For Goldman Sachs Group Inc.'s Special Situations Group, disasters can be a source of big profits. Now the secretive investing operation faces its own potential calamity.
Goldman has shut two units that made bets with its money as such trading will be barred by the Volcker Rule approved by Congress last year. The SSG still makes investments and named a new global head last month. Executives have said SSG shouldn't be affected because it is more of a lending than a trading business. SSG invests Goldman's money in the debt and equity of troubled companies and lends to high-risk borrowers. The effort to defend it illustrates how vital the business is to Goldman and may be a test of how flexible regulators will be in defining proprietary trading.
"It is proprietary trading, but the business can also be modified if you had to," said Brad Hintz, an analyst at Sanford C. Bernstein & Co. The question, he said, is, "Where will the regulators draw the line?"
SSG's financial results are not public, but the unit has been a major profit contributor, according to former SSG executives who asked not to be identified because they don't want to speak publicly about their former employer.
The newly created Goldman Sachs division that includes SSG, proprietary trading businesses and investments in hedge funds and private equity, generated 32% of the firm's 2010 pretax profit. Until last quarter, SSG's results were included in Goldman's largest segment by revenue: fixed income, currencies and commodities.
Richard Ruzika, a former Goldman commodities trading chief, is retiring next month after running SSG since 2007, according to a Feb. 17 memo obtained by Bloomberg. He will be succeeded by Jason Brown, who has led SSG in Asia since 2007, according to another memo. Brown, who joined Goldman from Bear Stearns Cos. in 1999 and became a partner in 2006, will remain in Hong Kong.
The unit bought distressed assets in the aftermath of Asia's financial crisis and profited in the Enron Corp. bankruptcy, a former employee said. A gain on an investment in Japan's largest golf-course operator contributed about $500 million to fixed income's $3.1 billion of revenue in the fourth quarter of 2006. Goldman did not disclose the gain until a year later.
Without those profits, it would be difficult to generate returns previously achieved, analysts said.
When Lloyd Blankfein, Goldman's chairman and CEO, addressed investors at a conference on November 2008, less than two months after rival Lehman Brothers Holdings Inc.'s bankruptcy, he tried to reassure them about Goldman's ability to make money. "We believe we have as strong a track record as anyone at being a nimble investor in special or distressed situations," he said. "We can decide the extent to which the firm itself will invest."
There are unanswered questions that could leave an opening for SSG, said Roberta Karmel, a former Securities and Exchange Commission member who now teaches at Brooklyn Law School. "These laws are too complicated, and they can find loopholes," he said. "I don't know how strictly the regulators will be able to define proprietary trading."
Goldman CFO David Viniar said on an Oct. 19 call with analysts that the Volcker Rule might not affect SSG.
"The predominant part of that business is actually a lending business, which we think is not only OK under the rules but is actually something that's encouraged," Viniar said.
