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For Goldman, Success Comes With Scrutiny

At Goldman Sachs, success has become something of a liability.

For years the investment bank has inspired praise and more than a little envy for its perennial dominance of investment banking, exceptional profits and its Who's Who of influential alumni.

Lately, its financial wizardry has stood out even more as it thrived, even as most of its rivals were saddled with billions of dollars in write-downs and credit losses.

Goldman Sachs
Goldman Sachs

But fame and fortune have their price. Goldman has increasingly been attracting more attention than the secretive firm desires, including unwanted scrutiny from regulators and lawmakers.

"They're the top of the heap. Their success is eye-popping. Their latest record earnings in the face of big losses taken by most of the other investment banks is impressive in itself," said Harvard Business School professor Samuel Hayes. "It inspires a lot of envy. There's a lot of resentment."

Goldman is expected to report a record $11 billion of annual profit on Tuesday, including billions of gains from bets against the subprime mortgage market. Rivals, such as Morgan Stanley and Merrill Lynch , have ousted top executives and are expected to cap the year with money-losing quarters.

And while year-end bonuses are expected to be flat or smaller across Wall Street, Goldman payouts will rise to roughly $18 billion. On average, that is about $600,000 per employee, or double the average paid at other firms.

The disparity of results has some accusing Goldman of having an unfair edge or of hiding its mistakes. The appointment of former Goldman CEO Hank Paulson as Treasury secretary has one New York tabloid columnist convinced Goldman gets inside information on the bond market.

DrawingAttention

Earlier this month, economist Ben Stein caused a stir when he accused Goldman economist Jan Hatzius of issuing bearish reports on the housing and mortgage market to support the firm's traders betting on the market's decline. Others say Goldman may be understating problems.

"People believe they haven't done anything wrong. I don'tthink they are impervious," said Jon Fisher, who helps oversee about $22 billion at Fifth Third Asset Management. "Just because they say something doesn't mean you have to believe it."

Taking shots at Goldman is hardly new. In 1996, buyout firms and some companies complained its dual roles as investor and adviser created a conflict of interests. That storm passed, but Goldman took some lumps, such as being left off the list of lead underwriters for the Blackstone Group IPO.

Goldman declined to respond to the criticism, which many market sources and analysts call unfounded. The bank maintains its research and economists are completely independent.

Still, the questions are drawing attention from regulators and politicians -- poison for an ultra-secretive bank that sometimes acts as if it is still a private partnership.

The Securities and Exchange Commission is taking a closer look at how Goldman and other banks value assets, particularly illiquid securities that have fueled losses at hedge funds and rival banks.

Sen. Chris Dodd of Connecticut, a Democratic presidential candidate, called for an investigationafter hearing about the Hatzius research and Goldman's mortgage trading.

"It's all generally unhelpful and it's unhelpful for the market," one Goldman official acknowledged.

Could Get Tougher

Goldman's delivered a standout performance in the third quarter, when it generated near-record profit, despite having to write down $1.7 billion on loan commitments to leveraged buyouts.

Fourth-quarter results -- expected to remain little changed while other banks have decreases or losses -- will likely add fuel to the fire. Goldman's bets against the subprime market are expected to generate more gains.

And as most of Wall Street hands out bonuses that are flat or lower, Goldman's payouts are expected to be generously higher.

Chief Executive Lloyd Blankfein will lead the way with as much as $70 million in salaryand bonus.

Goldman did take some hits this year. It lost $1.5 billion to $2 billion in mortgage-related businesses this year, analysts said, although these were more than offset by the bets against the subprime market.

The Wall Street Journal reported on Friday that Goldman generated $4 billion in gains from the subprime trades. But a Goldman spokesman said the report "overstates the profitability of the business."

Analyst Richard Bove of Punk Ziegel, who is critical of Goldman's reliance on proprietary trading and has a "sell" rating on its shares, says Goldman deserves credit for investing in superior trading data and risk management systems.

Goldman shares are up 6.4 percent this year, a period when the Amex Securities Broker Dealer Index (.XBD) fell 14 percent.

Goldman trades at 2.5 times its book value, according to Reuters Analytics, making it more richly valued than any major securities firm except for discount brokerages TD Ameritrade and Charles Schwab.

Still, Goldman will face questions on how it once again profited when everyone else, including clients, suffered.

More than any other firm, Goldman under Blankfein has deployed its capital boldly, pursuing strategies that can sometimes run contrary to what clients are doing.

Goldman's flagship Global Alpha hedge fund has lost about 60 percent of its value this year, even as the fixed-income trading desk minted money.

Another trouble spot could be how Goldman's underwriters issued collateralized debt obligations -- vehicles that invest in mortgage-backed securities -- through May, several months after it turned bearish on mortgages.

"You've got two departments not communicating, which are sent out to go make money," Bove said. "One part of the firm's underwriting CDOs and the other is shorting the hell out of them."

For most firms that would be chalked up to independence.

For Goldman, it may only convince rivals and conspiracy theorists that the firm is utterly conflicted.

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