There are various types of hedging strategies, many of which involve stock options. In one transaction, known as a covered call, a long-term shareholder can make income off a stock for a few months, provided it stays below a certain level. But if the price soars, the investor will not benefit from most of the rise.
In another hedge, known as a collar, an investor uses options to lock in the potential profits and losses on a stock. Although the move caps the potential upside, it also limits the risk.
Institutional hedging policies vary across Wall Street. Bank of America bans all employees from hedging their company stock, although management can make exceptions for “legitimate, nonspeculative purposes.”
But most big banks — including JPMorgan Chase, Morgan Stanley and Goldman Sachs — prohibit only their highest-ranking executives from such transactions. At Goldman, the chief executive, Lloyd C. Blankfein, and nine other top officers are not permitted to hedge their holdings, Mr. Duvally said.
The rest of Goldman’s employees can hedge shares they own outright. But they can’t make such moves with restricted stock. The partners, some of whom shape the firm’s strategy as heads of major business units, are required to hold 25 percent of their equity awards and are not allowed to hedge that portion of their holdings.
“Our equity awards vest over a multi-year period, are subject to clawbacks and cannot be hedged until they are delivered to our employees,” Mr. Duvally said. “These policies align equity compensation with the firm’s performance.”
The filings illustrate how routinely Goldman’s executives used the strategies. From July 2007 through November 2010, at least 135 partners used options to protect themselves from stock drops or to profit if shares held steady.
Several used such transactions routinely. Among them: David J. Greenwald, Goldman’s deputy general counsel overseeing its international businesses; Peter C. Aberg, a senior executive in the mortgage group; and Jack Levy, co-chairman of mergers and acquisitions. Howard Wietschner, the co-head of a hedge fund advisory group, had at least 32 such arrangements.
Shareholders over the same period endured roller coaster volatility. Goldman shares peaked at $248 in fall 2007 before dropping to $52 a year later after Lehman Brothers failed. At $164.83 on Friday, the stock still has not reached its former highs.
Regulators are taking a hard look at the practices. The Financial Stability Board, a group of global banking supervisors, wants firms to restrict employees from using the strategies. The Federal Reserve is examining hedging in its review of bank compensation.
And the Federal Deposit Insurance Corporation is expected to propose on Monday a new rule requiring big banks to defer at least 50 percent of annual stock and cash bonuses. That compensation would be released over the course of three years, so that executives don’t reap big, short-term windfalls even if their bets don’t pan out.
As part of the Dodd-Frank financial reform bill, the S.E.C. is hashing out regulations that would require all public companies to disclose their policies. Congress inserted the rule in the bill to discourage executives from hedging. The final S.E.C. proposal is anticipated during the second half of 2011.
For Goldman partners, the most popular hedging strategy was covered calls. Take Christopher Cole, chairman of Goldman’s investment bank and a member of the management committee. From 2007 to 2009, he made at least 11 such transactions, earning more than $675,000, according to the filings.
Not all strategies proved successful. With the stock around $98 in early February 2009, Milton R. Berlinski, who oversees a group that caters to private equity firms, made a risky bet called a short strangle. The maneuver would pay off if the stock stayed between $60 and $110 over the next six months. By mid-July 2009, Goldman shares were trading north of $156, meaning Mr. Berlinski took a loss.
Byron D. Trott, a Goldman partner best known as Warren E. Buffett’s investment banker, fared much better on one deal. In October 2008, Mr. Trott hedged 175,000 shares, using a collar to limit his profit potential but insulate him should the stock plummet over the next four months.
The transactions, set up months before, were executed just a few weeks after Mr. Buffett agreed to hand over $5 billion to Goldman in exchange for a potentially lucrative stake — a transaction Goldman hailed as a “strong validation of our client franchise and future prospects.” Mr. Trott, who did not return calls for comment, helped facilitate the investment. Goldman’s stock, which was trading around $128 that October, dropped to $73 by January. With the hedge, Mr. Trott lost roughly $2 million on the stake, less than a quarter of what he would have otherwise.
Two months later, Mr. Trott departed Goldman to start his own advisory firm.