENT AS ADJUSTED
HISTORICAL ADJUSTMENTS PRO FORMA FOR OFFERINGS FOR OFFERINGS
---------- ----------- ------------ ------------- -------------
Total revenues......................
Interest expense, principally on
short-term funding................ (a)(b)
----- ----- ----- ----- -----
Revenues, net of interest expense...
Compensation and benefits, excluding
Employee IPO Awards............... (c)
Employee IPO Awards................. (d)
Other operating expenses............
----- ----- ----- ----- -----
Total operating expenses............
Pre-tax earnings....................
Provision for taxes................. (e)
----- ----- ----- ----- -----
Net earnings........................
===== ===== ===== ===== =====
Common Shares outstanding........... (f) (f) (g) (g)
Earnings per share..................
PRO FORMA CONSOLIDATED BALANCE SHEET INFORMATION
($ in millions, except share and per share data)
AS OF AUGUST 1998
-----------------------------------------------------------------------
PRO FORMA
PRO FORMA ADJUSTMENT AS ADJUSTED
HISTORICAL ADJUSTMENTS PRO FORMA FOR OFFERINGS FOR OFFERINGS
---------- ----------- ------------ ------------- -------------
Total assets........................ (b)(i)(j)(l) (g)
Long-term borrowings................ (a)
Total liabilities................... (h)
Mandatorily redeemable preferred
securities (QUIPS)................ (b)
Partners' capital................... (a)(i)(j)(k)
Stockholders' equity................ (h)(k)(l) (g) (g)
Common Shares outstanding........... (f) (f) (g) (g)
Book value per share................
28
30
NOTE 1: BASIS OF PRESENTATION
The Pro Forma Balance Sheet Information was prepared as if the Pro Forma
Adjustments had occurred as of August 28, 1998. The Pro Forma Income Statement
Information for the fiscal year ended November 1997 and for the nine months
ended August 28, 1998, was prepared as if the Pro Forma Adjustments had taken
place at the beginning of 1997.
NOTE 2: PRO FORMA ADJUSTMENTS
(a) RLP EXCHANGE FOR DEBENTURES. Adjustment to reflect the issuance of
$ principal amount of the Junior Subordinated Debentures to the RLPs in
exchange for their interests in Group L.P. and certain affiliates.
(b) QUIPS. Adjustment to reflect the issuance of $ of QUIPS, with an
assumed distribution rate of % per annum.
(c) COMPENSATION AND BENEFITS, EXCLUDING EMPLOYEE IPO AWARDS. Adjustment
to reflect (i) total compensation that would have been paid to the former PLPs
of the Firm for services rendered, and (ii) equity-based compensation in the
form of restricted stock units, % of which will vest immediately, and
% of which will vest ratably over the next years. Equity-based
compensation in the form of stock options will be accounted for pursuant to APB
No. 25, as permitted by paragraph 5 of SFAS No. 123.
(d) EMPLOYEE IPO AWARDS. Adjustment to reflect (i) the amortization of the
Discretionary RSUs. Discretionary RSUs with a value of $ will be amortized
as a non-cash expense over the vesting period (i.e., over the years
following the date of grant); and (ii) the addition to equity, net of tax,
associated with the Formula RSUs and the contribution to the DCP. See
"Management -- The Employee IPO Awards".
(e) PRO FORMA PROVISION FOR INCOME TAXES. Adjustment to reflect a pro
forma provision for income taxes at a 41% income tax rate applied to pro forma
results of operations.
(f) PRO FORMA COMMON SHARES. Calculated based on Common Shares
outstanding after giving effect to the Pro Forma Adjustments. Common Shares
outstanding does not include shares of Common Stock deliverable pursuant
to the Discretionary RSUs and Discretionary Options.
(g) ADJUSTMENT FOR THE OFFERINGS. Common shares as adjusted to reflect the
issuance of shares of Common Stock offered by the Firm at the midpoint of
the range of initial public offering prices set forth on the cover page of this
Prospectus. Common Shares outstanding does not include shares of Common
Stock deliverable pursuant to the Discretionary RSUs and Discretionary Options.
Net proceeds to the Firm from the Offerings are after the deduction of
underwriting discounts and estimated expenses to be paid by the Firm.
(h) CHARITABLE CONTRIBUTION. Adjustment to reflect the Charitable
Contribution of $ .
(i) RLP EXCHANGE FOR CASH. Adjustment to reflect the exchange of RLP
interests in Group L.P. and certain affiliates for cash.
(j) CASH DISTRIBUTIONS. Adjustment to reflect cash distribution of
$ prior to the Incorporation Transactions.
(k) PLP, RLP, SBCM AND KAA EXCHANGE FOR COMMON SHARES. Adjustment to
reflect the issuance of shares of Common Stock to PLPs, shares of
Common Stock to RLPs, shares of Common Stock and shares of
Nonvoting Common Stock to SBCM and shares of Common Stock to KAA,
in exchange for their respective interests in Group L.P. and certain affiliates.
(l) DEFERRED TAXES. Adjustment to reflect the recognition of net deferred
tax assets associated with the conversion of Group L.P. to corporate form.
29
31
SELECTED CONSOLIDATED FINANCIAL DATA
The selected historical consolidated income statement and balance sheet
data set forth below have been derived from the Firm's consolidated financial
statements and the notes thereto. The Firm's consolidated financial statements
have been audited by PricewaterhouseCoopers LLP, independent public accountants,
as of November 1996 and November 1997 and for the years ended 1995, 1996 and
1997, and as of and for the six months ended May 1998. These financial
statements are included elsewhere in this Prospectus, together with the report
thereon of PricewaterhouseCoopers LLP.
The selected historical consolidated income statement and balance sheet
data set forth below as of November 1993, November 1994 and November 1995 and
for the years ended 1993 and 1994 have been derived from audited consolidated
financial statements of the Firm not included in this Prospectus.
The selected historical consolidated income statement and balance sheet
data set forth below as of and for the six months ended May 1997 have been
derived from the Firm's unaudited interim consolidated financial statements and,
in the opinion of management, include all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation. The interim results
set forth below for the six-month period ended May 1998 may not be indicative of
the results for the full year.
The pro forma data set forth below for the year ended November 1997 and as
of and for the six months ended May 1998 have been derived from the pro forma
data set forth in "Pro Forma Consolidated Financial Information".
The selected consolidated financial data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", "Pro Forma Consolidated Financial Information" and the consolidated
financial statements and the notes thereto.
AS OF OR FOR
SIX MONTHS
AS OF OR FOR YEAR ENDED NOVEMBER ENDED MAY
--------------------------------------------------- ----------------------
1993 1994(8) 1995 1996 1997 1997 1998
---- ------- ---- ---- ---- ---- ----
(unaudited)
($ in millions, except share and per share amounts)
INCOME STATEMENT DATA:
Total revenues............................ $ 14,848 $12,452 $ 14,324 $ 17,289 $ 20,433 $ 9,540 $ 12,466
Interest expense.......................... 9,084 8,915 9,841 11,160 12,986 5,909 7,005
-------- ------- -------- -------- -------- -------- --------
Net revenues.............................. 5,764 3,537 4,483 6,129 7,447 3,631 5,461
Compensation and benefits expense(1)...... 2,126 1,789 2,005 2,421 3,097 1,528 2,589
Other operating expenses.................. 980 1,240 1,110 1,102 1,336 588 813
-------- ------- -------- -------- -------- -------- --------
Pre-tax earnings(1)....................... $ 2,658 $ 508 $ 1,368 $ 2,606 $ 3,014 $ 1,515 $ 2,059
======== ======= ======== ======== ======== ======== ========
BALANCE SHEET DATA:
Total assets(2)........................... $115,900 $95,296 $100,066 $152,046 $178,401 $169,200 $241,852
Adjusted assets (unaudited)(3)............ 84,569 75,772 73,552 93,279 119,883 102,989 153,355
Long-term borrowings...................... 10,241 14,418 13,358 12,376 15,667 12,782 20,275
Total liabilities(2)...................... 110,073 89,981 94,686 145,753 171,864 163,045 234,648
Partners' capital......................... 5,008 4,771 4,905 5,309 6,107 5,609 6,638
PRO FORMA DATA:
Pro forma net earnings(4)................. -- -- -- -- --
Pro forma net earnings per share(4)(5).... -- -- -- -- --
Pro forma net earnings per share as
adjusted for the Offerings(4)(6)........ -- -- -- -- --
Pro forma Common Shares as adjusted for
the Offerings(6)........................ -- -- -- -- --
Pro forma stockholders' equity as adjusted
for the Offerings(4).................... -- -- -- -- -- --
Pro forma book value per share as adjusted
for the Offerings(6).................... -- -- -- -- -- --
30
32
AS OF OR FOR
SIX MONTHS
AS OF OR FOR YEAR ENDED NOVEMBER ENDED MAY
--------------------------------------------------- -------------------
1993 1994(8) 1995 1996 1997 1997 1998
---- ------- ---- ---- ---- ---- ----
($ in millions)
SELECTED DATA AND RATIOS (UNAUDITED):
Pre-tax return on average partners'
capital(1).............................. 61% 10% 28% 51% 53% 56%(9) 65%(9)
Ratio of compensation and benefits expense
to net revenues(1)...................... 37% 51% 45% 40% 42% 42% 47%
Employees:
United States........................... 5,528 5,822 5,356 5,818 6,879 6,027 7,331
International........................... 2,575 3,176 2,803 3,159 3,743 3,263 4,109
-------- ------- -------- -------- -------- -------- --------
Total employees(7)........................ 8,103 8,998 8,159 8,977 10,622 9,290 11,440
======== ======= ======== ======== ======== ======== ========
Assets under supervision:
Assets under management................. $ 41,710 $43,671 $ 52,358 $ 94,599 $135,929 $116,714 $165,226
Other client assets..................... 45,663 52,783 62,820 83,362 110,441 94,750 139,689
-------- ------- -------- -------- -------- -------- --------
Total assets under supervision............ $ 87,373 $96,454 $115,178 $177,961 $246,370 $211,464 $304,915
======== ======= ======== ======== ======== ======== ========
- ---------------
(1) The Firm's pre-tax earnings and compensation and benefits expense do not
reflect any payments for services rendered by its partners. Accordingly,
pre-tax earnings understate the expected operating costs to be incurred by
the Firm after the Offerings. See "Pro Forma Consolidated Financial
Information".
(2) Total assets and liabilities as of May 1998 were increased by $17 billion
due to the adoption of the provisions of SFAS No. 125 that were deferred by
SFAS No. 127. See "Accounting Developments" in Note 2 to the consolidated
financial statements.
(3) Adjusted assets represent total assets less (i) securities purchased under
agreements to resell, (ii) certain securities borrowed transactions and
(iii) with respect to May 1998, the increase of $17 billion in total assets
related to the adoption of the provisions of SFAS No. 125 that were deferred
by SFAS No. 127.
(4) Reflects such adjustments as are necessary, in the opinion of management,
for a fair presentation of the results of operations and stockholders'
equity of the Firm on a pro forma basis. See "Pro Forma Consolidated
Financial Information".
(5) Calculated based on Common Shares outstanding after giving effect to
the Pro Forma Adjustments. Common Shares outstanding does not include
shares of Common Stock deliverable pursuant to the Discretionary
RSUs and Discretionary Options. See "Pro Forma Consolidated Financial
Information".
(6) Calculated based on Common Shares outstanding after giving effect to
the Pro Forma Adjustments, as adjusted to reflect the issuance of
shares of Common Stock offered by the Firm at the midpoint of
the range of initial public offering prices set forth on the cover page of
this Prospectus, after deduction of underwriting discounts and estimated
expenses to be paid by the Firm. Common Shares outstanding does not include
shares of Common Stock deliverable pursuant to the Discretionary
RSUs and Discretionary Options. See "Pro Forma Consolidated Financial
Information".
(7) Excludes employees of the Firm's two property management subsidiaries,
Archon and GAH. Substantially all of the costs of these employees are
reimbursed to the Firm by the real estate investment funds to which the two
companies provide property management services. In addition, as of May 1998,
we had approximately 2,900 temporary staff and consultants. See
"Business -- Employees" and "-- Temporary Staff and Consultants".
(8) See "Business -- Trading and Principal Investments -- Trading Risk
Management -- 1994" for a discussion of the decrease in net revenues in 1994
compared to 1993.
(9) The pre-tax returns on average partners' capital for May 1997 and May 1998
have been annualized. Interim results may not be indicative of the results
for a full year. See "Risk Factors".
31
33
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The Firm is a preeminent global investment banking and securities firm that
provides a wide range of services worldwide to a substantial and diversified
client base.
The Firm's activities are divided into three principal business lines:
- - Investment Banking, which includes financial advisory services and
underwriting;
- - Trading and Principal Investments, which includes fixed income, currency and
commodities ("FICC"), equities and principal investments; and
- - Asset Management and Securities Services, which includes asset management,
securities services and commissions.
RESULTS OF OPERATIONS
Management believes that the best measure by which to assess the Firm's
historical profitability is pre-tax earnings because, as a partnership, the Firm
generally was not subject to U.S. federal or state income taxes. See
"-- Provision for Taxes" below and Note 2 to the consolidated financial
statements.
The Firm's compensation and benefits expense does not reflect any payments
for services rendered by its partners and therefore understates the expected
operating costs to be incurred by the Firm after the Offerings. Moreover, in
connection with the Offerings, the Firm will record the effect of certain non-
recurring items in the fourth quarter of 1998. These non-recurring items are:
(i) the award of the Formula RSUs; (ii) the initial irrevocable contribution of
shares of Common Stock to the DCP; (iii) the effect of recognition of net
deferred tax assets as a result of the conversion of Group L.P. to corporate
form; and (iv) the Charitable Contribution. See "Pro Forma Consolidated
Financial Information".
The composition of the Firm's historical revenues has varied over time as
financial markets and the scope of the Firm's operations have changed. As a
result, period-to-period comparisons may not be meaningful and interim period
operating results may not be indicative of the operating results for a full
year. See "Risk Factors".
OVERVIEW
The following table sets forth the Firm's net revenues and pre-tax
earnings:
FINANCIAL OVERVIEW
(in millions)
SIX MONTHS
YEAR ENDED NOVEMBER ENDED MAY
-------------------------- ----------------
1995 1996 1997 1997 1998
------ ------ ------ ------ ------
Net revenues....................... $4,483 $6,129 $7,447 $3,631 $5,461
Pre-tax earnings................... 1,368 2,606 3,014 1,515 2,059
------------------------
MAY 1998 VERSUS MAY 1997. The Firm's net revenues were $5.46 billion for
the six-month period ended May 1998, an increase of 50% compared to the same
period in 1997. Net revenue growth was strong in all of the Firm's principal
business lines. Pre-tax earnings increased 36% to $2.06 billion for the period.
1997 VERSUS 1996. The Firm's net revenues were $7.45 billion in 1997, an
increase of 22% compared to 1996. Net revenue growth was strong in Asset
Management and Securities Services and in Investment Banking, which increased
46% and 22%, respectively, primarily due to higher customer balances in
securities services, increased asset management fees and higher levels of
mergers and acquisitions and debt underwriting activity. Net revenues in Trading
and Principal Investments increased 9% over the prior year. Pre-tax earnings
increased 16% to $3.01 billion over the prior year.
1996 VERSUS 1995. The Firm's net revenues were $6.13 billion in 1996, an
increase
32
34
of 37% compared to 1995. Net revenue growth was strong in all of the Firm's
principal business lines, particularly in Trading and Principal Investments and
Investment Banking, which experienced net revenue increases of 54% and 32%,
respectively, primarily due to increased customer activity and trading in the
fixed income, currency and commodities mar- kets and higher levels of equity
underwriting activity. Net revenues in Asset Management and Securities Services
increased 16% compared to 1995. Pre-tax earnings nearly doubled to $2.61
billion.
The following table sets forth the net revenues of the Firm's principal
business lines:
NET REVENUES BY PRINCIPAL BUSINESS LINES
(in millions)
SIX MONTHS
YEAR ENDED NOVEMBER ENDED MAY
-------------------------- ----------------
1995 1996 1997 1997 1998
---- ---- ---- ---- ----
Investment Banking................. $1,595 $2,113 $2,587 $1,094 $1,587
Trading and Principal
Investments...................... 1,744 2,693 2,926 1,660 2,578
Asset Management and Securities
Services......................... 1,144 1,323 1,934 877 1,296
------ ------ ------ ------ ------
Total net revenues................. $4,483 $6,129 $7,447 $3,631 $5,461
====== ====== ====== ====== ======
------------------------
Net revenues in the Firm's principal business lines reflect allocations of
interest expense to specific securities, commodities and other positions in
relation to the level of financing incurred by each position. Interest expense
is allocated to Trading and Principal Investments and the securities services
component of Asset Management and Securities Services. Net revenues may not be
indicative of the relative profitability of any principal business line.
INVESTMENT BANKING
The Firm provides a broad range of investment banking services to a diverse
group of corporations, financial institutions, governments and individuals. The
Firm's investment banking activities are divided into two categories:
- - FINANCIAL ADVISORY. Financial advisory includes advisory assignments with
respect to mergers and acquisitions, divestitures, corporate defense
activities, restructurings and spin-offs; and
- - UNDERWRITING. Underwriting includes public offerings and private placements of
equity and debt securities.
The following table sets forth the net revenues generated by Investment
Banking:
INVESTMENT BANKING NET REVENUES
(in millions)
SIX MONTHS
YEAR ENDED NOVEMBER ENDED MAY
-------------------------- ----------------
1995 1996 1997 1997 1998
---- ---- ---- ---- ----
Financial advisory................. $ 793 $ 931 $1,184 $ 516 $ 799
Underwriting....................... 802 1,182 1,403 578 788
------ ------ ------ ------ ------
Total Investment Banking........... $1,595 $2,113 $2,587 $1,094 $1,587
====== ====== ====== ====== ======
33
35
MAY 1998 VERSUS MAY 1997. The Investment Banking business achieved net
revenues of $1.59 billion in the six-month period ended May 1998, an increase of
45% compared to the same period in 1997. Net revenue growth was strong in both
financial advisory and underwriting as the Firm's global presence and strong
client base enabled it to capitalize on higher levels of financial advisory and
underwriting activity in many industries, including communications, media and
entertainment, financial institutions, general industrials and real estate. The
Firm's Investment Banking business was particularly strong in the United States
and Europe during this period.
Financial advisory revenues increased 55% compared to the May 1997 period
primarily due to a significant increase in mergers and acquisitions advisory
assignments, which principally resulted from consolidations within certain
industries and favorable U.S. and European stock markets. Underwriting revenues
increased 36% as U.S. and European stock price appreciation and stable interest
rates contributed to increased levels of equity and high-yield corporate debt
underwriting.
1997 VERSUS 1996. The Investment Banking business achieved net revenues of
$2.59 billion in 1997, an increase of 22% compared to 1996. Net revenue growth
was strong in both financial advisory and underwriting, particularly in the
general industrials, retail, financial institutions and real estate industries.
Financial advisory revenues increased 27% compared to 1996 primarily due to
higher levels of mergers and acquisitions activity in the market as a whole.
Underwriting revenues increased 19% primarily due to increased levels of
investment grade and high-yield debt underwriting, which resulted from lower
interest rates. Revenues from equity underwriting increased modestly over 1996
levels.
1996 VERSUS 1995. The Investment Banking business achieved net revenues of
$2.11 billion in 1996, an increase of 32% compared to 1995. Underwriting and
financial advisory revenues increased 47% and 17%, respectively, compared to
1995, reflecting increased activity in the communications, media and
entertainment, financial institutions and healthcare industries. Revenue growth
was strong in all major regions.
Underwriting revenues reflected continued strength in global equity
markets, strong investor demand for initial public offerings and a declining
interest rate environment in the United States, which led to an increase in
corporate debt refinancing. The increase in financial advisory revenues was
primarily related to a higher volume of mergers and acquisitions transactions.
TRADING AND PRINCIPAL INVESTMENTS
The Firm's Trading and Principal Investments business facilitates customer
transactions and takes proprietary positions through market making in and
trading of fixed income and equity products, currencies, commodities, swaps and
other derivatives. In order to meet the needs of its clients, the Firm's Trading
and Principal Investments business is diversified across a wide range of
products. The Trading and Principal Investments business includes the following:
- - FICC. The Firm makes markets in and trades fixed income products, currencies
and commodities, structures and enters into a wide variety of derivative
transactions and engages in proprietary trading and arbitrage activities;
- - EQUITIES. The Firm makes markets in and trades equities and equity-related
products, structures and enters into equity derivative transactions and
engages in proprietary trading and equity arbitrage; and
- - PRINCIPAL INVESTMENTS. Principal investments represents the Firm's net
revenues from its investments in its merchant banking funds.
Substantially all of the Firm's inventory is marked-to-market daily and,
therefore, its value is subject to fluctuations based on market movements. In
addition, net revenues derived from the Firm's principal investments in
privately held concerns and in real estate may fluctuate significantly depending
on the revaluation or sale of these investments in any given period.
34
36
The following table sets forth the net revenues of the Firm's Trading and
Principal Investments business:
TRADING AND PRINCIPAL INVESTMENTS NET REVENUES
(in millions)
SIX MONTHS
YEAR ENDED NOVEMBER ENDED MAY
-------------------------- ----------------
1995 1996 1997 1997 1998
---- ---- ---- ---- ----
FICC............................... $ 822 $1,749 $2,055 $1,194 $1,675
Equities........................... 731 730 573 423 659
Principal investments.............. 191 214 298 43 244
------ ------ ------ ------ ------
Total Trading and Principal
Investments...................... $1,744 $2,693 $2,926 $1,660 $2,578
====== ====== ====== ====== ======
------------------------
MAY 1998 VERSUS MAY 1997. The Trading and Principal Investments business
achieved net revenues of $2.58 billion in the six-month period ended May 1998,
an increase of 55% compared to the same period in 1997. All major components of
the business line exhibited strong net revenue growth.
Net revenues in FICC increased 40% compared to the May 1997 period
primarily due to higher net revenues from market making in and trading of
derivatives, government securities, currencies, commodities and high-yield debt
securities partially offset by lower net revenues from emerging market debt and
corporate bond trading activities.
Net revenues in equities increased 56% compared to the May 1997 period as
the Firm's equity derivatives business rebounded sharply from a reduction in net
revenues in the fourth quarter of 1997. Strong customer over-the-counter ("OTC")
transaction volume, particularly in European equities, also contributed to the
increase.
Net revenues from principal investments increased significantly primarily
due to gains recognized on the disposition of certain privately held investments
and increases in the value of certain investments in publicly held concerns.
1997 VERSUS 1996. The Trading and Principal Investments business achieved
net revenues of $2.93 billion in 1997, an increase of 9% compared to 1996.
Strong performances in FICC and principal investments more than offset a net
revenue reduction in equities.
Net revenues in FICC increased 17% compared to 1996 due, in part, to higher
volatility in the currency markets and increased customer demand for fixed
income derivative and commodity products. Arbitrage activities also contributed
to net revenue growth in FICC. Market making in and trading of corporate bonds
and emerging market securities declined in 1997 compared to 1996.
Net revenues in equities decreased 22% in 1997 compared to 1996 due
principally to reductions in derivatives and convertibles resulting from
volatility in the global equity markets in October and November 1997 and
declining asset values in Japan in late November 1997. This reduction was
partially offset by increased net revenues from higher OTC customer trading
volume in certain European markets.
Net revenues from principal investments increased 39% in 1997 compared to
1996 as certain companies in which the Firm invested through its merchant
banking funds completed initial public offerings and other publicly held
concerns increased in value.
1996 VERSUS 1995. The Trading and Principal Investments business achieved
net revenues of $2.69 billion in 1996, an increase of 54% compared to 1995. In
1996, FICC net revenues more than doubled compared to the prior year. Net
revenues from principal invest-
35
37
ments increased modestly while net revenues in equities were virtually
unchanged.
Net revenues in FICC increased compared to 1995 primarily due to higher net
revenues in currencies, global governments and emerging markets. Net revenue
growth in derivatives, commodities and mortgage-backed products also contributed
to the increase.
Net revenues in equities remained stable in 1996 as increased net revenues
from arbitrage activities and increased market-making revenues due to strong OTC
customer transaction volume were offset by lower net revenues in the Firm's
equity derivatives business, primarily in the fourth quarter of 1996.
Net revenues in principal investments increased 12% in 1996 reflecting an
increase in the value of the Firm's investments in its merchant banking funds.
ASSET MANAGEMENT AND SECURITIES SERVICES
Asset Management and Securities Services is comprised of the following:
- - ASSET MANAGEMENT. Asset management generates management fees by providing
investment advisory services to a diverse and rapidly growing client base of
institutions and individuals;
- - SECURITIES SERVICES. Securities services includes prime brokerage, financing
services and securities lending and the Firm's matched book businesses, all of
which generate revenue primarily in the form of fees or interest rate spreads;
and
- - COMMISSIONS. Commission-based businesses include agency transactions for
clients on major stock and futures exchanges. Overrides derived from the
Firm's merchant banking funds are also included.
The following table sets forth the net revenues of the Firm's Asset
Management and Securities Services business:
ASSET MANAGEMENT AND SECURITIES SERVICES NET REVENUES
(in millions)
SIX MONTHS
YEAR ENDED NOVEMBER ENDED MAY
-------------------------- --------------
1995 1996 1997 1997 1998
---- ---- ---- ---- ----
Asset management..................... $ 167 $ 242 $ 458 $185 $ 284
Securities services.................. 330 354 487 237 344
Commissions.......................... 647 727 989 455 668
------ ------ ------ ---- ------
Total Asset Management and Securities
Services........................... $1,144 $1,323 $1,934 $877 $1,296
====== ====== ====== ==== ======
------------------------
The Firm's assets under supervision are comprised of assets under
management and other client assets. Assets under management typically generate
fees based on a percentage of their value and include the Firm's mutual funds,
separate accounts managed for institutional and individual investors, the Firm's
merchant banking funds and other alternative investment funds. Other client
assets are comprised of assets in brokerage accounts of high net worth
individuals on which the Firm earns primarily commissions.
The following table sets forth the amount of the Firm's assets under
supervision:
36
38
ASSETS UNDER SUPERVISION
(in millions)
AS OF NOVEMBER AS OF MAY
------------------------------ -------------------
1995 1996 1997 1997 1998
---- ---- ---- ---- ----
Assets under management........ $ 52,358 $ 94,599 $135,929 $116,714 $165,226
Other client assets............ 62,820 83,362 110,441 94,750 139,689
-------- -------- -------- -------- --------
Total assets under
supervision.................. $115,178 $177,961 $246,370 $211,464 $304,915
======== ======== ======== ======== ========
------------------------
MAY 1998 VERSUS MAY 1997. The Asset Management and Securities Services
business achieved net revenues of $1.30 billion in the six-month period ended
May 1998, an increase of 48% compared to the same period in 1997. All major
components of the business line exhibited strong net revenue growth.
Asset management revenues increased 54% during this period, primarily
reflecting a 42% increase in assets under management over the same period in
1997, primarily due to strong net asset inflows and net asset appreciation. Net
revenues from securities services increased 45% primarily due to growth in the
Firm's securities borrowing and lending business. Commission revenues increased
47% as continued strength in the U.S. equity markets increased transaction
volumes in equity securities. Merchant banking overrides also contributed
significantly to this increase.
1997 VERSUS 1996. The Asset Management and Securities Services business
achieved net revenues of $1.93 billion in 1997, an increase of 46% compared to
1996. All major components of the business line exhibited strong net revenue
growth.
Asset management revenues increased 89% during this period, reflecting a
44% increase in assets under management due to strong net asset inflows, net
asset appreciation and assets added through the acquisitions of Liberty
Investment Management in January 1997 and Commodities Corporation in June 1997.
Net revenue growth in securities services was 38%, principally reflecting growth
in the Firm's securities borrowing and lending business. Commission revenues
increased 36% as customer trading volumes increased significantly on many of the
world's principal stock exchanges, including in the United States where
industry-wide volumes increased substantially in the third and fourth quarters
of 1997. Increased merchant banking overrides also contributed to the revenue
growth in commissions.
1996 VERSUS 1995. The Asset Management and Securities Services business
achieved net revenues of $1.32 billion in 1996, an increase of 16% compared to
1995. Net revenue growth was particularly strong in asset management, which
increased 45%. Net revenues from commissions and securities services increased
12% and 7%, respectively.
Asset management revenues increased compared to 1995, primarily due to
higher assets under management, which increased to $95 billion from $52 billion,
primarily as a result of strong net asset inflows and approximately $25 billion
of assets acquired in connection with the Firm's purchase of CIN Management
Limited, a U.K. pension manager, in August 1996. Increases in commissions
revenue reflected increased transaction volume by investors globally.
OPERATING EXPENSES
In recent years, the Firm's operating expenses have increased as a result
of numerous factors, including (i) higher levels of compensation, (ii) expansion
of the Firm's asset management business, (iii) expansion of the Firm's global
operations, (iv) greater levels of business activity and complexity and (v)
additional systems and consulting costs relating to various technology
initiatives. The Firm's compensation and benefits expense does not reflect any
payments for services rendered by its partners. Accordingly, compensation and
benefits, the principal component of operating expenses, will increase
37
39
significantly after the Offerings. See "Pro Forma Consolidated Financial
Information".
The following table sets forth the Firm's operating expenses and number of
employees:
OPERATING EXPENSES AND EMPLOYEES
($ in millions)
AS OF OR FOR
AS OF OR FOR SIX MONTHS
YEAR ENDED NOVEMBER ENDED MAY
------------------------- ----------------
1995 1996 1997 1997 1998
---- ---- ---- ---- ----
Compensation and benefits............. $2,005 $2,421 $ 3,097 $1,528 $ 2,589
Brokerage, clearing and exchange
fees................................ 246 278 357 154 194
Market development.................... 97 137 206 78 134
Communications and technology......... 173 173 208 93 121
Depreciation and amortization......... 186 172 178 81 104
Occupancy............................. 175 154 168 78 93
Professional services and other....... 233 188 219 104 167
------ ------ ------- ------ -------
Total operating expenses.............. $3,115 $3,523 $ 4,433 $2,116 $ 3,402
====== ====== ======= ====== =======
Employees(1).......................... 8,159 8,977 10,622 9,290 11,440
- ---------------
(1) Excludes employees of the Firm's two property management subsidiaries,
Archon and GAH. Substantially all of the costs of these employees are
reimbursed to the Firm by the real estate investment funds to which the two
companies provide property management services. In addition, as of May 1998,
the Firm had approximately 2,900 temporary staff and consultants. See
"Business -- Employees" and "-- Temporary Staff and Consultants".
------------------------
MAY 1998 VERSUS MAY 1997. Operating expenses were $3.40 billion for the
six months ended May 1998, an increase of 61% over the same period in 1997.
Compensation and benefits increased as a percentage of net revenues to 47% from
42% in the comparable period in 1997. This increase reflected, in part, an
increase of $70 million in compensation and benefits expense in connection with
a new compensation plan for senior professionals. The increase in compensation
and benefits expense as a percentage of net revenues is also due to costs
associated with an increase in Firmwide employment levels of 23%, particularly
in asset management where the Firm continues to spend substantially all
incremental revenues on the hiring of additional professionals required to
expand the business. Other elements of compensation, primarily employee bonuses,
increased at a rate higher than that of net revenues.
Expenses associated with the Firm's temporary staff and consultant
populations are included in compensation and benefits. These expenses were $135
million for the six months ended May 1998, an increase of 78%, reflecting
greater business activity, the Firm's global expansion and consulting costs
associated with various technology initiatives.
Market development expenses increased 72% and professional services and
other expenses increased 61%, primarily due to higher levels of business
activity and the Firm's global expansion. Brokerage, clearing and exchange fees
increased 26% due to higher transaction volume in certain product areas,
including European equities, U.S. listed shares and currencies. Communications
and technology costs increased 30%, reflecting higher telecommunications and
market data costs associated with higher employment levels and additional
spending on technology
38
40
initiatives. Depreciation and amortization increased 28% principally due to
capital expenditures on telecommunications and technology-related equipment,
hardware, software and leasehold improvements. Occupancy expenses increased 19%,
reflecting additional office space needed to accommodate higher employment
levels.
1997 VERSUS 1996. Operating expenses were $4.43 billion in 1997, an
increase of 26% over 1996. Compensation and benefits were $3.10 billion,
reflecting higher compensation primarily due to higher profit levels.
Compensation and benefits were also affected by an 18% increase in employment
levels across the Firm due to higher levels of business activity and complexity,
and the Firm's global expansion into new businesses and markets. Higher sales
compensation due to increased customer transaction volume also contributed to
the increase in compensation and benefits. As a result, compensation and
benefits increased slightly as a percentage of net revenues to 42% from 40% in
1996.
Expenses associated with the Firm's temporary staff and consultant
populations were $178 million in 1997, an increase of 55%, reflecting greater
business activity, the Firm's global expansion and consulting costs associated
with various technology initiatives.
Brokerage, clearing and exchange fees increased 28% due to higher
transaction volumes in global equities, derivatives and currencies. Market
development expenses and professional services and other expenses increased
primarily due to greater levels of business activity and the Firm's global
expansion. Communications and technology costs increased 20%, reflecting
telecommunications and market data costs associated with higher employment
levels and additional spending on technology initiatives. Occupancy expenses
increased 9%, reflecting an increase in office space needed to accommodate
higher employment levels. Depreciation and amortization increased 3%.
1996 VERSUS 1995. Operating expenses were $3.52 billion in 1996, an
increase of 13% over 1995. Compensation and benefits were $2.42 billion,
reflecting higher compensation primarily due to higher profit levels and profit
sharing associated with the Firm's profit participation plan. Compensation and
benefits were also affected by an increase in employment levels across the Firm
due to higher levels of business activity and complexity and the Firm's global
expansion into new businesses and markets. Compensation and benefits decreased
as a percentage of net revenues to 40% from 45%.
Expenses associated with the Firm's temporary staff and consultant
populations were $115 million in 1996, an increase of 2%, reflecting various
technology initiatives.
Market development expenses increased 41%, primarily due to higher levels
of business activity and the Firm's global expansion. Brokerage, clearing and
exchange fees increased 13% primarily due to higher transaction volumes in
certain product areas including fixed income derivatives, Asian shares and U.S.
listed shares. Professional services and other expenses decreased 19% primarily
due to lower legal fees and reduced expenses associated with investment banking
transactions that were not consummated. Occupancy expenses decreased 12%,
reflecting higher space abandonment charges in 1995 that did not recur in 1996.
Depreciation and amortization decreased 8% primarily due to equipment write-offs
in 1995 that did not recur in 1996.
PROVISION FOR TAXES
The Firm, as a partnership, generally is not subject to U.S. federal and
state income taxes. Certain of the Firm's income is subject to the 4% New York
City unincorporated business tax. In addition, certain of the Firm's non-U.S.
subsidiaries are subject to income taxes in their local jurisdictions. The
amount of the Firm's provision for income and unincorporated business taxes
varies significantly from year to year depending on the earnings of the Firm's
subsidiaries. For a discussion of the pro forma effective tax rate of the Firm
as if its business was conducted as a corporation, see "Pro Forma Consolidated
Financial Information".
39
41
GEOGRAPHIC DATA
For a summary of the Firm's total revenues, net revenues, pre-tax earnings
and identifiable assets of the Firm's subsidiaries by geographic region, see
Note 9 to the consolidated financial statements.
CASH FLOWS
The Firm's cash flows are primarily related to the operating and financing
activities undertaken in connection with its trading and market-making
transactions.
SIX MONTHS ENDED MAY 1998
Cash and cash equivalents increased to $2.21 billion as of May 1998. Cash
of $17.25 billion was used for operating activities, primarily to fund higher
net trading assets generated by increased levels of business activity. Cash of
$356 million was used primarily for the purchase of telecommunications and
technology-related equipment and certain other assets. Financing activities
provided $18.49 billion of cash, reflecting an increase in net repurchase
agreements and the net issuance of long-term borrowings, partially offset by
distributions to partners and cash outflows related to partners' capital
reserved for income taxes and potential withdrawals.
YEAR ENDED NOVEMBER 1997
Cash and cash equivalents decreased to $1.33 billion in 1997. Operating
activities provided cash of $70 million. Cash of $693 million was used primarily
for the purchase of technology-related equipment and certain other assets. Cash
of $258 million was used for financing activities principally due to a decrease
in net repurchase agreements, distributions to partners and cash outflows
related to partners' capital reserved for income taxes and potential
withdrawals, partially offset by the net issuance of long-term borrowings.
YEAR ENDED NOVEMBER 1996
Cash and cash equivalents increased to $2.21 billion in 1996. Cash of
$14.63 billion was used for operating activities, primarily to fund higher net
trading assets due to increased levels of business activity. Cash of $218
million was used primarily for the purchase of technology-related equipment and
leasehold improvements. Financing activities provided $16.10 billion of cash,
reflecting an increase in net repurchase agreements and the net issuance of
long-term borrowings, partially offset by distributions to partners and cash
outflows related to partners' capital reserved for income taxes and potential
withdrawals.
LIQUIDITY
MANAGEMENT OVERSIGHT OF LIQUIDITY
Management believes that one of the most important issues for a company in
the financial services sector is access to liquidity. Accordingly, the Firm has
established a comprehensive structure to oversee its liquidity and funding
policies.
The Finance Committee has been delegated responsibility by the Executive
Committee for establishing and assuring compliance with the Firm's asset and
liability management policies and has oversight responsibility for managing
liquidity risk, the size and composition of the balance sheet and the credit
ratings of the Firm (see the description of the Firm's committee structure in
"-- Risk Management" below). This committee meets monthly, and more often when
necessary, to evaluate the Firm's liquidity position and funding requirements.
The Firm's Treasury Department manages the capital structure, funding,
liquidity and relationships with creditors, trading counterparties and rating
agencies on a global basis. The Treasury Department works jointly with the
Firm's global funding desk in managing the Firm's borrowings. The global funding
desk is primarily responsible for the transactional short-term funding activity
of the Firm.
LIQUIDITY POLICIES
In order to maintain an appropriate level of liquidity, management has
implemented several liquidity policies as outlined below.
DIVERSIFICATION OF FUNDING SOURCES AND LIQUIDITY PLANNING. The Firm
maintains diver-
40
42
sified funding sources with both banks and non-bank lenders globally. Management
believes that the Firm's relationships with its lenders are critical to its
liquidity. The Firm maintains close contact with its primary lenders to keep
them advised of significant developments affecting the Firm.
The Firm also has access to diversified funding sources with over 800
creditors, including banks, insurance companies, mutual funds, bank trust
departments and other asset managers. The Firm monitors its creditors to
maintain broad and diversified credit, and no single creditor represented more
than 4% of the Firm's uncollateralized funding sources as of May 1998.
Uncollateralized funding sources principally include the Firm's short-term and
long-term borrowings and letters of credit.
The Firm accesses liquidity in a variety of markets in the United States as
well as in Europe and Asia. In addition, the Firm makes extensive use of the
repurchase agreement market and has raised debt in the private placement, Rule
144A and commercial paper markets, as well as through Eurobonds, moneybroker
loans, commodity-based financings, letters of credit and promissory notes. The
Firm structures its liabilities to avoid significant concentrations of debt
coming due on any one day or during any single week or year. In addition, the
Firm maintains and updates annually a liquidity crisis manual that provides
guidance in the event of a liquidity crisis. The annual update of this manual is
reviewed and approved by the Finance Committee.
ASSET LIQUIDITY. The Firm maintains a highly liquid balance sheet. Many of
the Firm's assets are readily funded in the repurchase agreement markets, which
generally have proven to be a consistent source of funding, even in periods of
market stress. Substantially all of the Firm's inventory turns over rapidly and
is marked-to-market daily. The Firm maintains long-term borrowings and partners'
capital substantially in excess of its less liquid assets.
DYNAMIC LIQUIDITY MANAGEMENT. The Firm manages the composition of its
asset base and the maturity profile of its funding to ensure that it can
liquidate its assets prior to its liabilities coming due, even in times of
liquidity stress. The Firm has traditionally been able to fund its liquidity
needs through collateralized funding, such as repurchase transactions and
securities lending, short-term borrowings, long-term debt and partners' capital.
To further evaluate the adequacy of its liquidity management policies and
guidelines, the Firm performs weekly "stress funding" simulations of disruptions
to the Firm's access to unsecured credit. The Firm attempts to ensure that the
maturity structure of its debt is substantially longer than the time required to
liquidate the Firm's assets.
EXCESS LIQUIDITY. In addition to maintaining a highly liquid balance sheet
and a significant portion of longer-term liabilities to assure liquidity even
during adverse conditions, the Firm seeks to maintain a liquidity cushion that
consists principally of unencumbered U.S. government and agency obligations to
ensure the availability of immediate liquidity. This pool of highly liquid
assets averaged approximately $11.80 billion during the six months ended May
1998 and approximately $12.54 billion during 1997.
LIQUIDITY RATIO MAINTENANCE. It is the Firm's policy further to manage its
liquidity by maintaining a "liquidity ratio" of at least 100%. This ratio
measures the relationship between the loan value of the Firm's unencumbered
assets and its short-term unsecured liabilities. The maintenance of this
liquidity ratio is intended to ensure that the Firm could fund its positions on
a fully secured basis in the event that the Firm were unable to replace its
unsecured debt maturing within one year. Under this policy, the Firm seeks to
maintain unencumbered assets in an amount that, if pledged or sold, would
provide the funds necessary to replace unsecured obligations that are scheduled
to mature (or where holders have the option to redeem) within the coming year.
INTERCOMPANY FUNDING. Most of the liquidity of the Firm is raised by Group
L.P., which then lends the necessary funds to its subsidiaries and affiliates.
The Firm carefully manages its intercompany exposure by generally requiring
intercompany loans to have maturities equal to or shorter than the maturi-
41
43
ties of the aggregate borrowings of Group L.P. This policy ensures that the
subsidiaries' obligations to Group L.P. will generally mature in advance of
Group L.P.'s third-party long-term borrowings. In addition, many of the advances
made to the Firm's subsidiaries and affiliates are secured by marketable
securities or other liquid collateral. The Firm generally funds its equity
investments in subsidiaries with partners' capital.
THE BALANCE SHEET
In assessing the size of the Firm's balance sheet, it is important to
recognize that the Firm maintains a highly liquid balance sheet that fluctuates
significantly between statement dates. The Firm's total assets increased to
$241.85 billion as of May 1998 compared to $178.40 billion as of November 1997,
primarily due to growth in securities borrowed, securities purchased under
agreements to resell and U.S. government securities. Over the same period, the
Firm's adjusted assets increased to $153.36 billion from $119.88 billion. The
Firm's balance sheet size as of May 1998 increased by $17.33 billion due to the
adoption of the provisions of SFAS No. 125 that were deferred by SFAS No. 127.
See "-- Accounting Developments" below and Note 2 to the consolidated financial
statements.
CREDIT RATINGS
The Firm relies upon the debt capital markets to fund a significant portion
of its day-to-day operations. The cost and availability of debt financing is
influenced by the Firm's credit ratings. Credit ratings are also important to
the Firm when competing in certain markets and when seeking to engage in
longer-term transactions, including OTC derivatives. A reduction in the Firm's
credit ratings could adversely affect the Firm's ability to obtain funding in
the debt capital markets, impair the Firm's margins by increasing the cost of
doing business and reduce the Firm's ability to compete effectively in certain
markets.
The following table sets forth the Firm's credit ratings as of May 1998:
SHORT-TERM DEBT LONG-TERM DEBT
--------------- --------------
Moody's Investors Service..................... P-1 A1
Standard & Poor's Ratings Services............ A-1+ A+
Fitch IBCA, Inc. ............................. F1+ AA-
Canadian Bond Rating Service Inc. ............ A-1+ A+
------------------------
LONG-TERM DEBT
As of May 1998, the Firm's consolidated long-term borrowings were $20.28
billion. Substantially all of these borrowings were unsecured and consisted
principally of senior borrowings with maturities extending to 2024. See Note 5
to the consolidated financial statements. The weighted average maturity of the
Firm's long-term borrowings as of May 1998 was approximately four and a half
years. Substantially all of the Firm's long-term borrowings are swapped into
short-term floating-rate U.S. dollar obligations in order to minimize the Firm's
exposure to interest rates and foreign exchange movements.
REGULATED SUBSIDIARIES
Many of the Firm's principal subsidiaries are subject to extensive
regulation in the United States and elsewhere. GS&Co., a registered U.S.
broker-dealer, is regulated by the SEC, the CFTC, the Chicago Board of Trade
("CBT"), the NYSE and the NASD. GSI, a registered U.K. broker-dealer, is subject
to regulation by the Securities and Futures Authority Limited ("SFA") and the
Financial Services Authority ("FSA"). Goldman Sachs (Japan) Ltd., a Tokyo-based
broker-dealer, is subject to regulation by the Japanese Ministry of Finance, the
Financial Supervisory Agency, the Tokyo Stock Exchange and the Japan Securities
Dealers Association. Several other subsidiaries of the Firm are regulated by
securities, investment advisory, banking and other regulators and
42
44
authorities around the world. Compliance with the rules of these regulators may
prevent the Firm from receiving distributions, advances or repayment of
liabilities from these subsidiaries. See Note 8 to the consolidated financial
statements.
RISK MANAGEMENT
The Firm has a comprehensive risk management process to monitor, evaluate
and manage the principal risks assumed in conducting its activities. These risks
include market, credit, liquidity, operational, legal and reputational
exposures.
RISK MANAGEMENT STRUCTURE
The Firm seeks to monitor and control its risk exposure through a variety
of separate but complementary financial, credit, operational and legal reporting
systems. The Firm believes that it has effective procedures for evaluating and
managing the market, credit and other risks to which it is exposed.
The Firm has established risk control procedures at several levels
throughout the organization. Trading desk managers have the first line of
responsibility for managing risk within limits prescribed by the relevant Risk
Committees as described in the table below. These managers have in-depth
knowledge of the primary sources of risk in their individual markets and the
instruments available to hedge the Firm's exposures. In addition, a number of
committees described below are responsible for establishing trading limits,
monitoring adherence to these limits and for general oversight of the risk
management process.
43
45
- ---------------------------------------------------------------------------------------------------
COMMITTEE FUNCTION
- ---------------------------------------------------------------------------------------------------
Executive Committee All risk control functions ultimately report to the
Executive Committee. Through both direct and delegated
authority, the Executive Committee approves all of the
Firm's:
- operating activities;
- trading risk parameters; and
- customer review guidelines.
- ---------------------------------------------------------------------------------------------------
Risk Committees The Firmwide Risk Committee:
- periodically reviews (together, in most cases, with the
Global Compliance and Control Committee described below)
the activities of existing businesses;
- approves new businesses and products;
- approves Value-at-Risk ("VaR") market risk limits at the
divisional level;
- approves market risk limits for selected country
exposures and business units; and
- approves sovereign credit risk limits and credit risk
limits by ratings group.
The FICC Risk Committee sets VaR market risk limits for
individual business units and sets issuer-specific net
inventory position limits.
The Equities Risk Committee sets market risk limits for
individual business units that consist of gross and net
inventory position limits and, for equity derivatives,
limits based on market move scenario analysis.
The Asset Management Control, Oversight and Risk
Committees oversee various operational, credit, pricing
and business practices issues.
- ---------------------------------------------------------------------------------------------------
Global Compliance and Control The GCC provides oversight of the Firm's compliance and
Committee ("GCC") control functions, including internal audit, and reviews
the Firm's legal, reputational, operational and control
risks.
- ---------------------------------------------------------------------------------------------------
Commitments Committee The Commitments Committee approves:
- equity and non-investment grade debt underwriting
commitments;
- loans extended by the Firm; and
- unusual financing structures and transactions that
involve, among other risks, significant capital exposure.
The Commitments Committee has delegated to the Credit
Department the authority to approve underwriting
commitments for investment grade debt and certain other
products.
- ---------------------------------------------------------------------------------------------------
Credit Policy Committee The Credit Policy Committee establishes and reviews broad
credit policies and parameters that are implemented by the
Credit Department.
- ---------------------------------------------------------------------------------------------------
Finance Committee The Finance Committee is responsible for oversight of the
Firm's capital, liquidity and funding needs and for
setting certain inventory position limits, as appropriate.
- ---------------------------------------------------------------------------------------------------
44
46
Segregation of duties and management oversight are fundamental elements of
the Firm's risk management process. Accordingly, departments that are
independent of the revenue producing units, such as the Firmwide Risk, Credit,
Controllers, Global Operations, Compliance, Management Controls and Legal
Departments, perform risk management functions, which include monitoring,
analyzing and evaluating risk.
RISK LIMITS
Business unit risk limits are established by the Risk Committees and may be
further segmented by the business unit managers to individual trading desks.
Risk limits are monitored on a daily basis by the Firmwide Risk Department and
are reviewed regularly by the appropriate Risk Committee. Limit violations are
reported to the appropriate Risk Committee and the appropriate business unit
managers. Aggregate VaR risk limits, as well as market risk limits for selected
country exposures and business units, are monitored by the Firmwide Risk
Department and violations are reported to the Firmwide Risk Committee. Inventory
position limits are monitored by the Controllers Department and position limit
violations are reported to the appropriate business unit managers and the
Finance Committee. When inventory position limits are used to monitor market
risk, they are also monitored by the Firmwide Risk Department and violations are
reported to the appropriate Risk Committee.
MARKET RISK
The potential for changes in the market value of the Firm's trading
positions is referred to as "market risk". The Firm's trading positions result
from underwriting, market making and proprietary trading activities.
The broadly defined categories of market risk include exposures to interest
rates, currency rates, equity prices and commodity prices.
- - Interest rate risks primarily result from exposures to changes in the level,
slope and curvature of the yield curve, the volatility of interest rates,
mortgage prepayment speeds and credit spreads.
- - Currency rate risks result from exposures to changes in spot prices, forward
prices and volatilities of currency rates.
- - Equity price risks result from exposures to changes in prices and volatilities
of individual equities, equity baskets and equity indices.
- - Commodity price risks result from exposures to changes in spot prices, forward
prices and volatilities of commodities, such as electricity, natural gas,
crude oil, petroleum products and precious and base metals.
These risk exposures are managed through diversifying exposures,
controlling position sizes and establishing offsetting hedges in related
securities or derivatives. For example, the Firm may hedge a portfolio of common
stock by taking an offsetting position in a related equity-index futures
contract. The ability to manage these exposures may, however, be limited by the
liquidity of the security or the related hedge instrument.
VaR. The Firm uses a summary measure of its risk exposure referred to as
Value-at-Risk or "VaR" as one tool to help manage the market risk of its trading
positions. VaR is the potential loss in value of the Firm's trading positions
due to adverse movements in markets over a defined time horizon with a set
confidence level.
For the VaR numbers reported below, a one-day time horizon and a 95%
confidence level were used. This means that there is a one in 20 chance that
daily trading net revenues will fall below the expected daily trading net
revenues by an amount at least as large as the reported VaR. Thus, shortfalls
from expected trading net revenues greater than the reported VaR would be
anticipated by the method about once a month. Of course, much larger and more
frequent shortfalls are possible. The VaR numbers are shown separately for
interest rate, currency, equity and commodity products, as well as for the
Firm's overall trading positions.
These VaR numbers include the underlying product positions and related
hedges, which may include positions in other product areas. For example, the
hedge of a foreign
45
47
exchange forward may include an interest rate futures position and the hedge of
a long corporate bond position may include a short position in the related
equity.
VaR METHODOLOGY, ASSUMPTIONS AND LIMITATIONS. The modeling of the risk
characteristics of the Firm's trading positions involves a number of assumptions
and approximations. While the Firm feels that these assumptions and
approximations are reasonable, there is no uniform industry methodology for
estimating VaR, and different assumptions and/or approximations could produce
materially different VaR estimates.
The Firm uses historical return data to estimate its VaR and, to better
reflect market volatilities, these historical data are weighted to give greater
importance to more recent observations. Past changes in market risk factors,
even when weighted toward more recent observations, may not, however, produce
accurate predictions of future market risk. VaR should also be evaluated in
light of the methodology's other limitations. For example, when calculating the
VaR numbers shown below, the Firm assumes that asset returns are normally
distributed. Non-linear risk exposures on options and the potentially mitigating
impact of intra-day changes in related hedges would likely produce non-normal
asset returns. Different distributional assumptions could produce a materially
different VaR. Moreover, VaR calculated for a one-day time horizon does not
fully capture the market risk of positions that cannot be liquidated or hedged
within one day.
The following table sets forth the Firm's daily VaR for substantially all
of its trading positions:
DAILY VaR
(in millions)
AS OF
RISK CATEGORIES MAY 1998
--------------- --------
Interest rates............................................ $ 33
Currency rates............................................ 11
Equity prices............................................. 22
Commodity prices.......................................... 7
Diversification effect(1)................................. (26)
----
Firmwide.................................................. $ 47
====
- ---------------
(1) Equals the difference between Firmwide VaR and the sum of the VaRs for the
four risk categories. This effect arises because the four market risk
categories are not perfectly correlated.
------------------------
The Firm supplements VaR measures with a variety of scenario analyses. In
addition to providing senior management with estimates of how the Firm's trading
net revenues would be affected by large market moves, these scenario analyses
seek to estimate the potential impact of sustained market declines on the Firm's
investment banking and merchant banking activities.
VALUATION OF TRADING INVENTORY
Substantially all of the Firm's inventory positions are marked-to-market on
a daily basis and the changes are recorded in net revenues. The individual
business units are responsible for pricing the positions they manage. The
Controllers Department, in conjunction with the Firmwide Risk Department,
regularly performs pricing reviews.
TRADING NET REVENUES DISTRIBUTION
The following chart sets forth the frequency distribution of the Firm's
trading net revenues for substantially all of the Firm's trading positions for
the nine months ended August 1998:
46
48
TRADING NET REVENUES -- NINE MONTHS ENDED AUGUST 1998
(in millions)
[CHART TO BE PROVIDED]
------------------------
CREDIT RISK
Credit risk represents the loss that the Firm would incur if a counterparty
or issuer of securities or other instruments it holds fails to perform its
contractual obligations to the Firm. To reduce its credit exposures, the Firm
seeks to enter into netting agreements with counterparties that permit the Firm
to offset receivables and payables with such counterparties. The Firm does not
take into account any such agreements when calculating credit risk, however,
unless it has received reasonable assurance that the agreement will permit
netting of the counterparty's exposure under applicable law.
For most businesses, credit limits are established by the Credit
Department, which is independent of the revenue-producing departments, based on
guidelines set by the Firmwide Risk and Credit Policy Committees. The Firm's
global credit management systems capture current and potential credit exposure
to individual counterparties and on an aggregate basis to counterparties and
their affiliates. The systems also provide the Firm's management with
information regarding overall credit risk by product, industry sector, country
and region.
DERIVATIVE INSTRUMENTS
Derivatives contracts are financial instruments that derive their value
from underlying assets, indices, reference rates or a combination of these
factors. Derivative instruments may be entered into by the Firm in privately
negotiated contracts ("OTC derivatives"), or they may be listed and traded on an
exchange.
The Firm uses derivatives in its trading activities to facilitate customer
transactions, to take proprietary positions and as a means of risk management.
Derivatives are used in many of the Firm's businesses, and the Firm believes
that the associated market risk can only be understood relative to the
underlying assets or risks being hedged, or as part of a broader trading
strategy. Accordingly, the market risk of derivative positions is managed with
all of the Firm's other non-derivative risk. In addition, the Credit Department
sets and monitors limits for the amount of credit risk the Firm is willing to
take for each counterparty or sets required margin levels for certain customers
and products. Derivatives used for trading purposes are recorded at fair value
on the consolidated statements of financial condition. These values are reported
on a net-by-counterparty basis where management has received reasonable
assurance that netting of the counterparty's exposure will be permitted under
applicable law.
For an OTC derivative contract, the Firm's credit exposure is directly with
its counterparty and continues until the maturity or termination of such
contract.
47
49
The following table sets forth the distribution, by credit rating, of
substantially all of the Firm's exposure with respect to OTC derivatives as of
May 1998, after taking into consideration the effect of netting agreements. The
categories shown reflect the internally determined public rating agency
equivalents used by the Firm:
OTC DERIVATIVES CREDIT EXPOSURE
($ in millions)
CREDIT RATING EQUIVALENT AMOUNT PERCENTAGE
- ------------------------ ------ ----------
AAA/Aaa..................................... $ 1,660 12%
AA/Aa2...................................... 4,251 30
A/A2........................................ 3,839 27
BBB/Baa2.................................... 2,504 17
BB/Ba2 or lower............................. 1,351 9
Unrated(1).................................. 663 5
------- ----
$14,268 100%
======= ====
- ---------------
(1) The Firm has determined, in lieu of making an individual assessment of such
counterparties' credit, that the collateral held in respect of such
obligations is sufficient (taking into account various factors including
legal uncertainties and market volatility) to cover the Firm's exposure.
------------------------
As of May 1998, the Firm held approximately $2.22 billion in collateral
against these OTC derivatives exposures. This collateral consists predominantly
of cash, U.S. government and agency securities and is usually received by the
Firm pursuant to agreements entitling the Firm to require additional collateral
upon certain increases in exposure or the occurrence of negative credit events.
In addition to obtaining collateral and seeking netting agreements, the
Firm attempts to mitigate default risk on derivatives by entering into
agreements that enable the Firm to terminate or reset the terms of transactions
after certain time periods or upon the occurrence of credit-related events, and
by seeking third-party guaranties of the obligations of some counterparties.
Derivatives transactions may also involve the legal risk that they are not
authorized or appropriate for a counterparty, that documentation has not been
properly executed or that executed agreements may not be enforceable against the
counterparty. The Firm attempts to minimize these risks by obtaining, where
appropriate, advice of counsel on the enforceability of agreements as well as
the authority of a counterparty to effect the derivative transaction.
OPERATIONAL, YEAR 2000 AND EMU RISKS
OPERATIONAL RISK. The Firm may face reputational damage, financial loss or
regulatory risk in the event of an operational failure or error. A systems
failure or failure to enter a trade properly into the Firm's records may result
in an inability to settle transactions in a timely manner or a breach of
regulatory requirements. Settlement errors or delays may cause losses due to
damages owed to counterparties or movements in prices. These operational and
systems risks may arise in connection with the Firm's own systems or as a result
of the failure of an agent acting on the Firm's behalf.
The Global Operations Department is responsible for establishing,
maintaining and improving policies and controls with respect to the accurate
inputting and processing of transactions, clearance and settlement of
transactions, the custody of securities and other instruments and the detection
and prevention of employee errors or improper or fraudulent activities. Its
personnel work closely with the Information Technology Department in creating
systems to enable appropriate supervision and management of its policies. The
Global Operations Department is also responsible, together with other areas of
the Firm, including the Legal and Compliance
48
50
Departments, for ensuring compliance with applicable regulations with respect to
the clearance and settlement of transactions and the margining of positions. The
Network Management Department oversees the Firm's relationships with its
clearance and settlement agents, regularly reviews agents' performance and meets
with these agents to review operational issues.
YEAR 2000. The Firm has determined that it will be required to modify or
replace portions of its information technology systems, both hardware and
software, and its non-information technology systems so that they will properly
recognize and utilize dates beyond December 31, 1999. The Firm presently
believes that with modifications to existing software, conversions to new
software and replacement of some hardware, the Year 2000 issue will be
satisfactorily resolved in its own systems worldwide. However, if such
modifications and conversions are not made or are not completed on a timely
basis, the Year 2000 issue could have a material adverse effect on the Firm.
Moreover, even if these changes are successful, failure of third parties to
which the Firm is financially or operationally linked to address their own
system problems could have a material adverse effect on the Firm. For a
description of the Year 2000 issue and some of the related risks, including
possible "worst-case" scenarios, see "Risk Factors -- Firm and Third-Party
Computer Systems May Not Achieve Year 2000 or EMU Readiness".
The Firm has undertaken a Firmwide initiative to address the Year 2000
issue and has developed a plan to review and, as appropriate, modify or replace
the software (and replace some hardware) in its computer systems in its offices
around the world. The Firm's business and multi-disciplinary teams have
completed an education initiative (i.e., an awareness phase) and a global
inventory of the Firm's computer systems and non-information technology systems
and applications (i.e., an assessment phase) with regard to the Year 2000 issue.
The Firm participated in preliminary industry-wide, external systems tests
conducted by the Securities Industry Association in July 1998 and is in the
process of conducting its own internal tests to prepare for Year 2000
compliance. The Firm achieved successful results in each of the preliminary
industry-wide tests in which it participated.
As part of the plan, the Firm is continuing to renovate and test its
internal technologies and applications in partnership with an external
consulting organization. The Firm has established an internal auditing process
to track and verify the results of its plan and tests. Management believes the
Firm is currently on schedule to substantially complete the renovation,
validation and implementation phases of its plan with respect to its mission-
critical systems by year-end 1998. In addition, management expects the Firm to
participate in proposed industry-wide testing involving global market
participants throughout the first half of 1999. This external testing is
expected to involve major market participants that conduct business globally,
including competing firms and financial intermediaries, such as stock exchanges,
clearing agencies and commercial banks, that are prominent in the U.S. and major
foreign markets.
The Firm is also working with key external parties, including major
clients, counterparties, exchanges, clearing agencies, clearing houses,
commercial banks, utilities and other vendors to assess the remediation efforts
made by these parties with respect to their own systems. Accordingly, the Firm
has initiated communications with counterparties, intermediaries and vendors
with whom it has important financial and operational relationships to determine
the extent to which they are vulnerable to the Year 2000 issue. The Firm has not
yet received sufficient information from these parties about their remediation
plans to predict the outcome of their efforts. In addition, the Firm's Credit
Department is undertaking a comprehensive review of credit risks posed by Year
2000 problems at major third parties to which the Firm is financially or
operationally linked. The Firm is also developing a contingency plan that is
expected to address financial and operational problems that might arise on and
around January 1, 2000. This contingency plan would include establishing
additional sources of liquidity that could be drawn upon in the event of systems
disruption and identifying alterna-
49
51
tive vendors and back-up processes that do not rely on computers, whenever
possible.
The Firm has incurred and expects to continue to incur expenses allocable
to internal staff, as well as costs for outside consultants, computer systems'
remediation and replacement and non-information technology systems' remediation
and replacement (including validation) in order to achieve Year 2000 compliance.
The Firm currently estimates that these costs will total between $120 million
and $150 million, the majority of which will have been spent by the end of 1998.
The remaining cost of the Firm's Year 2000 program is expected to be incurred in
1999. The Year 2000 program costs will continue to be funded through operating
cash flow. These costs are expensed as incurred.
The costs of the Year 2000 program and the date on which the Firm plans to
complete the Year 2000 modifications are based on current estimates, which
reflect numerous assumptions about future events, including the continued
availability of certain resources, the timing and effectiveness of third-party
remediation plans and other factors. The Firm can give no assurance that these
estimates will be achieved, and actual results could differ materially from the
Firm's plans. Specific factors that might cause such material differences
include, but are not limited to, the availability and cost of personnel trained
in this area, the ability to locate and correct relevant computer source codes
and embedded technology, the results of internal and external testing and the
timeliness and effectiveness of remediation efforts of third parties.
EMU. Commencing on January 1, 1999, 11 European countries will enter into
the EMU and replace their local currencies with a single currency, the Euro.
During a three-year transition period, the national currencies will continue to
circulate but only as fixed denominations of the Euro. Commencing on January 1,
1999, the Euro will be the predominant currency to settle wholesale (non-cash)
transactions previously denominated in the participating national currencies.
In order to address the issues associated with the introduction of the
Euro, the Firm is implementing a worldwide EMU conversion and testing plan. The
Firm's plan is currently on schedule, and integrated enterprise testing has
commenced. The Euro conversion presents systems issues that are unprecedented in
three respects. First, the Firm must convert an exceptionally large amount of
the data in its systems. Second, the Firm has had to make system changes based
on numerous technical decisions that were made by the participating countries
only recently, thus making advanced planning difficult. Moreover, the
participating countries were under no obligation to reach a consensus on how
these technical issues were to be resolved, and the protocols they adopted
differ. Third, unlike the systems changes that will be required by the Year 2000
issue, those required by the adoption of the Euro must all be implemented
successfully over a single weekend, beginning when markets close on December 31,
1998. The Firm has incurred and expects to continue to incur expenses for
internal technology staff, as well as costs for outside consultants, in order to
implement its EMU conversion plan. Management currently estimates that the cost
of its EMU conversion program will be approximately $30 million.
The changes to the Firm's data and computer systems will affect its
clearance, settlement and financial reporting activities, among other key
operations of the Firm. If not properly implemented, these changes could lead to
failed trade settlements, inability to reconcile trading positions and funding
disruptions. These changes could also lead to erroneous entries in the Firm's
books and records. These events could result in misstatement of the Firm's
financial condition and results of operations and could impair its ability to
manage our risks.
The Firm is also dependent for proper transaction clearance and reporting
on many third parties, including counterparties, clearing agents, banks,
exchanges, clearing houses and providers of information. If these third parties'
systems do not appropriately reflect the introduction of the Euro, the Firm's
clearance, settlement and reporting activities could be adversely affected in
the manner described above.
50
52
Management can give no assurance that the Firm or third parties on whom it
depends will have the systems necessary to process Euro-denominated
transactions. Moreover, disruption in activity in European markets because of
the conversion to the Euro could hurt the Firm's businesses in those markets,
resulting in lost revenues.
ACCOUNTING DEVELOPMENTS
In June 1996, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities", effective for transactions occurring after
December 31, 1996. SFAS No. 125 establishes standards for distinguishing
transfers of financial assets that are accounted for as sales from transfers
that are accounted for as secured borrowings.
The provisions of SFAS No. 125 relating to repurchase agreements,
securities-lending transactions and other similar transactions were deferred by
the provisions of SFAS No. 127, "Deferral of the Effective Date of Certain
Provisions of FASB Statement No. 125", and became effective for transactions
entered into after December 31, 1997. This Statement requires that the
collateral obtained in certain types of secured lending transactions be recorded
on the balance sheet with a corresponding liability reflecting the obligation to
return such collateral to its owner. Effective January 1, 1998, the Firm adopted
the provisions of SFAS No. 125 that were deferred by SFAS No. 127. The adoption
of this standard increased the Firm's total assets and liabilities by $17.33
billion as of May 1998.
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share"
("EPS"), effective for periods ending after December 15, 1997, with restatement
required for all prior periods. SFAS No. 128 establishes new standards for
computing and presenting EPS. This Statement replaces primary and fully diluted
EPS with "basic EPS" which excludes dilution and "diluted EPS" which includes
the effect of all potentially dilutive common shares and other dilutive
securities. Because the Firm has not historically reported EPS, this Statement
will have no impact on the Firm's historical financial statements. This
Statement will, however, apply to financial statements of the Firm prepared
after the Offerings. See "Pro Forma Consolidated Financial Information".
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income", effective for fiscal years beginning after December 15, 1997, with
reclassification of earlier periods required for comparative purposes. SFAS No.
130 establishes standards for the reporting and presentation of comprehensive
income and its components in the financial statements. The Firm intends to adopt
this standard beginning in fiscal year 1999. This Statement is limited to issues
of reporting and presentation and, therefore, will not affect the Firm's results
of operations or financial condition.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information", effective for fiscal years beginning
after December 15, 1997, with reclassification of earlier periods required for
comparative purposes. SFAS No. 131 establishes the criteria for determining an
operating segment and establishes the disclosure requirements for reporting
information about operating segments. The Firm intends to adopt this standard
beginning in fiscal year 1999. This Statement is limited to issues of reporting
and presentation and, therefore, will not affect the Firm's results of
operations or financial condition.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits", effective for fiscal years
beginning after December 15, 1997, with restatement of disclosures for earlier
periods required for comparative purposes. SFAS No. 132 revises certain
employers' disclosures about pension and other post-retirement benefit plans.
The Firm intends to adopt this standard beginning in fiscal year 1999. This
Statement is limited to issues of reporting and presentation and, therefore,
will not affect the Firm's results of operations or financial condition.
In March 1998, the Accounting Standards Executive Committee of the American
Institute
51
53
of Certified Public Accountants issued Statement of Position ("SOP") No. 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use", effective for fiscal years beginning after December 15, 1998. SOP
No. 98-1 requires that certain costs of computer software developed or obtained
for internal use be capitalized and amortized over the useful life of the
related software. The Firm currently expenses the cost of all software
development in the period in which it is incurred. The Firm intends to adopt
this Statement beginning in fiscal year 2000 and is currently assessing its
effect.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", effective for fiscal years beginning after
June 15, 1999. SFAS No. 133 establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives), and for hedging
activities. This Statement requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial condition and measure
those instruments at fair value. The accounting for changes in the fair value of
a derivative instrument depends on its intended use and the resulting
designation. The Firm intends to adopt this standard beginning in fiscal year
2000 and is currently assessing its effect.
52
54
INDUSTRY AND ECONOMIC OUTLOOK
As a global provider of financial services, the Firm is affected by overall
macroeconomic and market conditions in various regions around the world. Over
the past few years, we have operated in a generally favorable macroeconomic
environment characterized by low inflation, low interest rates and strong equity
markets. In particular, the U.S. economy, the largest in the world and an
important influence on overall world economic activity, has been undergoing one
of the longest periods of post-war economic expansion. As of June 1998, the
current U.S. expansion had lasted 87 months compared to a post-war average
period of expansion of 46 months.
Recognizing that the favorable macroeconomic environment will be subject to
periodic reversals, we believe that significant long-term growth and profit
opportunities exist for financial intermediaries in the United States and
abroad. These opportunities derive from several long-term trends that have had,
and we believe should continue to have, a profound impact on the world markets
and financial services activity. These trends include the following:
- - DEREGULATION. Financial market deregulation has resulted in the creation of
new and broader sources of credit, which have reduced the variability and the
cyclicality in the supply of credit. This, in turn, has in the past reduced
volatility in economic activity, leading to longer economic expansions with
increased investment spending, thereby resulting in higher levels of capital
raising;
- - GLOBALIZATION. Heightened global competition has created a need for
cross-border capabilities and economies of scale, resulting in increased joint
venture and mergers and acquisitions activity;
- - FOCUS ON SHAREHOLDER VALUE. Increasing focus on shareholder value has fueled
an increase in restructuring and strategic initiatives, thereby yielding
additional financial advisory and capital-raising opportunities;
- - CONSOLIDATION. Moderate growth, limited pricing flexibility and the need for
economies of scale have substantially increased consolidation opportunities in
certain industries, and record levels of profit have provided companies with
the resources to pursue strategic combinations, thereby creating substantial
demand for mergers and acquisitions advisory services and subsequent capital
raising;
- - DEMOGRAPHICS. Changing demographics in the United States and other developed
economies have increased the pool of savings available for private investment
and the need for increased funding of pension plans due to the aging of the
population, creating substantial demand for investment products and services;
and
- - FINANCIAL PRODUCT INNOVATION. Technology and financial expertise have led to
the development of new financial products better tailored to the risk/reward
requirements of investors, thereby increasing trading flows and proprietary
investment opportunities.
As the table below demonstrates, over the last 15 years these trends have
contributed to a substantially higher rate of growth in activity in the
financial services industry than the overall growth in economic activity. We
believe that these long-term trends should continue to affect growth in the
financial services industry positively. See "Risk Factors -- Market Risk Could
Adversely Affect Our Businesses in Many Ways".
53
55
KEY INDUSTRY INDICATORS
($ in billions, except GDP)
(volume in millions of shares)
AS OF OR FOR YEAR ENDED DECEMBER 31,
-------------------------------------- CAGR
1982 1987 1992 1997 '82-'97
---- ---- ---- ---- -------
GENERAL ECONOMIC ACTIVITY:
($ in trillions)
Worldwide GDP(1).......................... $ 11 $ 16 $ 23 $ 29 7%
U.S. GDP(2)............................... 3 5 6 8 7
ADVISORY ACTIVITIES/FINANCING:
Worldwide mergers and acquisitions........ 56 327 353 1,579 25
Worldwide equity issued................... 22 89 131 285 19
Worldwide debt issued..................... 73 492 1,165 2,086 25
WORLD EQUITY MARKETS:
Worldwide equity market
capitalization(3)....................... 2,737 7,896 10,922 23,541 15
U.S. market capitalization(3)............. 1,520 2,589 4,485 11,309 14
FT/S&P Actuaries World Indices(TM) -- The
World Index(4).......................... NA 101 148 299 11
Dow Jones Industrial Average.............. 1,047 1,939 3,301 7,908 14
S&P 500................................... 141 247 436 970 14
NYSE average daily volume................. 65 189 202 527 15
INVESTED FUNDS:
Worldwide pension assets(5)............... $1,175 $3,407 $ 5,956 $ 9,694 15
Number of U.S. mutual funds(6)............ 857 2,317 3,850 6,778 15
U.S. mutual fund assets(6)................ $ 297 $ 770 $ 1,646 $ 4,490 20
- ---------------
(1) Gross domestic product. Source: The Economist Intelligence Unit, 1998.
(2) Source: U.S. Department of Commerce, Bureau of Economic Analysis.
(3) Source: Emerging Stock Markets Factbook, International Finance Corporation.
(4) Index is calculated on a local currency basis based on total returns. CAGR
is based on 1987-1997 data. The FT/S&P Actuaries World Indices are owned by
FTSE International Limited, GS & Co. and Standard & Poor's. The Indices are
compiled by FTSE International and Standard & Poor's in conjunction with the
Faculty of Actuaries and the Institute of Actuaries.
(5) Source: InterSec Research Corp.
(6) Source: Mutual Fund Factbook, Investment Company Institute.
------------------
We believe scale, global resources and leading market positions are
important competitive advantages for financial intermediaries in this
environment. As a result, we believe the Firm is well positioned to capitalize
on the worldwide opportunities created by these long-term trends.
In addition, we believe that circumstances unique to certain regions should
provide additional opportunities for the Firm.
- - EUROPE. The advent of the EMU is expected to change the economic face of
Europe and yield substantial opportunities for each of our core businesses.
The EMU is scheduled to commence on January 1, 1999 and will create a monetary
union in Europe with a single currency. As a result, we believe that over time
a pan-European capital market will develop that will rival that of the United
States in size and liquidity. Financial intermediaries are expected to benefit
from a number of anticipated developments including: (i) pan-European
consolidation and financial restructuring yielding an increase in mergers and
acquisitions activity; (ii) an increase in third-party assets under management
and a major shift towards investments in equity securities due to an expected
move to private pension fund systems, changing demographics and the
elimination of intra-
54
56
EMU currency risk; (iii) a reallocation of equity portfolios to reflect
pan-European indices; (iv) the establishment of a European high-yield market
to fund the growth of emerging high-growth industries and to satisfy
investors' demands for higher yield; and (v) increased equity issuance and
higher equity trading volumes. See "Business -- Competition";
- - ASIA. For most of 1997 and 1998, the currency weakness and disruptions, the
deterioration in certain of the region's banking systems, the weakness in the
property sector in many of these countries, as well as slowing consumer
income growth led to a significant and continuing weakening of these
economies and their stock markets. We believe that financial intermediaries
will have significant opportunities in this region as stability is expected
to improve and the economies, representing approximately 60% of the world's
population, resume their expected growth. In the near-term, these
opportunities are expected to include: (i) an increase in mergers and
acquisitions and other financial advisory services in connection with
corporate restructurings; (ii) an increase in trading opportunities as we
meet the liquidity needs of our clients; and (iii) an increase in capital
raising as Asian corporations and governments access the international
capital markets rather than the regional banking system to refinance and to
fund future growth. In the longer term, these opportunities are expected to
include: (i) the emergence of corporate and real estate principal investment
opportunities as a result of corporate and government restructurings, and
(ii) an increase in third-party assets under management and a major shift
towards investments in equity securities due to an anticipated move to
private pension fund systems, changing demographics and the relaxation of
foreign exchange restrictions; and
- - LATIN AMERICA AND EASTERN EUROPE. Weakness in the Asian economies and stock
markets has negatively affected other emerging markets including Latin
America and Eastern Europe. These two regions have experienced a weaker
market environment due to the decline in commodity prices, to which these
economies are particularly sensitive, and investor concerns about emerging
markets in general. Ultimately, we expect opportunities similar to those
anticipated for Asia to develop for financial intermediaries in Latin America
and Eastern Europe.
55
57
BUSINESS
OVERVIEW
Our mission is to be the preeminent global investment banking and
securities firm -- the advisor of choice for our clients and a leading
participant in global financial flows. We are a market leader in each of our
three principal business lines: (i) Investment Banking, (ii) Trading and
Principal Investments and (iii) Asset Management and Securities Services. We
provide services worldwide to a substantial and diversified client base, which
includes corporations, financial institutions, governments and high net worth
individuals. Our net revenues and pre-tax earnings for 1997 were $7.4 billion
and $3.0 billion, respectively, and for the six months ended May 1998 were $5.5
billion and $2.1 billion, respectively. As of May 1998, our total assets were
$241.9 billion and our partners' capital was $6.6 billion.
We have produced strong earnings growth and attractive returns on partners'
capital through various economic cycles and market conditions. Over the last 15
years, our pre-tax earnings have grown from $364 million in 1982 to $3.0 billion
in 1997, representing a CAGR of 15%. We have achieved this growth, which has
been almost exclusively organically generated, by maintaining an intense
commitment to our clients, focusing on our core businesses and key opportunities
and operating as a highly integrated, global franchise.
Because we believe that the needs of our clients are global and that
international markets have high growth potential, we have aggressively leveraged
our U.S. market leadership into leading positions in other parts of the world.
Today, the Firm has a strong global presence as evidenced by the geographic
breadth of our transactions, leadership in our core products and the scale of
our international operations. As of May 1998, we operated offices in 22
countries and had over 4,100 employees (representing 36% of total employees)
based outside the United States.
We are committed to a distinctive culture and set of core values. Our core
values are reflected in our Business Principles, which emphasize (i) placing our
clients' interests first, (ii) integrity, (iii) commitment to excellence and
innovation and (iv) teamwork.
The Firm is managed by its principal owners. Simultaneously with the
Offerings, we will make equity-based awards that will total over $ in
aggregate value, to substantially all of our employees. Following the Offerings,
our employees will own approximately % of the Company on a fully diluted
basis. None of our employees are selling shares in the Offerings.
PRINCIPAL BUSINESS LINES
Our business lines are comprised of various product and service offerings
that are set forth in the following chart:
PRIMARY PRODUCTS AND ACTIVITIES BY BUSINESS LINE
TRADING AND PRINCIPAL ASSET MANAGEMENT AND
INVESTMENT BANKING INVESTMENTS SECURITIES SERVICES
------------------ --------------------- --------------------
- -- Equity and debt -- Bank loans -- Commissions
underwriting -- Commodities -- Institutional and
- -- Financial restructuring -- Currencies high net worth asset
advisory services -- Equity and fixed income management
- -- Mergers and acquisitions derivatives -- Margin lending
advisory services -- Equity and fixed income -- Matched book
- -- Real estate advisory securities -- Merchant banking fees
services -- Principal investments and overrides
-- Proprietary arbitrage -- Mutual funds
-- Prime brokerage
-- Securities lending
56
58
INVESTMENT BANKING
Investment Banking represented 35% of 1997 net revenues. We are a market
leader in both our financial advisory and underwriting businesses, serving over
3,000 clients worldwide. For the period January 1, 1993 to June 30, 1998, in
worldwide mergers and acquisitions advisory services, we had the
industry-leading market share of 23.8%, having advised on over $1.4 trillion of
transactions. Over the same period, we also achieved the number one market share
in underwriting worldwide initial public offerings and all common stock issues
with market shares of 15.2% and 14.1%, respectively.
TRADING AND PRINCIPAL INVESTMENTS
Trading and Principal Investments represented 39% of 1997 net revenues. We
make markets in equity and fixed income products, currencies and commodities;
enter into swaps and other derivative transactions; engage in proprietary
trading and arbitrage; and make principal investments. In trading, we focus on
building lasting relationships with our most active clients while maintaining
leadership positions in our key markets. We believe our value-added research,
market-making roles and proprietary activities enhance our understanding of
markets and ability to serve our clients. Principal investments includes the net
revenues from the Firm's investments in its merchant banking funds.
ASSET MANAGEMENT AND SECURITIES SERVICES
Asset Management and Securities Services represented 26% of 1997 net
revenues. We provide global investment management and advisory services; earn
commissions on agency transactions; earn management fees and derive overrides
from our merchant banking funds; and provide prime brokerage, securities lending
and financing services. As of May 1998, the Firm had approximately $305 billion
of assets under supervision, of which $165 billion represented assets under
management. Our asset management business is rapidly growing with current net
asset inflows averaging over $115 million per business day. We manage one of the
largest private equity pools for corporate and real estate investments, having
raised over $13.2 billion of committed equity capital as of June 1998.
The following table sets forth net revenues for each of our three principal
business lines and for the Firm as a whole:
SUMMARY FINANCIAL DATA
($ in millions)
SIX MONTHS
YEAR ENDED NOVEMBER ENDED MAY
-------------------------- CAGR ---------------- INCREASE
1995 1996 1997 '95-'97 1997 1998 '97-'98
---- ---- ---- ------- ---- ---- --------
Net revenues:
Investment Banking.... $1,595 $2,113 $2,587 27% $1,094 $1,587 45%
Trading and Principal
Investments........ 1,744 2,693 2,926 30 1,660 2,578 55
Asset Management and
Securities
Services........... 1,144 1,323 1,934 30 877 1,296 48
------ ------ ------ ------ ------
Total net revenues...... $4,483 $6,129 $7,447 29 $3,631 $5,461 50
====== ====== ====== ====== ======
------------------------
COMPETITIVE STRENGTHS
STRONG CLIENT RELATIONSHIPS
We endeavor to treat each client relationship as a valued asset that we
develop over time. In 1997, over 75% of our Investment Banking revenues
represented business from existing clients of the Firm. We also aggressively
pursue new client relationships as evidenced by the over 400 investment banking
57
59
transactions we completed for first-time clients in 1997. In our trading
businesses, we focus on building lasting relationships with our clients, for
whom we structure and execute transactions across a wide array of markets and
countries. In our asset management business, we manage assets for three of the
five largest pension pools in the United States as ranked by Pension and
Investments, have 14 clients for which we manage at least $1 billion each and
maintain accounts for over 40% of the Forbes "Four Hundred".
DISTINCTIVE PEOPLE AND CULTURE
Our most important asset is our people. We seek to reinforce our employees'
commitment to our culture and values through recruiting, training, a
comprehensive 360-degree review system and a compensation philosophy that
rewards teamwork. We were ranked number 12 in Fortune magazine's 1998 "The 100
Best Companies to Work for in America" and were ranked number two in Fortune
magazine's 1998 "The Top 50 MBA Dream Companies", the highest-ranked investment
banking and securities firm in each case.
GLOBAL REACH
Over the past decade, we have made a significant commitment to building a
worldwide franchise. We have achieved leading positions in major international
markets by capitalizing on our product knowledge and global research, as well as
by building local presence where appropriate. In doing so, we have become one of
the few truly global investment banking and securities firms with the ability to
execute large and complex cross-border financial advisory and underwriting
assignments. We had the number one market share of 22.1% in cross-border mergers
and acquisitions for the period January 1, 1993 to June 30, 1998. More recently,
in the first six calendar months of 1998, we had the leading market share in the
newly developing European non-dollar high-yield debt underwriting markets,
according to MCM CorporateWatch Data Services. Furthermore, as of July 31, 1998,
we were the largest non-Japanese mutual fund manager in Japan, according to the
Investment Trust Association.
ABILITY TO MANAGE AND BENEFIT FROM RISK
We assume diversified risks in our business and devote substantial
resources to identify, analyze and benefit from these exposures. We believe our
willingness and ability to take risk distinguishes us and substantially enhances
our client relationships. By combining our strong fundamental research, access
to information, analytic capabilities, experience, judgment and risk
diversification skills, we have generated attractive returns through various
economic cycles and market conditions.
STRATEGY
LEVERAGE THE FRANCHISE
We believe our various businesses are generally stronger and more
successful because they are part of the Goldman Sachs franchise. Our culture of
teamwork fosters cooperation among our businesses, which allows us to leverage
our broad-based capabilities to provide our clients with an integrated,
full-service product. We also create multiple points of contact with our clients
to further enhance our relationships. For example, our merchant banking area
sources investment opportunities from our global network of client
relationships. Moreover, major selling shareholders of our investment banking
clients often become substantial asset management clients.
EXPAND LEADERSHIP POSITION IN HIGH
GROWTH, HIGH VALUE-ADDED BUSINESSES
We focus our human and capital resources to better serve our clients
through high value-added activities. Our growth strategy is based on leveraging
our leadership positions to pursue growth opportunities in both existing and new
markets where we believe we can earn high returns. For example, we have
substantially increased our headcount in Investment Banking in order to better
execute mergers and acquisitions, initial public offerings and high-yield
financings. Similarly, in trading, we have strategically deployed professionals
and capital to the
58
60
areas of greatest opportunity and importance to our clients. In asset
management, we have demonstrated our ability to build a leading business rapidly
and have grown assets under supervision from $87 billion as of November 1993 to
$305 billion as of May 1998, representing a CAGR of 32%.
PURSUE INTERNATIONAL OPPORTUNITIES
We believe that our global reach will allow us to take advantage of growth
in international markets. In Europe, the establishment of the EMU in 1999 will
create, over time, a large pan-European market rivaling the U.S. capital markets
in size and liquidity. This is expected to generate increased activity across
our principal business lines. In Asia, we expect increased trading opportunities
as we meet the liquidity needs of our clients and increased mergers and
acquisitions advisory opportunities as a result of corporate restructurings. In
the longer-term, we anticipate additional opportunities in these markets for
merchant banking, as well as increases in asset management activities due to an
expected shift towards privatization of pension systems and changing
demographics.
INVESTMENT BANKING
The Firm provides a broad range of investment banking services to a diverse
group of over 3,000 clients worldwide, including corporations, financial
institutions, governments and individuals. Our investment banking activities are
divided into two categories:
- - FINANCIAL ADVISORY. Financial advisory includes advisory assignments with
respect to mergers and acquisitions, divestitures, corporate defense
activities, restructurings and spin-offs; and
- - UNDERWRITING. Underwriting includes public offerings and private placements
of equity and debt securities.
The following table sets forth the net revenues generated by Investment
Banking:
INVESTMENT BANKING NET REVENUES
($ in millions)
SIX MONTHS
YEAR ENDED NOVEMBER ENDED MAY
------------------------ CAGR --------------- INCREASE
1995 1996 1997 '95-'97 1997 1998 '97-'98
---- ---- ---- ------- ---- ---- --------
Financial advisory.......... $ 793 $ 931 $1,184 22% $ 516 $ 799 55%
Underwriting................ 802 1,182 1,403 32 578 788 36
------ ------ ------ ------ ------
Total Investment Banking.... $1,595 $2,113 $2,587 27 $1,094 $1,587 45
====== ====== ====== ====== ======
------------------------
As a recognized leader in investment banking, we provide our clients with
quality advice and execution as part of our effort to develop and maintain
long-term relationships as our clients' lead investment bank. With over 75% of
Investment Banking revenues in 1997 generated from our existing clients, we are
committed to developing and maintaining long-term client relationships. We also
aggressively pursue new client relationships as evidenced by over 400 investment
banking transactions we completed for first-time clients in 1997.
ORGANIZATION
We have continuously adapted our organizational structure to meet changing
market dynamics and our clients' needs. Our current structure, which is
organized along regional, execution and industry groups, seeks to combine
client-focused investment bankers with execution and industry expertise. Through
our commitment to teamwork, we believe that we provide these services in an
integrated fashion for the benefit of our clients.
We believe an important competitive advantage in our marketing effort is
Investment Banking Services ("IBS"), a core group of professionals who focus on
developing and maintaining strong client relationships. These bankers, who are
organized regionally and/or by industry group, work with senior executives of
our clients to identify areas where
59
61
Goldman Sachs can provide capital-raising, financial advisory or other products
and services. The broad base of experience and knowledge of our IBS
professionals enables them to analyze our clients' objectives efficiently and to
bring to bear the appropriate resources of the Firm to satisfy those objectives.
Execution groups, such as Corporate Finance, Debt and Equity Capital
Markets, Leveraged Finance and Mergers and Acquisitions, bring sophisticated
product expertise and innovation to clients in a variety of industries. These
groups are also instrumental in the coverage of clients through their strong
relationships which are usually built over the course of specific client
transactions. We also try to maintain consistency in our client teams over
multiple transactions in order to enhance our relationships.
In a further effort to focus our investment banking effort around our
clients' needs and penetrate targeted industries, we have established several
industry focus groups. These include: Communications, Media and Entertainment;
Energy and Power; Financial Institutions; Healthcare; High Technology; Real
Estate; Retailing; and Transportation. Drawing on specialized knowledge of
industry-specific trends and leveraging the relevant investment research team,
these groups provide the full range of investment banking products and services
to our clients. An indicator of the success of these focus group initiatives is
our significant transaction volume. In the first six months of calendar 1998,
the Communications, Media and Entertainment group participated in 27 mergers and
acquisitions transactions, totaling $194 billion, and the Financial Institutions
group participated in 45 mergers and acquisitions transactions, totaling $238
billion. As a result, each of these groups achieved a number one market share
for this period.
Reflecting our commitment to innovation, Investment Banking has established
a New Products group whose professionals focus on creating new financial
products. These professionals have particular expertise in integrating finance
with accounting, tax and securities laws and work closely with other investment
banking teams to provide innovative solutions to difficult client problems. Our
structuring expertise has proven to be particularly valuable in addressing
client needs in areas such as complex cross-border mergers and acquisitions and
convertible and other hybrid equity financings.
FINANCIAL ADVISORY
Financial advisory includes a broad range of advisory assignments with
respect to mergers and acquisitions, divestitures, corporate defense activities,
restructurings and spin-offs. Goldman Sachs is a preeminent investment bank in
worldwide mergers and acquisitions. During calendar 1997, we advised on 343
mergers and acquisitions transactions with a combined value of $338 billion and,
during the first six months of calendar 1998, Goldman Sachs advised on 177
mergers and acquisitions transactions with a combined value of $594 billion.
The Firm's mergers and acquisitions capabilities are evidenced by our
significant share of assignments in large, complex transactions where we bring
multiple resources to bear on a variety of areas, including "one-stop"
acquisition financing, currency hedging and cross-border structuring expertise.
Of the 12 announced mergers and acquisitions transactions in the United States
with a value in excess of $20 billion as of June 30, 1998, Goldman Sachs has
been an advisor in eight. Internationally, we have achieved substantial success,
even in intra-country transactions, and we are a leading mergers and
acquisitions advisor in France and Germany.
The following table illustrates the Firm's leadership in the mergers and
acquisitions advisory market:
60
62
GOLDMAN SACHS' MERGERS AND ACQUISITIONS MARKET DATA
For the period January 1, 1993 through June 30, 1998
($ in billions)
MARKET NUMBER OF
CATEGORY RANK SHARE VOLUME TRANSACTIONS
-------- ---- ------ ------ ------------
Worldwide.................................... 1 23.8% $1,405 1,334
Worldwide, transactions over $500 million.... 1 33.1 1,287 420
Worldwide, transactions over $1 billion...... 1 36.5 1,172 259
United States................................ 1 30.7 1,098 932
United States, transactions over $500
million.................................... 1 39.2 1,009 304
United States, transactions over $1
billion.................................... 1 41.9 929 194
------------------------
Mergers and acquisitions is an excellent example of how one activity can
generate cross-selling opportunities for other activities and thereby increase
the Firm's revenue potential from a particular transaction. For example, a
client we are advising in a purchase transaction often will seek our assistance
in obtaining financing and in hedging interest rate or foreign currency risks
associated with the acquisition. In the case of dispositions, owners and senior
executives of the acquired company often will seek asset management services. In
these cases, our high net worth relationship managers are well prepared to
provide comprehensive advice on a range of investment alternatives and to
execute the client's desired strategy.
UNDERWRITING
Since January 1, 1993, Goldman Sachs has served as lead manager in
transactions that have raised approximately $1 trillion of capital for clients
worldwide. The Firm underwrites a wide range of securities and other
instruments, including common and preferred stock, convertible securities,
investment grade debt, high-yield debt, sovereign and emerging markets debt,
municipal debt, bank loans, asset-backed securities and real estate-related
securities, such as mortgage-backed securities and the securities of real estate
investment trusts.
EQUITY UNDERWRITING. Equity underwriting has been a long-term core
strength of the Firm. The Firm has ranked number one in worldwide initial public
offerings ("IPOs") based on total proceeds raised in every calendar year since
January 1, 1994.
The following table illustrates the Firm's leadership position in equity
underwriting:
GOLDMAN SACHS' EQUITY UNDERWRITING MARKET DATA
For the period January 1, 1993 through June 30, 1998
($ in billions)
TOTAL
MARKET PROCEEDS NUMBER OF
CATEGORY RANK SHARE RAISED ISSUES(1)
-------- ---- ------ -------- ---------
Worldwide IPOs............................... 1 15.2% $ 47 320
Worldwide IPOs, proceeds over $500 million... 1 27.0 26 61
Worldwide common stock offerings............. 1 14.1 103 698
U.S. IPOs.................................... 1 15.1 36 199
U.S. IPOs, proceeds over $500 million........ 1 38.2 15 19
U.S. common stock offerings.................. 2 14.0 78 432
- ---------------
(1) The number of issues reflects the number of tranches; an offering by a
single issuer could have multiple tranches.
61
63
As with mergers and acquisitions, the Firm has been particularly successful
in winning mandates for the largest, most complex equity underwritings. As
evidenced in the chart above, our market share of IPOs with total proceeds over
$500 million is substantially higher than our market share of all IPOs. We
believe our leadership in large IPOs reflects our expertise in complex
transactions, research strengths, track record and distribution capabilities. In
the international arena, we have also acted as lead manager on many of the
largest IPOs. We were named both the U.S. Equity House of the Year and the Asian
Equity House of the Year by International Financing Review ("IFR") in 1997.
We believe that a key factor in our equity underwriting success is the
close working relationship between the investment bankers, research analysts and
sales force as coordinated by our Equity Capital Markets group. Goldman Sachs'
equities sales force is one of the most experienced and effective sales
organizations in the industry. With over 700 institutional sales professionals
and high net worth relationship managers located in every major market around
the world, Goldman Sachs has relationships with a large and diverse group of
investors.
Our Global Investment Research professionals are critical to our ability to
succeed in the equity underwriting business. We believe that the quality of
equity research is an important factor that issuers consider when selecting an
investment bank to lead manage an offering. In this regard, Goldman Sachs'
research has been consistently ranked among the industry's global leaders. See
"-- Global Investment Research".
DEBT UNDERWRITING. We engage in the underwriting and origination of
various types of debt instruments that we broadly categorize as follows: (i)
investment grade debt for corporations, governments, municipalities and
agencies; (ii) high-yield debt and bank loans for non-investment grade issuers;
(iii) emerging market debt, which includes corporate and sovereign issues; and
(iv) asset-backed securities.
We have employed a focused approach in debt underwriting, emphasizing high
value-added areas in servicing our clients. Consistent with this approach, we
have targeted specific sectors such as debt issuance for industrial companies.
The table below sets forth our market position, our total proceeds raised
and the number of debt transactions in which we have acted as underwriter in the
following areas:
GOLDMAN SACHS' DEBT UNDERWRITING MARKET DATA
For the period January 1, 1993 through June 30, 1998
($ in billions)
TOTAL
MARKET PROCEEDS NUMBER OF
CATEGORY(1) RANK SHARE RAISED ISSUES(5)
----------- ---- ------ -------- ---------
Worldwide debt(2)............................ 3 8.6% $739 5,167
Worldwide straight debt(3)................... 2 8.9 578 4,547
U.S. investment grade straight debt(3)....... 2 12.7 428 3,865
U.S. investment grade industrial straight
debt(3).................................... 1 19.6 84 553
U.S. high-yield debt(4)...................... 5 7.9 33 191
- ---------------
(1) All categories include publicly registered and Rule 144A issues.
(2) Includes non-convertible preferred stock, mortgage-backed securities,
asset-backed securities and municipal debt.
(3) "Straight debt" excludes non-convertible preferred stock, mortgage-backed
securities and asset-backed securities.
(4) Excludes issues with both investment grade and non-investment grade ratings
("split-rated issues").
(5) The number of issues reflects the number of tranches; an offering by a
single issuer could have multiple tranches.
62
64
We believe that the leveraged finance market is a key growth opportunity
for our debt underwriting business. Over the last three years, we have more than
doubled the number of professionals devoted to this area and have increased
expertise throughout our Firm.
Total U.S. high-yield issuance has increased from $61 billion in 1993 to
$119 billion in 1997, representing a CAGR of 18%. U.S. leveraged loan volume has
increased from $28 billion in 1993 to $194 billion in 1997, representing a CAGR
of 62%, according to Loan Pricing Corporation. In Europe, where the high-yield
market is newly developing, issuance of non-dollar high-yield securities
increased from $1.1 billion in 1997 to $3.3 billion in the first six calendar
months of 1998, according to MCM CorporateWatch Data Services.
To date, we have increased our high-yield business from $4.3 billion of
lead-managed issuances in calendar 1993 to $6.4 billion in 1997 and $7.4 billion
in the first six months of 1998. In the European non-dollar high-yield market,
we had the number one market share in the first six calendar months of 1998,
according to MCM CorporateWatch Data Services. Finally, in the leveraged loan
market, we have increased our ranking from 34 in 1995 to nine in 1997 and were
the only non-commercial bank ranked in the top 10 originators of leveraged loans
in terms of total volume, according to Loan Pricing Corporation.
TRADING AND PRINCIPAL INVESTMENTS
The Firm's Trading and Principal Investments business facilitates customer
transactions and takes proprietary positions through market making in and
trading of fixed income and equity products, currencies, commodities, swaps and
other derivatives. In order to meet the needs of its clients, the Firm's Trading
and Principal Investments business is diversified across a wide range of
products. For example, we make markets in traditional investment grade debt
securities, structure complex derivatives and securitize mortgages and insurance
risk. A fundamental tenet of our approach is that we believe our willingness and
ability to take risk distinguishes us and substantially enhances our client
relationships. Our Trading and Principal Investments business includes the
following:
- - FIXED INCOME, CURRENCY AND COMMODITIES. The Firm makes markets in and trades
fixed income products, currencies and commodities, structures and enters into
a wide variety of derivative transactions and engages in proprietary trading
and arbitrage activities;
- - EQUITIES. The Firm makes markets in and trades equities and equity-related
products, structures and enters into equity derivative transactions and
engages in proprietary trading and equity arbitrage; and
- - PRINCIPAL INVESTMENTS. Principal investments represents the Firm's net
revenues from its investments in its merchant banking funds.
The following table sets forth the net revenues of the Firm's Trading and
Principal Investments business:
TRADING AND PRINCIPAL INVESTMENTS NET REVENUES
($ in millions)
SIX MONTHS
YEAR ENDED NOVEMBER ENDED MAY
------------------------ CAGR --------------- INCREASE
1995 1996 1997 '95-'97 1997 1998 '97-'98
---- ---- ---- ------- ---- ---- --------
FICC........................... $ 822 $1,749 $2,055 58% $1,194 $1,675 40%
Equities....................... 731 730 573 (11) 423 659 56
Principal investments.......... 191 214 298 25 43 244 467
------ ------ ------ ------ ------
Total Trading and Principal
Investments.................. $1,744 $2,693 $2,926 30 $1,660 $2,578 55
====== ====== ====== ====== ======
63
65
FIXED INCOME, CURRENCY AND COMMODITIES
FICC is an integral part of the Firm's growth and profitability. It is a
large and diversified operation through which we engage in a variety of
customer-driven market making and proprietary trading and arbitrage activities.
The principal products of FICC are the following:
- - Bank loans
- - Commodities
- - Currencies
- - Derivatives
- - Emerging market debt
- - Global government securities
- - High-yield securities
- - Investment grade corporate securities
- - Money market instruments
- - Mortgage securities and loans
- - Municipal securities
We generate trading net revenues from our customer-driven business and our
proprietary activities in three ways. First, in large, highly liquid markets we
undertake a high volume of transactions for modest spreads. Second, by
capitalizing on our strong market relationships and capital position, we also
undertake transactions in less liquid markets where spreads are generally
larger. Finally, we generate net revenues from structuring and executing
transactions that address complex client needs.
FICC has established itself as a leading market participant by using a
three-part approach to deliver high quality service to its
clients. First, we offer broad market making, research and market knowledge to
our clients on a global basis. Second, we create innovative solutions to complex
client problems by drawing upon our structuring and trading expertise. Third, we
use our expertise to take positions in markets when we believe the return is at
least commensurate with the risk.
A core activity in FICC is market making in a broad array of securities and
products. For example, we are a primary dealer in the largest government bond
markets around the world including the United States, Japan, the United Kingdom,
Germany, Canada, Italy and France; the Firm is a member of the major futures
exchanges; and we have interbank dealer status in the currency markets in New
York and London. The Firm's willingness to make markets in a broad range of
fixed income, currency, and commodity products and their derivatives is crucial
both to the Firm's client relationships and to support our underwriting business
by providing secondary market liquidity. Our clients value counterparties that
are active in the marketplace and are willing to provide liquidity and
research-based points of view. In addition, we believe that our significant
investment in research capabilities and proprietary analytical models are
critical to our ability to provide advice to our clients. Our research
capabilities include quantitative and qualitative analyses of global economic,
currency and financial market trends, as well as credit analyses of corporate
and sovereign fixed income securities.
64
66
Our clients often confront complex problems that require creative
approaches. We assist our clients who seek to hedge, reallocate their risks and
profit from expected price movements. To do this we bring to bear the ability of
our experienced professionals to understand the needs of our clients and our
ability to manage the risks associated with complex solutions to problems. In
recognition of our ability to meet these client needs, we were named by IFR as
the 1997 Derivatives House of the Year.
In our proprietary activities, we assume a variety of risks and devote
substantial resources to identify, analyze and benefit from these exposures. We
leverage our strong research capabilities and capitalize on our proprietary
analytical models to quickly analyze information and make informed trading
judgments. We seek to benefit from perceived disparities in the value of assets
in the trading markets and rely on our research and judgment to benefit from
certain macroeconomic and company-specific trends.
EQUITIES
The Firm makes markets in and trades equity securities and equity-related
products (such as convertible securities and equity derivative instruments) for
a wide range of clients on a global basis and undertakes proprietary activities.
Goldman Sachs makes markets and positions blocks of stock to facilitate
customers' transactions and to provide liquidity in the marketplace. The Firm is
a member of most of the major stock exchanges, including the New York, London,
Frankfurt, Tokyo and Hong Kong stock exchanges. In the Nasdaq National Market,
we were the leading market maker by aggregate volume of the top 100 most
actively traded stocks in calendar 1997.
The Firm trades and makes markets in equity securities of U.S., European,
U.K., Japanese, Canadian, Latin American, Southeast Asian and other issuers. As
agent, the Firm executes brokerage transactions in equity securities for
institutional and individual customers that generate commission revenues.
Commissions earned on agency transactions are recorded in Asset Management and
Securities Services.
In equity trading, as in FICC, the Firm generates net revenues in three
ways. First, in large, highly liquid markets, such as the OTC market for equity
securities, we undertake a high volume of transactions for modest spreads.
Second, by capitalizing on our strong market relationships and capital position,
we also undertake large transactions, such as block trades and positions in
securities, in which we benefit from spreads that are generally larger. Finally,
the Firm also benefits from structuring complex transactions.
Goldman Sachs was a pioneer and is a leader in the execution of large block
trades (trades of 50,000 or more shares) in the United States and abroad. In the
first half of 1998, we executed over 35 block trades of at least $100 million
each. The Firm has been able to capitalize on its expertise in block trading,
its global distribution network and its willingness to commit capital to effect
increasingly complex customer transactions. As corporate consolidation and
restructuring around the world continues, the Firm expects that the sales of
large blocks of stock will become more common (due to, among other factors,
monetizations of large holdings resulting from stock-for-stock combinations) and
that it will be able to benefit from this trend.
The Firm is active in the listed options and futures markets and
structures, distributes and executes OTC derivatives on market indices, industry
groups and individual company stocks to facilitate customer transactions and its
proprietary activities. The Firm develops quantitative strategies and renders
advice with respect to portfolio hedging and restructuring and asset allocation
transactions. The Firm also creates specially tailored instruments to enable
sophisticated investors to undertake hedging strategies and establish or
liquidate investment positions. The Firm is one of the leading participants in
the trading and development of equity derivative instruments. The Firm is an
active participant in the trading of futures and options on most of the major
exchanges in Europe, Asia and the United States.
65
67
Equity arbitrage has long been an important part of our equity franchise.
Our strategy is based on making investments on a global basis through a
diversified portfolio across different markets and event categories. This
business focuses on: (i) event-oriented special situations where the Firm is not
acting as an advisor, such as mergers and acquisitions, corporate
restructurings, recapitalizations, legal and regulatory events, as well as other
special situations and (ii) relative value trades. Equity arbitrage leverages
the Firm's global infrastructure and network of research analysts to analyze
carefully a broad range of trading and investment strategies across a wide
variety of markets. Investment decisions are the product of rigorous
fundamental, situational and, frequently, regulatory and legal analysis.
TRADING RISK MANAGEMENT
1994
In 1993, the Firm enjoyed then record net revenues, due, in large part, to
substantial and concentrated FICC positions that benefitted from declining
interest rates and the decline in relative value of certain European currencies.
In 1994, the Federal Reserve Board raised short-term interest rates six times in
ten months, contributing to a substantial decline in global bond prices and a
readjustment of relative currency values. These changes led to a corresponding
decline in the value of the Firm's positions. As a result, in 1994 the Firm
suffered a significant decline in net revenues.
ENHANCED RISK MANAGEMENT
In response to these adverse developments, the Firm significantly reduced
the size and concentration of positions, strengthened risk management policies
and accelerated the development of new, more sophisticated risk management
programs. For example, the Firm reconstituted and broadened representation in
its Firmwide Risk Committee and created several other committees to help monitor
and evaluate risk. These Committees substantially changed the Firm's approach to
risk management by making the risk management process more transparent to a
broader group through the implementation of more stringent policies and
procedures that now include the following:
- - REPORTING OF RISK VIOLATIONS. Any violation of a market risk limit is
required to be reported to the appropriate Risk Committee and the appropriate
business unit managers;
- - ACTIVE RISK MANAGEMENT. The FICC and Equities Risk Committees typically meet
twice every week and review all significant exposures across a variety of
dimensions, including risk concentrations by market, geography, credit and
product;
- - RISK ANALYSIS. The Firm's proprietary risk management software breaks down
the Firm's risks into their components. This "dissection" of the Firm's risks
permits the Firm more accurately to assess and hedge its risks; and
- - REGULAR DESK REPORTS. Each desk head is required to deliver regular risk
reports to the members of the appropriate Risk Committee.
In addition, the Firm substantially enhanced its risk management
infrastructure and technology and substantially increased the number of
professionals dedicated to this area.
Today the Firm measures VaR more comprehensively and maintains lower VaR
levels than in 1994. This reduction in VaR levels has occurred despite an
increase in the Firm's total assets from $116 billion at November 1993 to $242
billion at May 1998.
The Firm's enhanced risk management policies and procedures have allowed us
to increase FICC's net revenues while significantly reducing market risk as
measured by VaR. FICC's daily VaR, based on a 95% confidence level, peaked at
$94 million in January 1994 as measured over the six FICC businesses for which
VaR was then calculated.
As shown in the chart below, as of May 1998, the VaR for the same six
businesses had been reduced to $14 million and the VaR for substantially all of
the Firm's trading positions was $47 million.
66
68
COMPARATIVE VAR
(in millions)
Six FICC Businesses Measured in 1994
January 1994 $94
May 1998 $14
Total FICC
May 1998 $37
Firmwide
May 1998 $47
- ---------------
Note: For a description of VaR methodology, assumptions and limitations, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Risk Management".
------------------------
Notwithstanding these reductions in VaR, the Firm continues to hold trading
positions that are substantial in both number and size, and is subject to
significant market risk. See "Risk Factors -- Market Risk Could Adversely Affect
Our Businesses in Many Ways" and "-- Our Risk Management Policies and Procedures
May Leave Us Exposed to Unidentified or Unanticipated Risk".
PRINCIPAL INVESTMENTS
In connection with its merchant banking activities, the Firm invests with
its clients by making principal investments in funds that it raises and manages.
As of June 30, 1998, the Firm has provided $2.4 billion of the $13.2 billion
total equity capital committed for its merchant banking funds, of which
approximately $860 million has not yet been funded. The funds' investments
generate capital appreciation or depreciation and, upon disposition, realized
gains or losses. See "-- Asset Management and Securities Services -- Merchant
Banking". As of May 1998, the Firm's aggregate carrying value of its principal
investments held directly or through its merchant banking funds was
approximately $1.4 billion, which was comprised of corporate principal
investments with an aggregate carrying value of approximately $715 million and
real estate investments with an aggregate carrying value of approximately $682
million.
ASSET MANAGEMENT AND SECURITIES SERVICES
Asset Management and Securities Services is comprised of the following:
- - ASSET MANAGEMENT. Asset management generates management fees by providing
investment advisory services to a diverse and rapidly growing client base of
institutions and individuals;
- - SECURITIES SERVICES. Securities services includes prime brokerage, financing
services and securities lending and the Firm's matched book businesses, all of
which generate revenue primarily in the form of fees or interest rate spreads;
and
67
69
- - COMMISSIONS. Commission-based businesses include agency transactions for
clients on major stock and futures exchanges. Overrides derived from the
Firm's merchant banking funds are also included.
The following table sets forth the net revenues of the Firm's Asset
Management and Securities Services business:
ASSET MANAGEMENT AND SECURITIES SERVICES NET REVENUES
($ in millions)
SIX MONTHS
YEAR ENDED NOVEMBER ENDED MAY
------------------------ CAGR ------------- INCREASE
1995 1996 1997 '95-'97 1997 1998 '97-'98
---- ---- ---- ------- ---- ---- --------
Asset management................. $ 167 $ 242 $ 458 66% $185 $ 284 54%
Securities services.............. 330 354 487 21 237 344 45
Commissions...................... 647 727 989 24 455 668 47
------ ------ ------ ---- ------
Total Asset Management and
Securities Services............ $1,144 $1,323 $1,934 30 $877 $1,296 48
====== ====== ====== ==== ======
------------------------
ASSET MANAGEMENT
The Firm is seeking to build a premier global asset management business. We
offer a broad array of investment strategies and advice across all major asset
classes: global equity, fixed income (including money markets), currency and
alternative investment products (i.e., investment vehicles with non-traditional
investment objectives and/or strategies). Our assets under supervision are
comprised of assets under management and other client assets. Assets under
management typically generate fees based on a percentage of their value and
include our mutual funds, separate accounts managed for institutional and
individual investors, our merchant banking funds and other alternative
investment funds. Other client assets are comprised of assets in brokerage
accounts of high net worth individuals on which we earn primarily brokerage
commissions.
Over the last five years, the Firm has rapidly grown its assets under
supervision, as set forth in the graph below:
ASSETS UNDER SUPERVISION
(in billions)
Measurement Period Assets under Assets under
(Fiscal Year Covered) management Other client assets supervision
1993 $41 $46 $87
1994 43 53 96
1995 52 63 115
1996 95 83 178
1997 136 110 246
May-98 165 140 305
68
70
As of May 1998, equities and alternative investments represented 53% of our
total assets under management. Since 1995, these two asset classes have been the
primary drivers of our growth in assets under management. During the first half
of 1998, the Firm had net asset inflows averaging over $115 million per business
day, excluding market appreciation.
The following table sets forth the amount of assets under management by
asset class:
ASSETS UNDER MANAGEMENT BY ASSET CLASS
($ in billions)
AS OF NOVEMBER
------------------------ AS OF MAY CAGR
1995 1996 1997 1998 '95-'98
---- ---- ---- --------- -------
ASSET CLASS
Equity........................................ $ 9 $ 34 $ 52 $ 66 122%
Fixed income and currency..................... 19 26 36 43 39
Money markets................................. 20 27 31 34 24
Alternative investment(1)..................... 4 8 17 22 98
----- ----- ------ ------
Total......................................... $ 52 $ 95 $ 136 $ 165 59
===== ===== ====== ======
- ---------------
(1) Includes private equity, real estate, quantitative asset allocation and
other funds that are managed by the Firm.
------------------------
Since the beginning of 1996, we have increased the resources devoted to the
asset management business, including adding over 675 employees. In addition,
over the past three years, the Firm made three asset management acquisitions, in
order to expand our geographic reach and to broaden our global equity and
alternative investment portfolio management capabilities.
The global reach of the Firm has been important in growing assets under
management. The percentage of our assets under management, excluding our
merchant banking funds, sourced from outside the United States increased from
12% as of November 1995 to 38% as of May 1998. Currently, we manage
approximately $40 billion sourced from Europe and approximately $12 billion
sourced from Japan.
CLIENTS. Our primary clients are institutions, high net worth individuals
and retail investors. We access clients through both direct and third-party
channels.
The table below sets forth the amount of assets under supervision by
distribution channel and client category as of May 1998:
ASSETS UNDER SUPERVISION BY DISTRIBUTION CHANNEL
(in billions)
ASSETS UNDER
SUPERVISION(1) PRIMARY INVESTMENT VEHICLES
-------------- ---------------------------
- - Directly distributed
-- Institutional.............. $ 117 Separate managed accounts
Commingled vehicles
-- High net worth
individuals................ 142 Brokerage accounts
Limited partnerships
Separate managed accounts
- - Third-party distributed
-- Institutional and retail... 36 Mutual funds
------
Total........................... $ 295
======
- ---------------
(1) Excludes $10 billion in our merchant banking funds.
69
71
Our institutional clients include corporations, insurance companies,
pension funds, foundations and endowments. We manage assets for three of the
five largest pension pools in the U.S. as ranked by Pensions and Investments as
of January 31, 1998 and we have 14 clients for whom we manage at least $1
billion each.
In the individual high net worth area, we have established approximately
9,000 high net worth accounts worldwide, including accounts with over 40% of the
Forbes "Four Hundred". We believe this is a high growth opportunity because this
market (defined as the market for individual investors with a net worth in
excess of $5 million) is highly fragmented, growing rapidly, and accounts for
approximately $10 trillion of investable assets according to a recent study by
McKinsey & Co. At the center of our effort is a team of over 350 relationship
managers, located in 11 U.S. and six international offices. These professionals
have an average of over eight years of experience at the Firm and have exhibited
low turnover and superior productivity relative to the industry average.
In the third-party distribution channel, we distribute our mutual funds on
a worldwide basis through banks, brokerage firms, insurance companies and other
financial intermediaries. As of May 1998, we were the third largest manager in
the U.S. institutional money market sector according to information compiled by
Strategic Insight. In Japan, by utilizing a network of third parties,
principally the largest Japanese brokerage firms, we have become the largest
non-Japanese Investment Trust Manager based on mutual fund assets according to
the Investment Trust Association. In the aggregate, we had $11.8 billion in
mutual fund and institutional assets under management in Japan as of May 1998.
INVESTMENT CAPABILITIES. The Firm seeks to provide to its clients a broad
and deep product line with consistent above-average returns across all asset
classes. For 1996, we were ranked number one in the Barron's/ Lipper fund family
performance survey and for 1997 were again ranked in the top 20%.
MERCHANT BANKING
Goldman Sachs has an established and successful record in the corporate and
real estate merchant banking business, having raised $13.2 billion of committed
equity capital for 14 private investment funds as of June 30, 1998 of which $8.2
billion had been funded. The Firm has committed $2.4 billion and funded $1.5
billion of these amounts; clients of the Firm including pension plans,
endowments, charitable institutions and high net worth individuals have provided
the remainder. Some of these investment funds pursue, on a global basis,
long-term investments in equity and debt securities in privately negotiated
transactions, leveraged buyouts and acquisitions. As of June 30, 1998, these
funds had total committed capital of $7.7 billion, which includes two funds with
$1.0 billion of committed capital that are in the process of being wound down.
Other funds, with total committed capital of $5.5 billion as of June 30, 1998,
invest in real estate operating companies and debt and equity interests in real
estate assets.
Our strategy with respect to each merchant banking fund is to invest
opportunistically to build a portfolio of investments that is diversified by
industry, product type, geographic region and transaction structure and type.
Our merchant banking funds leverage the Firm's long-standing relationships with
companies, investors, entrepreneurs and financial intermediaries around the
world to source potential investment opportunities. In addition, our merchant
banking funds and their portfolio companies have generated business for other
areas of the Firm, including equity underwriting, leveraged and other financing
fees and merger advisory fees.
Located in eight offices around the world, our investment professionals
identify, manage and sell investments on behalf of our merchant banking funds.
The Firm has two majority-owned real estate asset management companies which
manage real estate assets. In addition, our merchant banking professionals work
closely with other parts of the Firm and benefit from the expertise of
specialists in debt and equity research, investment bank-
70
72
ing, leveraged and mortgage finance and equity capital markets.
Merchant banking activities generate three revenue streams. First, the Firm
receives a management fee that is generally a percentage of a fund's committed
capital, invested capital, total gross acquisition cost or asset value. These
annual management fees, which are included in our asset management revenues,
have historically been a recurring source of revenue. Second, the Firm receives
from each fund, after that fund has achieved a minimum return for fund
investors, an increased share of the fund's income and gains ("override") which
is a percentage, typically 20%, of the capital appreciation and gains from the
fund's investments. Revenues from overrides are included in commissions. Third,
the Firm, as a substantial investor in these funds, is allocated its
proportionate share of the funds' unrealized appreciation or depreciation
arising from changes in fair value as well as gains and losses upon realization.
These items are included in Trading and Principal Investments.
SECURITIES SERVICES
Securities services consists predominantly of Global Securities Services
("GSS"), which provides prime brokerage, financing services and securities
lending to a diversified U.S. and international customer base, including hedge
funds, pension funds and high net worth individuals. Securities services also
includes the Firm's matched book business.
We offer prime brokerage services to our clients, allowing them the
flexibility to trade with most brokers while maintaining a single source for
financing and portfolio reports. Our prime brokerage activities provide
multi-product clearing and custody in 50 countries, consolidated multi-currency
accounting and reporting and offshore fund administration and servicing for our
most active clients. Additionally, we provide financing to our clients through
margin loans collateralized by securities held in the client's account. In
recent years, the Firm has significantly increased its prime brokerage client
base.
Securities lending activities principally involve the borrowing and lending
of equity securities to cover customer and Firm short sales and to finance the
Firm's long positions. In addition, we are an active participant in the
securities lending broker-to-broker business and the third-party agency lending
business. Trading desks in New York, Boston, London, Tokyo and Hong Kong provide
24-hour coverage in equity markets worldwide. We believe the rapidly developing
international stock lending market presents a significant growth opportunity.
Lenders of securities include pension plan sponsors, mutual funds,
insurance companies, investment advisors, endowments, bank trust departments and
individuals. We have entered into exclusive relationships with certain lenders
that have given us access to large pools of securities, certain of which are
often hard to locate in the general lender market, thereby providing us with a
competitive advantage. The Firm believes that a significant driver in the growth
in short sales, which require the borrowing of securities, has been the rapid
increase in complex trading strategies such as index arbitrage, convertible bond
and warrant arbitrage, option strategies, and sector and market neutral
strategies where shares are sold short to hedge exposure from derivative
instruments.
In each of the past five years, GSS has posted significant increases in net
revenues and has substantially increased the resources devoted to this growing
market.
COMMISSIONS
The Firm generates commissions by executing agency transactions on major
stock and futures exchanges worldwide. The Firm effects agency transactions for
clients located throughout the world. In recent years, aggregate commissions
have increased as a result of growth in transaction volume on the major
exchanges. As discussed above, commissions also include overrides from merchant
banking funds and commissions earned from brokerage transactions for high net
worth individuals. With respect to overrides, see "-- Merchant Banking" above,
and with respect to high net worth individuals, see "-- Asset
Management -- Clients" above.
71
73
In anticipation of continued growth in online trading, the Firm has made
strategic investments in alternative trading systems to gain experience and
participate in the development of this market. See "Risk Factors -- The
Financial Services Industry Is Intensely Competitive and Rapidly Consolidating".
GLOBAL INVESTMENT RESEARCH
The Global Investment Research Department provides fundamental research on
economies, debt and equity markets, industries, and companies on a worldwide
basis. The Department provides a significant competitive advantage to many of
the Firm's important revenue generating activities. For over two decades, the
Firm has committed the resources on a global scale to develop an
industry-leading position for its investment research products. Major investors
worldwide recognize the Firm for its value-added research products, which are
highly rated in client polls across the Americas, Europe and Asia. The Firm's
Research Department is the only one to rank in the top three in each of the last
ten calendar years in Institutional Investor's "All-America Research Team"
survey. In Europe, based on the Institutional Investor "1998 All-Europe Research
Team" survey, the Research Department ranked number one for coverage of
continental sectors and number three in European Strategy and Economics.
The Firm believes that the prominence of the Global Investment Research
Department is also a significant factor in the Firm's strong competitive
position in debt and equity underwritings and in its generation of commission
revenues. The Department is recognized for a highly integrated team approach
that provides equity research coverage of approximately 2,200 companies
worldwide, 53 economies, and 25 stock markets. This is accomplished through
three groups: (i) the Economic Research group, which formulates macroeconomic
forecasts for economic activity, foreign exchange, and interest rates based on
the globally coordinated views of its regional economists; (ii) the Portfolio
Strategy group, which forecasts equity market returns and provides
recommendations on both asset allocation and industry representation; and (iii)
the Company/Industry group, which provides fundamental analysis, forecasts and
investment recommendations for companies and industries worldwide. Equity
research analysts are organized regionally by sector and globally into more than
20 industry teams, which allows for extensive collaboration and knowledge
sharing on important investment themes.
INFORMATION TECHNOLOGY
Technology is fundamental to our overall business strategy. The Firm is
committed to the ongoing development, maintenance and use of technology
throughout the organization, with expenditures, including employee costs, of
approximately $710 million in 1997 and a budget of $950 million in 1998. The
Firm has developed significant proprietary software and systems over the past
several years. Our technology initiatives can be broadly categorized into three
efforts: (i) enhancing client service through increased connectivity and the
provision of high value-added, tailored services; (ii) sophisticated risk
management; and (iii) overall efficiency and control.
We have tailored our services to our clients by providing them with
electronic access to our products and services. An example of this is the
development of the Financial Workbench, an Internet web site that clients and
employees can use to download research reports, access earnings and valuation
models, submit trades, monitor accounts, build and view presentations, calculate
derivative prices and view market data. First made available in early 1995, the
Financial Workbench represents a joint effort among all of our business areas to
create one comprehensive site for clients and employees to access the Firm's
products and services.
The Firm also has developed proprietary software that enables us to monitor
and analyze our market and credit risks. This risk management software not only
analyzes market risk on Firmwide, divisional and trading desk levels, but also
breaks down the Firm's risk into its underlying exposures, thereby permitting
management to evaluate exposures on the basis of specific interest rate,
currency
72
74
rate, equity price or commodity price changes. To further assist in the
management of the Firm's credit exposures, data from many sources are aggregated
daily into credit management systems that give senior management and
professionals in the Credit and Controllers Departments the ability to receive
timely information with respect to credit exposures worldwide, including netting
information, and the ability to manage complex risk situations effectively.
Proprietary software accesses these data, allows for quick analysis at the level
of individual trades and interacts with other systems in the Firm.
Technology has been a significant factor in improving the overall
efficiency of many areas of the Firm. By automating many trading procedures, we
have substantially increased our efficiency and accuracy.
The Firm currently has projects under way to ensure that the Firm's
technology is Year 2000 compliant and that it is prepared for the introduction
of the EMU. See "Risk Factors -- Firm and Third-Party Computer Systems May Not
Achieve Year 2000 or EMU Readiness" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Risk Management -- Operational,
Year 2000 and EMU Risks".
EMPLOYEES
Management believes that one of the strengths and principal reasons for the
success of Goldman Sachs is the quality and dedication of its people and the
shared sense of being part of a team. The Firm was ranked number 12 in Fortune
magazine's 1998 "The 100 Best Companies to Work for in America" and was ranked
number two in Fortune magazine's 1998 "The Top 50 MBA Dream Companies", the
highest ranking investment banking and securities firm in each case. The Firm
strives to maintain a work environment that fosters professionalism, excellence,
diversity and cooperation among its employees worldwide.
Instilling the Goldman Sachs culture in all employees is a continuous
process, of which training is an essential part. To facilitate the training of
its employees, the Firm recently opened a 34,000 square foot training center in
New York City, near its world headquarters. All employees are offered the
opportunity to participate in Firm-sponsored education and periodic seminars
that are held at various locations throughout the world. The Firm also sponsors
off-site meetings for the various business units that are designed to promote
collaboration among co-workers.
Another important part of instilling the Goldman Sachs culture in all
employees is the Firm's employee review process. Employees are reviewed by
supervisors, co-workers and employees they supervise in a 360-degree review
process that is integral to the Firm's team approach. In 1997, approximately
150,000 reviews were completed, evidencing the comprehensive nature of this
process.
The Firm also believes that good citizenship is an important part of being
a member of the Goldman Sachs team. To that end, the Firm established its
Community TeamWorks initiative. As part of Community TeamWorks, all employees
are offered the opportunity to spend a day working at a charitable organization
of their choice while continuing to receive their full salary for that day. In
1998, approximately two-thirds of the Firm's employees participated in Community
TeamWorks.
As of May 1998, we had approximately 11,400 employees. In addition, the
Firm owns a majority of the interests in both Archon and GAH, which provide real
estate services for the Firm's real estate investment funds and had
approximately 920 and 140 employees, respectively, as of May 1998. The Firm is
reimbursed for substantially all of the costs of these employees by these funds.
See "Risk Factors -- Our Conversion to Corporate Form May Adversely Affect
Our Ability to Recruit, Retain and Motivate Key Employees".
TEMPORARY STAFF AND CONSULTANTS
We use temporary staff and consultants to supplement our employees during
periods of high activity and for specific projects in areas such as information
technology and word-processing. As of May 1998, we had approximately 2,900
temporary staff and consultants. We believe our use of a significant
73
75
temporary and consultant staff gives us greater flexibility to match our
workforce to our business needs.
COMPETITION
All aspects of the financial services industry -- and all our
businesses -- are intensely competitive. Our competitors are other brokers and
dealers, investment banking firms, insurance companies, investment advisors,
mutual funds, hedge funds, commercial banks and merchant banks. We compete with
some of our competitors globally and with some others on a regional, product or
niche basis. We compete on the basis of a number of factors, including
execution, depth of product and service offerings, innovation, reputation and
price.
Competition is also intense for the attraction and retention of qualified
employees. Our ability to continue to compete effectively in our businesses will
depend upon our ability to attract new employees and retain and motivate our
existing employees. See "-- Employees".
In recent years there has been a significant consolidation and convergence
among participants in the financial services industry. In particular, a number
of large commercial banks, insurance companies and other broad-based financial
services firms have acquired or established broker-dealer affiliates. These
firms have the ability to offer a wide range of products, from loans,
deposit-taking and insurance to brokerage, investment management and investment
banking services, which may enhance their competitive position. They also have
the ability to support investment banking and securities products with
commercial banking, insurance and other financial services revenues in an effort
to gain market share, which could result in pricing pressure in our businesses.
This trend toward consolidation and convergence has significantly increased
the capital base and geographic reach of our competitors. This trend has also
hastened the globalization of the securities and other finan-cial services
markets. As a result, our businesses now require substantial amounts of capital.
We believe that some of our most significant opportunities for growth will
arise outside the United States. See "Industry and Economic Outlook". In order
to take advantage of these opportunities, we will have to compete successfully
with financial institutions based in important non-U.S. markets, especially
Europe and Asia. Certain of these institutions are larger, better capitalized
and have a stronger local presence and a longer operating history in these
markets.
We have experienced intense price competition in certain areas of our
business in recent years. For example, equity and debt underwriting discounts
have been under pressure for a number of years and the ability to execute trades
electronically, through the Internet and other alternative trading systems may
increase the pressure on trading commissions. It appears that this trend toward
alternative trading systems will continue and perhaps accelerate. Similarly,
underwriting spreads in Latin American and other privatizations have been
subject to considerable pressure in the last year. We expect that we may see
pricing pressures in other areas of our business as some of our competitors seek
to obtain market share by reducing fees or spreads.
We believe that we compete most effectively in value-added businesses where
timeliness, innovation and execution are important. We believe that in large
part, as a result of the quality and dedication of our employees, we are
generally perceived as a value-added firm. We also compete by allocating
resources to those businesses where we see the greatest potential for growth.
The appropriate allocation of our resources is critical to our being an
effective competitor.
REGULATION
Goldman Sachs' business is, and the securities and commodity futures and
options industries generally are, subject to extensive regulation in the United
States and elsewhere. As a matter of public policy, regulatory bodies in the
United States and the rest of the world are charged with safeguarding the
integrity of the securities and other financial markets and with protecting the
interests of customers
74
76
participating in those markets, not with protecting the interests of Goldman
Sachs' shareholders or creditors. In the United States, the SEC is the federal
agency responsible for the administration of the federal securities laws. GS&Co.
is registered as a broker-dealer with the SEC and in all 50 states and the
District of Columbia and as an investment advisor with the SEC. Certain self-
regulatory organizations, such as the NYSE, adopt rules and examine
broker-dealers, such as GS&Co. In addition, state securities and certain other
regulators also have regulatory or oversight authority over GS&Co. Similarly,
Goldman Sachs' business is also subject to regulation by various non-U.S.
governmental and regulatory bodies and self-regulatory authorities in virtually
all countries where the Firm has offices.
Broker-dealers are subject to regulations that cover all aspects of the
securities business, including sales methods, trade practices among
broker-dealers, use and safekeeping of customers' funds and securities, capital
structure, record-keeping, the financing of customers' purchases and the conduct
of directors, officers and employees. In December 1997, the SEC proposed a
revision of its Rule 15c3-1, the "Uniform Net Capital Rule", and related
regulations which, if adopted, would establish a second form of broker-dealer
registrant permitted to conduct a business in OTC derivatives. The capital
requirements applicable to this second form of registrant would be based upon
proprietary models for estimating market exposures. Goldman Sachs intends to
apply to the SEC to form such a broker-dealer should the SEC adopt its proposal.
Additional legislation, changes in rules promulgated by self-regulatory
organizations or changes in the interpretation or enforcement of existing laws
and rules, either in the United States or elsewhere, may directly affect the
mode of operation and profitability of Goldman Sachs.
The U.S. and non-U.S. government agencies and self-regulatory
organizations, as well as state securities commissions in the United States, are
empowered to conduct administrative proceedings that can result in censure,
fine, the issuance of cease-and-desist orders or the suspension or expulsion of
a broker-dealer or its directors, officers or employees. Occasionally, the
Firm's subsidiaries have been subject to investigations and proceedings, and
sanctions have been imposed for infractions of various regulations relating to
the Firm's activities, none of which has had a material adverse effect on
Goldman Sachs or its business.
The commodity futures and options industry in the United States is subject
to regulation under the Commodity Exchange Act, as amended ("CEA"). The CFTC is
the federal agency charged with the administration of the CEA and the
regulations thereunder and GS&Co. is registered with the CFTC as a futures
commission merchant, commodity pool operator and commodity trading advisor.
As a registered broker-dealer and member of various self-regulatory
organizations, GS&Co. is subject to the SEC's Uniform Net Capital Rule. The
Uniform Net Capital Rule specifies the minimum level of net capital a
broker-dealer must maintain and also requires that at least a minimum part of
its assets be kept in relatively liquid form. GS&Co. is also subject to the net
capital requirements of the CFTC and various securities and commodity exchanges.
See Note 8 to the consolidated financial statements for a discussion of the
Firm's net capital.
The SEC and various self-regulatory organizations impose rules that require
notification when net capital falls below certain predefined criteria, dictate
the ratio of subordinated debt to equity in the regulatory capital composition
of a broker-dealer and constrain the ability of a broker-dealer to expand its
business under certain circumstances. Additionally, the Uniform Net Capital Rule
imposes certain requirements that may have the effect of prohibiting a
broker-dealer from distributing or withdrawing capital and requiring prior
notice to the SEC for certain withdrawals of capital.
Goldman Sachs is an active participant in the international fixed income
and equity markets. Many of the Firm's affiliates that participate in those
markets are subject to comprehensive regulations that include some form of
capital adequacy rule and other
75
77
customer protection rules. For example, Goldman Sachs provides investment
services in and from the United Kingdom under a regulatory regime that is
undergoing comprehensive restructuring. The principal lines of business
conducted from London primarily are and will be regulated by the FSA, and by the
London Stock Exchange and other U.K. securities and commodities exchanges of
which it is a member. However, until the FSA is fully operational, relevant
Goldman Sachs entities also continue to be subject to the rules of the SFA (in
respect of their investment banking, individual asset management and principal
trading activities) and the Investment Management Regulatory Organisation (in
respect of their institutional asset management and fund management activities).
The investment services that are subject to oversight by U.K. regulators are
regulated in accordance with European Union directives requiring, among other
things, compliance with certain capital adequacy standards, customer protection
requirements and conduct of business rules. These standards, requirements and
rules are similarly implemented (under the same directives) throughout the
European Union and are broadly comparable in scope and purpose to the regulatory
capital and customer protection requirements imposed under the SEC and CFTC
rules. European Union directives also permit local regulation in each
jurisdiction, including those in which the Firm operates, to be more restrictive
than the requirements of such directives outside the European Union and these
local requirements can result in certain competitive disadvantages to the Firm.
In addition, the Japanese Ministry of Finance, the Financial Supervisory Agency
in Japan as well as U.K., German, French and Swiss banking authorities, among
others, regulate various of the Firm's subsidiaries and also have capital
standards and other requirements comparable to the rules of the SEC.
Compliance with net capital requirements of these and other regulators
could limit those operations of the Firm's subsidiaries that require the
intensive use of capital, such as underwriting and trading activities and the
financing of customer account balances, and also could restrict the Firm's
ability to withdraw capital from its regulated subsidiaries, which in turn could
limit the Firm's ability to repay debt or pay dividends on the Common Stock.
LEGAL MATTERS
We are involved in a number of judicial, regulatory and arbitration
proceedings (including those described below) concerning matters arising in
connection with the conduct of our businesses. We believe, based on currently
available information, that the results of such proceedings will not have a
material adverse effect on our financial condition, but might be material to our
operating results for any particular period, depending, in part, upon the
operating results for such period.
MOBILEMEDIA SECURITIES LITIGATION
GS&Co. has been named as a defendant in a purported class action lawsuit
commenced in December 1996 and pending in federal court in New Jersey brought on
behalf of (i) purchasers of common stock of MobileMedia Corporation
("MobileMedia") in an underwritten offering in 1995 and (ii) purchasers of
senior subordinated notes of MobileMedia Communications Inc. in a concurrent
underwritten offering. Defendants are MobileMedia, certain of its officers and
directors, and the lead underwriters, including GS&Co. MobileMedia is currently
reorganizing in bankruptcy.
GS&Co. underwrote 2,242,500 shares of common stock, for a total price of
approximately $53 million, and GSI underwrote 718,750 shares, for a total price
of approximately $17 million. GS&Co. underwrote approximately $38 million in
principal amount of the senior subordinated notes.
The consolidated class action complaint alleges violations of the
disclosure requirements of the federal securities laws and seeks compensatory
and/or rescissory damages. In light of MobileMedia's bankruptcy, the action
against it has been stayed. Defendants filed a motion to dismiss in January
1998, which is still pending.
76
78
INVESTORS EQUITY LIFE LITIGATION
Investors Equity Life Insurance Company of Hawaii, Ltd. ("IEL") and its
statutory liquidator (the "Liquidator") commenced in March 1996 an action in
Hawaii state court against GS&Co., alleging claims for negligence, breach of
duty, conversion and fraud arising out of GS&Co.'s execution of certain cash and
futures trades for IEL. The complaint also alleges that GS&Co. conspired with,
aided and abetted, and otherwise assisted several former IEL representatives in
breaching duties they owed to IEL. The other named defendants in the lawsuit are
Gary Vose, IEL's former chairman; Kenneth Fong, IEL's former president; and
Investors Equity Life Holding Company ("IELH"), IEL's parent company, which was
wholly owned by Mr. Vose.
Plaintiffs have alleged damages of approximately $24 million (plus
interest). IELH, Mr. Vose, and Mr. Fong have asserted crossclaims against
GS&Co.; GS&Co. has asserted crossclaims against IELH and Mr. Vose, counterclaims
against IEL and the Liquidator, and third-party claims against the State of
Hawaii and the Commissioner of the Hawaii Department of Insurance. The court has
dismissed GS&Co.'s counterclaims, ruling that they may be properly asserted as
affirmative defenses rather than claims. Trial is currently scheduled for
January 1999.
ROCKEFELLER CENTER PROPERTIES, INC. LITIGATION
Several former shareholders of Rockefeller Center Properties, Inc. ("RCPI")
brought purported class actions in the federal and state courts in Delaware
arising from the acquisition of RCPI by an investor group in July 1996. The
defendants in the actions include, among others, GS&Co., certain other
subsidiaries of the Firm, Whitehall Real Estate Partnership V (a fund advised by
GS&Co.), a GS&Co. Managing Director and other members of the investor group. The
federal court actions, which have since been consolidated, were filed beginning
in November 1996, and the state court action was filed in June 1998.
The complaints generally allege that the proxy statement disseminated to
former RCPI stockholders in connection with the transaction was deficient, in
violation of the disclosure requirements of the federal securities laws. The
plaintiffs are seeking, among other things, unspecified damages, rescission of
the acquisition, and/or disgorgement.
In a series of decisions, the federal court has granted summary judgment
dismissing all the claims in the federal action. Plaintiffs have filed a notice
of appeal.
The state action has been stayed pending disposition of the federal action.
OCTA/OCLTA LITIGATION
The Orange County Transportation Authority and the Orange County Local
Transportation Authority (collectively, "OCTA/ OCLTA") have sued GS&Co. in the
California Superior Court for negligence and breach of fiduciary duty in an
action commenced in December 1996. The complaint generally alleges that, in its
capacity as a commercial paper dealer and an underwriter of certain debt
offerings, GS&Co. breached a duty to warn OCTA/OCLTA not to invest the proceeds
of those financings with the Orange County Investment Pool ("OCIP"). OCTA/ OCLTA
seek to recover over $400 million they claim to have lost as a result of OCIP's
publicly reported losses and ensuing bankruptcy in 1994. The California Superior
Court has granted GS&Co.'s motion for summary judgment dismissing all of
OCTA/OCLTA's claims. OCTA/OCLTA are expected to appeal in due course. GS&Co.
believes that any ultimate award would reflect substantial actual and potential
recoveries by OCIP from other parties, portions of which are payable to
OCTA/OCLTA under an agreement with the County of Orange.
GS&Co. has filed a counterclaim based on certain express representations
made during the financings, as well as third-party claims for contribution and
indemnity against the County of Orange and OCTA/OCLTA's financial advisors.
GS&Co. and Orange County are parties in separate proceedings in U.S.
Bankruptcy Court concerning whether GS&Co.'s third-party claims against the
County of Orange are barred by the County's bankruptcy discharge.
77
79
The Bankruptcy Court has so ruled, and GS&Co. has appealed.
REICHHOLD CHEMICALS LITIGATION
Reichhold Chemicals, Inc. and Reichhold Norway ASA (collectively,
"Reichhold") brought a claim in March 1998 in the Commercial Court in London
against GSI in relation to Reichhold's 1997 purchase of the polymer division of
one of GSI's Norwegian clients, Jotun A/S. Reichhold claims that it overpaid by
$40 million based upon misrepresentations concerning the financial performance
of the polymer division.
GSI has applied for a stay of the actions on the ground that the purchase
contract sets forth specific resolution procedures for such claims, which
include arbitration proceedings with Jotun A/S in Norway.
MATTERS RELATING TO MUNICIPAL SECURITIES
GS&Co. (together with a number of other firms active in the municipal
securities area) has received requests beginning in June 1995 for information
from the SEC and certain other federal and state agencies and authorities with
respect to the pricing of escrow securities sold by GS&Co. to certain municipal
bond issuers in connection with the advanced refunding of municipal securities.
GS&Co. understands that certain municipal bond issuers to which GS&Co. sold
escrow securities have also received such inquiries. There have been published
reports that an action under the Federal False Claims Act was filed in February
1995 alleging unlawful and undisclosed overcharges in certain advance refunding
transactions has been filed by a plaintiff who, pursuant to the Federal False
Claims Act, filed an action on behalf of the United States and that
GS&Co. (together with a number of other firms) is a named defendant in that
action. The complaint was reportedly filed under seal while the government
determines whether it will pursue the claims directly.
PROPERTIES
Our principal executive offices are located at 85 Broad Street, New York,
New York and comprise approximately 969,000 square feet of leased space pursuant
to a lease agreement expiring in June 2008 (with an option to renew for up to 20
additional years). We also occupy over 500,000 square feet at each of 1 New York
Plaza and 10 Hanover Square in New York, New York pursuant to lease agreements
expiring in September 2004 (with options to renew for 10 years) and June 2018,
respectively. We have signed a 15 year lease for approximately 665,000 square
feet at 180 Maiden Lane in New York, New York commencing December 1998. The Firm
leases over 3.2 million square feet in the New York area, a 106% increase in
space since the end of fiscal 1996. Efforts are underway to secure additional
space in the New York area to address the Firm's potential future growth. We
have additional offices in the United States and elsewhere in the Americas.
Together, these offices comprise approximately 600,000 square feet of leased
space.
Consistent with the Firm's global approach to its business, we also have
offices in Europe, Asia, Africa and Australia. The Firm's largest presence in
Europe is in London, where we lease approximately 536,000 square feet through
various leases, with the principal one, for Peterborough Court, expiring in
2016. An additional 396,000 square feet of leased space in London is expected to
be occupied during 2001.
In Asia, we have offices that total approximately 300,000 square feet. Our
largest offices in these regions are in Tokyo and Hong Kong, where we have
leased approximately 127,000 and 103,000 square feet, respectively, under leases
that expire in June 2005 and May 1999, respectively. There are significant
expansion efforts underway in Tokyo, Hong Kong and Singapore.
The Firm's space requirements have increased significantly over the last
several years. Currently, the Firm is at or near capacity at most of its
locations. As a result, the Firm has been actively leasing additional space to
support its anticipated growth. Based on the Firm's progress to date, the Firm
believes that it will be able to acquire additional space to meet its
anticipated needs.
78
80
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The following table provides information concerning the directors and
executive officers of the Company, each of whom has served in the capacity
indicated since August 1998. The Company anticipates appointing at least two
additional directors who are not employees of the Company or affiliated with
management to its Board of Directors shortly after completion of the Offerings.
NAME AGE POSITION
---- --- --------
Jon S. Corzine 51 Director, Co-Chairman and Co-Chief Executive Officer
Henry M. Paulson, Jr. 52 Director, Co-Chairman and Co-Chief Executive Officer
Robert J. Hurst 52 Director and Vice Chairman
Roy J. Zuckerberg 62 Director and Vice Chairman
John A. Thain 43 Director and Chief Financial Officer
John L. Thornton 44 Director and Chairman of International Operations
------------------------
Executive officers are appointed by and serve at the pleasure of the Board
of Directors. A brief biography of each director and executive officer follows.
Mr. Corzine has been Co-Chairman and Co-Chief Executive Officer of Group
L.P. since June 1998 and served as Chairman and Chief Executive Officer of Group
L.P. from December 1994 to June 1998. From December 1988 to November 1994, he
was co-head of Fixed Income. Mr. Corzine is a member of the NASD's Board of
Governors.
Mr. Paulson has been Co-Chairman and Co-Chief Executive Officer of Group
L.P. since June 1998 and served as Chief Operating Officer of Group L.P. from
December 1994 to June 1998. From 1990 to November 1994, he was co-head of
Investment Banking.
Mr. Hurst has been Vice Chairman of Group L.P. since February 1997 and
served as head or co-head of Investment Banking since 1990. He is also a
director of IDB Holding Corporation Ltd. and VF Corporation.
Mr. Zuckerberg has been Vice Chairman of Group L.P. since February 1997 and
has been head or co-head of Equities since 1990. He is Chairman-elect of the
Securities Industry Association.
Mr. Thain has been Chief Financial Officer of Group L.P. and head of
Operations, Technology and Finance since December 1994. From July 1995 to
September 1997, he was also co-chief executive officer for European Operations.
Mr. Thain is a director of The Depository Trust Company.
Mr. Thornton has had oversight responsibility for International Operations
since August 1998. From September 1996 until then he had such oversight
responsibility for Asia, in addition to his senior strategic responsibilities in
Europe. From July 1995 to September 1997, he was co-chief executive officer for
European Operations. From 1994 to 1995, he was co-head of Investment Banking in
Europe and from 1992 to 1994 was head of European Investment Banking Services.
He is also a director of the Ford Motor Company, BSkyB PLC, Laura Ashley PLC and
the Pacific Century Group.
All of the current members of the Board of Directors were members of Group
L.P.'s Executive Committee, which was the Firm's primary governing body. Under
the new corporate structure, Messrs. Corzine, Paulson, Hurst, Thain and Thornton
will constitute the Office of the Chairmen. Mr. Zuckerberg will be an ex-officio
member. The Office of the Chairmen will focus on overall Firm policy and
strategy, culture and operations, relationships with the Firm's clients and
shareholders and the development of senior management.
There are no family relationships between any of the executive officers or
directors of the Company.
79
81
INFORMATION REGARDING THE BOARD OF DIRECTORS
The Company's Amended and Restated Certificate of Incorporation provides
for a classified Board of Directors consisting of three classes. The term of the
initial Class I directors will terminate on the date of the 1999 annual meeting
of shareholders, the term of the Class II directors will terminate on the date
of the 2000 annual meeting and the term of the Class III directors will
terminate on the date of the 2001 annual meeting of shareholders. Mr. Zuckerberg
is a member of Class I, Messrs. Hurst, Thain and Thornton are members of Class
II and Messrs. Corzine and Paulson are members of Class III. Beginning in 1999,
at each annual meeting of shareholders, successors to the class of directors
whose term expires at that annual meeting will be elected for a three-year term
and until their respective successors have been elected and qualified. Mr.
Zuckerberg intends not to stand for re-election at the end of his term as a
Class I director in 1999. A director may be removed only for cause by the
affirmative vote of the holders of not less than 66 2/3% of the outstanding
shares of capital stock entitled to vote in the election of directors.
Members of the Board of Directors of the Company (the "Board") who are
employees of the Company or of any of its subsidiaries will not be compensated
for service on the Board of Directors or any committee thereof. It is
anticipated that the Board of Directors will meet at least quarterly.
COMMITTEES OF THE BOARD OF DIRECTORS
The Company will have an Audit Committee, composed of directors who are not
employed by the Company or affiliated with management. The Audit Committee will
review the results and scope of the audit and other services provided by the
Company's independent auditors as well as review the Company's internal
accounting and control procedures and policies.
The Board of Directors will also have a Compensation Committee. The
Compensation Committee will oversee the compensation and benefits of the
management and employees of the Company and will consist entirely of
non-employee directors.
The Board of Directors may from time to time establish other committees to
facilitate the management of the Company.
EXECUTIVE COMPENSATION
Prior to the Offerings, our business was carried on in partnership form. As
a result, meaningful individual compensation information for directors and
executive officers of the Company based on operating in corporate form is not
available for periods prior to the Offerings.
The following table sets forth the salaries that the Company intends to pay
the Company's Co-Chief Executive Officers and the other four most highly
compensated executive officers of the Company (the "Named Executive Officers")
during the fiscal year 1999. The Named Executive Officers will also be entitled
to participate in the Partner Pool and are eligible to receive awards under the
1998 Stock Incentive Plan which are described below.
Because the amounts payable under the Partner Pool will be dependent upon
the Company's operating results and because awards under the 1998 Stock
Incentive Plan will be determined after the Offerings, it is not currently
possible for the Company to estimate the amount of such payments or awards.
However, the amounts payable under the Partner Pool are expected to exceed the
base salaries indicated. See "-- The Partner Pool" below. None of the Named
Executive Officers is receiving a Formula or Discretionary Award or is currently
participating in the DCP.
80
82
SUMMARY SALARY TABLE
NAMES AND PRINCIPAL POSITION YEAR SALARY
---------------------------- ---- ------
Jon S. Corzine,............................................. 1999 $
Director, Co-Chairman and Co-Chief Executive Officer
Henry M. Paulson, Jr.,...................................... 1999
Director, Co-Chairman and Co-Chief Executive Officer
Robert J. Hurst,............................................ 1999
Director and Vice Chairman
Roy J. Zuckerberg,.......................................... 1999
Director and Vice Chairman
John A. Thain,.............................................. 1999
Director and Chief Financial Officer
John L. Thornton,........................................... 1999
Director and Chairman of International Operations
------------------------
Aggregate compensation paid to key employees who are not Named Executive
Officers may exceed that paid to the Named Executive Officers.
EMPLOYMENT, NONCOMPETITION AND PLEDGE
AGREEMENTS
The Company is entering into employment agreements with each PLP who
continues as a Managing Director and confidentiality, noncompetition and
nonsolicitation and pledge agreements with all of the PLPs, whether or not they
retire, including, in both cases, each director and executive officer. The Firm
expects to enter into similar employment, confidentiality, noncompetition and
nonsolicitation arrangements (without providing for any type of liquidated
damages remedy) with all other Managing Directors.
The following descriptions of the agreements with the PLPs are not intended
to be complete and are qualified in their entirety by reference to the full text
of such agreements, the form of each of which has been filed as an exhibit to
the Registration Statement of which this Prospectus is a part.
EMPLOYMENT AGREEMENTS
Each Employment Agreement has a two-year term, requires the continuing PLP
to devote his or her entire working time to the business and affairs of the Firm
and may be terminated by either the continuing PLP or the Firm on 90 days' prior
written notice.
NONCOMPETITION AGREEMENTS
Each confidentiality, noncompetition and nonsolicitation agreement
("Noncompetition Agreement") provides as follows:
CONFIDENTIALITY. Each PLP is required to protect and use "confidential
information" in accordance with the restrictions placed by the Firm on its use
and disclosure.
NONCOMPETITION. During the Noncompetition Period (as defined below), the
PLP may not (i) form, or acquire a 5% or greater ownership interest in, any
"Competitive Enterprise" (as defined below) or (ii) associate (including, but
not limited to, association as an officer, employee, partner, director,
consultant, agent or advisor) with any Competitive Enterprise and in connection
with such association engage in, or directly or indirectly manage or supervise
personnel engaged in, any activity (for any purpose) (A) which is similar or
substantially related to any activity in which the PLP was engaged, (B) for
which the PLP had direct or indirect managerial or supervisory responsibility at
the Firm or (C) which calls for the application of the same or similar
specialized knowledge or skills as those utilized by the PLP in his or her
activities with the Firm, in each case, at any time during the one-year period
immediately prior to the PLP's termination of employment. "Noncompetition
Period" is the period commencing on the date the Noncompetition Agreement is
entered into and ending 12 months after the later of the date of the
consummation of the Offerings (the "IPO
81
83
Date") and the date the PLP is no longer employed by the Firm. "Competitive
Enterprise" is any business enterprise that engages in an activity, or owns a
significant interest in an entity, that competes with any activity the Firm is
engaged in at the time of termination of the PLP's employment or, if later, the
IPO Date.
NONSOLICITATION. During the Nonsolicitation Period (as defined below), the
PLP is prohibited from (i) soliciting any client or prospective client of the
Firm to whom such PLP provided services, or for whom such PLP transacted
business, or whose identity became known to such PLP in connection with such
PLP's employment with the Firm, to transact business with a Competitive
Enterprise or reduce or refrain from doing any business with the Firm or (ii)
interfering with or damaging any relationship between the Firm and any such
client or prospective client. Also, during the Nonsolicitation Period, the PLP
is prohibited from soliciting any person who is an employee of the Firm to apply
for, or accept employment with, any Competitive Enterprise. "Nonsolicitation
Period" is the period commencing on the date the Noncompetition Agreement is
entered into and ending 18 months after the later of the IPO Date and the date
of termination of the PLP's employment.
LIQUIDATED DAMAGES. In the case of any breach of the noncompetition and
nonsolicitation provisions by the PLP prior to the fifth anniversary of the IPO
Date, such PLP is liable for liquidated damages. The amount of liquidated
damages for each PLP who has been named a director of GS Inc. is $25 million,
$17 million and $8 million through the third, fourth and fifth anniversaries of
the IPO Date, respectively. The minimum amount of liquidated damages for any
other PLP is $10 million, $7 million and $3 million through the third, fourth
and fifth anniversaries of the IPO Date, respectively. These liquidated damages
are in addition to the forfeiture of any future equity-based awards that may
occur as a result of the breach of any noncompetition and nonsolicitation
provisions contained in these awards.
PLEDGE AGREEMENT
In order to secure the payment obligations of each PLP under the liquidated
damage provisions of his or her Noncompetition Agreement, each PLP will enter
into a Pledge Agreement. The Pledge Agreement requires the PLP to pledge Common
Stock (or other collateral acceptable to the Firm) with a market value equal to
125% of such PLP's liquidated damages amount in effect on the IPO Date.
Collateral will be released on the third and fourth anniversaries of the IPO
Date to the extent that the pledged collateral exceeds 125% of the amount of the
then applicable liquidated damages. Substitution of collateral is permitted so
long as the substituted collateral has a value at least equal to the value of
the released collateral and, together with the value of any remaining
collateral, to 125% of the then applicable liquidated damages amount.
Each Pledge Agreement will terminate on the earliest of (i) the PLP's death
or termination of employment due to disability, (ii) the expiration of the
24-month period following the later of (A) termination of the PLP's employment
or (B) the IPO Date, and (iii) the fifth anniversary of the IPO Date. No
collateral, however, will be released from the pledge if there are any pending
disputes between the PLP and the Firm.
NONEXCLUSIVITY AND ARBITRATION
The liquidated damages and pledge arrangements discussed above are not
exclusive of any injunctive relief that the Firm may be entitled to for a breach
of a Noncompetition Agreement, and, after expiration of the liquidated damage
provisions, the Firm will be entitled to all available damage remedies for a
breach of a Noncompetition Agreement.
The Employment, Noncompetition and Pledge Agreements generally provide that
any disputes thereunder will be resolved by binding arbitration.
THE EMPLOYEE IPO AWARDS
The Company intends to provide, on the date of consummation of the
Offerings, equity-based awards to its employees (and a limited
82
84
number of consultants) other than PLPs in one or more of the following forms:
(i) substantially all employees will receive a grant of Formula RSUs, with
respect to which up to an aggregate of shares of Common Stock will
be deliverable, (ii) certain senior employees (principally non-PLP Managing
Directors) will be selected to participate in the DCP described below, to which
the Company will make an initial irrevocable contribution of up to
shares of Common Stock (the "DCP Contribution"), (iii) certain employees will
receive Discretionary RSUs, with respect to which up to an aggregate of
shares of Common Stock will be deliverable and (iv) certain employees
will receive Discretionary Options, with respect to which up to an
aggregate of shares of Common Stock will be deliverable. The Formula
RSUs, Discretionary RSUs and the Discretionary Options will be granted under the
SIP described below. Awards made to employees in certain foreign jurisdictions
may be in a different form but will be designed to confer substantially the same
economic benefit. Recipients of Formula RSUs and Discretionary RSUs described
below will have only the rights of a general unsecured creditor of the Firm and
no rights as a shareholder of GS Inc. Any shares of Common Stock acquired by a
Managing Director pursuant to the awards will be subject to the Shareholders'
Agreement described in "Certain Relationship and Related
Transactions -- Shareholders' Agreement".
THE FOLLOWING DESCRIPTIONS OF THE FORMULA AND DISCRETIONARY AWARDS AND THE
DCP ARE PRELIMINARY AND ARE SUBJECT TO CHANGE.
FORMULA AWARD
The Formula RSUs will be granted to substantially all of our employees and
will be determined based on a formula that takes into account each employee's
1998 compensation and years of service to the Firm. The Common Stock underlying
the Formula RSUs generally will be deliverable in equal installments on the
first, second and third anniversaries of the date of grant. While no additional
service will be required to obtain delivery of the underlying Common Stock
(i.e., the award is "vested"), such delivery will be conditioned on the
grantee's satisfying certain requirements, including (i) not being terminated
for cause (as defined in the award agreement) prior to delivery and (ii) not
violating any Firm policy (including in respect of hedging) or otherwise acting
in a manner detrimental to the Firm, including violating confidentiality,
non-competition and non-solicitation provisions of the award. Amounts equal to
dividends that would be paid on the Common Stock underlying the Formula RSUs (as
if the Common Stock had been actually issued) will be paid in cash at the same
time that the dividends are paid generally to the shareholders.
DISCRETIONARY AWARDS
CONTRIBUTION TO DCP. On the date of the consummation of the Offerings, the
Company will make an initial irrevocable contribution of up to shares
of Common Stock to the DCP. Certain senior employees (principally non-PLP
Managing Directors) will be selected to participate in the DCP. The right to
receive such shares will vest and the underlying Common Stock will be
deliverable to participants in the DCP in equal installments on the third,
fourth and fifth anniversaries of the initial contribution if the grantee has
satisfied certain conditions and is still employed with the Firm on each
applicable vesting date with certain exceptions for terminations of employment
due to death, retirement or disability. Dividends paid on such shares will be
distributed currently.
DISCRETIONARY RSUS. The Discretionary RSUs will vest (and the underlying
Common Stock will be delivered) in equal installments on the third, fourth and
fifth anniversaries of the date of grant if the grantee has satisfied certain
conditions and is still employed with the Firm on each applicable vesting date
with certain exceptions for terminations of employment due to death, retirement
or disability. Amounts equal to dividends that would be paid on the Common Stock
underlying the Discretionary RSUs (as if the Common Stock had been actually
issued) will be paid in cash at the same time that the dividends are paid
generally to the shareholders.
83
85
DISCRETIONARY OPTIONS. The Discretionary Options will be granted with an
exercise price generally equal to the initial public offering price set forth on
the cover page of this Prospectus although in certain jurisdictions certain
employees may be granted Discretionary Options with a lower exercise price. The
Discretionary Options will generally be exercisable in equal installments
commencing on the third, fourth and fifth anniversaries of the date of grant if
the grantee has satisfied certain conditions and is still employed with the Firm
on each applicable vesting date with certain exceptions for terminations of
employment due to death, retirement or disability. Discretionary Options will
thereafter generally remain exercisable until the tenth anniversary of the date
of grant.
THE 1998 STOCK INCENTIVE PLAN
The following description of The Goldman Sachs 1998 Stock Incentive Plan
(the "SIP") does not purport to be complete and is qualified in its entirety by
reference to the full text of the SIP, which has been filed as an exhibit to the
Registration Statement of which this Prospectus is a part.
TYPES OF AWARDS. The SIP provides for grants of incentive stock options
("ISOs") (within the meaning of section 422 of the Internal Revenue Code of
1986, as amended (the "Code")), nonqualified stock options, stock appreciation
rights ("SARs"), dividend equivalent rights, restricted stock, restricted stock
units ("RSUs"), performance shares, performance share units and other equity-
based and equity-related awards (collectively, "Awards").
SHARES SUBJECT TO THE SIP; OTHER LIMITATIONS ON AWARDS. The total number
of shares of Common Stock of the Company which may be issued under the SIP may
not exceed shares. These shares may be authorized but unissued
Common Stock or authorized and issued Common Stock held in the Company's
treasury. If any Award is forfeited or otherwise terminates or is canceled
without the delivery of shares of Common Stock, shares of Common Stock are
surrendered or withheld from any Award to satisfy a grantee's income tax
withholding obligations, or shares of Common Stock owned by a grantee are
tendered to pay the exercise price of Awards, then the shares covered by any
forfeited, terminated or canceled Award or the shares so surrendered, withheld
or tendered, will again become available under the SIP.
The SIP Committee (as defined below) has the authority to adjust the terms
of any outstanding Awards and the number of shares of Common Stock issuable
under the SIP for any increase or decrease in the number of issued shares of
Common Stock resulting from a stock split, reverse stock split, stock dividend,
spin-off, combination or reclassification of the Common Stock, or any other
event that the SIP Committee determines affects the Firm's capitalization.
ELIGIBILITY. Awards may be made to any director, officer or employee of
the Firm (including any prospective employee) and to any consultant to the Firm
selected by the Committee (collectively, "key persons").
ADMINISTRATION. The SIP will be administered by the Board of Directors or
a committee appointed by the Board (the "SIP Committee").
The SIP Committee will have the authority to construe, interpret and
implement the SIP, and prescribe, amend and rescind rules and regulations
relating to the SIP. The SIP Committee may accelerate the date on which any
Award becomes exercisable or fully vested, declare that any Award will terminate
as of a specified date and otherwise amend any Award agreement in any respect.
The determination of the SIP Committee on all matters relating to the SIP
or any Award agreement will be final and binding.
STOCK OPTIONS AND SARS. The SIP Committee may grant ISOs and nonqualified
stock options (collectively, "options") to purchase shares of Common Stock from
the Company, and SARs in such amounts, and subject to such terms and conditions,
as the SIP Committee may determine. The grantee of an SAR will have the right to
receive from the Company an amount equal to (i) the excess of the fair market
value of a share of Common Stock on the date of exercise of the SAR
84
86
over (ii) the exercise price of such right as set forth in the Award agreement,
multiplied by (iii) the number of shares with respect to which the SAR is
exercised.
No grantee of an option or SAR (or other person having the right to
exercise such Award) will have any of the rights of a shareholder of GS Inc.
with respect to shares subject to such Award until the issuance of a stock
certificate to such person for such shares. In general, a person exercising an
option or SAR will not be entitled to any dividends or distributions on the
Common Stock for which the record date is prior to the date the stock
certificate is issued.
The SIP Committee may in its discretion include in any Award agreement with
respect to an option (the "original option") a provision that an additional
option (the "additional option") may be granted to any grantee who delivers
shares of Common Stock in partial or full payment of the exercise price of the
original option. The additional option will be for a number of shares of Common
Stock equal to the number delivered, will have an exercise price equal to the
fair market value of a share of Common Stock on the date of exercise of the
original option and will have an expiration date no later than the expiration
date of the original option.
RESTRICTED STOCK. The SIP Committee may grant restricted shares of Common
Stock, in such amounts, and subject to such terms and conditions, as the SIP
Committee may determine. The grantee will have the rights of a shareholder with
respect to the restricted stock, subject to any restrictions and conditions as
the SIP Committee may include in the Award agreement. The SIP Committee at the
time of grant will specify the date or dates (which may depend upon or be
related to the attainment of performance goals and other conditions) on which
the nontransferability of the restricted stock will lapse.
RESTRICTED STOCK UNITS. The SIP Committee may grant RSUs in such amounts,
and subject to such terms and conditions, as the SIP Committee may determine.
Recipients of RSUs have only the rights of a general unsecured creditor of the
Firm and no rights as a shareholder of GS Inc. The SIP Committee will specify
the conditions on which the RSUs will become non-forfeitable and the underlying
Common Stock will be deliverable.
PERFORMANCE SHARES AND SHARE UNITS. The SIP Committee may grant performance
shares in the form of actual shares of Common Stock or share units having a
value equal to an identical number of shares of Common Stock in such amounts,
and subject to such terms and conditions, as the SIP Committee may determine.
OTHER STOCK-BASED AWARDS. The SIP Committee may grant other types of
equity-based or equity-related Awards (including the grant of unrestricted
shares) in such amounts, and subject to such terms and conditions, as the SIP
Committee may determine. These Awards may entail the transfer of actual shares
of Common Stock, or payment in cash or otherwise of amounts based on the value
of shares of Common Stock and may include awards designed to comply with, or
take advantage of certain benefits of, the local laws of non-U.S. jurisdictions.
CHANGE OF CONTROL. The SIP Committee may provide in any Award agreement
for provisions relating to a "change in control" of the Company or any of its
subsidiaries or affiliates, including, without limitation, the acceleration of
the exercisability of, or the lapse of restrictions with respect to, any
outstanding Awards.
DIVIDEND EQUIVALENT RIGHTS. The SIP Committee may in its discretion
include in the Award agreement a dividend equivalent right entitling the grantee
to receive amounts equal to the dividends that would be paid, during the time
such Award is outstanding, on the shares of Common Stock covered by such Award
as if such shares were then outstanding.
NONASSIGNABILITY. Except to the extent otherwise provided in the Award
agreement or approved by the SIP Committee, no Award or right granted to any
person under the SIP will be assignable or transferable other than by will or by
the laws of descent and distribution, and all Awards and rights will be
exercisable during the life of the grantee only by
85
87
the grantee or the grantee's legal representative.
AMENDMENT AND TERMINATION. The Board may from time to time suspend,
discontinue, revise or amend the SIP in any respect whatsoever.
U.S. FEDERAL INCOME TAX IMPLICATIONS OF THE SIP. The following is a brief
description of the U.S. federal income tax consequences generally arising with
respect to Awards.
The grant of an option or SAR will create no tax consequences for the
participant or the Company. A participant will not recognize taxable income upon
exercising an ISO (except that the alternative minimum tax may apply). Upon
exercising an option other than an ISO, the participant will generally recognize
ordinary income equal to the difference between the exercise price and fair
market value of the freely transferable and nonforfeitable shares acquired on
the date of exercise. Upon exercising an SAR, the participant will generally
recognize ordinary income equal to the cash or the fair market value of the
freely transferable and nonforfeitable shares received.
Upon a disposition of shares acquired upon exercise of an ISO before the
end of the applicable ISO holding periods, the participant will generally
recognize ordinary income equal to the lesser of (i) the fair market value of
the shares at the date of exercise of the ISO minus the exercise price, or (ii)
the amount realized upon the disposition of the ISO shares minus the exercise
price. Otherwise, a participant's disposition of shares acquired upon the
exercise of an option (including an ISO for which the ISO holding periods are
met) or SAR generally will result in short-term or long-term capital gain or
loss measured by the difference between the sale price and the participant's tax
basis in such shares (the tax basis generally being the exercise price plus any
amount recognized as ordinary income in connection with the exercise of the
option or SAR).
The Company generally will be entitled to a tax deduction equal to the
amount recognized as ordinary income by the participant in
connection with an option or SAR. The Company generally is not entitled to a tax
deduction relating to amounts that represent a capital gain to a participant.
Accordingly, the Company will not be entitled to any tax deduction with respect
to an ISO if the participant holds the shares for the ISO holding periods prior
to disposition of the shares.
With respect to Awards that result in the payment or issuance of cash or
shares or other property that is either not restricted as to transferability or
not subject to a substantial risk of forfeiture (e.g., RSUs), the participant
will generally recognize ordinary income equal to the cash or the fair market
value of shares or other property delivered. The Company generally will be
entitled to a deduction coincident with the employee's recognition of income in
an amount equal to the ordinary income recognized by the participant.
With respect to Awards involving the issuance of shares or other property
that is restricted as to transferability or subject to a substantial risk of
forfeiture (e.g., restricted stock), the participant will generally recognize
ordinary income equal to the fair market value of the shares or other property
at the first time the shares or other property becomes transferable or is not
subject to a substantial risk of forfeiture, whichever occurs earlier. Subject
to the consent of the Company, a participant may elect to be taxed at the time
of receipt of shares or other property rather than upon lapse of restrictions on
transferability or substantial risk of forfeiture, but if the participant
subsequently forfeits such shares or property, the participant would not be
entitled to any tax deduction, including as a capital loss, for the value of the
shares or property on which he or she previously paid tax. The participant must
file such election with the Internal Revenue Service within 30 days of receipt
of the shares or other property. The Company generally will be entitled to a
deduction in an amount equal to the ordinary income recognized by the
participant. Because an RSU is a mere contractual right to receive Common Stock,
the grantee of an RSU is not eligible to make the election described above.
86
88
THE DEFINED CONTRIBUTION PLAN
The Goldman Sachs Defined Contribution Plan (the "DCP") is not intended to
be qualified under Section 401(a) of the Code and is not subject to the Employee
Retirement Income Security Act of 1974, as amended.
The following description of the DCP does not purport to be complete and is
qualified in its entirety by reference to the full text of the DCP, which has
been filed as an exhibit to the Registration Statement of which this Prospectus
is a part.
ELIGIBILITY AND PARTICIPATION. Each employee designated by the Board of
Directors or a committee appointed by the Board (the "DCP Committee") will be a
participant in the DCP from the date on which he or she is so designated until
the earlier of (i) his or her termination of employment or (ii) the date he or
she receives a distribution of all of the Common Stock credited to his or her
account ("Account") under the DCP.
CONTRIBUTIONS. The Company will make an initial irrevocable contribution
to the trust underlying the DCP (the "Trust") of shares of Common
Stock simultaneously with the closing of the Offerings. The Company may
contribute additional shares of Common Stock or cash to the Trust from time to
time in its sole discretion. The Company currently intends to make ongoing
contributions to the DCP and to reallocate forfeitures under the DCP to
participants according to a formula as determined by the DCP Committee.
ALLOCATION OF CONTRIBUTIONS. There will be established an Account in the
name of each participant and a separate account (the "Unallocated Account") to
which any forfeitures of Common Stock will be credited pending allocation to
participants. The DCP Committee will designate the number of shares of Common
Stock allocable to the Account of each participant. Unless otherwise determined
by the DCP Committee, any Common Stock remaining in the Unallocated Account as
of the last day of each plan year (due to forfeitures and any distributions
received on Common Stock credited to the Unallocated Account) will be allocated
among the Accounts of each participant who is an employee on the last day of
such plan year in the proportion that each such employee's allocation in respect
of the Company contributions for such plan year bears to the allocation of such
contributions for all such employees.
VOTING OF COMMON STOCK. Each participant will be entitled to direct the
trustee of the Trust, on a confidential basis, as to the manner in which the
shares of Common Stock allocated to his or her Account will be voted.
Participants who are parties to the Shareholders' Agreement will appoint an
attorney-in-fact to make such directions on their behalf and such shares will be
voted in accordance with the Shareholders' Agreement. See "Certain Relationships
and Related Transactions -- Shareholders' Agreement". Any shares of Common Stock
with respect to which the trustee of the Trust does not receive voting
directions will not be voted.
DIVIDENDS. Any cash dividends on shares of Common Stock allocated to a
participant's Account will be distributed to each participant no later than the
end of the calendar quarter in which such dividend is received.
VESTING AND DELIVERY. With respect to the initial contribution by the
Company of Common Stock to the DCP, the right to receive shares of Common Stock
allocated to a participant's Account generally will be vested and the Common
Stock generally will be distributable ratably on the third, fourth and fifth
anniversaries of the date of such contribution if the participant satisfies
certain conditions and is still employed by the Firm on each applicable
anniversary. With respect to contributions to the DCP (other than such initial
contribution), the DCP Committee may determine the dates on which the right to
receive Common Stock allocated to a participant's account will vest and the
Common Stock will be delivered.
ADMINISTRATION OF THE DCP. The DCP will be administered by the DCP
Committee. The Board may, however, determine allocations of contributions or
resolve to otherwise administer the DCP.
87
89
AMENDMENTS. The Board reserves the right to modify, alter, amend or
terminate the DCP or the Trust. No modification or amendment of the DCP may be
made which would cause or permit any part of the assets of the Trust to be used
for, or diverted to, purposes other than for the exclusive benefit of
participants or their beneficiaries, or which would cause any part of the assets
of the Trust to revert to or become the property of the Firm.
LIMIT ON LIABILITY. All distributions under the DCP will be paid or
provided solely from the assets of the Trust. After the initial contribution of
shares of Common Stock to the DCP, the Company will have no responsibility or
liability for the obligations of the Trust. The agreement establishing the Trust
will provide that no creditor of the Company will have any rights to the assets
of the Trust.
U.S. FEDERAL INCOME TAX CONSEQUENCES. The following is a brief description
of the material U.S. federal income tax consequences generally arising with
respect to participation in the DCP. A participant in the DCP will recognize
ordinary income upon the vesting and delivery of shares of Common Stock
allocated to such participant's Account in an amount equal to the fair market
value of the number of shares of Common Stock so delivered. The Company will
generally be entitled to a deduction equal to the fair market value of the
shares at the time of the contribution in the taxable year in which the
participant recognizes income under the DCP in respect of the vesting and
delivery of shares of Common Stock.
THE PARTNER POOL
OVERVIEW. To perpetuate the sense of partnership and teamwork which exists
among the Firm's senior professionals, and to reinforce the alignment of
employee and shareholder interests, the Board of Directors has adopted The
Goldman Sachs Partner Pool (the "Partner Pool") for the purpose of compensating
senior professionals. The Partner Pool will be administered by the Board or a
committee appointed by the Board (the "Partner Pool Committee").
Consistent with the Firm's historical practice of partnership elections,
participants will be elected to the Partner Pool every two years, for two-year
terms. Upon selection to the Partner Pool, participants will be allocated a
percentage interest in a pool for annual bonus payments in addition to base
salaries. The size of the pool will be established by the Partner Pool Committee
annually, taking into account the Firm's results of operations and other
measures of financial performance. The Partner Pool Committee may also retain an
unallocated percentage of the Pool that it may allocate in its discretion. By
linking the Partner Pool participant's annual bonus payments to the Firm's
results as a whole, as opposed to the results of any participant's individual
business unit, the Firm believes it will provide additional incentives for
teamwork. Further, the Firm believes that the tying of the bonus payments to
overall financial results will more closely align the interests of the
participants with the Firm's shareholders.
The following description of the Partner Pool does not purport to be
complete and is qualified in its entirety by reference to the full text of the
Partner Pool, which has been filed as an exhibit to the Registration Statement
of which this Prospectus is a part.
ELIGIBILITY AND PARTICIPATION. Although the employees who will participate
in the Partner Pool during the 1999 fiscal year have not yet been designated, it
is estimated that there will be approximately 210 initial participants,
including all executive officers, in the Partner Pool. Prior to the
two-fiscal-year period ("Partner Pool Cycle") commencing with the 1999 fiscal
year, and on or before each succeeding Partner Pool Cycle, the Partner Pool
Committee will determine the participants in the Partner Pool. Individual
participants may also be added from time to time outside the biennial selection
process.
DETERMINATION OF AWARDS. The aggregate amount of compensation to be
included in the Partner Pool for each fiscal year will be determined by the
Partner Pool Committee taking into account such measures of the Company's
financial performance as it deems appropriate, including but not limited to,
earnings per share, return on average common equity, pre-tax income, pre-tax
operating income, net revenues, net income, profits
88
90
before taxes, book value per share, stock price and earnings available to common
shareholders.
Prior to the commencement of the first fiscal year in any Partner Pool
Cycle, the Partner Pool Committee will determine the percentage of the Partner
Pool that may be allocable to any particular participant (the "Allocation
Percentage"). The Allocation Percentage so determined will be applicable for
each fiscal year within a Partner Pool Cycle. Any remaining portion of the
Partner Pool not so allocated with respect to any fiscal year will be allocated
to individual participants at the end of such fiscal year as determined by the
Partner Pool Committee.
PAYMENT OF AWARDS. Any bonus amount payable to a participant in respect of
any fiscal year will be paid to such participant within 2 1/2 months following
the end of such fiscal year. If a participant dies or becomes disabled during
the fiscal year, such participant (or his beneficiary or estate, as applicable)
may receive a portion of the bonus otherwise payable to such participant as
determined by the Partner Pool Committee. Unless otherwise provided by the
Partner Pool Committee, if a participant terminates employment other than as a
result of death or disability before the end of the Firm's then current fiscal
year, the participant will not receive any bonus under the Partner Pool. Amounts
payable under the Partner Pool will be satisfied in cash or as Awards under the
SIP, as determined by the Partner Pool Committee and recommended to the SIP
Committee.
89
91
PRINCIPAL AND SELLING SHAREHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Shares (i) immediately prior to the
consummation of the Offerings, but after giving effect to the Incorporation
Transactions and (ii) as adjusted to reflect the sale of the shares of Common
Stock pursuant to the Offerings by (a) each person who is known to the Company
to be the beneficial owner of more than five percent of the Company's Common
Shares after the Offerings, (b) each director and Named Executive Officer of the
Company and (c) all directors and executive officers of the Company as a group.
Except as otherwise indicated, the persons or entities listed below have sole
voting and investment power with respect to Common Shares beneficially owned by
them. None of our employees is selling shares in the Offerings.
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED PRIOR OWNED AFTER
TO OFFERINGS(2) NUMBER OF OFFERINGS(2)
------------------- SHARES -------------------
NAME NUMBER PERCENT(3) OFFERED(2) NUMBER PERCENT(3)
- ---- ------ ---------- ---------- ------ ----------
5% Shareholders:
Directors and Executive Officers:
Jon S. Corzine(1).........................
Henry M. Paulson, Jr.(1)..................
Robert J. Hurst(1)........................
Roy J. Zuckerberg(1)......................
John A. Thain(1)..........................
John L. Thornton(1).......................
All Directors and Executive Officers as a
group ( persons).................
- ---------------
(1) c/o The Goldman Sachs Group, Inc., 85 Broad Street, New York, New York
10004. Excludes any shares of Common Stock subject to the Shareholders'
Agreement that are owned by other Parties to the Shareholders' Agreement.
While each of Messrs. Corzine, Paulson, Hurst, Zuckerberg, Thain and
Thornton is a party to the Shareholders' Agreement and a member of the
Shareholders' Committee, each disclaims beneficial ownership of the shares
of Common Stock subject to the Shareholders' Agreement other than those
specified above for each such person individually. See "Certain
Relationships and Related Transactions -- Shareholders' Agreement".
(2) For purposes of this table, information as to the shares of Common Stock
assumes that the Underwriters' options to purchase additional shares are not
exercised. For purposes of this table, "beneficial ownership" is determined
pursuant to Rule 13d-3 under the Securities Exchange Act of 1934, as
amended, pursuant to which a person or group of persons is deemed to have
"beneficial ownership" of any shares of Common Stock which such person has
the right to acquire within 60 days after the date of this Prospectus. For
purposes of computing the percentage of outstanding shares of Common Stock
held by each person or group of persons named above, any shares which such
person or persons has the right to acquire within 60 days after the date of
this Prospectus are deemed to be outstanding but are not deemed to be
outstanding for the purpose of computing the percentage ownership of any
other person.
(3) Based on shares of Common Stock outstanding prior to the
consummation of the Offerings and shares of Common Stock outstanding
after the consummation of the Offerings.
90
92
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The description of certain provisions of the agreements or other documents
set forth below in this section does not purport to be complete and is qualified
in its entirety by reference to the form of such agreements or other documents,
each of which is filed as an exhibit to the Registration Statement of which this
Prospectus is a part.
INCORPORATION AND RELATED TRANSACTIONS
Simultaneously with the consummation of the Offerings, we will complete a
number of transactions in order to have the Company succeed to the business of
Group L.P.
The principal incorporation transactions (the "Incorporation Transactions")
and related transactions (the "Related Transactions") are summarized below:
INCORPORATION TRANSACTIONS
- - The Goldman Sachs Corporation ("GS Corp."), which is the general partner of
Group L.P., will merge into GS Inc. In this transaction, the PLPs who are
shareholders of GS Corp. will receive Common Stock of GS Inc. and the other
shareholders in GS Corp. will receive Common Stock of GS Inc., Junior
Subordinated Debentures or cash (or a combination thereof). It is expected
that this transaction will result in the issuance of shares of Common
Stock, $ principal amount of Junior Subordinated Debentures and the
payment of $ ;
- - The PLPs will exchange their interests in Group L.P. and certain affiliates
for shares of Common Stock of GS Inc.;
- - The RLPs will exchange their interests in Group, L.P. and certain affiliates
for Common Stock of GS Inc., Junior Subordinated Debentures or cash (or a
combination thereof). It is expected that these transactions will result in
the issuance of approximately shares of Common Stock of GS Inc., $
principal amount of Junior Subordinated Debentures and the payment of
approximately $ million;
- - SBCM will exchange its interests in Group L.P. and GS&Co. for shares
of Common Stock and shares of Nonvoting Common Stock;
- - KAA will exchange its interests in Group L.P. for shares of Common
Stock; and
- - After all the interests of Group L.P. have been transferred to GS Inc., Group
L.P. will be merged into GS Inc.
RELATED TRANSACTIONS
- - The Formula RSUs, Discretionary RSUs and Discretionary Options will be
granted, the initial irrevocable contribution of shares of Common Stock to the
DCP will be made and employees will be selected to participate in the DCP;
- - After the closing of the Offerings, we will make a $ contribution to
a Goldman Sachs charitable foundation; and
- - At or about the time of the Offerings, we plan to make the QUIPS Offering. See
"Description of Capital Securities".
PARTNERSHIP CAPITAL ADJUSTMENTS
Prior to our conversion to corporate form, we will adjust our partners'
capital by, among other things, making a cash distribution of $ . This
distribution is not conditioned on the incorporation of the Firm or the
completion of the Offerings.
SHAREHOLDERS' AGREEMENT
PERSONS AND SHARES COVERED
Each PLP and each other person who is a Managing Director on the IPO Date
or becomes a Managing Director thereafter will be a party to the Shareholders'
Agreement (collectively, the "Parties"). After completion of the Offerings,
approximately shares of Common Stock will be subject to the
Shareholders' Agreement.
The shares covered by the Shareholders' Agreement (the "Covered Shares")
include (i) all of the shares of Common Stock
91
93
received by the PLPs in the Incorporation Transactions (with certain limited
exceptions that aggregate less than shares), (ii) all shares of Common
Stock held for Parties in, or received by Parties from, the DCP, (iii) all
shares of Common Stock received by Parties pursuant to the Formula or
Discretionary Awards and (iv) all shares of Common Stock received by the Parties
from the Company through any employee compensation, benefit or similar plan. See
"Management -- The Employee IPO Awards" for a description of the terms of the
Formula and Discretionary RSUs, the Discretionary Options and the DCP. Covered
Shares do not include any shares of Common Stock purchased by a Party in the
Directed Offering or in the open market.
TRANSFER RESTRICTIONS
Covered Shares held by Parties to the Shareholders' Agreement are subject
to transfer restrictions. The Shareholders' Agreement requires each Party for so
long as such Party is an employee of the Company to beneficially own a number of
shares of Common Stock at least equal to 25% of the total number of Covered
Shares ever owned by such Party while a Party to the Shareholders' Agreement
(the "General Transfer Restriction").
Each Party also agrees in the Shareholders' Agreement to comply with the
Underwriters' 180-day lockup arrangement described under "Underwriting" and with
the Company's hedging policies. In addition, each Party who is an employee of
the Firm agrees to comply with certain "black-out" restrictions relating to
future offerings of the Firm, with the trading restrictions imposed by the
Company as part of its internal trading policies and with reasonable
restrictions that may be imposed by the Company from time to time to the extent
required to enable the Company to account for a business combination using the
pooling-of-interests method of accounting.
The PLPs will also be subject to significant limitations on their ability
to transfer shares of Common Stock received in connection with the Incorporation
Transactions. Under these restrictions, each PLP has agreed that such PLP will
not transfer the shares acquired in exchange for the PLP's interests in Group
L.P. and certain of its affiliates until the third anniversary of the date of
this Prospectus (the "PLP Transfer Restriction" and, together with the General
Transfer Restriction, the "Transfer Restrictions"). The PLP Transfer Restriction
will lapse as to such Covered Shares in equal instalments on each of the third,
fourth and fifth anniversaries of the date of this Prospectus.
The PLP Transfer Restriction may be waived or amended only with the
approval of the Shareholders' Committee and the affirmative vote of 60% of the
votes cast by the Voting Interests (as defined below), except in the case of a
third-party tender or exchange offer or an Extraordinary Transaction, in which
case it may be waived or amended by the affirmative vote of 60% of the votes
cast by the Voting Interests alone. The Shareholders' Committee also has the
power to waive the Transfer Restrictions in particular circumstances as
discussed below under "-- Administration". The Transfer Restrictions applicable
to a Party terminate upon the death or permanent disability of such Party. If
the Shareholders' Agreement is terminated prior to the expiration or termination
of the PLP Transfer Restriction, the PLP Transfer Restriction will continue to
apply unless waived or amended by the Board of Directors of the Company.
The term "transfer" for purposes of the restrictions described above,
includes any sale, transfer, pledge or other disposition, including hedging
arrangements.
VOTING
Prior to any vote of the shareholders of the Company, the Shareholders'
Agreement requires a separate, preliminary vote on each matter upon which a vote
of the shareholders of the Company is proposed to be taken (the "Preliminary
Vote"). In general, each Covered Share held by Parties who are employees of the
Firm and other Covered Shares subject to the Transfer Restrictions will be voted
in accordance with the majority of the votes cast by the Voting Interests in the
Preliminary Vote. In elections of directors,
92
94
each such Covered Share will be voted in accordance with the plurality of the
votes cast by the Voting Interests in the Preliminary Vote. In the case of a
proposal relating to an Extraordinary Transaction, each such Covered Share will
be voted against such proposal unless such proposal is approved by the
affirmative vote of not less than 60% of the votes cast by the Voting Interests.
"Voting Interests" are Covered Shares of all Parties until January 1, 2000 and
thereafter are Covered Shares beneficially owned by Parties who are employees of
the Firm. "Extraordinary Transactions" include mergers, consolidations,
mandatory share exchanges, a sale of all or substantially all of the Firm's
assets and similar events upon which a vote of the shareholders is to be taken.
OTHER RESTRICTIONS
The Shareholders' Agreement also prevents the Parties from engaging in
certain activities with persons who are not Parties to the Shareholders'
Agreement ("Non-Parties"). Among other things, a Party may not solicit a proxy
from any Non-Party other than pursuant to the recommendation of the Board of
Directors; deposit any Covered Shares in a voting trust or subject any Covered
Shares to any voting agreement or arrangement that includes any Non-Party; or
form, join or in any way participate in a "group" with any Non-Party.
TERM, AMENDMENT AND TERMINATION
The Shareholders' Agreement is to continue in effect until the earlier of
January 1, 2050 and the date on which 60% of the votes cast by the Voting
Interests agree to terminate it. The Shareholders' Agreement can generally be
amended by a majority of the votes cast by the Voting Interests except that (i)
60% of the votes cast by the Voting Interests are required to waive the Transfer
Restrictions in connection with tender and exchange offers and the approval of
Extraordinary Transactions and (ii) 60% of the votes cast by the Voting
Interests and the consent of the Shareholders' Committee are required to waive
the PLP Transfer Restriction in circumstances other than those described in
clause (i). In the event of any transaction in which a third party succeeds to
the business of the Company and in which the parties to the Shareholders'
Agreement hold securities of such third party, the Shareholders' Agreement will
remain in full force and effect as to the securities of such third party, and
such third party shall succeed to the rights and obligations of the Company
under the Shareholders' Agreement.
ADMINISTRATION
A Shareholders' Committee will be formed to administer the terms and
provisions of the Shareholders' Agreement, and a majority of its members will
have the power to waive the Transfer Restrictions to permit Parties to (i)
participate as sellers in underwritten offerings, self tender offers and share
repurchase programs by the Company, (ii) transfer Covered Shares to charities,
including charitable foundations, and (iii) transfer Covered Shares in specific
transactions (for example, to immediate family members and trusts). The
Shareholders' Committee will consist of those Parties who are employees of the
Firm and members of the Board of Directors of the Company. Thus, the
Shareholders' Committee will initially consist of Messrs. Corzine, Paulson,
Hurst, Zuckerberg, Thain and Thornton.
INSTRUMENT OF INDEMNIFICATION
In connection with the Offerings, the Company will enter into an Instrument
of Indemnification (the "Instrument of Indemnification"). The Instrument of
Indemnification will cover certain former partners of the Firm, including the
PLPs, including each current director and executive officer of GS Inc., the
RLPs, SBCM and KAA (each an "Indemnitee"). Under the Instrument of
Indemnification, in the event any Indemnitee is, or is threatened to be, made a
party to an action, suit or proceeding by reason of the fact that such
Indemnitee was (i) a general or limited partner, shareholder, member, director,
officer, employee or agent (each, a "Designated Capacity") of Group L.P. or
certain of its affiliates or (ii) serving or served, at the request of Group
L.P. or certain of its affiliates, in a Designated Capacity in another
enterprise, the Company is, subject to certain
93
95
exceptions, obligated to indemnify and hold such Indemnitee harmless from any
losses, damages or expenses incurred by such Indemnitee in such action, suit or
proceeding. The Instrument of Indemnification does not duplicate the obligations
of the Company under the Tax Indemnification Agreement described below. The
indemnification obligation of the Company under the Instrument of
Indemnification also extends to the indemnification obligations that certain
Indemnitees, including each current director and executive officer of GS Inc.,
may have to other Indemnitees.
The Instrument of Indemnification also provides that the Company will,
subject to certain exceptions, release each Indemnitee from all actions, suits
or other claims which the Company, as a successor to Group L.P., may have
arising out of an Indemnitee's partnership or other interest in Group L.P. or
certain of its affiliates or arising out of the conduct of such Indemnitee in
connection with such Indemnitee's duties in the conduct of the business of Group
L.P. or such affiliates.
TAX INDEMNIFICATION AGREEMENT
An entity that has historically operated in corporate form generally is
liable for any adjustments to the corporation's taxes for periods prior to its
initial public offering. In contrast, the partners of Group L.P., rather than
the Company, will be liable for any adjustments to many taxes (including U.S.
federal and state income taxes) attributable to the operations of Group L.P. and
its affiliates prior to the Offerings. In connection with the Offerings, the
Company will enter into an agreement (the "Tax Indemnification Agreement") to
indemnify certain former limited partners of Group L.P., including the PLPs,
each current director and executive officer of GS Inc., the RLPs, SBCM and KAA
(collectively, the "Tax Indemnitees"), against certain increases in each such
Tax Indemnitee's taxes that relate to activities of Group L.P. or certain of its
affiliates in respect of periods prior to the Offerings ("Increased Taxes"). The
Company will be required to make additional payments to offset any taxes payable
by a Tax Indemnitee in respect of payments made pursuant to the Tax
Indemnification Agreement only to the extent the payments made to that Tax
Indemnitee exceed a fixed amount. Any payment of Increased Taxes by the Company
will be offset by any tax benefit received by the Tax Indemnitee.
The Tax Indemnification Agreement includes provisions that permit the
Company to control any tax proceeding or contest which might result in the
Company being required to make a payment under the Tax Indemnification
Agreement.
94
96
DESCRIPTION OF CAPITAL STOCK
GENERAL
Pursuant to the Company's Amended and Restated Certificate of
Incorporation, the Company's authorized capital stock consists of
shares, of which (i) shares of par value of $.01
per share are a separate class designated as preferred stock ("Preferred
Stock"), (ii) shares of par value of $.01 per share are a
separate class designated as common stock ("Common Stock"), approximately
shares of which will be outstanding as of the closing of the
Offerings, and (iii) shares of par value $.01 per share are a
separate class designated as nonvoting common stock ("Nonvoting Common Stock"),
approximately shares of which will be outstanding as of the
closing of the Offerings. All outstanding Common Shares are, and the shares of
Common Stock offered hereby will be, when issued and sold, validly issued, fully
paid and nonassessable.
The Shareholders' Agreement contains provisions relating to the voting and
disposition of certain shares of Common Stock owned by the parties thereto. See
"Certain Relationships and Related Transactions -- Shareholders' Agreement".
PREFERRED STOCK
The authorized capital stock of the Company includes shares
of Preferred Stock, of which shares have been designated as
Series A Participating Preferred Stock and reserved for issuance upon exercise
of the Rights. See "-- Shareholder Protection Rights" below. The Company's Board
of Directors is authorized to divide the Preferred Stock into series and, with
respect to each series, to determine the powers, preferences and rights and the
qualifications, limitations and restrictions thereof, including the dividend
rights, conversion rights, voting rights, redemption rights and terms,
liquidation preferences, sinking fund provisions, the number of shares
constituting the series and the designation of such series. The Board of
Directors could, without shareholder approval, issue Preferred Stock with voting
and other rights that could adversely affect the voting power of the holders of
Common Stock and which could have certain anti-takeover effects.
Subject to the rights of the holders of any series of Preferred Stock, the
number of authorized shares of any series of Preferred Stock may be increased or
decreased (but not below the number of shares thereof then outstanding) by
resolution adopted by the Board of Directors of the Company and approved by the
affirmative vote of the holders of a majority of the voting power of all
outstanding shares of capital stock entitled to vote on the matter, voting as a
single class.
COMMON STOCK
Each holder of Common Stock is entitled to one vote for each share owned of
record on all matters submitted to a vote of shareholders. There are no
cumulative voting rights. Accordingly, the holders of a majority of the shares
of Common Stock voting for the election of directors can elect all the directors
if they choose to do so, subject to any voting rights of holders of Preferred
Stock to elect directors. See "Risk Factors -- The Firm Will Be Controlled by
Its Principal Shareholders and Will Be Subject to Anti-Takeover Provisions".
Subject to the preferential rights of any outstanding series of Preferred Stock,
the holders of Common Stock, together with the holders of the Nonvoting Common
Stock, will be entitled to such dividends as may be declared from time to time
by the Board of Directors from funds legally available therefor, and will be
entitled, after payment of all prior claims, to receive pro rata all assets of
the Company upon the liquidation, dissolution or winding up of the Company (with
the shares of the Common Stock and the Nonvoting Common Stock being considered
as a single class for this purpose). Any dividend in shares of Common Stock paid
on or with respect to shares of Common Stock may be paid only with shares of
Common Stock. Other than the Shareholder Protection Rights discussed below,
holders of Common Stock have no redemption or conversion rights or
95
97
preemptive rights to purchase or subscribe for securities of the Company.
NONVOTING COMMON STOCK
The Nonvoting Common Stock will have the same rights and privileges as, and
will rank equally and share ratably with, and be identical in all respects as to
all matters to, the Common Stock, except that the Nonvoting Common Stock will
have no voting rights other than such rights as may be required by law.
The Board of Directors will not declare or pay dividends, and no dividend
will be paid, with respect to any outstanding share of Common Stock or Nonvoting
Common Stock, unless, simultaneously, the same dividend is paid with respect to
each share of Common Stock and Nonvoting Common Stock, except that in the case
of any dividend in the form of capital stock of a subsidiary of the Company, the
capital stock of the subsidiary distributed to holders of Common Stock may
differ from the capital stock of the subsidiary distributed to holders of the
Nonvoting Common Stock to the extent and only to the extent that the Common
Stock and the Nonvoting Common Stock differ as provided in the Amended and
Restated Certificate of Incorporation. Any dividend in shares of Nonvoting
Common Stock paid on or with respect to Nonvoting Common Stock may be paid only
with shares of Nonvoting Common Stock.
All of the outstanding shares of Nonvoting Common Stock will be
beneficially owned by SBCM. The shares of Nonvoting Common Stock will
automatically convert into shares of Common Stock on a one-for-one basis upon
any transfer by SBCM of the shares of Nonvoting Common Stock to a third party.
SHAREHOLDER PROTECTION RIGHTS
Attached to each Common Share is a Shareholder Protection Right (the
"Right"). Until it is announced that a person or group has acquired 15% or more
of the Company's Common Stock (exclusive of (i) Parties to the Shareholders'
Agreement in their capacities as such and (ii) certain other persons) (an
"Acquiring Person") or ten days after a person or group commences a tender offer
that will result in such person or group owning 15% or more of the Common Stock,
the Rights will be evidenced by the certificates for the Common Shares, will
automatically trade with the Common Shares and will not be exercisable.
Thereafter, separate Rights certificates will be distributed and each Right will
entitle its holder to purchase 1/100 of a share of Series A Participating
Preferred Stock having economic and voting terms similar to those of one Common
Share for an exercise price of $ .
Upon announcement by the Company that any person or group has become an
Acquiring Person (the "Flip-in Date") each Right (other than Rights beneficially
owned by any Acquiring Person or transferees thereof, which Rights become void)
will entitle its holder to purchase, for the exercise price, a number of Common
Shares having a market value of twice the exercise price. Also, if after an
Acquiring Person controls the Company's Board of Directors, the Company is
involved in a merger or sells more than 50% of its assets or earning power or is
involved with an Acquiring Person in certain "self-dealing" transactions (or has
entered an agreement to do any of the foregoing) and, in the case of a merger
where the Acquiring Person will receive different treatment than all other
shareholders, each Right will entitle its holder to purchase, for the exercise
price, a number of shares of common stock of the Acquiring Person having a
market value of twice the exercise price. If any person or group acquires
between 15% and 50% of the Common Stock, the Company's Board of Directors may,
at its option, exchange one Common Share for each Right.
The Rights may be redeemed by the Board of Directors for $0.001 per Right
prior to the Flip-in Date.
The Rights will not prevent a takeover of the Company. However, the Rights
may cause substantial dilution to a person or group that acquires 15% or more of
the Common Stock unless the Rights are first redeemed by the Board of Directors
of the Company. Nevertheless, the Rights should not interfere with a transaction
that the Board of Directors believes is in the best interests of
96
98
the Company and its shareholders because the Rights can be redeemed on or prior
to the close of business on the Flip-in Date, before the consummation of such
transaction.
LIMITATION OF LIABILITY AND
INDEMNIFICATION MATTERS
The Amended and Restated Certificate of Incorporation of the Company
provides that a director of the Company will not be liable to the Company or its
shareholders for monetary damages for breach of fiduciary duty as a director,
except in certain cases where liability is mandated by the Delaware General
Corporation Law (the "DGCL"). The By-Laws of the Company provide for
indemnification, to the fullest extent permitted by law, of any person made or
threatened to be made a party to any action, suit or proceeding by reason of the
fact that such person is or was a director or officer (as such term is defined
in the Company's By-Laws) of the Company, or is or was a director of a
Subsidiary (as such term is defined in the Company's By-Laws) of the Company, is
or was a member of the Shareholders' Committee acting pursuant to the
Shareholders' Agreement or, at the request of the Company, serves or served as a
director or officer of or in any other capacity for any other enterprise,
against all expenses, liabilities, losses and claims actually incurred or
suffered by such person in connection with the action, suit or proceeding. The
By-Laws of the Company also provide that, to the extent authorized from time to
time by the Board of Directors, the Company may provide to any one or more
employees and other agents of the Company or any Subsidiary or other enterprise,
rights of indemnification and to receive payment or reimbursement of expenses,
including attorneys' fees, that are similar to the rights conferred by the
By-Laws on directors and officers of the Company or any Subsidiary or other
enterprise.
SECTION 203 OF THE DGCL
Upon completion of the Offering, the Company will be subject to the
provisions of section 203 ("Section 203") of the DGCL. In general, Section 203
prohibits a publicly held Delaware corporation from engaging in a "business
combination" with an "interested stockholder" for a period of three years after
the date of the transaction in which the person became an interested
stockholder, unless the business combination is approved in a prescribed manner.
A "business combination" includes a merger, asset sale or other transaction
resulting in a financial benefit to the interested stockholder. An "interested
stockholder" is a person who, together with affiliates and associates, owns (or,
in certain cases, within three years prior, did own) 15% or more of the
corporation's voting stock. Under Section 203, a business combination between
the Company and an interested stockholder is prohibited unless it satisfies one
of the following conditions: (i) the Company's Board of Directors must have
previously approved either the business combination or the transaction that
resulted in the stockholder becoming an interested stockholder or (ii) on
consummation of the transaction that resulted in the stockholder becoming an
interested stockholder, the interested stockholder owned at least 85% of the
voting stock of the Company outstanding at the time the transaction commenced
(excluding, for purposes of determining the number of shares outstanding, shares
owned by (a) persons who are directors and also officers and (b) employee stock
plans, in certain instances) or (iii) the business combination is approved by
the Board of Directors and authorized at an annual or special meeting of the
stockholders by the affirmative vote of at least 66 2/3% of the outstanding
voting stock which is not owned by the interested stockholder. Prior to the
execution of the Shareholders' Agreement, the Board of Directors will approve
the Shareholders' Agreement for purposes of Section 203.
CERTAIN ANTI-TAKEOVER MATTERS
The Amended and Restated Certificate of Incorporation and By-Laws of the
Company will, upon consummation of the Offerings, include a number of provisions
that may have the effect of encouraging persons considering unsolicited tender
offers or other unilateral takeover proposals to negotiate with the Board of
Directors rather than pursue non-
97
99
negotiated takeover attempts. These provisions include:
CLASSIFIED BOARD OF DIRECTORS
The Amended and Restated Certificate of Incorporation of the Company
provides for a Board of Directors divided into three classes, with one class to
be elected each year to serve for a three-year term (except that the terms of
the initial classes of directors will expire at the annual meetings of
shareholders in 1999, 2000 and 2001). As a result, at least two annual meetings
of shareholders may be required for the shareholders to change a majority of the
Board of Directors. In addition, the shareholders of the Company can only remove
directors for cause by the affirmative vote of the holders of not less than
66 2/3% of the outstanding shares of capital stock of the Company entitled to
vote in the election of directors and only the Board of Directors may fill
vacancies on the Board. The classification of directors and the inability of
shareholders to remove directors without cause and to fill vacancies on the
Board will make it more difficult to change the composition of the Board of
Directors, but will promote a continuity of existing management.
CONSTITUENCY PROVISION
Pursuant to the Company's Amended and Restated Certificate of
Incorporation, a director of the Company may (but is not required to), in taking
any action (including action that may involve or relate to a change or potential
change in control of the Company), consider the effects that the Company's
actions may have on other interests or persons (including employees) in addition
to the shareholders of the Company.
ADVANCE NOTICE REQUIREMENTS
The By-Laws establish advance notice procedures with regard to shareholder
proposals relating to the nomination of candidates for election as directors or
new business to be brought before meetings of shareholders of the Company. These
procedures provide that notice of such shareholder proposals must be timely
given in writing to the Secretary of the Company prior to the meeting at which
the action is to be taken. Generally, to be timely, notice must be received at
the principal executive offices of the Company not less than 75 days nor more
than 100 days prior to the first anniversary date of the annual meeting for the
preceding year. The notice must contain certain information specified in the
By-Laws. The Company anticipates that its 1999 annual meeting will be held in
April 1999.
SPECIAL MEETINGS OF SHAREHOLDERS
The Amended and Restated Certificate of Incorporation and By-Laws of the
Company deny shareholders the right to call a special meeting of shareholders.
The Amended and Restated Certificate of Incorporation and By-Laws provide that
special meetings of the shareholders may be called only by a majority of the
Company's Board of Directors.
NO WRITTEN CONSENT OF SHAREHOLDERS
The Amended and Restated Certificate of Incorporation of the Company
requires all shareholder actions to be taken by a vote of the shareholders at an
annual or special meeting, and denies the power of shareholders of the Company
to consent in writing, without a meeting, to the taking of any action.
MAJORITY VOTE NEEDED FOR SHAREHOLDER PROPOSALS
The By-Laws of the Company require that any shareholder proposal be
approved by a majority of all of the outstanding shares of Common Stock and not
only a majority of the shares present at the meeting and entitled to vote. This
requirement may make it more difficult to approve shareholder resolutions.
AMENDMENT OF BY-LAWS AND CHARTER
The Amended and Restated Certificate of Incorporation of the Company
requires the approval of not less than 85% of the voting power of all
outstanding shares of the Company's capital stock entitled to vote to amend any
By-Law by shareholder action or those provisions of the Amended and Restated
Certificate of Incorporation described in this section. These provisions will
make it more difficult to dilute the anti-takeover effects of
98
100
the By-Laws and the Amended and Restated Certificate of Incorporation.
BLANK CHECK PREFERRED STOCK
The Amended and Restated Certificate of Incorporation of the Company
provides for authorized shares of Preferred Stock, of which none
is outstanding and shares have been designated as the Series A
Participating Preferred Stock for delivery upon exercise of the Rights. The
existence of authorized but unissued Preferred Stock may enable the Board of
Directors to render more difficult or to discourage an attempt to obtain control
of the Company by means of a merger, tender offer, proxy contest or otherwise.
For example, if in the due exercise of its fiduciary obligations, the Board of
Directors were to determine that a takeover proposal is not in the Company's
best interests, the Board of Directors could cause shares of Preferred Stock to
be issued without shareholder approval in one or more private offerings or other
transactions that might dilute the voting or other rights of the proposed
acquiror or insurgent shareholder or shareholder group. In this regard, the
Amended and Restated Certificate of Incorporation grants the Board of Directors
broad power to establish the rights and preferences of authorized and unissued
Preferred Stock. The issuance of shares of Preferred Stock pursuant to the Board
of Directors' authority described above could decrease the amount of earnings
and assets available for distribution to holders of Common Shares and adversely
affect the rights and powers, including voting rights, of such holders and may
have the effect of delaying, deterring or preventing a change in control of the
Company. The Board of Directors currently does not intend to seek shareholder
approval prior to any issuance of Preferred Stock, unless otherwise required by
law.
LISTING
The Company intends to list the Common Stock on the NYSE.
TRANSFER AGENT
The transfer agent for the Common Stock will be ChaseMellon Shareholder
Services, L.L.C.
99
101
DESCRIPTION OF CAPITAL SECURITIES
At or about the time of the Offerings, the Firm plans to issue and sell up
to $ in aggregate liquidation amount of Cumulative Quarterly
Income Preferred Securities. The Firm expects to use the net proceeds from the
QUIPS Offering for general corporate purposes. See "Use of Proceeds" and "Pro
Forma Consolidated Financial Information".
The QUIPS will represent preferred beneficial interests in a special
purpose trust. All of the common beneficial interests of the trust will be owned
by the Firm. The holders of the QUIPS will be entitled to receive from the trust
cumulative cash distributions that will accrue on the liquidation amount of the
QUIPS at a specified annual rate (to be determined at the pricing for the
offering) and will be payable periodically. The Firm will be entitled to defer
payment of these distributions at any time and from time to time, for certain
periods, but not beyond the maturity of the QUIPS. During any deferral period,
or after certain defaults, the Firm will not be permitted to declare or pay any
cash dividends on the Common Stock or to repurchase any Common Stock for cash.
Deferred distributions will continue to accrue and be payable when the relevant
deferral period ends. Upon the occurrence of specified events of default, the
holders of the QUIPS will be entitled to exercise creditor rights.
The trust will use the net proceeds from the sale of QUIPS, together with
certain other proceeds, to purchase $ principal amount of
subordinated debentures to be issued by GS Inc. The payment terms of the
debentures will match those of the QUIPS and amounts paid on the debentures will
be used by the trust to fund amounts payable on the QUIPS. Through the
debentures and related agreements, GS Inc. will effectively guarantee all the
trust's obligations under the QUIPS. The obligations of GS Inc. in respect of
the debentures and the QUIPS will be subordinated in right of payment to
substantially all of its debt but will rank senior in right of payment to the
Common Shares.
100
102
SHARES ELIGIBLE FOR FUTURE SALE
Prior to the Offerings, there has been no public market for the Common
Stock. Future sales of substantial amounts of Common Stock in the public market,
or the perception that such sales could occur, could adversely affect the
prevailing market price of the Common Stock. Upon completion of the Offerings,
there will be shares of Common Stock outstanding. Of these
shares, shares of Common Stock expected to be sold in the
Offerings (excluding the Directed Offering) will be freely transferable without
restriction or further registration under the Securities Act, except for shares
purchased by "affiliates" of the Company, as that term is defined in Rule 144.
Of the remaining shares of Common Stock outstanding up to
shares of Common Stock will be sold in the Directed Offering and
shares will be "restricted securities", as that term is defined in Rule 144. Of
these restricted shares:
- - shares will be held by the PLPs will not be transferrable until
the third, fourth and fifth anniversaries of the date of this Prospectus,
unless these restrictions are waived. See "Certain Relationships and Related
Transactions--Shareholders' Agreement";
- - shares held by the RLPs will be freely transferrable pursuant
to Rule 144(k) commencing December 1, 1998; and
- - shares held by the DCP will not be deliverable to the plan
participants until the third, fourth and fifth anniversaries of the date of
this Prospectus, assuming the relevant conditions are satisfied. See
"Management--The Employee IPO Award".
All the restricted shares described above, as well as the shares sold in
the Directed Offering, will be subject to the 180-day Underwriters' lockup
described below.
The Firm, the Selling Shareholders, the parties to the Shareholders'
Agreement, including all of the directors and executive officers of GS Inc., the
RLPs and the purchasers in the Directed Offering have agreed with the
Underwriters not to dispose of or hedge any of their Common Stock or securities
convertible into or exchangeable for shares of Common Stock during the period
from the date of this Prospectus continuing through the date 180 days after the
date of this Prospectus, except with the prior written consent of GS&Co.
Shares of Common Stock underlying the Formula RSUs and Discretionary RSUs
will be deliverable beginning on the first and third anniversaries of the date
of grant, respectively, assuming the relevant conditions are satisfied. The
Discretionary Options will be exercisable beginning on the third anniversary of
the date of grant, assuming the relevant conditions are satisfied. See
"Management--The Employee IPO Awards" for a discussion of the terms of the
Formula and Discretionary RSUs and the Discretionary Options.
In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated), including an affiliate, who has beneficially owned
"restricted securities" for at least one year would be entitled to sell within
any three-month period a number of shares that does not exceed the greater of
(i) 1% of the number of shares of Common Stock then outstanding (which will
equal approximately shares immediately after the Offerings) or
(ii) the average weekly trading volume of the Common Stock on the NYSE during
the four calendar weeks preceding the filing of a notice of Form 144 with
respect to such sale with the SEC. Sales under Rule 144 are also subject to
certain other requirements regarding the manner of sale, notice and availability
of current public information about the Company. Under Rule 144(k), a person who
is not, and has not been at any time during the 90 days preceding a sale, an
affiliate of the Company and who has beneficially owned the shares proposed to
be sold for at least two years (including the holding period of any prior owner
except an affiliate), is entitled to sell such shares without complying with the
manner of sale, public information, volume limitation or notice provisions of
Rule 144.
101
103
VALIDITY OF COMMON STOCK
The validity of the Common Stock offered hereby will be passed upon for the
Company by Sullivan & Cromwell, New York, New York, and for the Underwriters by
Cleary, Gottlieb, Steen & Hamilton, New York, New York. Certain legal matters
will be passed upon by one of the Company's Co-General Counsels, Robert J. Katz
or Gregory K. Palm. Sullivan & Cromwell has in the past represented and
continues to represent one or more of the Underwriters and their affiliates in a
variety of matters. Cleary, Gottlieb, Steen & Hamilton has in the past
represented and continues to represent the Company in a variety of matters.
EXPERTS
The financial statements of the Firm as of November 29, 1996 and November
28, 1997 and for each of the three fiscal years in the fiscal period ended
November 28, 1997 and, as of and for the six months ended May 29, 1998, included
in this Prospectus have been so included in reliance on the report of
PricewaterhouseCoopers LLP independent accountants, given on the authority of
said firm as experts in auditing and accounting.
The income statement data and balance sheet data (excluding adjusted
assets) set forth in "Selected Consolidated Financial Data" for each of the five
fiscal years ended November 28, 1997 and the six months ended May 29, 1998
included in this Prospectus have been so included in reliance on the report of
PricewaterhouseCoopers LLP, independent accountants, given on the authority of
said firm as experts in auditing and accounting.
With respect to the unaudited interim financial information as of May 30,
1997 and for the period ended May 30, 1997 included in this Prospectus,
PricewaterhouseCoopers LLP have reported that they have applied limited
procedures in accordance with professional standards for a review of such
information. However, their separate report included herein states that they did
not audit and they do not express an opinion on that interim financial
information. Accordingly, the degree of reliance on their report on such
information should be restricted in light of the limited nature of the review
procedures applied. The accountants are not subject to the liability provisions
of Section 11 of the Securities Act for their report on the unaudited interim
financial information because this report is not a "report" or a "part" of the
Registration Statement prepared or certified by the accountants within the
meaning of Sections 7 and 11 of the Securities Act.
AVAILABLE INFORMATION
Upon completion of the Offerings, the Company will be required to file
annual, quarterly and current reports, proxy statements and other information
with the SEC. You may read and copy any documents filed by the Company at the
SEC's public reference room at 450 Fifth Street, N.W., Washington, D.C. 20549.
Please call the SEC at 1-800-SEC-0330 for further information on the public
reference room. The Company's filings with the SEC are also available to the
public through the SEC's Internet site at http://www. sec.gov and through the
New York Stock Exchange, Inc., 20 Broad Street, New York, New York 10005, on
which the Common Stock is listed. After the Offerings, we expect to provide
annual reports to our shareholders that include financial information reported
on by our independent public accountants.
The Company has filed a Registration Statement on Form S-1 with the SEC.
This Prospectus is a part of the Registration Statement and does not contain all
of the information in the Registration Statement. Whenever a reference is made
in this Prospectus to a contract or other document of the Company, please be
aware that such reference is not necessarily complete and that you should refer
to the exhibits that are a part of the Registration Statement for a copy of the
contract or other document. You may review a copy of the Registration Statement
at the SEC's public reference room in Washington, D.C. as well as through the
SEC's Internet site.
102
104
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Report of Independent Accountants........................... F-2
Review Report of Independent Accountants.................... F-3
Consolidated Statements of Earnings for the fiscal years
ended November 24, 1995, November 29, 1996 and November
28, 1997 and the six-month fiscal periods ended May 30,
1997 (unaudited) and May 29, 1998......................... F-4
Consolidated Statements of Financial Condition as of
November 29, 1996 and November 28, 1997 and May 30, 1997
(unaudited) and May 29, 1998.............................. F-5
Consolidated Statements of Changes in Partners' Capital for
the fiscal years ended November 24, 1995, November 29,
1996 and November 28, 1997 and the six-month fiscal
periods ended May 30, 1997 (unaudited) and May 29, 1998... F-6
Consolidated Statements of Cash Flows for the fiscal years
ended November 24, 1995, November 29, 1996 and November
28, 1997 and the six-month fiscal periods ended May 30,
1997 (unaudited) and May 29, 1998......................... F-7
Notes to Consolidated Financial Statements.................. F-8
F-1
105
REPORT OF INDEPENDENT ACCOUNTANTS
------------------------
To the Partners,
The Goldman Sachs Group, L.P.:
In our opinion, the accompanying consolidated statements of financial condition
and the related consolidated statements of earnings, changes in partners'
capital and cash flows (included on pages F-4 to F-24 of this Prospectus)
present fairly, in all material respects, the consolidated financial position of
The Goldman Sachs Group, L.P. and Subsidiaries at May 29, 1998, November 28,
1997 and November 29, 1996, and the results of their consolidated operations and
their consolidated cash flows for the six-month fiscal period ended May 29, 1998
and the three fiscal years in the period ended November 28, 1997, in conformity
with generally accepted accounting principles. These financial statements are
the responsibility of the Firm's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audits to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
We have also previously audited, in accordance with generally accepted auditing
standards, the consolidated statements of financial condition as of November 24,
1995, November 25, 1994 and November 26, 1993, and the related consolidated
statements of earnings, changes in partners' capital and cash flows for the
fiscal years ended November 25, 1994 and November 26, 1993 (none of which are
presented herein); and we expressed unqualified opinions on those consolidated
financial statements. In our opinion, the information set forth in the selected
historical income statement and balance sheet data (excluding adjusted assets)
for each of the five fiscal years in the period ended November 28, 1997 and the
six-month fiscal period ended May 29, 1998 (included on pages 30-31 of this
Prospectus) is fairly stated, in all material respects, in relation to the
consolidated financial statements from which it has been derived.
PricewaterhouseCoopers LLP
New York, New York
August 3, 1998.
F-2
106
REVIEW REPORT OF INDEPENDENT ACCOUNTANTS
------------------------
To the Partners,
The Goldman Sachs Group, L.P.:
We have reviewed the consolidated statement of financial condition of The
Goldman Sachs Group, L.P. and Subsidiaries, as of May 30, 1997, and the related
consolidated statements of earnings, changes in partners' capital and cash flows
for the six-month fiscal period ended May 30, 1997. These financial statements
are the responsibility of the Firm's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytic procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying financial statements for them to be in conformity
with generally accepted accounting principles.
Coopers & Lybrand L.L.P.
New York, New York
July 14, 1997.
F-3
107
THE GOLDMAN SACHS GROUP, L.P. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
SIX MONTHS
YEAR ENDED NOVEMBER ENDED MAY
----------------------------- ----------------------
1995 1996 1997 1997 1998
---- ---- ---- ---- ----
(unaudited)
(in millions)
REVENUES:
Investment banking................. $ 1,595 $ 2,113 $ 2,587 $1,094 $ 1,587
Trading and principal
investments...................... 1,916 2,496 2,303 1,362 2,426
Asset management and securities
services......................... 827 981 1,456 655 981
Interest income.................... 9,986 11,699 14,087 6,429 7,472
------- ------- ------- ------ -------
Total revenues........... 14,324 17,289 20,433 9,540 12,466
Interest expense, principally on
short-term funding............... 9,841 11,160 12,986 5,909 7,005
------- ------- ------- ------ -------
Revenues, net of interest
expense................ 4,483 6,129 7,447 3,631 5,461
OPERATING EXPENSES:
Compensation and benefits.......... 2,005 2,421 3,097 1,528 2,589
Brokerage, clearing and exchange
fees............................. 246 278 357 154 194
Market development................. 97 137 206 78 134
Communications and technology...... 173 173 208 93 121
Depreciation and amortization...... 186 172 178 81 104
Occupancy.......................... 175 154 168 78 93
Professional services and other.... 233 188 219 104 167
------- ------- ------- ------ -------
Total operating
expenses............... 3,115 3,523 4,433 2,116 3,402
Pre-tax earnings................... 1,368 2,606 3,014 1,515 2,059
Provision for taxes................ 20 207 268 143 328
------- ------- ------- ------ -------
Net earnings....................... $ 1,348 $ 2,399 $ 2,746 $1,372 $ 1,731
======= ======= ======= ====== =======
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
108
THE GOLDMAN SACHS GROUP, L.P. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
AS OF NOVEMBER AS OF MAY
------------------- ----------------------
1996 1997 1997 1998
---- ---- ---- ----
(unaudited)
(in millions)
ASSETS:
Cash and cash equivalents..................... $ 2,209 $ 1,328 $ 1,540 $ 2,210
Cash and securities segregated in compliance
with U.S. federal and other regulations
(principally U.S. government obligations)... 4,232 4,903 3,833 6,042
Receivables from brokers, dealers and clearing
organizations............................... 2,422 3,754 2,465 3,773
Receivables from customers and
counterparties.............................. 5,777 10,060 7,061 13,855
Securities borrowed........................... 36,654 51,058 45,253 67,343
Securities purchased under agreements to
resell...................................... 40,614 39,376 46,365 47,584
Right to receive securities................... -- -- -- 13,204
Financial instruments owned, at fair value:
Commercial paper, certificates of deposit
and time deposits........................ 1,053 1,477 1,275 1,864
U.S. government, federal agency and
sovereign obligations.................... 27,592 25,736 27,089 38,068
Corporate debt.............................. 9,414 11,321 11,115 12,342
Equities and convertible debentures......... 9,424 11,870 10,778 14,984
State, municipal and provincial
obligations.............................. 1,340 1,105 831 1,046
Derivative contracts........................ 8,769 13,788 9,474 17,020
Physical commodities........................ 1,206 1,092 646 416
Other assets.................................. 1,340 1,533 1,475 2,101
-------- -------- -------- --------
$152,046 $178,401 $169,200 $241,852
======== ======== ======== ========
LIABILITIES AND NET WORTH:
Short-term borrowings, including commercial
paper....................................... $ 17,337 $ 21,008 $ 20,668 $ 23,722
Payable to brokers, dealers and clearing
organizations............................... 1,220 952 959 1,023
Payable to customers and counterparties....... 16,547 22,995 21,075 30,047
Securities loaned............................. 11,347 17,627 15,426 22,075
Securities sold under agreements to
repurchase.................................. 50,012 44,057 50,058 64,499
Obligation to return securities............... -- -- -- 25,386
Financial instruments sold, but not yet
purchased, at fair value:
U.S. government, federal agency and
sovereign obligations.................... 19,938 22,371 23,444 15,894
Corporate debt.............................. 1,821 1,708 1,811 1,345
Equities and convertible debentures......... 2,957 6,357 4,100 6,619
Derivative contracts........................ 9,982 15,964 10,593 19,253
Physical commodities........................ 86 78 278 551
Other liabilities and accrued expenses........ 2,130 3,080 1,851 3,959
Long-term borrowings.......................... 12,376 15,667 12,782 20,275
-------- -------- -------- --------
145,753 171,864 163,045 234,648
Commitments and contingencies
Partners' capital reserved for income taxes
and potential withdrawals................... 984 430 546 566
Partners' capital............................. 5,309 6,107 5,609 6,638
-------- -------- -------- --------
$152,046 $178,401 $169,200 $241,852
======== ======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
109
THE GOLDMAN SACHS GROUP, L.P. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
SIX MONTHS
YEAR ENDED NOVEMBER ENDED MAY
------------------------------ ----------------------
1995 1996 1997 1997 1998
---- ---- ---- ---- ----
(unaudited)
(in millions)
Partners' capital, beginning of
period........................... $ 4,771 $ 4,905 $ 5,309 $ 5,309 $ 6,107
Additions:
Net earnings..................... 1,348 2,399 2,746 1,372 1,731
Capital contributions............ 276 4 89 75 6
------- ------- ------- ------- -------
Total additions.......... 1,624 2,403 2,835 1,447 1,737
Deductions:
Returns on capital and certain
distributions to partners..... (449) (473) (557) (288) (311)
Redemption of institutional
limited partners.............. (275) -- -- -- --
Transfers to partners' capital
reserved for income taxes and
potential withdrawals, net.... (766) (1,526) (1,480) (859) (895)
------- ------- ------- ------- -------
Total deductions......... (1,490) (1,999) (2,037) (1,147) (1,206)
------- ------- ------- ------- -------
Partners' capital, end of period... $ 4,905 $ 5,309 $ 6,107 $ 5,609 $ 6,638
======= ======= ======= ======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
110
THE GOLDMAN SACHS GROUP, L.P. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS
YEAR ENDED NOVEMBER ENDED MAY
------------------------------ ----------------------
1995 1996 1997 1997 1998
---- ---- ---- ---- ----
(unaudited)
(in millions)
Cash flows from operating activities:
Net earnings........................................ $ 1,348 $ 2,399 $ 2,746 $ 1,372 $ 1,731
Non-cash items included in net earnings:
Depreciation and amortization..................... 186 172 178 81 104
Deferred income taxes............................. (53) 85 32 32 24
Decreases/(increases) in operating assets and
liabilities:
Cash and securities segregated in compliance with
U.S. federal and other regulations.............. 1,056 (1,445) (670) 399 (1,140)
Net receivables from brokers, dealers and clearing
organizations................................... 1 169 (1,599) (304) 52
Net payables to customers and counterparties...... (322) 4,279 2,339 3,300 3,083
Securities borrowed, net.......................... 2,308 (17,075) (8,124) (4,520) (11,837)
Financial instruments owned, at fair value........ (3,118) (9,415) (7,439) (2,383) (14,897)
Financial instruments sold, but not yet purchased,
at fair value................................... 2,179 5,276 11,702 5,451 5,243
Other............................................. (164) 926 905 (322) 383
------- -------- ------- ------- --------
Net cash provided by/(used for) operating
activities................................... 3,421 (14,629) 70 3,106 (17,254)
------- -------- ------- ------- --------
Cash flows from investing activities:
Property, leasehold improvements and equipment...... (118) (258) (259) (125) (197)
Financial instruments owned, at fair value.......... 4 115 (360) (110) (159)
Acquisitions, net of cash acquired.................. -- (75) (74) (62) --
------- -------- ------- ------- --------
Net cash used for investing activities.......... (114) (218) (693) (297) (356)
------- -------- ------- ------- --------
Cash flows from financing activities:
Short-term borrowings............................... (4,705) 391 1,082 1,645 (863)
Securities sold under agreements to repurchase,
net............................................... (5,099) 16,012 (4,717) (5,705) 12,234
Issuance of long-term borrowings.................... 5,934 5,172 7,734 3,171 9,210
Repayment of long-term borrowings................... (3,624) (3,986) (1,855) (1,080) (1,025)
Capital contributions............................... 276 4 89 75 6
Returns on capital and certain distributions to
partners.......................................... (449) (473) (557) (288) (311)
Redemption of institutional limited partners........ (275) -- -- -- --
Partners' capital reserved for income taxes and
potential withdrawals............................. (835) (1,017) (2,034) (1,296) (759)
------- -------- ------- ------- --------
Net cash (used for)/provided by financing
activities................................... (8,777) 16,103 (258) (3,478) 18,492
------- -------- ------- ------- --------
Net (decrease)/increase in cash and cash
equivalents....................................... (5,470) 1,256 (881) (669) 882
Cash and cash equivalents, beginning of period........ 6,423 953 2,209 2,209 1,328
------- -------- ------- ------- --------
Cash and cash equivalents, end of period.............. $ 953 $ 2,209 $ 1,328 $ 1,540 $ 2,210
======= ======== ======= ======= ========
SUPPLEMENTAL DISCLOSURES:
Cash payments for interest approximated the related expense for each of the
fiscal periods presented. Payments of income taxes were not material.
A zero coupon bond of $32 million representing a portion of the acquisition
price of CIN Management Limited was recorded on the consolidated statement of
financial condition at November 29, 1996 and was excluded from the consolidated
statement of cash flows as it represented a non-cash item.
The adjustment of $17 billion related to the provisions of SFAS No. 125 that
were deferred under SFAS No. 127 was excluded from the consolidated statement of
cash flows for the six months ended May 1998 as it represents a non-cash item.
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
111
THE GOLDMAN SACHS GROUP, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. DESCRIPTION OF BUSINESS
The Goldman Sachs Group, L.P., a Delaware limited partnership ("Group
L.P."), together with its consolidated subsidiaries (collectively, the "Firm"),
is a global investment banking and securities firm that provides a wide range of
services worldwide to a substantial and diversified client base.
The Firm's activities are divided into three principal business lines:
- Investment Banking, which includes financial advisory services and
underwriting;
- Trading and Principal Investments, which includes fixed income, currency
and commodities ("FICC"), equities and principal investments; and
- Asset Management and Securities Services, which includes asset
management, securities services and commissions.
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Group L.P.
and its U.S. and international subsidiaries including Goldman, Sachs & Co.
("GS&Co.") and J. Aron & Company ("J. Aron") in New York, Goldman Sachs
International ("GSI") in London and Goldman Sachs (Japan) Ltd. ("GSJL") in
Tokyo. Certain reclassifications have been made to prior year amounts to conform
to the current presentation.
These consolidated financial statements have been prepared in accordance
with generally accepted accounting principles which require management to make
estimates and assumptions regarding trading inventory valuations, partner
retirements, the outcome of pending litigation and other matters that affect the
consolidated financial statements and related disclosure. These estimates and
assumptions are based on judgment and available information and, consequently,
actual results could be materially different from these estimates.
It is the opinion of management that all adjustments necessary for a fair
statement of the interim results of operations and financial condition for the
six-month fiscal period ended May 30, 1997 have been reflected therein. All such
adjustments were of a normal recurring nature.
Unless otherwise stated herein, all references to 1995, 1996 and 1997 refer
to the Firm's fiscal year ended, or the date, as the context requires, November
24, 1995, November 29, 1996 and November 28, 1997, respectively, and all
references to May 1997 and May 1998 refer to the Firm's six-month fiscal period
ended, or the date, as the context requires, May 30, 1997 and May 29, 1998,
respectively.
FINANCIAL INSTRUMENTS
Gains and losses on financial instruments and commission income and related
expenses are recorded on a trade date basis in the consolidated statements of
earnings. For purposes of the consolidated statements of financial condition
only, purchases and sales of financial instruments, including agency
transactions, are generally recorded on a settlement date basis. Recording such
transactions on a trade date basis would not result in a material adjustment to
the consolidated statements of financial condition.
Substantially all financial instruments used in the Firm's trading and
investment activities are carried at fair value and unrealized gains and losses
are recognized in income. Fair value is
F-8
112
THE GOLDMAN SACHS GROUP, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
based generally on listed market prices or broker or dealer price quotations. To
the extent prices are not readily available, fair value is based on either
internal valuation models or management's estimate of amounts that could be
realized under current market conditions, assuming an orderly liquidation over a
reasonable period of time. Certain over-the-counter ("OTC") derivative
instruments are valued using pricing models that consider current and
contractual market prices, time value and yield curve and/or volatility factors
of the underlying positions. Substantially all other non-trading instruments are
carried at fair value or amounts that approximate fair value.
DERIVATIVES
Derivative contracts are financial instruments that derive their fair value
from underlying assets, indices or reference rates, or any combination thereof,
such as futures, forwards, swaps or option contracts. Derivative financial
instruments exclude certain cash instruments, such as mortgage-backed
securities, interest-only and principal-only obligations and indexed debt
instruments, that derive their values or contractually required cash flows from
the price of some other security or index. Derivatives also exclude option
features that are embedded in cash instruments, such as the conversion features
and call provisions embedded in bonds.
The Firm has elected to include commodity-related contracts in its
derivative disclosures, although not required to do so, as these contracts may
be settled in cash or are readily convertible into cash.
Derivatives used for trading purposes are recorded at fair value and
included in "Derivative contracts" on the consolidated statements of financial
condition. These values are reported on a net-by-counterparty basis where
management believes a legal right of setoff exists under an enforceable master
netting agreement. Gains and losses on derivatives are included in "Trading and
Principal Investments" on the consolidated statements of earnings.
Derivatives used for purposes other than trading include interest rate
futures contracts and interest rate and currency swap agreements, which are
utilized to convert a substantial portion of the Firm's fixed term debt into
U.S. dollar-based floating rate obligations. Gains and losses on these
transactions are generally deferred and recognized as adjustments to interest
expense over the life of the underlying asset or liability.
REPURCHASE AGREEMENTS AND COLLATERALIZED FINANCING ARRANGEMENTS
Securities purchased under agreements to resell and securities sold under
agreements to repurchase, principally U.S. government, federal agency and
investment-grade foreign sovereign obligations, represent short-term
collateralized financing transactions and are carried at their contractual
amounts plus accrued interest, on a net-by-counterparty basis, where management
believes a legal right of setoff exists under an enforceable master netting
agreement. Carrying value approximates fair value for these transactions due to
their short-term nature. The Firm takes possession of securities purchased under
agreements to resell, monitors the market value of the underlying securities on
a daily basis and obtains additional collateral as appropriate.
Securities borrowed and loaned are recorded on the statements of financial
condition based on the amount of cash collateral advanced or received. These
transactions are generally collateralized by either cash, securities or letters
of credit. Carrying value approximates fair value for these transactions due to
their short-term nature. Regardless of the type of collateral, the Firm takes
possession of securities borrowed, monitors the market value of securities
loaned and obtains additional collateral as appropriate. Income or expense is
recognized as interest over the life of the transaction.
F-9
113
THE GOLDMAN SACHS GROUP, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
PROPERTY, LEASEHOLD IMPROVEMENTS AND EQUIPMENT
Depreciation and amortization generally are computed using accelerated cost
recovery methods for all property and equipment and for leasehold improvements
where the term of the lease is greater than the economic useful life of the
asset. All other leasehold improvements are amortized on a straight-line basis
over the life of the lease.
FOREIGN CURRENCY TRANSLATION
Assets and liabilities of subsidiaries whose functional currency is other
than the U.S. dollar are translated using currency exchange rates prevailing at
the end of the period presented, while revenues and expenses are translated
using average exchange rates during the period. Gains or losses resulting from
the translation of foreign currency financial statements are recorded as
cumulative translation adjustments, and are included as a component of
"Partners' capital reserved for income taxes and potential withdrawals" on the
consolidated statements of financial condition. Gains or losses resulting from
foreign exchange transactions are recorded in earnings.
GOODWILL
The cost of acquired companies in excess of the fair value of net assets
acquired at acquisition date is recorded as goodwill and amortized over periods
of 15 to 25 years on a straight-line basis.
INVESTMENT BANKING
Underwriting revenues and fees from mergers and acquisitions and other
corporate finance advisory assignments are recorded when the underlying
transaction is completed under the terms of the engagement. Syndicate expenses
related to securities offerings in which the Firm acts as an underwriter or
agent are deferred until the related revenue is recognized.
PRINCIPAL INVESTMENTS
Principal investments are carried at fair value, generally as evidenced by
quoted market prices or by comparable substantial third-party transactions.
Where fair value is not readily ascertainable, principal investments are
recorded at initial cost or management's estimate of the realizable value.
The Firm is entitled to receive overrides when the return on investments
exceeds certain threshold returns to the funds. Overrides are based on
investment performance over the life of each merchant banking fund, and future
investment underperformance may require the return to the funds of amounts
previously distributed to the Firm. Accordingly, overrides are recognized in
income only when the probability of returning them is determined to be remote.
PROVISION FOR TAXES
The Firm accounts for income taxes incurred by its corporate subsidiaries
in accordance with SFAS No. 109, "Accounting for Income Taxes". The consolidated
statements of earnings for the periods presented include a provision for, or
benefit from, income taxes on income earned, or losses incurred, by the Firm and
its subsidiaries including a provision for, or benefit from, unincorporated
business tax on income earned, or losses incurred, by the Firm and its
subsidiaries conducting business in New York City. No additional income tax
provision is required in the consolidated statements of earnings because the
Firm is a partnership and the remaining tax effects accrue directly to its
partners.
F-10
114
THE GOLDMAN SACHS GROUP, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CASH AND CASH EQUIVALENTS
The Firm defines cash equivalents as highly liquid overnight deposits held
in the ordinary course of business.
ACCOUNTING DEVELOPMENTS
In June 1996, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities", effective for transactions occurring after
December 31, 1996. Statement of Financial Accounting Standards ("SFAS") No. 125
establishes standards for distinguishing transfers of financial assets that are
accounted for as sales from transfers that are accounted for as secured
borrowings.
The provisions of SFAS No. 125 relating to repurchase agreements,
securities-lending transactions and other similar transactions were deferred by
the provisions of SFAS No. 127, "Deferral of the Effective Date of Certain
Provisions of FASB Statement No. 125", and became effective for transactions
entered into after December 31, 1997. This Statement requires that the
collateral obtained in certain types of secured lending transactions be recorded
on the balance sheet with a corresponding liability reflecting the obligation to
return such collateral to its owner. Effective January 1, 1998, the Firm adopted
the provisions of SFAS No. 125 that were deferred by SFAS No. 127. The adoption
of this standard increased the Firm's total assets and liabilities by $17
billion as of May 1998.
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share"
("EPS"), effective for periods ending after December 15, 1997, with restatement
required for all prior periods. SFAS No. 128 establishes new standards for
computing and presenting EPS. This Statement replaces primary and fully diluted
EPS with "basic EPS" which excludes dilution and "diluted EPS" which includes
the effect of all potentially dilutive common shares and other dilutive
securities. Because the Firm has not historically reported EPS, this Statement
will have no impact on the Firm's historical financial statements. This
Statement will, however, apply to financial statements of the Firm prepared
after the Offerings.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income", effective for fiscal years beginning after December 15, 1997, with
reclassification of earlier periods required for comparative purposes. SFAS No.
130 establishes standards for the reporting and presentation of comprehensive
income and its components in the financial statements. The Firm intends to adopt
this standard beginning in fiscal year 1999. This Statement is limited to issues
of reporting and presentation and, therefore, will not affect the Firm's results
of operations or financial condition.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information", effective for fiscal years beginning
after December 15, 1997, with reclassification of earlier periods required for
comparative purposes. SFAS No. 131 establishes the criteria for determining an
operating segment and establishes the disclosure requirements for reporting
information about operating segments. The Firm intends to adopt this standard
beginning in fiscal year 1999. This Statement is limited to issues of reporting
and presentation and, therefore, will not affect the Firm's results of
operations or financial condition.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits", effective for fiscal years
beginning after December 15, 1997, with restatement of disclosures for earlier
periods required for comparative purposes. SFAS No. 132 revises certain
employers' disclosures about pension and other post-retirement benefit
F-11
115
THE GOLDMAN SACHS GROUP, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
plans. The Firm intends to adopt this standard beginning in fiscal year 1999.
This Statement is limited to issues of reporting and presentation and,
therefore, will not affect the Firm's results of operations or financial
condition.
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position ("SOP")
No. 98-1, "Accounting for the Costs of Computer Software Developed or Obtained
for Internal Use", effective for fiscal years beginning after December 15, 1998.
SOP No. 98-1 requires that certain costs of computer software developed or
obtained for internal use be capitalized and amortized over the useful life of
the related software. The Firm currently expenses the cost of all software
development in the period in which it is incurred. The Firm intends to adopt
this Statement beginning in fiscal year 2000 and is currently assessing its
effect.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", effective for fiscal years beginning after
June 15, 1999. SFAS No. 133 establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives), and for hedging
activities. This Statement requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial condition and measure
those instruments at fair value. The accounting for changes in the fair value of
a derivative instrument depends on its intended use and the resulting
designation. The Firm intends to adopt this standard beginning in fiscal year
2000 and is currently assessing its effect.
NOTE 3. FINANCIAL INSTRUMENTS
Financial instruments, including derivatives, are used to manage market
risk, facilitate customer transactions, engage in trading transactions and meet
financing objectives. These instruments can be executed on an exchange or
negotiated in the OTC market. Derivative financial instruments may involve
future commitments to purchase or sell financial instruments or commodities, or
to exchange currency or interest payment streams. The amounts exchanged are
based on the specific terms of the contract with reference to specified rates,
securities, commodities or indices.
Transactions involving financial instruments sold, but not yet purchased,
entail an obligation to purchase a financial instrument at a future date. The
Firm may incur a loss if the market value of the financial instrument
subsequently increases prior to the purchase of the instrument.
TRADING AND PRINCIPAL INVESTMENTS TRANSACTIONS
The Firm's Trading and Principal Investments businesses facilitate customer
transactions and take proprietary positions in securities, derivatives,
currencies and commodities. Derivative financial instruments are often used to
hedge cash instruments or other derivative financial instruments as an integral
part of the Firm's strategies. As a result, it is necessary to view the results
of any activity on a fully-integrated basis, including cash positions, the
effect of related hedging transactions and the financing of the underlying
positions.
Net revenues reflect allocations of interest expense to the specific
securities, commodities, and other positions in relation to the level of
financing incurred by each.
F-12
116
THE GOLDMAN SACHS GROUP, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table sets forth the net revenues of the Firm's Trading and
Principal Investments business line:
SIX MONTHS ENDED
YEAR ENDED NOVEMBER MAY
------------------------------ ---------------------
1995 1996 1997 1997 1998
---- ---- ---- ---- ----
(unaudited)
(in millions)
FICC......................... $ 822 $1,749 $2,055 $1,194 $1,675
Equities..................... 731 730 573 423 659
Principal investments........ 191 214 298 43 244
------ ------ ------ ------ ------
Total Trading & Principal
Investments................ $1,744 $2,693 $2,926 $1,660 $2,578
====== ====== ====== ====== ======
RISK MANAGEMENT
The Firm seeks to monitor and control its risk exposure through a variety
of separate but complementary financial, credit, operational and legal reporting
systems for individual entities and the Firm as a whole. The Firm believes that
it has effective procedures for evaluating and managing the market, credit and
other risks to which it is exposed. The Executive Committee, the Firm's primary
decision-making body, determines (both directly and through delegated authority)
the types of business in which the Firm engages, approves guidelines for
accepting customers for all product lines, outlines the terms under which
customer business is conducted and establishes the parameters for the risks that
the Firm is willing to undertake in its business.
MARKET RISK
The Firmwide Risk Committee, which reports to the Executive Committee and
meets weekly, is responsible for managing and monitoring all of the Firm's risk
exposures. In addition, the Firm maintains segregation of duties, with credit
review and risk-monitoring functions performed by groups that are independent
from revenue-producing departments.
The potential for changes in the market value of the Firm's trading
positions is referred to as "market risk". The Firm's trading positions result
from underwriting, market making and proprietary trading activities.
The broadly defined categories of market risk include exposures to interest
rates, currency rates, equity prices and commodity prices.
- - Interest rate risks primarily result from exposures to changes in the level,
slope and curvature of the yield curve, the volatility of interest rates,
mortgage prepayment speeds and credit spreads.
- - Currency rate risks result from exposures to changes in spot prices, forward
prices and volatilities of currency rates.
- - Equity price risks result from exposures to changes in prices and volatilities
of individual equities, equity baskets and equity indices.
- - Commodity price risks result from exposures to changes in spot prices, forward
prices and volatilities of commodities, such as electricity, natural gas,
crude oil, petroleum products and precious and base metals.
F-13
117
THE GOLDMAN SACHS GROUP, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
These risk exposures are managed through diversification, by controlling
position sizes and by establishing offsetting hedges in related securities or
derivatives. For example, the Firm may hedge a portfolio of common stock by
taking an offsetting position in a related equity-index futures contract. The
ability to manage these exposures may, however, be limited by the liquidity of
the security or the related hedge instrument.
CREDIT RISK
Credit risk represents the loss that the Firm would incur if a counterparty
or issuer of securities or other instruments it holds fails to perform its
contractual obligations to the Firm. To reduce its credit exposures, the Firm
seeks to enter into netting agreements with counterparties that permit the Firm
to offset receivables and payables with such counterparties. The Firm does not
take into account any such agreements when calculating credit risk, however,
unless it has received reasonable assurance that the agreement will permit
netting of the counterparty's exposure under applicable law.
CONCENTRATION OF CREDIT RISK
Credit concentrations may arise from trading, underwriting and securities
borrowing activities and may be impacted by changes in economic, industry or
political factors. The Firm's concentration of credit risk is monitored actively
by the Credit Policy Committee. As of May 1998, U.S. government and federal
agency obligations represented 11% of the Firm's total assets. In addition, most
of the Firm's securities purchased under agreements to resell are collateralized
by U.S. government, federal agency and sovereign obligations.
DERIVATIVE ACTIVITIES
The Firm uses derivatives in its trading activities to facilitate customer
transactions, to take proprietary positions and as a means of risk management.
The gross notional (or contractual) amounts of derivative financial
instruments are used to express the volume of these transactions and do not
represent the amounts potentially subject to market risk. In addition,
measurement of market risk is meaningful only when all related and
F-14
118
THE GOLDMAN SACHS GROUP, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
offsetting transactions are taken into consideration. Gross notional (or
contractual) amounts of derivative financial instruments with off-balance-sheet
market risk are set forth below:
AS OF NOVEMBER AS OF MAY
-------------------- -------------------------
1996 1997 1997 1998
---- ---- ---- ----
(unaudited)
(in millions)
INTEREST RATE RISK:
Financial futures and forward
settlement contracts........... $216,700 $334,916 $296,175 $456,707
Swap agreements.................. 434,005 925,658 632,416 1,280,825
Written option contracts......... 258,388 351,359 297,282 393,106
EQUITY PRICE RISK:
Financial futures contracts...... 6,583 7,457 8,018 6,882
Swap agreements.................. 1,516 1,993 2,733 1,593
Written option contracts......... 26,029 51,916 26,149 47,529
CURRENCY AND COMMODITY PRICE
RISK:
Financial futures and forward
settlement contracts........... 268,036 355,882 341,662 464,419
Swap agreements.................. 21,924 33,472 27,287 43,955
Written option contracts......... 149,311 179,481 171,016 186,881
Market risk on purchased option contracts is limited to the market value of
the option; therefore, purchased option contracts have no off-balance-sheet
market risk. The gross notional (or contractual) amounts of purchased option
contracts are set forth below:
AS OF NOVEMBER AS OF MAY
-------------------- -------------------------
1996 1997 1997 1998
---- ---- ---- ----
(unaudited)
(in millions)
PURCHASED OPTION CONTRACTS:
Interest rate.................... $196,496 $301,685 $220,724 $342,001
Equity........................... 22,275 24,021 29,452 49,492
Currency and commodity........... 143,568 180,859 148,031 197,336
The Firm utilizes replacement cost as its measure of derivative credit
risk. Replacement cost, as reported in financial instruments owned, at fair
value on the consolidated statements of financial condition, represents amounts
receivable from various counterparties, net of any unrealized losses owed where
management believes a legal right of setoff exists under an enforceable master
netting agreement. Replacement cost for purchased option contracts is the market
value of the contract. The Firm controls its credit risk through an established
credit approval process, by monitoring counterparty limits, obtaining collateral
where appropriate and, in some cases, using legally enforceable master netting
agreements.
F-15
119
THE GOLDMAN SACHS GROUP, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The fair value of derivative financial instruments, computed in accordance
with the Firm's netting policy, are set forth below:
AS OF NOVEMBER AS OF MAY
-------------------------------------------- --------------------------------------------
1996 1997 1997 1998
-------------------- --------------------- -------------------- ---------------------
ASSETS LIABILITIES ASSETS LIABILITIES ASSETS LIABILITIES ASSETS LIABILITIES
------ ----------- ------ ----------- ------ ----------- ------ -----------
(unaudited)
(in millions)
PERIOD END:
Forwards................... $2,410 $2,330 $ 3,634 $ 3,436 $2,451 $ 2,671 $ 3,938 $ 3,067
Swaps...................... 3,203 3,932 4,367 5,362 2,860 3,375 6,641 7,039
Options.................... 3,156 3,720 5,787 7,166 4,163 4,547 6,441 9,147
------ ------ ------- ------- ------ ------- ------- -------
Total...................... $8,769 $9,982 $13,788 $15,964 $9,474 $10,593 $17,020 $19,253
====== ====== ======= ======= ====== ======= ======= =======
MONTHLY AVERAGE:
Forwards................... $2,139 $1,904 $ 3,351 $ 3,162 $2,938 $ 2,916 $ 3,949 $ 3,526
Swaps...................... 2,690 2,784 3,507 4,022 3,201 3,621 5,801 6,401
Options.................... 2,956 3,347 4,511 5,059 3,695 4,027 6,085 8,519
------ ------ ------- ------- ------ ------- ------- -------
Total...................... $7,785 $8,035 $11,369 $12,243 $9,834 $10,564 $15,835 $18,446
====== ====== ======= ======= ====== ======= ======= =======
NOTE 4. SHORT-TERM BORROWINGS
The Firm obtains secured short-term financing principally through the use
of repurchase agreements and securities lending agreements, collateralized
mainly by U.S. government, federal agency, investment grade foreign sovereign
obligations and equity securities. The Firm obtains unsecured short-term
borrowings through issuance of commercial paper, promissory notes and bank
loans. The carrying value of these short-term obligations approximates fair
value due to their short-term nature.
Short-term borrowings are set forth below:
AS OF AS OF
NOVEMBER MAY
1997 1998
-------- -----
(in millions)
Commercial paper....................................... $ 4,468 $ 6,486
Promissory notes(1).................................... 10,411 10,227
Bank loans and other(1)................................ 6,129 7,009
------- -------
Total(2)............................................... $21,008 $23,722
======= =======
- ---------------
(1) As of May 1998 and November 1997, short-term borrowings included $3,081
million and $2,454 million of long-term borrowings maturing within one year,
respectively.
(2) Weighted average interest rates for total short-term borrowings, including
commercial paper, were 5.55% as of May 1998 and 5.43% as of November 1997.
The Firm maintains unencumbered securities with a market value in excess of
all uncollateralized short-term borrowings. The Firm has also arranged committed
standby loan facilities under agreements with numerous banks, primarily on an
unsecured basis. As of May 1998, the aggregate amount of these unused facilities
was approximately $2 billion.
F-16
120
THE GOLDMAN SACHS GROUP, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 5. LONG-TERM BORROWINGS
The Firm's long-term borrowings are set forth below:
AS OF AS OF
NOVEMBER MAY
1997 1998
-------- -----
(in millions)
Fixed-rate obligations(1)
U.S. dollar denominated.............................. $ 5,217 $ 5,759
Non-U.S. dollar denominated.......................... 1,556 2,284
Floating-rate obligations(2)
U.S. dollar denominated.............................. 8,342 11,603
Non-U.S. dollar denominated.......................... 552 629
------- -------
Total long-term borrowings(3).......................... $15,667 $20,275
======= =======
- ---------------
(1) Interest rate ranges for U.S. dollar and non-U.S. dollar fixed rate
obligations are set forth below:
AS OF AS OF
NOVEMBER MAY
1997 1998
-------- -----
U.S. dollar denominated
High...................................................... 10.10% 10.10%
Low....................................................... 5.82 5.74
Non-U.S. dollar denominated
High...................................................... 9.51 9.51
Low....................................................... 1.90 1.90
(2) Floating interest rates generally are based on LIBOR, the U.S. treasury bill
rate or the federal funds rate. Certain equity-linked and indexed
instruments are included in floating rate obligations.
(3) Long-term borrowings bear fixed or floating interest rates and have
maturities that range from 1 to 30 years from the date of issue.
Long-term borrowings by maturity date are set forth below:
AS OF NOVEMBER 1997 AS OF MAY 1998
------------------------------ ------------------------------
U.S. NON-U.S. U.S. NON-U.S.
DOLLAR DOLLAR TOTAL DOLLAR DOLLAR TOTAL
------ -------- ----- ------ -------- -----
(in millions)
MATURITY DATES:
1998................. $ 1,159 $ 135 $ 1,294 -- -- --
1999................. 2,436 451 2,887 $ 3,542 $ 371 $ 3,913
2000................. 2,544 263 2,807 3,724 253 3,977
2001................. 971 142 1,113 1,900 137 2,037
2002................. 1,376 281 1,657 1,807 184 1,991
2003................. 941 109 1,050 1,251 511 1,762
2004-24.............. 4,132 727 4,859 5,138 1,457 6,595
------- ------ ------- ------- ------ -------
Total................ $13,559 $2,108 $15,667 $17,362 $2,913 $20,275
======= ====== ======= ======= ====== =======
The Firm enters into non-trading derivative contracts, such as interest
rate and currency swap agreements, that effectively convert a substantial
portion of its fixed rate long-term borrowings into U.S. dollar-based floating
rate obligations. Accordingly, the aggregate carrying value of these long-term
borrowings and the related hedges approximates fair value for each of
F-17
121
THE GOLDMAN SACHS GROUP, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the fiscal periods presented. The effective weighted average interest rates for
long-term borrowings, after hedging activities, are set forth below:
AS OF AS OF
NOVEMBER 1997 MAY 1998
--------------- ---------------
AMOUNT RATE AMOUNT RATE
------ ---- ------ ----
($ in millions)
LONG-TERM BORROWINGS:
Fixed-rate obligations................. $ 291 7.76% $ 226 8.04%
Floating-rate obligations.............. 15,376 5.84 20,049 5.85
------- -------
Total long-term borrowings............. $15,667 5.88 $20,275 5.87
======= =======
The notional amounts and fair value of the related hedges are set forth
below:
AS OF AS OF
NOVEMBER MAY
1997 1998
-------- -----
(in millions)
Notional amount........................................ $8,708 $10,675
Fair value............................................. 208 236
NOTE 6. COMMITMENTS AND CONTINGENCIES
LITIGATION
The Firm is involved in a number of judicial, regulatory and arbitration
proceedings concerning matters arising in connection with the conduct of its
businesses. Management believes, based on currently available information, that
the results of such proceedings will not have a material adverse effect on the
Firm's financial condition, but might be material to the Firm's operating
results for any particular period, depending, in part, upon the operating
results for such period.
LEASES
The Firm has obligations under long-term lease agreements, principally for
office space, expiring on various dates through 2016. Certain agreements are
subject to periodic escalation charges for increases in real estate taxes and
other charges. Minimum rental commitments, net of minimum sublease rentals,
under non-cancelable leases for the remainder of 1998 and the succeeding four
years and rent charged to operating expense for the last three years and in each
of the six months ended May 1998 and May 1997 are set forth below:
(in millions)
MINIMUM RENTAL COMMITMENTS:
1998 (remainder).............................. $ 57
1999.......................................... 99
2000.......................................... 97
2001.......................................... 94
2002.......................................... 93
Thereafter.................................... 494
----
Total............................... $934
====
F-18
122
THE GOLDMAN SACHS GROUP, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(in millions)
NET RENT EXPENSE:
1995.......................................... $ 87
1996.......................................... 83
1997.......................................... 87
May 1997...................................... 42
May 1998...................................... 46
OTHER COMMITMENTS
The Firm acts as an investor in merchant banking transactions which
includes making long-term investments in equity and debt securities in privately
negotiated transactions, corporate acquisitions and real estate transactions. In
connection with these merchant banking activities, the Firm had commitments to
invest up to $524 million, $591 million, $670 million and $816 million in
merchant banking investment, real estate merchant banking investment and bridge
loan funds as of May 1998, May 1997, November 1997 and November 1996,
respectively.
In June 1998, the Firm increased its commitments to invest in merchant
banking investment and bridge loan funds by $580 million.
As of May 1998, the Firm had pledged securities of $23 billion as
collateral for securities borrowed of approximately equivalent value.
The Firm obtains letters of credit issued to counterparties by various
banks that are used in lieu of securities or cash to satisfy various collateral
and margin deposit requirements. Letters of credit outstanding amounted to $9
billion, $11 billion, $10 billion and $11 billion as of May 1998, May 1997,
November 1997 and November 1996, respectively.
NOTE 7. EMPLOYEE BENEFIT PLANS
The Firm sponsors various pension plans and certain other post-retirement
benefit plans, primarily health care and life insurance, for eligible employees
worldwide. The Firm also provides
F-19
123
THE GOLDMAN SACHS GROUP, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
certain benefits to former or inactive employees prior to retirement. The
following summarizes these plans:
PENSION PLANS
The components of pension expense/(income) are set forth below:
SIX MONTHS
YEAR ENDED NOVEMBER ENDED MAY
----------------------------- -------------------
1995 1996 1997 1997 1998
---- ---- ---- ---- ----
(unaudited)
(in millions)
Service cost, benefits earned
during the period............... $ 14 $ 15 $ 15 $ 8 $ 8
Interest cost on projected benefit
obligation...................... 7 8 10 5 5
Return on plan assets............. (19) (24) (18) (10) (12)
Net amortization.................. 10 14 4 3 5
---- ---- ---- ---- ----
Total pension expense... $ 12 $ 13 $ 11 $ 6 $ 6
==== ==== ==== ==== ====
PENSION EXPENSE/(INCOME):
U.S. plans........................ $ (1) $ (1) $ (3) $ (1) $ (1)
International plans............... 13 14 14 7 7
---- ---- ---- ---- ----
Total pension expense... $ 12 $ 13 $ 11 $ 6 $ 6
==== ==== ==== ==== ====
The following table sets forth the assumptions used in determining the
projected benefit obligation for the U.S. and international plans:
SIX MONTHS
YEAR ENDED NOVEMBER ENDED MAY
-------------------- ------------------
1995 1996 1997 1997 1998
---- ---- ---- ---- ----
(unaudited)
U.S. PLANS:
Weighted average discount rate............... 7.25% 7.50% 7.50% 8.00% 7.50%
Rate of increase in future compensation
levels..................................... 5.00 5.00 5.00 5.00 5.00
Expected long-term rate of return on plan
assets..................................... 7.50 7.50 7.50 7.50 7.50
INTERNATIONAL PLANS:
Weighted average discount rate............... 5.70 5.70 5.70 5.70 5.30
Rate of increase in future compensation
levels..................................... 5.30 5.30 5.30 5.30 5.30
Expected long-term rate of return on plan
assets..................................... 7.00 7.00 7.00 7.00 7.00
F-20
124
THE GOLDMAN SACHS GROUP, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The funded status of the qualified plans is set forth below:
YEAR ENDED SIX MONTHS
NOVEMBER ENDED MAY
-------------- --------------------
1996 1997 1997 1998
---- ---- ---- ----
(unaudited)
(in millions)
Actuarial present value of vested benefit
obligation............................... $(132) $(149) $(131) $(164)
----- ----- ----- -----
Accumulated benefit obligation............. (134) (151) (133) (167)
Effect of future salary increases.......... (15) (16) (18) (16)
----- ----- ----- -----
Projected benefit obligation............... (149) (167) (151) (183)
Plan assets at fair market value (primarily
listed stocks and bonds)................. 164 187 177 208
----- ----- ----- -----
Projected benefit obligation less than
plan assets.............................. 15 20 26 25
Unrecognized net loss/(gain)............... 3 2 (7) (2)
Unrecognized net transition gain........... (19) (20) (19) (20)
----- ----- ----- -----
(Accrued)/prepaid pension cost at period-
end...................................... $ (1) $ 2 $ -- $ 3
===== ===== ===== =====
(ACCRUED)/PREPAID PENSION COST:
U.S. plans................................. $ (1) $ 2 $ -- $ 3
International plans........................ -- -- -- --
----- ----- ----- -----
(Accrued)/prepaid pension cost at period-
end...................................... $ (1) $ 2 $ -- $ 3
===== ===== ===== =====
POST-RETIREMENT PLANS
The Firm has unfunded post-retirement benefit plans that provide medical
and life insurance for eligible retirees, employees and dependents. The Firm's
accrued post-retirement benefit liability was $53 million, $48 million, $50
million and $46 million as of May 1998, May 1997, November 1997 and November
1996, respectively. The Firm's expense for these plans was $3 million in each of
the six months ended May 1998 and May 1997, and $7 million, $6 million and $12
million in the years ended 1997, 1996 and 1995, respectively.
POST-EMPLOYMENT PLANS
Post-employment benefits include, but are not limited to, salary
continuation, supplemental unemployment benefits, severance benefits,
disability-related benefits, and continuation of health care and life insurance
coverage provided to former or inactive employees after employment but before
retirement. The accrued but unfunded liability under the plans was $12 million
as of May 1998, May 1997, November 1997 and November 1996. The Firm's expense
for these plans was $1 million in each of the six months ended May 1998 and May
1997, and $2 million, $2 million and $5 million in the fiscal years ended 1997,
1996 and 1995, respectively.
DEFINED CONTRIBUTION PLANS
The Firm contributes to employer sponsored U.S. and international defined
contribution plans. The Firm's contribution to the U.S. plans was $24 million
and $20 million for the six months ended May 1998 and May 1997, and $44 million,
$39 million and $42 million for the years
F-21
125
THE GOLDMAN SACHS GROUP, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ended 1997, 1996 and 1995, respectively. The Firm's contribution to the
international plans was $7 million and $6 million for the six months ended May
1998 and May 1997, and $14 million, $7 million and $7 million for the years
ended 1997, 1996 and 1995, respectively.
NOTE 8. CAPITAL
PARTNERS' CAPITAL
Partners' capital includes both the general partner's and limited partners'
capital and certain employee interests and is subject to certain withdrawal
restrictions. As of May 1998, the Firm had $6,638 million in partners' capital.
Managing directors that are participating limited partners in Group L.P.
("PLPs") who elect to retire are entitled to redeem their capital over a period
of not less than five years following retirement, but often reinvest a
significant portion of their capital as limited partners for longer periods.
Partners' capital reserved for income taxes and potential withdrawals relates
primarily to activity with regard to the capital accounts of PLPs and includes a
foreign currency cumulative translation loss of $87 million.
Sumitomo Bank Capital Markets, Inc. ("SBCM"), a limited partner that had
capital invested of approximately $835 million as of May 1998, may require the
Firm to redeem its capital over a five-year period beginning no earlier than
2007. Kamehameha Activities Association ("KAA"), a limited partner that had
capital invested of approximately $705 million as of May 1998, may require the
Firm to redeem $366 million of its capital over the five-year period beginning
no earlier than 2010 and $339 million of its capital over the five-year period
beginning no earlier than 2013.
Institutional Limited Partners (other than SBCM and KAA) had aggregate
capital invested of $755 million as of May 1998. The Firm must repay these
Institutional Limited Partners' capital as follows: $270 million in six equal
annual installments commencing in December 2001, $257 million in March 2005,
$146 million in November 2013 and $82 million in November 2023.
The Firm may defer any required redemption of capital if the redemption
would cause a subsidiary subject to regulatory authority to be in violation of
the rules of such authority or if the withdrawal of funds to satisfy the
redemption from an unregulated subsidiary would have a material effect on such
subsidiary.
REGULATED SUBSIDIARIES
GS&Co. is a registered U.S. broker-dealer subsidiary, which is subject to
the Securities and Exchange Commission's "Uniform Net Capital Rule", and has
elected to compute its net capital in accordance with the "Alternative Net
Capital Requirement" of that rule. As of May 1998 and November 1997, GS&Co. had
regulatory net capital, as defined, of $2.24 billion and $1.77 billion,
respectively, which exceeded the amounts required by $1.77 billion and $1.37
billion, respectively.
GSI, a registered U.K. broker-dealer and subsidiary of Group L.P., is
subject to the capital requirements of the Securities and Futures Authority
Limited and GSJL, a Tokyo-based broker-dealer, is subject to the capital
requirements of the Japanese Ministry of Finance and the Financial Supervisory
Agency. As of May 1998 and November 1997, GSI and GSJL were in compliance with
their local capital adequacy requirements.
Certain other subsidiaries of the Firm are also subject to capital adequacy
requirements promulgated by authorities of the countries in which they operate.
As of May 1998 and November 1997, these subsidiaries were in compliance with
their local capital adequacy requirements.
F-22
126
THE GOLDMAN SACHS GROUP, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9. GEOGRAPHIC DATA
The Firm's activities as an investment banking and securities firm
constitute a single business segment pursuant to SFAS No. 14 "Financial
Reporting for Segments of a Business Enterprise".
Due to the highly integrated nature of international financial markets, the
Firm manages its business based on the profitability of the enterprise as a
whole, not by geographic region. Accordingly, management believes that
profitability by geographic region is not necessarily meaningful.
The total revenues, net revenues, pre-tax earnings and identifiable assets
of Group L.P. and its consolidated subsidiaries by geographic region are
summarized below:
SIX MONTHS
YEAR ENDED NOVEMBER ENDED MAY
----------------------------- ----------------------
1995 1996 1997 1997 1998
---- ---- ---- ---- ----
(unaudited)
(in millions)
TOTAL REVENUES:
Americas(1)................ $10,565 $12,864 $15,091 $6,964 $ 9,015
Europe..................... 3,069 3,762 4,463 2,223 2,817
Asia....................... 690 663 879 353 634
------- ------- ------- ------ -------
Total...................... $14,324 $17,289 $20,433 $9,540 $12,466
======= ======= ======= ====== =======
NET REVENUES:
Americas(1)................ $ 3,462 $ 4,397 $ 5,104 $2,490 $ 3,644
Europe..................... 742 1,355 1,739 903 1,345
Asia....................... 279 377 604 238 472
------- ------- ------- ------ -------
Total...................... $ 4,483 $ 6,129 $ 7,447 $3,631 $ 5,461
======= ======= ======= ====== =======
PRE-TAX EARNINGS:
Americas(1)................ $ 1,442 $ 1,963 $ 2,061 $ 989 $ 1,113
Europe..................... (15) 536 683 436 694
Asia....................... (59) 107 270 90 252
------- ------- ------- ------ -------
Total...................... $ 1,368 $ 2,606 $ 3,014 $1,515 $ 2,059
======= ======= ======= ====== =======
AS OF NOVEMBER AS OF MAY
------------------------------- -----------------------
1995 1996 1997 1997 1998
---- ---- ---- ---- ----
(unaudited)
(in millions)
IDENTIFIABLE ASSETS:
Americas(1)............... $123,195 $171,345 $ 206,312 $ 191,309 $ 250,675
Europe.................... 43,191 62,172 80,551 80,390 108,200
Asia...................... 11,267 6,894 13,240 8,664 13,092
Eliminations.............. (77,587) (88,365) (121,702) (111,163) (130,115)
-------- -------- --------- --------- ---------
Total..................... $100,066 $152,046 $ 178,401 $ 169,200 $ 241,852
======== ======== ========= ========= =========
- ---------------
(1) Americas principally represents the United States.
F-23
127
THE GOLDMAN SACHS GROUP, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 10. QUARTERLY RESULTS (UNAUDITED)
1996
------------------------------------
1ST 2ND 3RD 4TH
--- --- --- ---
(in millions)
Total revenues....................................... $4,030 $4,656 $4,313 $4,290
Interest expense, principally on short-term
funding............................................ 2,566 2,986 2,845 2,763
------ ------ ------ ------
Revenues, net of interest expense.................... 1,464 1,670 1,468 1,527
Operating expenses................................... 899 961 879 784
------ ------ ------ ------
Pre-tax earnings..................................... 565 709 589 743
Provision for taxes.................................. 21 23 31 132
------ ------ ------ ------
Net earnings.................................... $ 544 $ 686 $ 558 $ 611
====== ====== ====== ======
1997 1998
--------------------------------- ---------------
1ST 2ND 3RD 4TH 1ST 2ND
--- --- --- --- --- ---
(in millions)
Total revenues............................ $4,932 $4,608 $5,957 $4,936 $5,903 $6,563
Interest expense, principally on
short-term funding...................... 2,975 2,934 3,727 3,350 3,431 3,574
------ ------ ------ ------ ------ ------
Revenues, net of interest expense......... 1,957 1,674 2,230 1,586 2,472 2,989
Operating expenses........................ 1,052 1,064 1,298 1,019 1,450 1,952
------ ------ ------ ------ ------ ------
Pre-tax earnings.......................... 905 610 932 567 1,022 1,037
Provision for taxes....................... 44 99 60 65 138 190
------ ------ ------ ------ ------ ------
Net earnings......................... $ 861 $ 511 $ 872 $ 502 $ 884 $ 847
====== ====== ====== ====== ====== ======
F-24
128
UNDERWRITING
The Firm, the Selling Shareholders and the underwriters for the U.S.
offering (the "U.S. Underwriters") named below have entered into an underwriting
agreement with respect to the shares being offered in the United States. Subject
to certain conditions, each U.S. Underwriter has severally agreed to purchase
the number of shares indicated in the following table. Goldman, Sachs & Co.
and are the representatives of the U.S. Underwriters.
Number of
Underwriters Shares
------------ ---------
Goldman, Sachs & Co. .......................................
-------
Total.......................................................
=======
---------------
If the U.S. Underwriters sell more shares than the total number set forth
in the table above, the U.S. Underwriters have an option to buy up to an
additional shares from the Firm to cover such sales. They may
exercise that option for 30 days. If any shares are purchased pursuant to this
option, the U.S. Underwriters will severally purchase shares in approximately
the same proportion as set forth in the table above.
The following tables show the per share and total underwriting discounts
and commissions to be paid to the U.S. Underwriters by the Firm and the Selling
Shareholders. Such amounts are shown assuming both no exercise and full exercise
of the U.S. Underwriters' option to purchase additional shares.
Paid by the Firm
---------------------------
No Full
Exercise Exercise
----------- -------------
Per Share............ $ $
Total................ $ $
Paid by the Selling Shareholders
-------------------------------------
No Full
Exercise Exercise
----------- -------------
Per Share............ $ $
Total................ $ $
Shares sold by the Underwriters to the public will initially be offered at
the initial public offering price set forth on the cover page of this
Prospectus. Any shares sold by the Underwriters to securities dealers may be
sold at a discount of up to $ per share from the initial public offering
price. Any such securities dealers may resell any shares purchased from the
Underwriters to certain other brokers or dealers at a discount of up to $
per share from the initial public offering price. If all of the shares are not
sold at the initial offering price, the representatives may change the offering
price and the other selling terms.
The Firm and the Selling Shareholders have entered into underwriting
agreements with Underwriters for the sale of shares outside of
the United States and the Asia/Pacific region and shares in the
Asia/Pacific region. The terms and conditions of all three Offerings are the
same and the sale of shares in all three Offerings are conditioned on each
other. Goldman Sachs International and are representatives of the
underwriters for the international offering outside the United States and the
Asia/Pacific region (the "International Underwriters") and Goldman Sachs (Asia)
L.L.C. and are representatives of the underwriters for the
Asia/Pacific region offering (the "Asia/Pacific Underwriters"). The Firm has
granted the International and Asia/Pacific Underwriters options similar to that
described above to purchase up to an aggregate of an additional
shares.
The Underwriters for each of the three Offerings have entered into an
agreement in which they agree to restrictions on where and to whom they and any
dealer purchasing from them may offer shares as a part of the
U-1
129
distribution of the shares. The Underwriters have also agreed that they may sell
shares among each of the underwriting groups.
The Firm, the Selling Shareholders, the parties to the Shareholders'
Agreement, including all of the directors and executive officers of GS Inc., the
RLPs and the purchasers in the Directed Offering have agreed with the
Underwriters not to dispose of or hedge any of their Common Stock or securities
convertible into or exchangeable for shares of Common Stock during the period
from the date of this Prospectus continuing through the date 180 days after the
date of this Prospectus, except with the prior written consent of Goldman, Sachs
& Co. This agreement does not apply to any of the Firm's existing employee
benefit plans. See "Shares Eligible for Future Sale" for a discussion of certain
transfer restrictions.
Prior to the Offerings, there has been no public market for the shares. The
initial public offering price will be negotiated among the Firm and the
representatives. Among the factors to be considered in determining the initial
public offering price of the shares, in addition to prevailing market
conditions, will be the Firm's historical performance, estimates of the business
potential and earnings prospects of the Firm, an assessment of the Firm's
management and the consideration of the above factors in relation to market
valuation of companies in related businesses.
The Common Stock will be listed on the New York Stock Exchange under the
symbol "GS". In order to meet one of the requirements for listing the Common
Stock on the NYSE, the underwriters have undertaken to sell lots of 100 or more
shares to a minimum of 2,000 beneficial holders.
In connection with the Offerings, the Underwriters may purchase and sell
shares of Common Stock in the open market. These transactions may include short
sales, stabilizing transactions and purchases to cover positions created by
short sales. Short sales involve the sale by the Underwriters of a greater
number of shares than they are required to purchase in the Offerings.
Stabilizing transactions consist of certain bids or purchases made for the
purpose of preventing or retarding a decline in the market price of the Common
Stock while the Offerings are in progress.
The Underwriters also may impose a penalty bid. This occurs when a
particular Underwriter repays to the Underwriters a portion of the underwriting
discount received by it because the representatives have repurchased shares sold
by or for the account of such Underwriter in stabilizing or short covering
transactions.
These activities by the Underwriters may stabilize, maintain or otherwise
affect the market price of the Common Stock. As a result, the price of the
Common Stock may be higher than the price that otherwise might exist in the open
market. If these activities are commenced, they may be discontinued by the
Underwriters at any time. These transactions may be effected on the NYSE, in the
over-the-counter market or otherwise.
After the Offerings, because Goldman, Sachs & Co. is a member of the NYSE
and because of its relationship to the Firm, it will not be permitted under the
rules of the NYSE to make markets in or recommendations regarding the purchase
or sale of the Common Stock. This may adversely affect the trading market for
the Common Stock.
Also because of the relationship between Goldman, Sachs & Co. and the Firm,
the Offerings are being conducted in accordance with Rule 2720 of the National
Association of Securities Dealers. That rule requires that the initial public
offering price can be no higher than that recommended by a "qualified
independent underwriter", as defined by the NASD. and
have served in that capacity and performed due diligence
investigations and reviewed and participated in the preparation of the
Registration Statement of which this Prospectus forms a part. Each of
and has received $10,000 from the Firm as
compensation for such role.
The Underwriters may not confirm sales to discretionary accounts without
the prior written approval of the customer.
Goldman, Sachs & Co., Goldman Sachs International and Goldman Sachs (Asia)
U-2
130
L.L.C. are subsidiaries of the Firm. In aggregate, these three affiliated
Underwriters have severally agreed to purchase % of the shares being
offered in the three Offerings. If any of the shares underwritten by these three
affiliates are sold by them at a price less than the initial public offering
price, the net proceeds from the Offerings to the Firm on a consolidated basis
will be reduced because such affiliates and the Firm are accounted for on a
consolidated basis.
The Firm and the Selling Shareholders estimate that their shares of the
total expenses of the Offerings, excluding underwriting discounts and
commissions, will be approximately $ and $ , respectively.
At the request of the Firm, up to shares have been reserved
for sale by Goldman, Sachs & Co. to employees of the Firm and its affiliates and
certain other purchasers. Such shares will be sold at the initial public
offering price and, to the extent sold, will not otherwise be available for sale
as a part of the Offerings. If any such shares are not sold in this manner they
will be offered by Goldman, Sachs & Co. as a part of the Offerings. Purchasers
in the Directed Offering are subject to the 180-day lockup described above.
The Firm and the Selling Shareholders have agreed to indemnify the several
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933.
This Prospectus may be used by the Underwriters and other dealers in
connection with offers and sales of the shares, including sales of shares
initially sold by the Underwriters in the Offerings being made outside of the
United States, to persons located in the United States.
U-3
131
- -------------------------------------------------------
- -------------------------------------------------------
No dealer, salesperson or other person is authorized to give any information
or to represent anything not contained in this prospectus. You must not rely on
any unauthorized information or representations. This prospectus is an offer to
sell or to buy only the shares offered hereby, but only under circumstances and
in jurisdictions where it is lawful to do so. The information contained in this
prospectus is current only as of its date.
------------------
TABLE OF CONTENTS
Page
----
Our Business Principles................ 3
Certain Introductory Matters........... 4
Prospectus Summary..................... 5
Risk Factors........................... 14
Use of Proceeds........................ 24
Dividend Policy........................ 24
Dilution............................... 25
Capitalization......................... 26
Pro Forma Consolidated Financial
Information.......................... 27
Selected Consolidated Financial Data... 30
Management's Discussion and Analysis of
Financial Condition and Results of
Operations........................... 32
Industry and Economic Outlook.......... 53
Business............................... 56
Management............................. 79
Principal and Selling Shareholders..... 90
Certain Relationships and Related
Transactions......................... 91
Description of Capital Stock........... 95
Description of Capital Securities...... 100
Shares Eligible for Future Sale........ 101
Validity of Common Stock............... 102
Experts................................ 102
Available Information.................. 102
Index to Consolidated Financial
Statements........................... F-1
Underwriting........................... U-1
------------------
Through and including , 1998 (the 25th day after the date of
this prospectus), all dealers effecting transactions in these securities,
whether or not participating in this offering, may be required to deliver a
prospectus. This is in addition to the dealers' obligation to deliver a
prospectus when acting as underwriters and with respect to their unsold
allotments or subscriptions.
- -------------------------------------------------------
- -------------------------------------------------------
- -------------------------------------------------------
- -------------------------------------------------------
Shares
THE GOLDMAN SACHS
GROUP, INC.
Common Stock
------------------
[GOLDMAN SACHS LOGO]
------------------
GOLDMAN, SACHS & CO.
Representatives of the Underwriters
-------------------------------------------------------
-------------------------------------------------------
132
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following is a statement of the estimated expenses, other than
underwriting discounts and commissions, to be incurred in connection with the
distribution of the securities registered under this Registration Statement:
AMOUNT
TO BE PAID
----------
Securities and Exchange Commission registration fee......... $ 2,950
NASD fees and expenses...................................... 1,500
Legal fees and expenses..................................... *
Fees and expenses of qualification under state securities
laws (including legal fees)............................... *
NYSE listing fees and expenses.............................. *
Accounting fees and expenses................................ *
Printing and engraving fees................................. *
Registrar and transfer agent's fees......................... *
Miscellaneous............................................... *
-------
Total............................................. $
=======
- ---------------
* To be completed by amendment.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the Delaware General Corporation Law provides that a
corporation may indemnify directors and officers as well as other employees and
individuals against expenses (including attorneys' fees), judgments, fines and
amounts paid in settlement actually and reasonably incurred by such person in
connection with any threatened, pending or completed actions, suits or
proceedings in which such person is made a party by reason of such person being
or having been a director, officer, employee of or agent to the Registrant. The
statute provides that it is not exclusive of other rights to which those seeking
indemnification may be entitled under any by-law, agreement, vote of
stockholders or disinterested directors or otherwise. Section 6.4 of the
Registrant's By-Laws provides for indemnification by the Registrant of directors
and officers (as such terms are defined in the By-Laws) of the Registrant, who
is or was acting as such, is or was a member of the Shareholders' Committee
acting pursuant to the Shareholders' Agreement or, at the request of the
Registrant, are or were serving as directors or officers of any other
enterprise, to the fullest extent permitted by law. The By-Laws also provide
that the Registrant shall advance expenses to a director or officer and, if
reimbursement of such expenses is demanded in advance of the final disposition
of the matter with respect to which such demand is being made, upon receipt of
an undertaking by or on behalf of such director or officer to repay such amount
if it is ultimately determined that the director or officer is not entitled to
be indemnified by the Registrant. To the extent authorized from time to time by
the Board of Directors of the Registrant, the Registrant may provide to any one
or more employees and other agents of the Registrant or any subsidiary or other
enterprise, rights of indemnification and to receive payment or reimbursement of
expenses, including attorneys' fees, that are similar to the rights conferred in
the By-Laws of the Registrant on directors and officers of the Registrant or any
subsidiary or other enterprise.
Section 102(b)(7) of the Delaware General Corporation Law permits a
corporation to provide in its certificate of incorporation that a director of
the corporation shall not be personally
II-1
133
liable to the corporation or its stockholders for monetary damages for breach of
fiduciary duty as a director, except for liability (i) for any breach of the
director's duty of loyalty to the corporation or its stockholders, (ii) for acts
or omissions not in good faith or which involve intentional misconduct or a
knowing violation of law, (iii) for payments of unlawful dividends or unlawful
stock repurchases or redemptions, or (iv) for any transaction from which the
director derived an improper personal benefit. The Registrant's Amended and
Restated Certificate of Incorporation provides for such limitation of liability.
Policies of insurance are maintained by the Registrant under which its
directors and officers are insured, within the limits and subject to the
limitations of the policies, against certain expenses in connection with the
defense of, and certain liabilities which might be imposed as a result of,
actions, suits or proceedings to which they are parties by reason of being or
having been such directors or officers.
Reference is also made to Section of the Underwriting Agreement filed
as Exhibit 1.1 to the Registration Statement for information concerning the
Underwriters' obligation to indemnify the Registrant and its officers and
directors in certain circumstances.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
As part of the Incorporation Transactions (as defined in the Prospectus),
the Registrant has entered into definitive binding agreements to issue: (i)
shares of the Registrant's common stock, par value $.01 per share (the "Common
Stock"), to certain limited partners (the "PLPs") of Group, L.P. ("Group L.P.")
in exchange for all of the PLPs' interests in Group L.P. and certain other
entities; and (ii) shares of Common Stock and 12% junior subordinated debentures
(the "Junior Subordinated Debentures") of the Registrant to certain limited
partners of Group L.P. in exchange for all of such limited partners' interests
in Group L.P. and certain other entities. The Registrant will also make an award
of restricted stock units and stock options to substantially all of its
employees and will make an irrevocable contribution of Common Stock to a
non-qualified deferred contribution plan. These shares of Common Stock and
Junior Subordinated Debentures will be issued in reliance on the exemption from
registration contained in Section 4(2) of the Securities Act and Rule 506
thereunder, will not be subject to the registration requirements of the
Securities Act because the securities were offered and sold outside the United
States to persons who are not citizens or residents of the United States in
reliance upon the exemption provided by Regulation S under the Securities Act or
will not involve an offer or sale for purposes of Section 2(3) of the Securities
Act.
II-2
134
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) EXHIBITS
1.1 Form of Underwriting Agreement.*
2.1 Plan of Incorporation.*
3.1 Form of Amended and Restated Certificate of Incorporation of
the Company.*
3.2 By-Laws of the Company.*
4.1 Specimen of certificate representing the Company's Common
Stock, par value $.01 per share.*
4.2 Rights Agreement, dated as of , 1998, between
The Goldman Sachs Group, L.P. ("Group L.P.") and
, as Rights Agent.*
5.1 Opinion of Sullivan & Cromwell, counsel to the Company.*
10.1 Lease, dated June 11, 1985, between Metropolitan Life
Insurance Company and Goldman, Sachs & Co.
10.2 Lease, dated April 5, 1994, between The Chase Manhattan Bank
(National Association) and Group L.P., as amended.*
10.3 Lease, dated as of August 22, 1997, between Ten Hanover LLC
and Group L.P.
10.4 Lease, dated as of July 16, 1998, between TCC Acquisition
Corp. and Group L.P.
10.5 Agreement for Lease, dated April 2, 1998, among (i) JC No. 3
(UK) Limited and Fleet Street Square Management Limited
trading as Fleet Street Partnership, (ii) Goldman Sachs
International ("GSI"), (iii) Restamove Limited, (iv) Group
L.P. and (v) Itochu Corporation.*
10.6 Annexure 1 to Agreement for Lease, dated April 2, 1998,
among (i) JC No. 3 (UK) Limited and Fleet Street Square
Management Limited trading as Fleet Street Partnership, (ii)
GSI, (iii) Restamove Limited, (iv) Group L.P. and (v) Itochu
Corporation (Form of Occupational Lease, dated ,
19 , among (i) JC No. 3 (UK) Limited and Fleet Street
Square Management Limited trading as Fleet Street
Partnership, (ii) GSI and (iii) Group L.P.).*
10.7 Agreement relating to Developer's Fit Out Works to be
carried out at 120 Fleet Street, London, dated April 2,
1998, among (i) JC No. 3 (UK) Limited and Fleet Street
Square Management Limited, (ii) Goldman Sachs Property
Management, (iii) Itochu Corporation and (iv) Group L.P.*
10.8 Agreement relating to One Carter Lane, London EC4, dated
March 25, 1998, among Britel Fund Trustees Limited, GSI,
Group L.P., English Property Corporation plc and MEPC plc.
10.9 Fit Out Works Agreement relating to One Carter Lane, London
EC4, dated March 25, 1998, among Britel Fund Trustees
Limited, GSI, Goldman Sachs Property Management, Group L.P.,
English Property Corporation plc and MEPC plc.
10.10 Form of Underlease of premises known as One Carter Lane,
London EC4, dated , 1998, among Britel Fund Trustees
Limited, GSI and Group L.P.
10.11 Lease, dated March 5, 1994, among Shine Hill Development
Limited, Shine Belt Limited, Fair Page Limited, Panhy
Limited, Maple Court Limited and Goldman Sachs (Asia)
Finance.
10.12 Guarantee, dated November 17, 1993, between Shine Hill
Development Limited and Group L.P.
10.13 Summary of Tokyo Leases.*
10.14 Goldman Sachs 1998 Stock Incentive Plan.*
10.15 The Goldman Sachs Defined Contribution Plan.*
10.16 Trust Agreement.*
10.17 The Goldman Sachs Partner Pool.*
10.18 Form of Employment Agreement.*
10.19 Form of Confidentiality, Noncompetition and Nonsolicitation
Agreement.*
II-3
135
10.20 Form of Pledge Agreement.*
10.21 Award Agreement (Formula RSUs).*
10.22 Award Agreement (Discretionary RSUs).*
10.23 Form of Option Agreement (Discretionary Options).*
10.24 Form of Tax Indemnification Agreement, dated as of November , 1998, by and among the Schedule I and
Schedule II Limited Partners, and other former partners of Group L.P. who or which have accepted the Plan
of Incorporation, Sumitomo Bank Capital Markets, Inc., Kamehameha Activities Association and The Goldman
Sachs Group, Inc.*
10.25 Shareholders' Agreement, dated as of , 1998, among The Goldman Sachs Group, Inc. and various
parties.*
10.26 Instrument of Indemnification.*
11.1 Statement re computation of per share earnings.*
15.1 Letter of PricewaterhouseCoopers LLP regarding unaudited interim financial information.
21.1 List of subsidiaries of the Company.
23.1 Consent of PricewaterhouseCoopers LLP.
23.2 Consent of Sullivan & Cromwell (included in Exhibit 5.1 above).*
24.1 Powers of Attorney (included on signature page).
27.1 Financial Data Schedule.
- ---------------
* To be filed by amendment.
(b) FINANCIAL STATEMENT SCHEDULES
Condensed financial information of Group L.P. and report of
PricewaterhouseCoopers LLP thereon.
ITEM 17. UNDERTAKINGS
The undersigned registrant hereby undertakes:
(a) Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the registrant pursuant to the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Securities Act of 1933 and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than the payment by
the registrant of expenses incurred or paid by a director, officer or
controlling person of the Registrant in the successful defense of any action,
suit or proceeding) is asserted against the registrant by such director, officer
or controlling person in connection with the securities being registered, the
registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate jurisdiction
the question whether such indemnification by it is against public policy as
expressed in the Securities Act of 1933 and will be governed by the final
adjudication of such issue.
(b) The undersigned registrant hereby undertakes to provide to the
underwriters at the closing specified in the underwriting agreement certificates
in such denominations and registered in such names as required by the
underwriters to permit prompt delivery to each purchaser.
(c) The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part
of this registration statement in reliance upon Rule 430A and contained in
a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act of 1933 shall be deemed to be part
of this registration statement as of the time it was declared effective.
II-4
136
(2) For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
II-5
137
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of New York, New York on the
24th day of August, 1998.
THE GOLDMAN SACHS GROUP, INC.
By: /s/ JON S. CORZINE
------------------------------------
Name: Jon S. Corzine
Title: Co-Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints John A. Thain, Robert J. Katz, Gregory K.
Palm and David A. Viniar and each of them severally, his or her true and lawful
attorney-in-fact with power of substitution and resubstitution to sign in his or
her name, place and stead, in any and all capacities, to do any and all things
and execute any and all instruments that such attorney may deem necessary or
advisable under the Securities Act of 1933 (the "Securities Act"), and any
rules, regulations and requirements of the U.S. Securities and Exchange
Commission in connection with the registration under the Securities Act of the
Common Stock of the Registrant, including specifically, but without limiting the
generality of the foregoing, the power and authority to sign his or her name in
his or her respective capacity as a member of the Board of Directors or officer
of the Registrant, this Registration Statement and/or such other form or forms
as may be appropriate to be filed with the Commission as any of them may deem
appropriate in respect of the Common Stock of the Registrant, to any and all
amendments thereto (including post-effective amendments) to this Registration
Statement, to any related Rule 462(b) Registration Statement and to any other
documents filed with the Securities and Exchange Commission, as fully for all
intents and purposes as he or she might or could do in person, and hereby
ratifies and confirms all said attorneys-in-fact and agents, each acting alone,
and his or her substitute or substitutes, may lawfully do or cause to be done by
virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities indicated on August 24, 1998:
TITLE SIGNATURE
----- ---------
Director, Co-Chairman of the Board and
Co-Chief Executive Officer (Principal Executive
Officer) /s/ JON S. CORZINE
----------------------------------------------
Jon S. Corzine
Director, Co-Chairman of the Board and
Co-Chief Executive Officer (Principal Executive
Officer) /s/ HENRY M. PAULSON, JR.
----------------------------------------------
Henry M. Paulson, Jr.
Director and Vice Chairman /s/ ROBERT J. HURST
----------------------------------------------
Robert J. Hurst
Director and Vice Chairman /s/ ROY J. ZUCKERBERG
----------------------------------------------
Roy J. Zuckerberg
II-6
138
TITLE SIGNATURE
----- ---------
Director and Chief Financial Officer (Principal
Financial Officer) /s/ JOHN A. THAIN
----------------------------------------------
John A. Thain
Deputy Chief Financial Officer
(Principal Accounting Officer) /s/ DAVID A. VINIAR
----------------------------------------------
David A. Viniar
Director and Chairman of International Operations /s/ JOHN L. THORNTON
----------------------------------------------
John L. Thornton
II-7
139
REPORT OF INDEPENDENT ACCOUNTANTS
To the Partners,
The Goldman Sachs Group, L.P.:
In connection with our audits of the consolidated financial statements of The
Goldman Sachs Group, L.P. and Subsidiaries as of May 29, 1998, November 28, 1997
and November 29, 1996, and for the six-month fiscal period ended May 29, 1998
and the three fiscal years in the period ended November 28, 1997, which
financial statements are included on pages F-4 to F-24 of this Form S-1, we have
also audited the financial statement schedules listed in Item 16(b) herein.
In our opinion, these financial statement schedules, when considered in relation
to the basic financial statements taken as a whole, present fairly, in all
material respects, the information required to be included therein.
PricewaterhouseCoopers LLP
New York, New York
August 3, 1998.
S-1
140
SCHEDULE IV
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
THE GOLDMAN SACHS GROUP, L.P.
CONDENSED STATEMENTS OF EARNINGS (PARENT COMPANY ONLY)
SIX MONTHS
YEAR ENDED NOVEMBER ENDED MAY
---------------------------- --------------------
1995 1996 1997 1997 1998
---- ---- ---- ---- ----
(unaudited)
(in millions)
REVENUES:
Equity in earnings of subsidiaries........... $ 746 $2,184 $2,378 $1,310 $1,332
Principal investments........................ 654 208 339 76 433
Interest income, principally from
affiliates................................. 3,008 2,602 2,943 1,348 1,989
------ ------ ------ ------ ------
Total revenues..................... 4,408 4,994 5,660 2,734 3,754
Interest expense, principally on
short-term funding......................... 3,025 2,547 2,858 1,346 1,989
------ ------ ------ ------ ------
Revenues, net of interest expense.......... 1,383 2,447 2,802 1,388 1,765
OPERATING EXPENSES:
Compensation and benefits.................... 7 13 12 1 2
Other........................................ 23 33 29 13 16
------ ------ ------ ------ ------
Total operating expenses........... 30 46 41 14 18
Pre-tax earnings............................. 1,353 2,401 2,761 1,374 1,747
Provision for unincorporated business
taxes...................................... 5 2 15 2 16
------ ------ ------ ------ ------
Net earnings................................. $1,348 $2,399 $2,746 $1,372 $1,731
====== ====== ====== ====== ======
See note to condensed financial statements.
S-2
141
THE GOLDMAN SACHS GROUP, L.P.
CONDENSED STATEMENTS OF FINANCIAL CONDITION (PARENT COMPANY ONLY)
AS OF NOVEMBER AS OF MAY
------------------ ----------------------
1996 1997 1997 1998
---- ---- ---- ----
(unaudited)
(in millions)
ASSETS:
Cash and cash equivalents...................... $ 116 $ 4 $ 46 $ 14
Financial instruments owned, at fair value..... 1,171 1,896 1,381 2,063
Receivables from affiliates.................... 19,361 23,767 21,819 29,567
Subordinated loan receivables from
affiliates................................... 5,361 6,889 5,751 8,608
Investment in subsidiaries..................... 4,774 5,005 5,036 4,924
Other.......................................... 306 434 469 743
------- ------- ------- -------
$31,089 $37,995 $34,502 $45,919
======= ======= ======= =======
LIABILITIES AND NET WORTH:
Short-term borrowings, including commercial
paper........................................ $13,756 $16,597 $16,763 $19,128
Payable to affiliates.......................... 34 119 12 48
Other.......................................... 93 137 105 135
Long-term borrowings:
With third parties........................... 10,744 14,290 11,324 18,838
With affiliates.............................. 169 315 143 566
------- ------- ------- -------
24,796 31,458 28,347 38,715
Partners' capital reserved for income taxes
and potential withdrawals.................... 984 430 546 566
Partners' capital.............................. 5,309 6,107 5,609 6,638
------- ------- ------- -------
$31,089 $37,995 $34,502 $45,919
======= ======= ======= =======
See note to condensed financial statements.
S-3
142
THE GOLDMAN SACHS GROUP, L.P.
CONDENSED STATEMENTS OF CASH FLOWS (PARENT COMPANY ONLY)
SIX MONTHS
YEAR ENDED NOVEMBER ENDED MAY
--------------------------- ---------------------
1995 1996 1997 1997 1998
---- ---- ---- ---- ----
(unaudited)
(in millions)
Cash flows from operating activities:
Net earnings............................. $ 1,348 $ 2,399 $ 2,746 $ 1,372 $ 1,731
Non-cash items included in net earnings:
Equity in earnings of subsidiaries.... (746) (2,184) (2,378) (1,310) (1,332)
Depreciation and amortization......... 17 25 19 9 9
(Increases)/decreases in operating assets
and liabilities:
Financial instruments owned, at fair
value................................. (114) (110) (395) (135) 16
Other, net............................... (105) (43) (98) (160) (227)
------- ------- ------- ------- -------
Net cash provided by/(used for)
operating activities................ 400 87 (106) (224) 197
------- ------- ------- ------- -------
Cash flows from investing activities:
Financial instruments owned, at fair
value................................. 111 126 (331) (75) (183)
Receivable from affiliates, net.......... 3,650 (1,476) (4,320) (2,480) (5,871)
Subordinated loan receivables from
affiliates............................ (101) (480) (1,528) (390) (1,719)
Investments in subsidiaries.............. 334 2,031 2,147 1,049 1,412
Property, leasehold improvements and
equipment............................. (34) (1) (4) (1) (93)
------- ------- ------- ------- -------
Net cash provided by/(used for)
investing activities................ 3,960 200 (4,036) (1,897) (6,454)
------- ------- ------- ------- -------
Cash flows from financing activities:
Short-term borrowings, including
commercial paper...................... (5,537) 496 39 1,370 (945)
Issuance of long-term borrowings......... 5,515 4,636 7,498 3,196 9,110
Repayment of long-term borrowings........ (3,067) (3,886) (1,005) (1,005) (834)
Capital contributions.................... 276 4 89 75 6
Returns on capital and certain
distributions to partners............. (449) (473) (557) (288) (311)
Redemption of institutional limited
partners.............................. (275) -- -- -- --
Partners' capital reserved for income
taxes and potential withdrawals,
net................................... (835) (1,017) (2,034) (1,297) (759)
------- ------- ------- ------- -------
Net cash (used for)/provided by
financing activities............. (4,372) (240) 4,030 2,051 6,267
------- ------- ------- ------- -------
Net (decrease)/increase in cash and cash
equivalents.............................. (12) 47 (112) (70) 10
Cash and cash equivalents, beginning
of period................................ 81 69 116 116 4
------- ------- ------- ------- -------
Cash and cash equivalent, end of period.... $ 69 $ 116 $ 4 $ 46 $ 14
======= ======= ======= ======= =======
SUPPLEMENTAL DISCLOSURES:
Cash payments for interest approximated the related expense for each of the
fiscal periods presented. Payments of unincorporated businesses taxes were not
material.
See note to condensed financial statements.
S-4
143
THE GOLDMAN SACHS GROUP, L.P.
NOTE TO CONDENSED FINANCIAL STATEMENTS (PARENT COMPANY ONLY)
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The condensed unconsolidated financial statements of The Goldman Sachs
Group, L.P. should be read in conjunction with the consolidated financial
statements of The Goldman Sachs Group, L.P. and Subsidiaries and the footnotes
thereto. Certain reclassifications have been made to prior year amounts to
conform to the current presentation.
Investment in subsidiaries is accounted for using the equity method.
The condensed unconsolidated financial statements have been prepared in
accordance with generally accepted accounting principles which require
management to make estimates and assumptions regarding investment valuations,
partner retirements, the outcome of pending litigation and other matters that
affect the condensed unconsolidated financial statements and related disclosure.
These estimates and assumptions are based on judgment and available information
and, consequently, actual results could be different from these estimates.
S-5
144
INDEX TO EXHIBITS
SEQUENTIALLY
EXHIBIT NUMBERED
NO. DESCRIPTION PAGE
- ------- ------------------------------------------------------------ ------------
1.1 Form of Underwriting Agreement.*
2.1 Plan of Incorporation.*
3.1 Form of Amended and Restated Certificate of Incorporation of
the Company.*
3.2 By-Laws of the Company.*
4.1 Specimen of certificate representing the Company's Common
Stock, par value $.01 per share.*
4.2 Rights Agreement, dated as of , 1998, between
The Goldman Sachs Group, L.P. ("Group L.P.") and
, as Rights Agent.*
5.1 Opinion of Sullivan & Cromwell, counsel to the Company.*
10.1 Lease, dated June 11, 1985, between Metropolitan Life
Insurance Company and Goldman, Sachs & Co.
10.2 Lease, dated April 5, 1994, between The Chase Manhattan Bank
(National Association) and Group L.P., as amended.*
10.3 Lease, dated as of August 22, 1997, between Ten Hanover LLC
and Group L.P.
10.4 Lease, dated as of July 16, 1998, between TCC Acquisition
Corp. and Group L.P.
10.5 Agreement for Lease, dated April 2, 1998, among (i) JC No. 3
(UK) Limited and Fleet Street Square Management Limited
trading as Fleet Street Partnership, (ii) Goldman Sachs
International ("GSI"), (iii) Restamove Limited, (iv) Group
L.P. and (v) Itochu Corporation.*
10.6 Annexure 1 to Agreement for Lease, dated April 2, 1998,
among (i) JC No. 3 (UK) Limited and Fleet Street Square
Management Limited trading as Fleet Street Partnership, (ii)
GSI, (iii) Restamove Limited, (iv) Group L.P. and (v) Itochu
Corporation (Form of Occupational Lease, dated ,
19 , among (i) JC No. 3 (UK) Limited and Fleet Street
Square Management Limited trading as Fleet Street
Partnership, (ii) GSI and (iii) Group L.P.).*
10.7 Agreement relating to Developer's Fit Out Works to be
carried out at 120 Fleet Street, London, dated April 2,
1998, among (i) JC No. 3 (UK) Limited and Fleet Street
Square Management Limited, (ii) Goldman Sachs Property
Management, (iii) Itochu Corporation and (iv) Group L.P.*
10.8 Agreement relating to One Carter Lane, London EC4, dated
March 25, 1998, among Britel Fund Trustees Limited, GSI,
Group L.P., English Property Corporation plc and MEPC plc.
10.9 Fit Out Works Agreement, dated March 25, 1998, among Britel
Fund Trustees Limited, GSI, Goldman Sachs Property
Management, Group L.P., English Property Corporation plc and
MEPC plc.
10.10 Form of Underlease, dated , 1998, among Britel Fund
Trustees Limited, GSI and Group L.P.
10.11 Lease, dated March 5, 1994, among Shine Hill Development
Limited, Shine Belt Limited, Fair Page Limited, Panhy
Limited, Maple Court Limited and Goldman Sachs (Asia)
Finance.
10.12 Guarantee, dated November 17, 1993, between Shine Hill
Development Limited and Group L.P.
10.13 Summary of Tokyo Leases.*
10.14 Goldman Sachs 1998 Stock Incentive Plan.*
10.15 The Goldman Sachs Defined Contribution Plan.*
10.16 Trust Agreement.*
10.17 The Goldman Sachs Partner Pool.*
10.18 Form of Employment Agreement.*
145
SEQUENTIALLY
EXHIBIT NUMBERED
NO. DESCRIPTION PAGE
- ------- ------------------------------------------------------------ ------------
10.19 Form of Confidentiality, Noncompetition and Nonsolicitation
Agreement.*
10.20 Form of Pledge Agreement.*
10.21 Award Agreement (Formula RSUs).*
10.22 Award Agreement (Discretionary RSUs).*
10.23 Form of Option Agreement (Discretionary Options).*
10.24 Form of Tax Indemnification Agreement, dated as of November
, 1998, by and among the Schedule I and Schedule II
Limited Partners, and other former partners of Group L.P.
who or which have accepted the Plan of Incorporation,
Sumitomo Bank Capital Markets, Inc., Kamehameha Activities
Association and The Goldman Sachs Group, Inc.*
10.25 Shareholders' Agreement, dated as of , 1998, among
The Goldman Sachs Group, Inc. and various parties.*
10.26 Instrument of Indemnification.*
11.1 Statement re computation of per share earnings.*
15.1 Letter of PricewaterhouseCoopers LLP regarding unaudited
interim financial information.
21.1 List of subsidiaries of the Company.
23.1 Consent of PricewaterhouseCoopers LLP.
23.2 Consent of Sullivan & Cromwell (included in Exhibit 5.1
above).*
24.1 Powers of Attorney (included on signature page).
27.1 Financial Data Schedule.
- ---------------
* To be filed by amendment.