01/08/2024 - The Goldman Sachs Group Inc.: 1999 Form 10-K

The Goldman Sachs Group, Inc.

Annual Report on Form 10-K for the Fiscal Year Ended November 26, 1999

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PART I

Item 1. Business

Overview

Goldman Sachs is a leading global investment banking and securities Ñrm that provides a wide range of services worldwide to a substantial and diversiÑed client base that includes corporations, Ñnancial institutions, governments and high-net-worth individuals. As of Novem- ber 26, 1999, we operated oÇces in over 20 countries and 37% of our 15,361 employees were based outside the United States.

Goldman Sachs is the successor to a commercial paper business founded in 1869 by Marcus Goldman. Since then, we have expanded our business as a participant and intermediary in securities and other Ñnancial activities to become one of the leading Ñrms in the industry.

In 1989, The Goldman Sachs Group, L.P. was formed to serve as the parent company of the Goldman Sachs organization. On May 7, 1999, The Goldman Sachs Group, Inc. succeeded to the business of The Goldman Sachs Group, L.P. and completed an initial public oÅering of its common stock.

All references to 1999, 1998 and 1997 refer to our Ñscal year ended, or the date, as the context requires, November 26, 1999, November 27, 1998 and November 28, 1997, respectively.

When we use the terms ""Goldman Sachs'', ""we'' and ""our'', we mean, prior to our conversion to corporate form, The Goldman Sachs Group, L.P., a Delaware limited partnership, and its consolidated subsidiaries and, after our conversion to corporate form, The Goldman Sachs Group, Inc., a Delaware corporation, and its consolidated subsidiaries.

Financial information concerning our business segments and geographic regions for each of 1999, 1998 and 1997 is set forth in the consolidated Ñnancial statements and the notes thereto in our 1999 Annual Report to Shareholders, which are incorporated by reference in Part II, Item 8 of this Annual Report on Form 10-K.

Business Segments

Our activities are divided into two segments:

• Global Capital Markets; and
• Asset Management and Securities Services.

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These segments consist of various product and service oÅerings that are set forth in the following chart:

Primary Products and Activities by Business Segment

Global Capital Markets

The Global Capital Markets segment, which represented 76% of 1999 net revenues, consists of the following:

• Investment Banking. Investment Banking consists of our Financial Advisory and Under- writing businesses; and
• Trading and Principal Investments. Trading and Principal Investments consists of our Fixed Income, Currency and Commodities (""FICC''), Equities and Principal Investments businesses.

Investment Banking

Investment Banking represented 33% of 1999 net revenues. We provide a broad range of investment banking services to a diverse group of corporations, Ñnancial institutions, governments and individuals and seek to develop and maintain long-term relationships with these clients as their lead investment bank.

Our current structure, which is organized along regional, product and industry groups, seeks to combine client-focused investment bankers with execution and industry expertise. Because our businesses are global, we have adapted our organization to meet the demands of our clients in each geographic region. Through our commitment to teamwork, we believe that we provide services in an integrated fashion for the beneÑt of our clients.

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-oÅs; and
• Underwriting. Underwriting includes public oÅerings and private placements of equity and debt securities.

Financial Advisory. Goldman Sachs is a leading investment bank in worldwide mergers and acquisitions. Our mergers and acquisitions capabilities are evidenced by our signiÑcant share of

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assignments in large, complex transactions for which we provide multiple services, including ""one-stop'' acquisition Ñnancing, currency hedging and cross-border structuring expertise.

Underwriting. We underwrite 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 Goldman Sachs. As with mergers and acquisitions, we have been particularly successful in winning mandates for large, complex equity underwritings. We believe our leadership in large initial public oÅerings reÖects our expertise in complex transactions, research strengths, track record and distribution capabilities. We have also acted as lead manager on many of the largest initial public oÅerings in the international arena.

We believe that a key factor in our equity underwriting success is the close working relationship among the investment bankers, research analysts and sales force as coordinated by our Equity Capital Markets group. With 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.

Debt Underwriting. We engage in the underwriting and origination of various types of debt instruments that we broadly categorize as follows:

• investment-gradedebt for corporations, governments, municipalities and agencies;
• leveraged Ñnance, which includes high-yield debt and bank loans for non-investment-grade issuers;
• emerging market debt, which includes corporate and sovereign issues; and
• asset-backedsecurities.

We have employed a focused approach in debt underwriting, emphasizing high value-added areas in servicing our clients.

Trading and Principal Investments

Trading and Principal Investments represented 43% of 1999 net revenues. Our Trading and Principal Investments business facilitates transactions with a diverse group of corporations, Ñnancial institutions, governments and individuals and takes proprietary positions through market making in and trading of Ñxed income and equity products, currencies, commodities, and swaps and other derivatives. In order to meet the needs of our clients, our Trading and Principal Investments business is diversiÑed 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. We believe our willingness and ability to take risk distinguishes us and substantially enhances our client relationships.

Trading and Principal Investments is divided into three categories:

• Fixed Income, Currency and Commodities. Goldman Sachs makes markets in and trades Ñxed income products, currencies and commodities, structures and enters into a wide variety of derivative transactions, and engages in proprietary trading and arbitrage activities;
• Equities. Goldman Sachs 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

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• Principal Investments. Principal Investments primarily represents net revenues from our merchant banking investments.

Fixed Income, Currency and Commodities. FICC is a large and diversiÑed operation through which we engage in a variety of customer-drivenmarket-making and proprietary trading and arbitrage activities. FICC's principal products are:

• Bank loans
• Commodities
• Currencies
• Derivatives
• Emerging market debt
• Global government securities
• High-yieldsecurities
• Investment-gradecorporate securities
• Money market instruments
• Mortgage securities and loans
• Municipal securities

We generate trading net revenues from our customer-driven business 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.

In our proprietary activities, we assume a variety of risks and devote substantial resources to identify, analyze and beneÑt from these exposures. We leverage our strong research capabilities and capitalize on our proprietary analytical models to analyze information and make informed trading judgments. We seek to beneÑt from perceived disparities in the value of assets in the trading markets and from macroeconomic and company-speciÑc trends.

FICC uses a three-part approach to deliver high quality service to its clients. First, we oÅer 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 many of the largest government bond markets around the world, including the United States, Japan, the United Kingdom and Canada. We are a member of the major futures exchanges, and also have interbank dealer status in the currency markets in New York, London, Tokyo and Hong Kong. Our willingness to make markets in a broad range of Ñxed income, currency and commodity products and their derivatives is crucial both to our client relationships and to support our underwriting business by providing secondary market liquidity. Our research capabilities include quantitative and qualitative analyses of global economic, currency and Ñnancial market trends, as well as credit analyses of corporate and sovereign Ñxed income securities.

Equities. Goldman Sachs engages in a variety of market-making, proprietary trading and arbitrage activities in equity securities and equity-related products (such as convertible securities

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and equity derivative instruments) on a global basis. Goldman Sachs makes markets and positions blocks of stock to facilitate customers' transactions and to provide liquidity in the marketplace. Goldman Sachs is a member of most of the major stock exchanges, including New York, London, Frankfurt, Tokyo and Hong Kong.

As agent, we execute 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, we generate net revenues from our customer-driven business in three ways. First, in large, highly liquid principal markets, such as the over-the-counter 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 beneÑt from spreads that are generally larger. Finally, we also beneÑt from structuring complex transactions.

Goldman Sachs was a pioneer and is currently active in the execution of large block trades (trades of 50,000 or more shares) in the United States and abroad. We have been able to capitalize on our expertise in block trading, our global distribution network and our willingness to commit capital to eÅect increasingly large and complex customer transactions. We expect corporate consolidation and restructuring and increased demand for certainty and speed of execution by sellers and issuers of securities to increase both the frequency and size of sales of large blocks of equity securities. Block transactions, however, expose us to increased risks, including those arising from holding large and concentrated positions, and decreasing spreads.

We are active in the listed options and futures markets, and we structure, distribute and execute over-the-counter derivatives on market indices, industry groups and individual company stocks to facilitate customer transactions and our proprietary activities. We develop quantitative strategies and render advice with respect to portfolio hedging and restructuring and asset allocation transactions. We also create specially tailored instruments to enable sophisticated investors to undertake hedging strategies and establish or liquidate investment positions. We are one of the leading participants in the trading and development of equity derivative instruments. We are an active participant in the trading of futures and options on most of the major exchanges in the United States, Europe and Asia.

We remain committed to being at the forefront of technological innovation in the global

capital markets. To pursue our strategy of expanding our electronic market-making capabilities, on September 24, 1999, Goldman Sachs completed its acquisition of The Hull Group, a leading global electronic market maker in exchange-traded equity derivatives and an active market maker in equity securities worldwide.

In addition, 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 diversiÑed portfolio across diÅerent markets and event categories. This business focuses on event-oriented special situations where we are not acting as an advisor and on relative value trades. These special situations include mergers and acquisitions, corporate restructurings, recapitalizations and legal and regulatory events.

Trading Risk Management. We believe that our trading and market-making capabilities are key ingredients to our success. While these businesses have generally earned attractive returns, we have in the past incurred signiÑcant trading losses in periods of market turbulence, such as in 1994 and the second half of 1998.

Our trading risk management process seeks to balance our ability to proÑt from trading positions with our exposure to potential losses. Risk management includes input from all levels of Goldman Sachs, from the trading desks to the Firmwide Risk Committee. For a further discussion of our risk management policies and procedures, see ""Management's Discussion and

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Analysis Ì Risk Management'' in the 1999 Annual Report to Shareholders, which is incorporated by reference in Part II, Item 7 of this Annual Report on Form 10-K.

Principal Investments. In connection with our merchant banking activities, we invest by making principal investments directly and through funds that we raise and manage. As of November 1999, we had committed $3.06 billion, of which $2.33 billion had been funded, of the $17.27 billion total equity capital committed for our merchant banking funds. The funds' investments generate capital appreciation or depreciation and, upon disposition, realized gains or losses. See ""Ì Asset Management and Securities Services Ì Merchant Banking'' for a discussion of our merchant banking funds. As of November 1999, the aggregate carrying value of our principal investments held directly or through our merchant banking funds was approximately $2.88 billion, which consisted of corporate principal investments with an aggregate carrying value of approximately $1.95 billion and real estate investments with an aggregate carrying value of approximately $928 million.

Asset Management and Securities Services

The components of the Asset Management and Securities Services segment, which represented 24% of 1999 net revenues, are set forth below:

• Asset Management. Asset Management generates management fees by providing investment advisory services to a diverse client base of institutions and individuals;
• Securities Services. Securities Services includes prime brokerage, Ñnancing services and securities lending, and our matched book businesses, all of which generate revenue primarily in the form of fees or interest rate spreads; and
• Commissions. Commissions includes agency transactions for clients on major stock and futures exchanges and revenues from the increased share of the income and gains derived from our merchant banking funds.

Asset Management

Goldman Sachs is seeking to build a premier global asset management business. We oÅer a broad array of investment strategies and advice across all major asset classes: global equity; Ñxed income, including money markets; currency; and alternative investment products (i.e., investment vehicles with non-traditional investment objectives and/or strategies). Assets under supervision consist 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 consist of assets in brokerage accounts of primarily high-net-worth individuals, on which we earn commissions.

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Our growth in assets under supervision is set forth in the graph below:

Assets Under Supervision

(in billions)

As of November 1999, equities and alternative investments represented 59% of our total assets under management. Since 1996, these two asset classes have been the primary drivers of our growth in assets under management.

The following table sets forth the amount of assets under management by asset class:

Assets Under Management by Asset Class

(in billions)

1. Includes private equity, real estate, quantitative asset allocation and other funds that we manage.

Since the beginning of 1996, we have increased the resources devoted to our Asset Management business, including the addition of over 1,000 employees. In addition, Goldman Sachs has made three asset management acquisitions in order to expand its geographic reach and broaden its global equity and alternative investment portfolio management capabilities.

Clients. Our primary clients are institutions, high-net-worth individuals and retail investors. We access clients through both direct and third-party channels. Our institutional clients include corporations, insurance companies, pension funds, foundations and endowments. In the third- party distribution channel, we distribute our mutual funds on a worldwide basis through banks, brokerage Ñrms, insurance companies and other Ñnancial intermediaries.

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The table below sets forth the amount of assets under supervision by distribution channel and client category as of November 1999:

Assets Under Supervision by Distribution Channel

(in billions)

(1) Excludes $16 billion in our merchant banking funds.

Merchant Banking

Goldman Sachs has established a successful record in the corporate and real estate merchant banking business, with $17.27 billion of committed capital as of November 1999, of which $13.03 billion has been funded. We have committed $3.06 billion and funded $2.33 billion of these amounts. Our clients, including pension plans, endowments, charitable institutions and high-net-worth individuals, have provided the remainder.

Our strategy with respect to each merchant banking fund is to invest opportunistically to build a portfolio of investments that is diversiÑed by industry, product type, geographic region and transaction structure and type. 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 November 1999, our corporate merchant banking funds had total committed capital of $9.50 billion. Other funds, with total committed capital of $7.77 billion as of November 1999, invest in real estate operating companies and debt and equity interests in real estate assets.

Merchant banking activities generate three revenue streams. First, we receive 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 are included in our Asset Management revenues. Second, after that fund has achieved a minimum return for fund investors, we receive an increased share of the fund's income and gains that is a percentage, typically 20%, of the capital appreciation and gains from the fund's investments. Revenues from the increased share of the funds' income and gains are included in Commissions. Finally, Goldman Sachs, 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 the Trading and Principal Investments component of Global Capital Markets.

Securities Services

Securities Services consists predominantly of Global Securities Services, which provides prime brokerage, Ñnancing services and securities lending to a diversiÑed U.S. and international

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