Monday, July 17, 2006

Who is mindful of the dual roles investment banks play?

Goldman Sachs's Conflicts of Interest Convulse Chicago, Indiana


Copyright 2006

If you want to know about conflicts of interest at Goldman Sachs Group Inc., just ask Chicago's city government.

Goldman, the world's most profitable securities firm, was a frontrunner to advise Chicago on the potential sale of Midway Airport after helping the city lease a toll highway last year. That was until April, when Dana Levenson, Chicago's chief financial officer, read about Goldman's plan to buy an airport company in Europe that might eventually bid for Midway. Within a day, he called Goldman to complain and in May told the New York- based firm that it wouldn't get the assignment.

"It's an obligation we have to taxpayers,'' said Levenson, who denied Goldman a formal interview at his office and hired Credit Suisse Group. "If we think anything could hinder us from maximizing proceeds, we have to fix the situation. And that may involve making sure our advisers don't have conflicts.''

A growing number of U.S. public officials are asking how an adviser charged with selling assets at the highest price can play the role of investor at the same time, seeking to buy them for as little as possible. Like Levenson, 49, administrators in Indiana, Oregon and Texas are getting wise to Wall Street's efforts and forcing firms to choose between fees and investment returns.

"In the corporate world, and to a growing degree in the municipal world, Goldman Sachs's clients are asking us for advice, for financing and to invest alongside them,'' Goldman spokesman Michael DuVally said in a statement. "We take conflict and business selection issues seriously and carefully think through each situation.''

Millions in Fees

At least 13 U.S. states may hire private companies to help build and operate $34.5 billion in toll roads spanning 2,700 miles (4,344 kilometers), according to the Federal Highway Administration. That means about $175 million in fees are up for grabs, based on rates charged on the handful of completed road sales and leases.

There are probably more to come. Local and state governments oversee about $1.7 trillion of roadways nationwide, and billions more in other infrastructure, from subways to sewers, the U.S. Bureau of Economic Analysis estimates. Less than 4 percent of the 5,244 miles of U.S. toll roads are now privately run, a figure that may jump to 32 percent based on the number of deals being considered.

"If you think about the potential market, it's huge,'' said Frank Chin, 56, the New York-based head of Citigroup Inc.'s public-finance department. "How many transactions get done, we'll see.''

Ex-Investment Banker

Levenson knows how investment banks operate first-hand. Before joining the Chicago government in 2004, he had a 25-year career managing corporate-bond sales at Bank One Corp., Bank of America Corp. and Kidder Peabody & Co.

Many municipal and state officials don't consider all the potential hazards of dealing with securities firms that invest or trade securities in addition to advising clients. While Texas Department of Transportation rules prevent such firms from buying or running the state's highways while helping it sell or lease toll roads, CFO James Bass said he likes the idea of hiring an experienced investor as an adviser.

"It puts them deeper into that market with a better understanding from the equity side,'' said Bass, 39, who first worked for the Department of Transportation after graduating from high school in 1985 and isn't related to the family of Texas investors with the same surname. "We can't have all of the developers in the room with us, but we can have Goldman in there to give us the viewpoint of equity investors.''

Paulson's Rebuke

Goldman, the No. 1 arranger on mergers and acquisitions this year, courted conflicts twice with its unsolicited bid for BAA Plc, the offer that riled Levenson in April. Bankers at the firm made their approach to BAA, owner of London's Heathrow airport, less than two months after offering to help it fend off a hostile takeover from Spain's Grupo Ferrovial SA.

The situation prompted Goldman's chief executive officer at the time, newly appointed U.S. Treasury Secretary Henry Paulson, to warn senior managers he was concerned about the "perception'' of the firm's actions. Paulson, 60, was succeeded last month by Lloyd Blankfein, 51, who had been Goldman's president.

Levenson also faced potential conflicts with Zurich-based Credit Suisse, the main adviser he chose over Goldman for Midway Airport, the 29th-largest U.S. airfield by passengers.

Credit Suisse, Switzerland's second-largest bank, told Chicago officials that it planned to raise together with Fairfield, Connecticut-based General Electric Co. a fund to invest in infrastructure assets. To clear the obstacle, Credit Suisse agreed to put a clause into its contract with Chicago restricting the fund from taking a controlling stake in any airport operator.

Buying Cheap

Goldman is raising a $3 billion infrastructure fund. New York-based JPMorgan Chase & Co., the No. 3 U.S. bank, Morgan Stanley, the world's largest securities firm by market value, are considering similar steps.

"The objective of these funds is to buy assets on the cheap,'' Chicago's Levenson said. "We're concerned, but it's unavoidable. It would be a lot easier if there were no funds housed in investments banks, but that's not going to be the case.''

Credit Suisse spokeswoman Victoria Harmon, JPMorgan's Brooke Harlow and Morgan Stanley's Andrea Slattery declined to comment.

More firms soon may find themselves in Goldman's situation.

"Virtually every major financial institution on Wall Street has created, or is in the process of creating, an infrastructure fund with transportation as a major component,'' Norman Mineta, 64, said in his last speech as U.S. Transportation Secretary, at the U.S. Chamber of Commerce in Washington on July 6. ``They correctly recognize the enormous potential in American infrastructure.''

Contentious Sales

Sales of public assets were contentious even without the question of conflicts. From the beginning, community activists and government officials wary of ceding control over public works have threatened to derail privatizations.

The administrations that pursue sales, such as Chicago, do so largely because higher taxes are the only other way to plug deficits, fund pension obligations and combat rising fuel costs.

"You need to fund all of these fundamental programs, and raising taxes is not very palatable,'' said Sujit CanagaRetna, a senior fiscal analyst in Atlanta for the Council of State Governments, a research association for legislators.

Indiana budget director Charles Schalliol is another official who's mindful of the dual roles investment banks can play. Schalliol, a former executive director of corporate finance at drugmaker Eli Lilly & Co., helped pick Goldman last year to advise Indiana on the lease of a 157-mile toll road, turning down pitches from finalists Citigroup, JPMorgan and New York-based Bear Stearns Cos., the No. 5 U.S. securities firm.

Called Banker

The state, which received $3.8 billion for the 75-year lease when it closed June 29, paid Goldman $20 million in fees.

Schalliol, 58, said he later found out Goldman had started raising its fund to invest in toll highways and similar projects after winning the assignment from Indiana. Perturbed, he raised concerns with the firm's top infrastructure banker, 48-year-old Mark Florian.

"I told Mark Florian, after the transaction was done, it would have been a significant area of conversation,'' Schalliol said. "I would not go so far as to say it's unacceptable to have a fund. I would say it creates some serious questions for the engagement.''

Goldman spokesman DuVally said Florian wouldn't comment.

Skyway Deal

Before its conflicts came to light, Goldman had an inside track on the Midway assignment because of prior work for the city. In January 2005, it helped Chicago arrange a $1.83 billion, 99-year lease for the Chicago Skyway, a 7.8-mile elevated toll road stretching from the city's South Side to the Indiana border.

Chicago paid Goldman and Loop Capital Markets LLC $12 million in fees on the deal, the first of its kind in the U.S. The Midway transaction would be just as groundbreaking, placing a major U.S. airport into private hands for the first time.

Together with Citigroup, Goldman then arranged a bond sale and interest-rate swap for the lessors, the infrastructure unit of Australia's Macquarie Bank Ltd. and Spain's Cintra Concesiones de Infraestructuras de Transporte SA, to refinance debt incurred in the transaction. Macquarie and Cintra also leased and now operate the Indiana toll road.

"If you consider both the M&A fee as well as the financing fee, it's probably one of the biggest revenue opportunities on Wall Street today,'' Levenson said.

$50 Billion

Murray Bleach, Macquarie's head of infrastructure banking in North America, said he expects more states and cities to follow Chicago and Indiana, and sell roads and other assets. Apart from those sales, Bleach, 47, estimates an additional $50 billion of new U.S. toll-road projects will be won by private developers in the next three to five years.

Oregon, which has a contract with Sydney-based Macquarie covering the potential development of three toll roads, is about to conduct a search for financial advisers. James Whitty, head of the Office of Innovative Partnerships and Alternative Funding at the state's transportation department, said he's on the lookout for firms that also want to invest in Oregon motorways.

"We have conflict-of-interest provisions, so whoever we sign a contract with will have to commit to not be on the other side,'' Whitty said.

Some governments are even more circumspect.

In Houston last month, more than 10 bankers from Goldman, JPMorgan, Loop Capital and Puerto Rico's Banco Popular filed into the Harris County Commissioners Court and found themselves seats in its rows of wooden pews. A portrait of Sam Houston, who won Texas's independence from Mexico in 1836, watched over the windowless, ninth-floor room.

Not for Sale

The bankers were there on June 20 to argue why Harris County should sell or lease Houston's toll roads, an 83-mile system that encircles the city and links with George Bush International Airport. Twenty-five minutes later, they filed out, some having never had a chance to unsheathe their slides and whiteboards.

The five-member court cut short the parade of presentations, voting unanimously to keep control of the roads and dashing the banks' hopes for a piece of the $13 billion deal and the $65 million in advisory fees it might have paid.

"Now we know what it's worth,'' Commissioner Steve Radack told the standing room-only crowd of observers. "We can erect a sign on the toll road that says, 'Not for Sale.'''

To contact the reporters on this story:
Eddie Baeb in Chicago at;
Justin Baer in New York at
Last Updated: July 17, 2006 00:22 EDT

© 2006 Bloomberg LP :