While Goldman Sachs contends with the government's civil fraud charges, an equally serious problem looms: a damaged reputation that may cost it clients.
The Securities and Exchange Commission's bombshell civil fraud charge against Goldman has tarnished the Wall Street bank's already bruised image, analysts say. It could also hurt its ability to do business in an industry based largely on trust.
Damage from the case could hit other big banks as well. The SEC charges are expected to help the Obama administration as it seeks to more tightly police lucrative investment banking activities.
Goldman has denied the SEC's allegation that it sold risky mortgage investments without telling buyers that the securities were crafted in part by a billionaire hedge fund manager who was betting on them to fail. A 31-year-old Goldman employee is also accused in the civil suit that was announced Friday.
The charges could result in fines and restitution of more than $700 million, predicted Brad Hintz, an analyst at Sanford Bernstein. Yet, even if Goldman beats the charge, the hit to its reputation could carry a greater cost.
The company, founded in 1869, grew a one-man outfit trading promissory notes in New York to the world's most powerful, most profitable and arguably most envied securities and investment firm. From its 43-story glass-and-steel headquarters in Lower Manhattan, Goldman oversees a financial empire that spans more than 30 countries and includes more than 30,000 employees.
It has long attracted some of the world's best and brightest. Some have gone on to lofty careers in public life, enhancing the firm's aura of mystique and influence. Goldman alumni include former Treasury Secretaries Henry Paulson and Robert Rubin and former New Jersey Gov. Jon Corzine.
In its corporate profile, the company says its culture distinguishes it from other firms and "helps to make us a magnet for talent." That culture is summed up in the firm's "14 Business Principles," which preach an almost militant philosophy of putting the client before the firm.
Now, that very philosophy that has been questioned by the government.
So far, no Goldman clients have publicly condemned the bank's alleged actions. But the negative publicity and regulatory scrutiny could cause some to distance themselves, said Mark T. Williams, a professor of finance and economics at Boston University.
Goldman earned a record $4.79 billion during the fourth quarter of last year and is expected to report blowout first-quarter results on Tuesday. A big chunk of its profits are from fee-based client businesses, such as investment advising, underwriting securities and brokering billion-dollar mergers.
"Goldman can really only truly be effective in the marketplace if it maintains a strong reputation," Williams said.
Morgan Stanley, the No. 2 U.S. investment bank after Goldman, could be in a position to poach some Goldman clients, which include hedge funds, pension funds and other big institutional investors. Overseas, European rivals such as Deutsche Bank AG and UBS could benefit.
Investors are already betting the legal troubles will hurt Goldman's finances. The company's shares plunged 13 percent after the charges were announced Friday, erasing a staggering $12.5 billion in market value.
"Reputation risk is the biggest issue in our view," Citigroup analyst Keith Horowitz wrote in a note to clients. He predicted the fraud case won't be a "life-threatening issue" but that it "clearly seems like a black eye for Goldman."
It's not the first. The company came under criticism for receiving billions in bailout money that the government funneled into crippled insurer American International Group Inc. at the height of the financial crisis in 2008. Goldman was owed the money, but critics argued it should've been treated like other creditors and be forced to accept less.
Goldman CEO Lloyd Blankfein angered the bank's critics last year after The Times of London quoted him as saying he was "doing God's work" running the firm and handing out big employee bonuses. Blankfein himself got a $9 million stock bonus for 2009.
Mishaps like those have been surprising given how much attention Goldman pays to its image. "Our clients' interests always come first," the company says on its Web site under the heading, "Goldman Sachs Business Principle No. 1."
It's a sales pitch that few Wall Street firms always live up to. Some analysts blame that on a shift in the industry's business model from traditional investment banking to one that focuses on making big bets for itself or clients.
That shift culminated in the rise of Blankfein, a former commodities trader, to the position of CEO in 2003. Today, trading accounts for nearly 70 percent of Goldman's revenue. Most of that trading is done on behalf of clients, though Goldman generates about 10 percent of its revenue by trading for itself.
The heavy reliance on trading and Goldman's peerless performance have left the firm open to criticism that it uses its market knowledge to game the system to benefit itself and a select group of clients.
The SEC charges seemingly support that assertion. Fabrice Tourre, the 31-year-old Goldman executive accused of shepherding the deal in question, boasted about the "exotic trades" he created "without necessarily understanding all of the implications of those monstrosities!!!," according to the SEC complaint.
In another e-mail, he describes as "surreal" a meeting between his hedge fund client and another firm that allegedly wasn't told that the bundle of securities it was buying were chosen with input from a third party who was betting they would fail.
"Once upon a time, Wall Street firm protected clients," said Christopher Whalen, managing director of financial research firm Institutional Risk Analytics. "This litigation exposes the cynical, savage culture of Wall Street that allows a dealer to commit fraud on one customer to benefit another."
In a lengthy rebuttal to the SEC charges Friday, Goldman insisted it was a middleman in the transaction and did nothing wrong by not disclosing bearish bets against the pool by Paulson & Co., a major hedge fund led by billionaire investor John Paulson. Goldman said it lost $90 million on the deal.
The SEC said Goldman had a duty to inform buyers of the mortgage investments that Paulson had played a major role in choosing the securities that went into the derivatives product and then bet that they would go bust.
Derivatives are complex financial products whose value is based on an underlying asset like mortgages or other types of debt. They're not traded on a public exchange, allowing firms like Goldman to generate fees by brokering deals between buyers and sellers.
The charges strengthen the government's case for increased regulation of derivatives like those Goldman is accused of using, analysts said.
Regardless, Goldman ability to weather the storm should not be discounted, said Janet Tavakoli, president of Tavakoli Structured Finance, a Chicago consulting firm.
"The benefits of the crisis have so far swamped the reputation risks for Goldman," she said.
"If anything," she added, "they may wind up getting more customers if people can't avoid doing business with them."