By playing all sides of the NYSE deal, Goldman Sachs sent a powerful message. Here's how it got so far ahead.
By Justin Fox

(FORTUNE Magazine) – IT WAS AS CLEAR A STATEMENT AS could be made about who runs Wall Street these days: The New York Stock Exchange, partly owned by Goldman Sachs and headed by a former Goldman president, announced in late April that it was merging with electronic-trading network Archipelago, in which Goldman is a major shareholder. The advisor to both sides in the merger? Goldman Sachs, of course.

There's a half-admiring, half-resentful saying on the Street: "That's so Goldman." This deal fits the description to a tee--so ambitious and yet so smooth that no one else could have pulled it off. When some complained about Goldman working both sides of the deal, firm spokesman Lucas van Praag nonchalantly responded, "Life is filled with conflicts, some real, some imagined."

For most of its 136-year history, Goldman was a second-string player on a Wall Street ruled by J.P. Morgan, its stepchild Morgan Stanley, and since-departed firms like Dillon Read and Kuhn Loeb. But over the past quarter-century Goldman has ridden successive waves of market upheaval to the top--thanks in large part, as the stock exchange deal shows, to its almost unerring sense of just how far it can push the boundary between serving customers and serving itself.

"How remarkable that you can simultaneously act for all those people," says former investment banker Philip Augar, whose new book, The Greed Merchants, explores how the Big Three investment banks--Goldman, Morgan Stanley, and Merrill Lynch--have thrived in an era of deregulation and global competition. "But that's the system. It's allowed." Augar attributes the Big Three's success to what he calls "the edge": the informational advantage that a firm intimately connected with governments, corporations, and investors around the world has over those governments, corporations, and investors--a.k.a. customers. With Morgan Stanley caught in a power struggle and retail-dependent Merrill Lynch still recovering from the stock market's boom and bust, Goldman is currently in by far the best position to exploit that edge.

Such customer exploitation can go too far, though. In the 1920s the firm launched Goldman Sachs Trading Corp., a closed-end mutual fund with aspects of a Ponzi scheme, which made tons of money before collapsing in the Great Crash of 1929 and tarnishing Goldman's reputation for decades.

It was the dogged courtship of corporate America by Sidney Weinberg, the former office boy who became chairman in 1930 (and stayed in the job until 1969), that brought Goldman back, according to Lisa Endlich's 1999 history of the firm. Weinberg convinced the likes of Henry Ford II that he had their best interests at heart and began landing deals like Ford Motor's mammoth 1956 IPO. But it wasn't all about playing nice. The other power in the firm was trader Gus Levy, who pioneered the block trade and the practice of risk arbitrage. The chief interest he had at heart was making money.

What finally shot Goldman past its rivals was its decision during the 1980s takeover wars to side with corporate America against the LBO artists--cementing its status as the CEO's friend. But now Goldman's big paydays come from trading. Of the $6.7 billion it earned before taxes last year (it also paid $9.6 billion, or $463,000 per employee, in compensation and benefits), 75% came from trading and investments like its 15.5% stake in Archipelago.

It was the insider knowledge gained through that investment that led to the merger. "Goldman was the company that knew Archipelago best and the NYSE best," says NYSE chairman Marshall Carter. "They were the ones that saw that synergy." Goldman's $7 million in fees on the deal is dwarfed by the $120 million rise (so far) in the value of its Archipelago shares and NYSE seats. That the price of both went up after the merger was announced indicates that the market likes the deal a lot--although it's always possible it would like a rival bid even more.

But is it all, well, appropriate? That is an ever-shifting standard: Lots of things that were accepted practice on Wall Street in the 1990s became unacceptable after the market tanked. Our era's chief arbiter of acceptability, New York attorney general Eliot Spitzer, will weigh in when the NYSE applies to ditch its nonprofit status. Anticipating such scrutiny, Goldman steered clear of any role in the deal's final price negotiations. In other words: So Goldman.