Goldman Sachs 2002 Annual Report Download - page 55

Goldman Sachs manages operational risk through the
application of control standards; the review, training and
supervision of our people; the active participation and
commitment of senior management; a continuous review
of our processes designed to identify key operational
risks; a commitment to continuous improvement; and a
system of control departments each with responsibilities
and processes for managing specific aspects of opera-
tional risk relevant to each department. Together, these
elements comprise a strong firmwide control culture that
helps Goldman Sachs remain focused on minimizing
operational failures and the damage they can cause.
In 2000, we established an Operational Risk Manage-
ment Department to monitor our firmwide operational
risk. While each business unit has processes and systems
in place to address operational risks within the unit, it is
the job of Operational Risk Management to develop a
framework for measuring our operational risk more
broadly. Operational Risk Management’s long-term goal
is to provide consistent measures of operational perfor-
mance so that it can evaluate that performance over time
and across Goldman Sachs and identify areas that need
special attention. In addition, it is the role of Operational
Risk Management to report its findings to senior man-
agement to help them bring increased business focus on
operational risk and facilitate improvements in opera-
tional risk management.
The Operational Risk Management Department works
closely with other control and support areas –
Compliance, Legal, Management Controls (Internal
Audit), Technology, Human Capital Management,
Controllers and Global Operations – as well as the busi-
ness units to monitor, measure, and help them improve
our overall operational risk management.
OFF-BALANCE-SHEET ARRANGEMENTS
In the normal course of business, Goldman Sachs enters
into arrangements with unconsolidated entities. These
arrangements may involve retained interests in assets
transferred to special-purpose entities (SPEs) in connec-
tion with our securitization activities, variable interests in
SPEs to which we did not transfer assets and obligations
under certain guaranty contracts.
Goldman Sachs utilizes SPEs to securitize commercial
and residential mortgages and home equity loans, gov-
ernment and corporate bonds and other types of financial
assets. SPEs are critical to the functioning of several sig-
nificant investor markets, including the mortgage-backed
and asset-backed securities markets, since they provide
market liquidity to financial assets by offering investors
access to specific cash flows and risks created through the
securitization process. In addition to retained interests in
assets that we transferred to SPEs, we also hold variable
interests in similar SPEs to which we did not transfer
assets. Our variable interests in these SPEs include the
rights to specific cash flows from purchased interests as
well as derivative transactions.
Certain of these SPEs are not consolidated for one or
more of the following reasons: (i) the entity is a qualify-
ing SPE under SFAS No. 140 to which we have trans-
ferred financial assets, (ii) the entity is not controlled by
us, (iii) we do not have a majority of the entity’s substan-
tive risks and rewards or (iv) independent investors have
substantive majority equity investments in legal form.
Our retained and other variable interests in, and deriva-
tive transactions with, unconsolidated SPEs are
accounted for at fair value, in the same manner as our
other financial instruments. As of November 2002, we
had no material additional financial commitments or
guarantees in respect of these entities. In addition, we
have not entered into any derivative contracts that are
indexed or linked to our stock.
As discussed below in “—Recent Accounting Develop-
ments,” in January 2003, the Financial Accounting
Standards Board (FASB) issued FASB Interpretation
(FIN) No. 46, “Consolidation of Variable Interest
Entities.” SPEs are generally considered variable interest
entities under FIN No. 46. See Note 2 and Note 4 to the
consolidated financial statements for additional informa-
tion about our basis of presentation, our retained inter-
ests, securitization activities and variable interests in
variable interest entities. See Note 7 to the consolidated
financial statements for information about our guaran-
tees to entities that are not SPEs.
CRITICAL ACCOUNTING POLICIES
“Financial instruments owned, at fair value” and
“Financial instruments sold, but not yet purchased, at
fair value” in the consolidated statements of financial
condition are carried at fair value or amounts that
approximate fair value, with related unrealized gains
or losses recognized in our results of operations. The
determination of fair value is fundamental to our state-
ments of financial condition and earnings and, in cer-
tain circumstances, it requires management to make
complex judgments.
How We Determine Fair Value
The fair value of a financial instrument is the amount at
which the instrument could be exchanged in a current
transaction between willing parties, other than in a
forced or liquidation sale.
Managem ent’s D iscussion and A nalysis
GO L D M A N SA CH S 2002 A N N UAL R EPO RT 53