10-K
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
     
For the fiscal year ended November 24, 2006
  Commission File Number: 001-14965
The Goldman Sachs Group, Inc.
(Exact name of registrant as specified in its charter)
     
Delaware   13-4019460
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. employer
identification no.)
 
85 Broad Street
New York, N.Y.
(Address of principal executive offices)
  10004
(Zip Code)
(212) 902-1000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
         
Title of each class:
 
Name of each exchange on which registered:
Common stock, par value $.01 per share, and attached Shareholder Protection Rights
    New York Stock Exchange  
 
Depositary Shares, Each Representing 1/1,000th Interest in a Share of Floating Rate Non-Cumulative Preferred Stock, Series A
    New York Stock Exchange  
 
Depositary Shares, Each Representing 1/1,000th Interest in a Share of 6.20% Non-Cumulative Preferred Stock, Series B
    New York Stock Exchange  
 
Depositary Shares, Each Representing 1/1,000th Interest in a Share of Floating Rate Non-Cumulative Preferred Stock, Series C
    New York Stock Exchange  
 
Depositary Shares, Each Representing 1/1,000th Interest in a Share of Floating Rate Non-Cumulative Preferred Stock, Series D
    New York Stock Exchange  
 
Medium-Term Notes, Series B, 0.25% Exchangeable Notes due 2007; Index-Linked Notes due 2013; Index-Linked Notes due April 2013; Index-Linked Notes due May 2013; Index-Linked Notes due July 2010; and Index-Linked Notes due 2011
    American Stock Exchange  
 
Medium-Term Notes, Series B, 7.35% Notes due 2009; 7.80% Notes due 2010; Floating Rate Notes due 2008; and Floating Rate Notes due 2011
    New York Stock Exchange  
Securities registered pursuant to Section 12(g) of the Act: None
 
         Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes    x         No    o
         Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.
Yes    o         No    x
         Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes    x         No    o
         Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Annual Report on Form 10-K or any amendment to the Annual Report on Form 10-K.         x
         Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer    x         Accelerated filer    o         Non-accelerated filer    o
         Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes    o         No    x
         As of May 26, 2006 the aggregate market value of the common stock of the registrant held by non-affiliates of the registrant was approximately $63.3 billion.
         As of January 26, 2007 there were 411,359,918 shares of the registrant’s common stock outstanding.
         Documents incorporated by reference: Portions of The Goldman Sachs Group, Inc.’s Proxy Statement for its 2007 Annual Meeting of Shareholders to be held on March 27, 2007 are incorporated by reference in the Annual Report on Form 10-K in response to Part III, Items 10, 11, 12, 13 and 14.
 
 


 

THE GOLDMAN SACHS GROUP, INC.
ANNUAL REPORT ON FORM 10-K FOR THE FISCAL Year Ended NOVEMBER 24, 2006
INDEX
             
   
Page
Form 10-K Item Number:
 
No.
 PART I      1  
      1  
        1  
        2  
        3  
        4  
        13  
        14  
        14  
        14  
        15  
        16  
      20  
      29  
      29  
      30  
      42  
        43  
 
 PART II      45  
      45  
      46  
      47  
      106  
      107  
      167  
      167  
      167  
 
 PART III      168  
      168  
      168  
      168  
      169  
      169  
 
 PART IV      170  
      170  
        F-1  
 SIGNATURES     II-1  
 POWER OF ATTORNEY     II-2  
 EX-10.30: FORM OF RSU AWARD AGREEMENT (SUBJECT TO RESTRICTIONS)
 EX-10.31: FORM OF RSU AWARD AGREEMENT(NOT SUBJECT TO RESTRICTIONS)
 EX-10.36: FORM OF YEAR-END OPTION AWARD AGREEMENT
 EX-10.37: FORM OF YEAR-END RSU AWARD AGREEMENT
 EX-10.39:FORM OF NON-EMPLOYEE DIRECTOR OPTION AGREEMENT
 EX-10.40: FORM OF NON-EMPLOYEE DIRECTOR RSU AGREEMENT
 EX-10.41: DESCRIPTION OF NON-EMPLOYEE DIRECTOR COMPENSATION
 EX-10.43: FORM OF ONE-TIME RSU AWARD AGREEMENT
 EX-10.49: FORM OF SIGNATURE CARD FOR 2006 YEAR-END AWARDS
 EX-10.50: FORM OF EMPLOYMENT AGREEMENT FOR POST-IPO PARTICIPATING MANAGING DIRECTORS
 EX-10.51: FORM OF SECOND AMENDMENT TO THE AGREEMENT RE: NONCOMPETITION AND OTHER COVENANTS
 EX-12.1: COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES AND RATIOS OF EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
 EX-21.1: LIST OF SIGNIFICANT SUBSIDIARIES
 EX-23.1: CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 EX-31.1: RULE 13a-14(a) CERTIFICATIONS
 EX-32.1: SECTION 1350 CERTIFICATIONS
 EX-99.1: REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON SELECTED FINANCIAL DATA


Table of Contents

PART I
Item 1. Business
Introduction
       Goldman Sachs is a leading global investment banking, securities and investment management firm that provides a wide range of services worldwide to a substantial and diversified client base that includes corporations, financial institutions, governments and high-net-worth individuals. As of November 24, 2006, we operated offices in over 25 countries and approximately 42% of our 26,467 employees were based outside the United States.
       Goldman Sachs is the successor to a commercial paper business founded in 1869 by Marcus Goldman. On May 7, 1999, we converted from a partnership to a corporation and completed an initial public offering of our common stock.
       Our activities are divided into three segments: (i) Investment Banking, (ii) Trading and Principal Investments and (iii) Asset Management and Securities Services.
       All references to 2006, 2005 and 2004 refer to our fiscal years ended, or the dates, as the context requires, November 24, 2006, November 25, 2005, and November 26, 2004, respectively.
       When we use the terms “Goldman Sachs,” “the firm,” “we,” “us” and “our,” we mean The Goldman Sachs Group, Inc., a Delaware corporation, and its consolidated subsidiaries. References herein to the Annual Report on Form 10-K are to our Annual Report on Form 10-K for the fiscal year ended November 24, 2006.
       Financial information concerning our business segments and geographic regions for each of 2006, 2005 and 2004 is set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the consolidated financial statements and the notes thereto, which are in Part II, Items 7, 7A and 8 of the Annual Report on Form 10-K.
       Our Internet address is www.gs.com and the investor relations section of our web site is located at www.gs.com/our_firm/investor_relations/. We make available free of charge, on or through the investor relations section of our web site, annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as well as proxy statements, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission. Also posted on our web site, and available in print upon request of any shareholder to our Investor Relations Department, are our certificate of incorporation and by-laws, charters for our Audit Committee, Compensation Committee, and Corporate Governance and Nominating Committee, our Policy Regarding Director Independence Determinations, our Policy on Reporting of Concerns Regarding Accounting and Other Matters, our Corporate Governance Guidelines and our Code of Business Conduct and Ethics governing our directors, officers and employees. Within the time period required by the SEC and the New York Stock Exchange, we will post on our web site any amendment to the Code of Business Conduct and Ethics and any waiver applicable to any executive officer, director or senior financial officer (as defined in the Code). In addition, our web site includes information concerning purchases and sales of our equity securities by our executive officers and directors, as well as disclosure relating to certain non-GAAP financial measures (as defined in the SEC’s Regulation G) that we may make public orally, telephonically, by webcast, by broadcast or by similar means from time to time.
       Our Investor Relations Department can be contacted at The Goldman Sachs Group, Inc., 85 Broad Street, 17th Floor, New York, New York 10004, Attn: Investor Relations, telephone: 212-902-0300, e-mail: gs-investor-relations@gs.com.

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Cautionary Statement Pursuant to the Private Securities Litigation Reform Act of 1995
       We have included or incorporated by reference in the Annual Report on Form 10-K, and from time to time our management may make, statements that may constitute “forward-looking statements” within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not historical facts but instead represent only our beliefs regarding future events, many of which, by their nature, are inherently uncertain and outside our control. These statements include statements other than historical information or statements of current condition and may relate to our future plans and objectives and results, among other things, and may also include our belief regarding the effect of various legal proceedings, as set forth under “Legal Proceedings” in Part I, Item 3 of the Annual Report on Form 10-K, as well as statements about the objectives and effectiveness of our liquidity policies, statements about trends in or growth opportunities for our businesses and statements about our investment banking transaction backlog, in Part II, Item 7 of the Annual Report on Form 10-K. By identifying these statements for you in this manner, we are alerting you to the possibility that our actual results may differ, possibly materially, from the anticipated results indicated in these forward-looking statements. Important factors that could cause actual results to differ from those in the forward-looking statements include, among others, those discussed below and under “Risk Factors” in Part I, Item 1A of the Annual Report on Form 10-K and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Annual Report on Form 10-K.
       In the case of statements about our investment banking transaction backlog, such statements are subject to the risk that the terms of these transactions may be modified or that they may not be completed at all; therefore, the net revenues, if any, that we actually earn from these transactions may differ, possibly materially, from those currently expected. Important factors that could result in a modification of the terms of a transaction or a transaction not being completed include, in the case of underwriting transactions, a decline in general economic conditions, outbreak of hostilities, volatility in the securities markets generally or an adverse development with respect to the issuer of the securities and, in the case of financial advisory transactions, a decline in the securities markets, an adverse development with respect to a party to the transaction or a failure to obtain a required regulatory approval.

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Segment Operating Results
(in millions)
                             
        Year Ended November
         
        2006   2005   2004
                 
Investment Banking
  Net revenues   $ 5,629     $ 3,671     $ 3,374  
    Operating expenses     4,062       3,258       2,973  
                             
    Pre-tax earnings   $ 1,567     $ 413     $ 401  
                             
 
Trading and Principal
  Net revenues (1)   $ 25,562     $ 16,818     $ 13,728  
Investments
  Operating expenses (1)     14,962       10,600       8,688  
                             
    Pre-tax earnings   $ 10,600     $ 6,218     $ 5,040  
                             
 
Asset Management and
  Net revenues   $ 6,474     $ 4,749     $ 3,849  
Securities Services
  Operating expenses     4,036       3,070       2,430  
                             
    Pre-tax earnings   $ 2,438     $ 1,679     $ 1,419  
                             
 
Total
  Net revenues (1)   $ 37,665     $ 25,238     $ 20,951  
    Operating expenses (1)(2)     23,105       16,965       14,275  
                             
    Pre-tax earnings   $ 14,560     $ 8,273     $ 6,676  
                             
 
 
  (1)  Beginning in the fourth quarter of 2006, “Cost of power generation” in the consolidated statements of earnings was reclassified to operating expenses. “Cost of power generation” was previously reported as a reduction to revenues. Prior periods have been reclassified to conform to the current presentation, with no impact to our reported pre-tax earnings. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations — Financial Overview — Operating Expenses — Operating Expenses and Employees” in Part II, Item 7 of the Annual Report on Form 10-K for further discussion of the effect of this reclassification.
 
  (2)  Includes the following expenses that have not been allocated to our segments: (i) net provisions for a number of litigation and regulatory proceedings of $45 million, $37 million and $103 million for the years ended November 2006, November 2005 and November 2004, respectively; (ii) $62 million in connection with the establishment of our joint venture in China for the year ended November 2004; and (iii) the amortization of employee initial public offering awards, net of forfeitures, of $19 million for the year ended November 2004.
     
(2006 NET REVENUES CHART)
  (2006 PRE-TAX EARNINGS CHART)
   
(1) Includes a net provision of $45 million for a number of litigation and regulatory proceedings, which has not been allocated to our segments.

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Business Segments
       The primary products and activities of our business segments are set forth in the following chart:
           
         
  Business Segment/Component     Primary Products and Activities  
         
 Investment Banking:
       
   
 
 Financial Advisory
    • Mergers and acquisitions advisory services  
      • Financial restructuring advisory services  
   
 
 Underwriting
    • Equity and debt underwriting  
   
         
 Trading and Principal Investments:
       
   
 
 Fixed Income, Currency and Commodities
    • Commodities and commodity derivatives, including power generation activities  
      • Credit products, including trading and investing in credit derivatives, investment-grade corporate securities, high-yield securities, bank and secured loans, municipal securities, emerging market and distressed debt, public and private equity securities and real estate  
      • Currencies and currency derivatives  
      • Interest rate products, including interest rate derivatives, global government securities and money market instruments, including matched book positions  
      • Mortgage-related securities and loan products and other asset-backed instruments  
   
 
 Equities
    • Equity securities and derivatives  
      • Securities, futures and options clearing services  
      • Specialist and market-making activities in equity securities and options  
      • Insurance activities  
   
 
 Principal Investments
    • Principal investments in connection with merchant banking activities  
      • Investment in the convertible preferred stock of Sumitomo Mitsui Financial Group, Inc.  
      • Investment in the ordinary shares of Industrial and Commercial Bank of China Limited  
   
         
 Asset Management and Securities Services:
       
   
 
Asset Management
    • Asset management, advisory services and investment products (primarily through separate accounts and funds) across all major asset classes, including money markets, fixed income, equities and alternative investments (including hedge funds, private equity, real estate, currencies, commodities and asset allocation strategies), for institutional and individual investors (including high-net-worth clients, as well as retail clients through third-party channels)  
      • Management of merchant banking funds  
   
 
 Securities Services
    • Prime brokerage  
      • Financing services  
      • Securities lending  
   
         

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Investment Banking
       Investment Banking represented 15% of 2006 net revenues. We provide a broad range of investment banking services to a diverse group of corporations, financial institutions, investment funds, governments and individuals and seek to develop and maintain long-term relationships with these clients as their lead investment bank.
       Our current structure, which is organized by regional, industry and product groups, seeks to combine client-focused investment bankers with execution and industry expertise. We continually assess and adapt our organization to meet the demands of our clients in each geographic region. Through our commitment to teamwork, we believe that we provide services in an integrated fashion for the benefit of our clients.
       Our goal is to make available to our clients the entire resources of the firm in a seamless fashion, with investment banking serving as “front of the house.” To accomplish this objective, we focus on coordination among our equity and debt underwriting businesses and our corporate risk and liability management businesses. This coordination is intended to assist our investment banking clients in managing their asset and liability exposures.
       Our Investment Banking segment is divided into two components: Financial Advisory and Underwriting.
(2006 NET REVENUES CHART)
  Financial Advisory
       Financial Advisory includes advisory assignments with respect to mergers and acquisitions, divestitures, corporate defense activities, restructurings and spin-offs. Our mergers and acquisitions capabilities are evidenced by our significant share of assignments in large, complex transactions for which we provide multiple services, including “one-stop” acquisition financing and cross-border structuring expertise, as well as services in other areas of the firm, such as interest rate and currency hedging.
  Underwriting
       Underwriting includes public offerings and private placements of a wide range of securities and other financial instruments, including common and preferred stock, convertible and exchangeable securities, investment-grade debt, high-yield debt, sovereign and emerging market debt, municipal debt, bank loans, asset-backed securities and real estate-related securities, such as mortgage-related securities and the securities of real estate investment trusts.
       Equity Underwriting. Equity underwriting has been a long-term core strength of Goldman Sachs. As with mergers and acquisitions, we have been particularly successful in winning mandates for large, complex transactions. We believe our leadership in worldwide initial public offerings and

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worldwide public common stock offerings reflects our expertise in complex transactions, prior experience and distribution capabilities.
       Debt Underwriting. We engage in the underwriting and origination of various types of debt instruments, including investment-grade debt securities, high-yield debt securities, bank and bridge loans and emerging market debt securities, which instruments may be issued by, among others, corporate, sovereign and agency issuers. In addition, we underwrite and originate structured securities, which include mortgage-related securities and other asset-backed securities and collateralized debt obligations.
Trading and Principal Investments
       Trading and Principal Investments represented 68% of 2006 net revenues. Trading and Principal Investments facilitates client transactions with a diverse group of corporations, financial institutions, investment funds, governments and individuals and takes proprietary positions through market making in, trading of and investing in fixed income and equity products, currencies, commodities and derivatives on these products. In addition, we engage in specialist and market-making activities on equities and options exchanges, and we clear client transactions on major stock, options and futures exchanges worldwide. In connection with our merchant banking and other investing activities, we make principal investments directly and through funds that we raise and manage.
       To meet the needs of our clients, Trading and Principal Investments is diversified across a wide range of products. We believe our willingness and ability to take risk to facilitate client transactions distinguishes us from many of our competitors and substantially enhances our client relationships.
       Our Trading and Principal Investments segment is divided into three components: Fixed Income, Currency and Commodities; Equities; and Principal Investments.
(2006 NET REVENUES CHART)
  Fixed Income, Currency and Commodities and Equities
       Fixed Income, Currency and Commodities (FICC) and Equities are large and diversified operations through which we engage in a variety of customer-driven and proprietary trading and investing activities.
       In our customer-driven businesses, FICC and Equities strive to deliver high-quality service by offering broad market-making and market knowledge to our clients on a global basis. In addition, we use our expertise to take positions in markets, by committing capital and taking risk, to facilitate client transactions and to provide liquidity. Our willingness to make markets, commit capital and take risk in a broad range of fixed income, currency, commodity and equity products and their derivatives is crucial to our client relationships and to support our underwriting business by providing secondary market liquidity.

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       A core activity in FICC and Equities is market making in a broad array of securities and products. For example, we are a primary dealer in many of the largest government bond markets around the world, including the United States, Japan and the United Kingdom. We are a member of the major futures exchanges, and also have interbank dealer status in the currency markets in New York, London, Tokyo and Hong Kong.
       We generate trading net revenues from our customer-driven businesses in three ways:
  •  First, in large, highly liquid markets, we undertake a high volume of transactions for modest spreads and fees.
 
  •  Second, by capitalizing on our strong relationships and capital position, we undertake transactions in less liquid markets where spreads and fees are generally larger.
 
  •  Finally, we structure and execute transactions that address complex client needs.
       Our FICC and Equities businesses operate in close coordination to provide clients with services and cross-market knowledge and expertise.
       In our proprietary activities in both FICC and Equities, we assume a variety of risks and devote resources to identify, analyze and benefit from these exposures. We capitalize on our analytical models to analyze information and make informed trading judgments, and we seek to benefit from perceived disparities in the value of assets in the trading markets and from macroeconomic and issuer-specific trends.
  FICC
       Our FICC business makes markets in and trades interest rate and credit products, mortgage-related securities and loan products and other asset-backed instruments, currencies and commodities, structures and enters into a wide variety of derivative transactions, and engages in proprietary trading and investing. FICC has five principal businesses: commodities; credit products; currencies; interest rate products, including money market instruments; and mortgage-related securities and loan products and other asset-backed instruments.
       Commodities. We make markets in, and trade for our clients and our own account, a wide variety of commodities and commodity derivatives, including oil and oil products, metals, natural gas and electricity, and forest products. We are also a member of or have relationships with major commodities exchanges worldwide.
       As part of our commodities business, we acquire and dispose of interests in, and engage in the development and operation of, electric power generation facilities. As of January 15, 2007, we owned interests in 19 power generation facilities located in the United States. Of these facilities, seven are fueled by natural gas, eight by coal and four by waste coal. Most of our power plants have contracted to sell their electricity to utilities under long-term agreements. We seek to generate attractive risk-adjusted returns from our portfolio of power plants that have entered into these contracts by using our commodities trading and capital markets expertise to selectively restructure the underlying power sale contracts and to refinance related project-level debt.
       Credit Products. We offer to and trade for our clients a broad array of credit and credit-linked products all over the world, including credit derivatives, investment-grade corporate securities, high-yield securities, bank and secured loans (origination and trading), municipal securities, and emerging market and distressed debt. For example, we enter, as principal, into complex structured transactions designed to meet client needs.

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       In addition, we increasingly provide credit through bridge and other loan facilities to a broad range of clients. Commitments that are extended for contingent acquisition financing are often short-term in nature, as borrowers often replace them with other funding sources. As part of our ongoing credit origination activities, we may seek to reduce our credit risk on commitments by syndicating all or substantial portions of commitments to other investors or, upon funding, by securitizing the positions through investment vehicles sold to other investors. Revenues from any syndications of these commitments are included in the debt underwriting business in our Investment Banking segment. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Contractual Obligations and Commitments” in Part II, Item 7 of the Annual Report on Form 10-K for additional information on our commitments.
       Our credit products business includes making significant long-term and short-term investments for our own account (sometimes investing together with our merchant banking funds) in a broad array of asset classes (including distressed debt) globally. We opportunistically invest in debt and equity securities and secured loans, and in private equity, real estate and other assets.
       Currencies. We act as a dealer in foreign exchange and trade for our clients and ourselves in most currencies on exchanges and in cash and derivative markets globally.
       Interest Rate Products. We trade and make markets in a variety of interest rate products, including interest rate swaps, options and other derivatives, and government bonds, as well as money market instruments, such as commercial paper, treasury bills, repurchase agreements and other highly liquid securities and instruments. This business includes our matched book, which consists of short-term collateralized financing transactions.
       Mortgage Business. We make markets in and trade for our clients and ourselves commercial and residential mortgage-related securities and loan products (including prime, subprime and other nontraditional mortgages) and other asset-backed instruments. We regularly acquire large proprietary positions in these products with a view toward securitizing the underlying positions. We also originate and service commercial mortgages and service residential mortgages.
  Equities
       We make markets in, trade and act as a specialist for equities and equity-related products, structure and enter into equity derivative transactions, and engage in proprietary trading. In addition, we engage in insurance activities. We generate commissions from executing and clearing client transactions on major stock, options and futures exchanges worldwide through our Equities customer franchise and clearing activities.
       Equities includes three principal businesses: our customer franchise business, principal strategies and specialist activities.
       Customer Franchise Business. Our customer franchise business includes primarily customer-driven activities in the shares, convertible securities and equity derivatives markets. These activities also include clearing client transactions on major stock, options and futures exchanges worldwide, as well as our options specialist and market-making businesses. Our customer franchise business increasingly involves providing our clients with access to electronic “low-touch” equity trading platforms, and electronic trades now account for the majority of our customer trading activity in this business. However, a majority of our net revenues in this business continues to be derived from our traditional “high-touch,” non-automated handling of more complex trades. We expect both types of trading activities to remain important components of our customer franchise business.

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       We trade equity securities and equity-related products, including convertible securities, options, futures and over-the-counter (OTC) derivative instruments, on a global basis as an agent, as a market maker or otherwise as a principal. As a principal, we facilitate client transactions, often by committing capital and taking risk, to provide liquidity to clients with large blocks of stocks or options. For example, we are active in the execution of large block trades. We also execute transactions as agent and offer clients direct electronic access to trading markets.
       We are a member of most of the world’s major stock, options and futures exchanges and marketplaces, including those located in New York, Chicago, London, Paris, Frankfurt, Tokyo and Hong Kong.
       In the options and futures markets, we structure, distribute and execute derivatives on market indices, industry groups and individual company stocks to facilitate client transactions and our proprietary activities. We develop strategies and render advice with respect to portfolio hedging and restructuring and asset allocation transactions. We also create specially tailored instruments to enable sophisticated investors to undertake hedging strategies and to establish or liquidate investment positions. We are one of the leading participants in the trading and development of equity derivative instruments. We are an active participant in the trading of futures and options on most of the major exchanges in the United States, Europe and Asia. In options, we are a specialist and market maker on the International Securities Exchange, the Chicago Board Options Exchange and NYSE Arca and a market maker on the Boston Options Exchange, the Philadelphia Stock Exchange and the American Stock Exchange.
       Principal Strategies. Our principal strategies business is a multi-strategy proprietary investment business that invests and trades for our own account. Principal strategies trades and invests our capital across global markets employing strategies that are primarily focused on public markets. Most strategies involve fundamental equities and relative value trading (which involves trading strategies designed to take advantage of perceived discrepancies in the relative value of financial instruments, including equity, equity-related and debt instruments). Other strategies involve event-driven investments (which focus on event-oriented special situations such as corporate restructurings, bankruptcies, recapitalizations, mergers and acquisitions, and legal and regulatory events) as well as convertible bond trading, various types of volatility trading and principal finance (which includes private structured investments in public or private companies).
       Specialist Activities. Our specialist activities business consists of our stock and exchange-traded funds (ETF) specialist and market-making businesses. We engage in specialist and market-making activities on equities exchanges. In the United States, we are one of the leading stock specialists on the NYSE. For ETFs, we are a specialist on the NYSE, the American Stock Exchange and NYSE Arca.
       Insurance Activities. Through our insurance subsidiaries, we own closed blocks of variable annuity and variable life insurance contracts. In 2006, we began to participate opportunistically in both the life and annuity reinsurance and property catastrophe reinsurance businesses.
  Principal Investments
       Principal Investments primarily represents net revenues from four primary sources: returns on corporate and real estate investments, overrides on corporate and real estate investments, our investment in the convertible preferred stock of Sumitomo Mitsui Financial Group, Inc. (SMFG) and our investment in the ordinary shares of Industrial and Commercial Bank of China Limited (ICBC).
       Returns on Corporate and Real Estate Investments. As of November 2006, the aggregate carrying value of our principal investments held directly or through our merchant banking funds, excluding our investment in the convertible preferred stock of SMFG and the ordinary shares of ICBC, was $4.26 billion, comprised of corporate principal investments with an aggregate carrying value of $3.68 billion and real estate investments with an aggregate carrying value of $588 million.

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In addition, as of November 2006, we had outstanding unfunded equity capital commitments of up to $6.36 billion.
       Overrides. Consists of the increased share of the income and gains derived from our merchant banking funds when the return on a fund’s investments over the life of the fund exceeds certain threshold returns (typically referred to as an “override”). Overrides are recognized in net revenues when all material contingencies have been resolved.
       SMFG. Our investment in the convertible preferred stock of SMFG is generally nontransferable without the consent of SMFG but is freely convertible into SMFG common stock. As of November 2006, we had hedged two-thirds of the common stock underlying our investment in SMFG. Restrictions on our ability to hedge or sell the remaining shares will lapse on February 7, 2007. As of November 2006, the carrying value of our investment in the SMFG preferred stock was $4.51 billion. See Note 2 to the consolidated financial statements in Part II, Item 8 of the Annual Report on Form 10-K for further discussion of our investment in SMFG.
       ICBC. Our investment in the ordinary shares of ICBC was acquired on April 28, 2006. The ordinary shares acquired from ICBC are subject to transfer restrictions that, among other things, prohibit any sale, disposition or other transfer until April 28, 2009. From April 28, 2009 to October 20, 2009, we may transfer up to 50% of the aggregate ordinary shares of ICBC that we owned as of October 20, 2006. We may transfer the remaining shares after October 20, 2009. As of November 2006, the carrying value of our investment in the ordinary shares of ICBC was $5.19 billion. A portion of our interest is held by investment funds managed by Goldman Sachs. For further information regarding our investment in the ordinary shares of ICBC, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies — Fair Value — Principal Investments” in Part II, Item 7 of the Annual Report on Form 10-K.
Asset Management and Securities Services
       Asset Management and Securities Services represented 17% of 2006 net revenues. Our Asset Management business provides investment advisory and financial planning services and offers investment products (primarily through separate accounts and funds) to a diverse group of institutions and individuals worldwide and primarily generates revenues in the form of management and incentive fees. Securities Services provides prime brokerage services, financing services and securities lending services to institutional clients, including hedge funds, mutual funds, pension funds and foundations, and to high-net-worth individuals worldwide, and generates revenues primarily in the form of interest rate spreads or fees.
       Our Asset Management and Securities Services segment is divided into two components: Asset Management and Securities Services.
(2006 NET REVENUE CHART)

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  Asset Management
       We offer a broad array of investment strategies, advice and planning. We provide asset management services and offer investment products (primarily through separate accounts and funds) across all major asset classes: money markets, fixed income, equities and alternative investments (including hedge funds, private equity, real estate, currencies, commodities and asset allocation strategies). Through our subsidiary, The Ayco Company, L.P. (Ayco), we also provide fee-based financial counseling and financial education in the United States.
       Assets under management (AUM) typically generate fees as a percentage of asset value. In certain circumstances, we are also entitled to receive incentive fees based on a percentage of a fund’s return or when the return on assets under management exceeds specified benchmark returns or other performance targets. Incentive fees are recognized when the performance period ends and they are no longer subject to adjustment. We have numerous incentive fee arrangements, many of which have annual performance periods that end on December 31. For that reason, incentive fees have been seasonally weighted to our first quarter.
       AUM includes our mutual funds, alternative investment funds and separately managed accounts for institutional and individual investors. Alternative investments include our merchant banking funds, which generate revenues as described below under “Management of Merchant Banking Funds.” AUM does not include assets in brokerage accounts, which generate commissions, mark-ups and spreads. Net revenues from brokerage accounts are included in our Trading and Principal Investments segment. Increasingly, many of our individual clients’ brokerage accounts pay fees based on the assets in their accounts rather than commissions on transactional activity in the accounts. AUM also does not include non-fee-paying assets, including money market assets that were transferred to Goldman Sachs Bank USA (GS Bank) during 2006.
       The amount of AUM is set forth in the graph below. In the following graph, as well as in the following tables, substantially all assets under management are valued as of November 30.
Assets Under Management
(in billions)
(ASSETS UNDER MANAGEMENT CHART)

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       The following table sets forth AUM by asset class:
Assets Under Management by Asset Class (1)
(in billions)
             
    As of November 30
     
    2006   2005   2004
             
Asset Class
           
 
Alternative investments (2)
  $145   $110   $95
Equity
  215   167   133
Fixed income
  198   154   134
             
Total non-money market assets
  558   431   362
Money markets
  118   101   90
             
Total assets under management
  $676   $532   $452
             
 
 
  (1)  In the first quarter of 2006, we changed the methodology for classifying certain non-money market assets. The changes were made primarily to reclassify certain assets allocated to external investment managers out of alternative investment assets and to reclassify currency funds into alternative investment assets. The changes did not impact total assets under management and prior periods have been reclassified to conform to the current presentation.
 
  (2)  Primarily includes hedge funds, private equity, real estate, currencies, commodities and asset allocation strategies.
 
       Clients. Our clients are institutions and individuals, including both high-net-worth and retail investors. We access institutional and high-net-worth clients through both direct and third-party channels and retail clients primarily through third-party channels. Our institutional clients include pension funds, governmental organizations, corporations, insurance companies, banks, foundations and endowments. In third-party distribution channels, we distribute our mutual funds, alternative investment funds and separately managed accounts through brokerage firms, banks, insurance companies and other financial intermediaries. Our clients are located worldwide.
       The table below sets forth the amount of AUM by distribution channel and client category:
Assets Under Management by Distribution Channel (1)
(in billions)
                 
        As of November 30
         
        2006   2005   2004
                 
Distribution Channel            
 
  Directly Distributed            
    — Institutional   $296   $226   $183
    — High-net-worth individuals   177   148   130
  Third-Party Distributed            
    — Institutional, high-net-worth individuals and retail   203   158   139
                 
Total   $676   $532   $452
             
 
 
  (1)  The primary investment vehicles for these assets under management are separately managed accounts and commingled vehicles, such as mutual funds and private investment funds.
 
       Management of Merchant Banking Funds. Goldman Sachs sponsors numerous corporate and real estate private investment funds. Our strategy with respect to these funds generally is to invest opportunistically to build a portfolio of investments that is diversified by industry, product type, geographic region, and transaction structure and type. Our corporate investment funds pursue, on a

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global basis, long-term investments in equity and debt securities in privately negotiated transactions, leveraged buyouts, acquisitions and investments in funds managed by external parties. Our real estate investment funds invest in real estate operating companies, debt and equity interests in real estate assets, and other real estate-related investments.
       Since inception, we have raised $70 billion of committed equity capital in these funds, of which $51 billion relates to our corporate funds and $19 billion relates to our real estate funds. As of November 2006, $45 billion of the committed equity capital was funded and the amount of AUM remaining in these funds after distributions was $44 billion.
       Merchant banking activities generate three primary revenue streams. First, we receive a management fee that is generally a percentage of a fund’s committed capital, invested capital, total gross acquisition cost or asset value. These annual management fees are included in our Asset Management net revenues. Second, Goldman Sachs, as a substantial investor in some of these funds, is allocated its proportionate share of the funds’ unrealized appreciation or depreciation arising from changes in fair value as well as gains and losses upon realization. Third, after a fund has achieved a minimum return for fund investors, we receive an increased share of the fund’s income and gains that is a percentage of the income and gains from the fund’s investments. The second and third of these revenue streams are included in Principal Investments within our Trading and Principal Investments segment.
  Securities Services
       Securities Services provides prime brokerage services, financing services and securities lending services to institutional clients, including hedge funds, mutual funds, pension funds and foundations, and to high-net-worth individuals worldwide.
       Prime brokerage services. We offer prime brokerage services to our clients, allowing them the flexibility to trade with most brokers while maintaining a single source for financing and consolidated portfolio reports. Our prime brokerage business provides clearing and custody in 45 markets and provides consolidated multi-currency accounting and reporting, offshore fund administration and other ancillary services.
       Financing services. A central element of our prime brokerage business involves providing financing to our clients for their securities trading activities through margin and securities loans that are collateralized by securities, cash or other acceptable collateral.
       Securities lending services. Securities lending services principally involve the borrowing and lending of securities to cover clients’ and Goldman Sachs’ short sales and otherwise to make deliveries into the market. In addition, we are an active participant in the broker-to-broker securities lending business and the third-party agency lending business. Net revenues in securities lending services are, as a general matter, weighted toward our second and third quarters each year due to seasonally higher activity levels in Europe.
Global Investment Research
       Global Investment Research provides fundamental research on companies, industries, economies, currencies, commodities and macro strategy research on a worldwide basis.
       Global Investment Research employs a team approach that as of November 2006 provided research coverage of approximately 2,750 companies worldwide and over 50 national economies. This is accomplished by the following departments:
  •  The Equity Research Departments provide fundamental analysis, earnings forecasts and investment opinions for equity securities;
 
  •  The Credit Research Department provides fundamental analysis, forecasts and investment opinions as to investment-grade and high-yield corporate bonds and credit derivatives;

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  •  The Economic Research Department formulates macroeconomic forecasts for economic activity, foreign exchange and interest rates;
 
  •  The Commodities Research Department provides research on the commodity markets; and
 
  •  The Strategy Research Department provides equity market forecasts, opinions on both asset and industry sector allocation, equity trading strategies, credit trading strategies and options research.
       Further information regarding research at Goldman Sachs is provided below under “— Regulation —
Regulations Applicable in and Outside the United States” and “Legal Proceedings — Research Independence Matters” in Part I, Item 3 of the Annual Report on Form 10-K.
Technology
       Goldman Sachs is committed to the ongoing development, maintenance and use of technology throughout the organization. Our technology initiatives can be broadly categorized into four efforts:
  •  Enhancing client service through increased connectivity and the provision of value-added, tailored products and services;
 
  •  Improving our trading, execution and clearing capabilities;
 
  •  Risk management; and
 
  •  Overall efficiency, productivity and control.
       We have tailored our services to our clients by providing them with electronic access to our products and services. In particular, we provide global electronic trading and information distribution capabilities covering many of our fixed income, currency, commodity, equity and mutual fund products around the world.
       Electronic commerce and technology have changed and will continue to change the ways that securities and other financial products are traded, distributed and settled. This creates both opportunities and challenges for our businesses. We remain committed to being at the forefront of technological innovation in the global capital markets.
Business Continuity and Information Security
       Business continuity and information security are high priorities for Goldman Sachs. Our Business Continuity Program has been developed to provide reasonable assurance of business continuity in the event of disruptions at the firm’s critical facilities and to comply with NYSE and National Association of Securities Dealers, Inc. regulatory requirements. The key elements of the program are crisis management, business recovery, systems and data recovery, people recovery facilities and process improvement. In the area of information security, we have developed and implemented a framework of principles, policies and technology to protect the information assets of the firm and our clients. Safeguards are applied to maintain the confidentiality, integrity and availability of information resources.
Employees
       Management believes that a major strength and principal reason for the success of Goldman Sachs is the quality and dedication of our people and the shared sense of being part of a team. We strive to maintain a work environment that fosters professionalism, excellence, diversity, cooperation among our employees worldwide and high standards of business ethics.
       Instilling the Goldman Sachs culture in all employees is a continuous process, in which training plays an important part. All employees are offered the opportunity to participate in education and

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periodic seminars that we sponsor at various locations throughout the world. Another important part of instilling the Goldman Sachs culture is our employee review process. Employees are reviewed by supervisors, co-workers and employees they supervise in a 360-degree review process that is integral to our team approach.
       As of November 2006, we had 26,467 employees, including 1,326 employees of Goldman Sachs’ consolidated property management and loan servicing subsidiaries and excluding 3,868 employees of certain consolidated entities that are held for investment purposes only. Consolidated entities held for investment purposes include entities that are held strictly for capital appreciation, have a defined exit strategy and are engaged in activities that are not closely related to our principal businesses.
Competition
       The financial services industry — and all of our businesses — are intensely competitive, and we expect them to remain so. Our competitors are other brokers and dealers, investment banking firms, commercial banks, insurance companies, investment advisers, mutual funds, hedge funds, private equity funds and merchant banks. We compete with some of our competitors globally and with others on a regional, product or niche basis. Our competition is based on a number of factors, including transaction execution, our products and services, innovation, reputation and price.
       We also face intense competition in attracting and retaining qualified employees. Our ability to continue to compete effectively in our businesses will depend upon our ability to attract new employees and retain and motivate our existing employees.
       Over time, there has been substantial consolidation and convergence among companies in the financial services industry, due in part to U.S. federal legislation that has expanded the activities permissible for firms affiliated with a U.S. bank. In particular, a number of large commercial banks, insurance companies and other broad-based financial services firms have established or acquired broker-dealers or have merged with other financial institutions. Many of these firms have the ability to offer a wide range of products, from loans, deposit-taking and insurance to brokerage, asset management and investment banking services, which may enhance their competitive position. They also have the ability to support investment banking and securities products with commercial banking, insurance and other financial services revenues in an effort to gain market share, which has resulted in pricing pressure in certain of our businesses and could result in pricing pressure in other of our businesses.
       Moreover, we have faced, and expect to continue to face, pressure to retain market share by committing capital to businesses or transactions on terms that offer returns that may not be commensurate with their risks. In particular, corporate clients increasingly seek such commitments (such as agreements to participate in their commercial paper backstop or other loan facilities) from financial services firms in connection with investment banking and other assignments. We provide these commitments either through our William Street entities, primarily for investment-grade clients, or through Goldman Sachs Credit Partners L.P. or our other subsidiaries, primarily for other clients. With respect to substantially all of the William Street commitments, SMFG provides us with credit loss protection that is generally limited to 95% of the first loss we realize on approved loan commitments, up to a maximum of $1.00 billion. In addition, subject to the satisfaction of certain conditions, upon our request, SMFG will provide protection for 70% of the second loss on such commitments, up to a maximum of $1.13 billion. We also use other financial instruments to mitigate credit risks related to certain William Street commitments not covered by SMFG. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Annual Report on Form 10-K and Note 6 to our consolidated financial statements in Part II, Item 8 of the Annual Report on Form 10-K for more information regarding the William Street entities and for a description of the credit loss protection provided by SMFG. An increasing number of our commitments in connection with investment banking and other assignments do not meet the

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criteria established for the William Street entities and do not benefit from the SMFG loss protection. These commitments are issued through Goldman Sachs Credit Partners L.P. or our other subsidiaries.
       The trend toward consolidation and convergence has significantly increased the capital base and geographic reach of some of our competitors. This trend has also hastened the globalization of the securities and other financial services markets. As a result, we have had to commit capital to support our international operations and to execute large global transactions. To take advantage of some of our most significant challenges and opportunities, we will have to compete successfully with financial institutions that are larger and better capitalized and that may have a stronger local presence and longer operating history outside the United States.
       We have experienced intense price competition in some of our businesses in recent years. There has been considerable pressure in the pricing of block trades. Also, equity and debt underwriting discounts, as well as trading spreads, have been under pressure for a number of years and the ability to execute trades electronically, through the Internet and through other alternative trading systems, has increased the pressure on trading commissions. It appears that this trend toward electronic and other “low-touch,” low-commission trading will continue. We believe that we will continue to experience competitive pressures in these and other areas in the future as some of our competitors seek to obtain market share by reducing prices.
Regulation
       Goldman Sachs, as a participant in the securities and commodity futures and options industries, is subject to extensive regulation in the United States and the other countries in which we operate. As a matter of public policy, regulatory bodies around the world are charged with safeguarding the integrity of the securities and other financial markets and with protecting the interests of clients participating in those markets. They are not, however, charged with protecting the interests of Goldman Sachs’ shareholders or creditors.
       Broker-dealers, in particular, are subject to regulations that cover all aspects of the securities business, including sales methods, trade practices, use and safekeeping of clients’ funds and securities, capital structure, recordkeeping, the financing of clients’ purchases, and the conduct of directors, officers and employees. A number of our affiliates are regulated by investment advisory laws in the countries in which we operate. See “Risk Factors — Our businesses and those of our clients are subject to extensive and pervasive regulation around the world” in Part I, Item 1A of the Annual Report on Form 10-K for a further discussion of the effect that regulation may have on our businesses.
Regulation in the United States
       In the United States, the SEC is the federal agency responsible for the administration of the federal securities laws. The Goldman Sachs Group, Inc. is subject to regulation by the SEC as a Consolidated Supervised Entity. As such, it is subject to group-wide supervision and examination by the SEC and to minimum capital requirements on a consolidated basis. As part of a Consolidated Supervised Entity, Goldman, Sachs & Co. (GS&Co.), our principal U.S. broker-dealer, is permitted to calculate its regulatory capital requirements in accordance with the market and credit risk standards of Appendix E of Rule 15c3-1 under the Securities Exchange Act of 1934.
       GS&Co. is registered as a broker-dealer and as an investment adviser with the SEC and as a broker-dealer in all 50 states and the District of Columbia. Self-regulatory organizations, such as the NYSE and NASD, adopt rules that apply to, and examine, broker-dealers such as GS&Co. In addition, state securities and other regulators also have regulatory or oversight authority over GS&Co. Similarly, our businesses are also subject to regulation by various non-U.S. governmental and regulatory bodies and self-regulatory authorities in virtually all countries where we have offices. Goldman Sachs Execution & Clearing, L.P. (GSEC) and two of its subsidiaries are registered

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U.S. broker-dealers and are regulated by the SEC and NYSE, and GSEC is also regulated by the NASD. Goldman Sachs Financial Markets, L.P. is registered with the SEC as an OTC derivatives dealer and conducts certain OTC derivatives businesses.
       The NYSE and the NASD, which have regulatory authority over a large amount of our businesses and activities, have announced that they intend to merge their regulatory operations into a single regulatory body, expected to begin operations in the second quarter of 2007.
       The commodity futures and commodity options industry in the United States is subject to regulation under the Commodity Exchange Act. The Commodity Futures Trading Commission is the federal agency charged with the administration of the Commodity Exchange Act. Several of Goldman Sachs’ subsidiaries, including GS&Co. and GSEC, are registered with the CFTC and act as futures commission merchants, commodity pool operators or commodity trading advisors and are subject to the Commodity Exchange Act. The rules and regulations of various self-regulatory organizations, such as the Chicago Board of Trade and the Chicago Mercantile Exchange, other futures exchanges and the National Futures Association, also govern the commodity futures and commodity options businesses of these entities.
       GS&Co. and GSEC are subject to Rule 15c3-1 of the SEC and Rule 1.17 of the CFTC, which specify uniform minimum net capital requirements and also effectively require that a significant part of the registrants’ assets be kept in relatively liquid form. GS&Co. and GSEC have elected to compute their minimum capital requirements in accordance with the “Alternative Net Capital Requirement” as permitted by Rule 15c3-1. As of November 2006, GS&Co. and GSEC had net capital in excess of their minimum capital requirements. In addition to its alternative minimum net capital requirements, GS&Co. is also required to hold tentative net capital in excess of $1 billion and net capital in excess of $500 million in accordance with the market and credit risk standards of Appendix E of Rule 15c3-1. GS&Co. is required to notify the SEC in the event that its tentative net capital is less than $5 billion. As of November 2006, GS&Co. had tentative net capital and net capital in excess of both the minimum and the notification requirements. These net capital requirements may have the effect of prohibiting these entities from distributing or withdrawing capital and may require prior notice to the SEC for certain withdrawals of capital. See Note 15 to the consolidated financial statements in Part II, Item 8 of the Annual Report on Form 10-K.
       Goldman Sachs has established three limited purpose trust companies under state or federal law. They are not permitted to and do not accept deposits (other than as incidental to their trust activities) or make loans and, as a result, are not considered to be banks for purposes of the Bank Holding Company Act, nor are they insured by the FDIC or subject to the Community Reinvestment Act. These entities and their regulators are: The Goldman Sachs Trust Company, N.A., a national bank that is limited to having only trust powers, is regulated by the Office of the Comptroller of the Currency and is a member bank of the Federal Reserve System; The Goldman Sachs Trust Company, a New York limited purpose trust company that is regulated by the New York State Banking Department; and The Goldman Sachs Trust Company of Delaware, a Delaware limited purpose trust company that is regulated by the Office of the Delaware State Bank Commissioner.
       Goldman Sachs has established GS Bank, a wholly owned industrial bank, to extend credit and to take deposits, other than demand deposits. GS Bank is regulated by the FDIC and the State of Utah Department of Financial Institutions and is subject to minimum capital requirements. As of November 2006, GS Bank was in compliance with all regulatory capital requirements. Because it does not accept demand deposits, GS Bank is not considered to be a bank for purposes of the Bank Holding Company Act. The deposits maintained at GS Bank are insured by the FDIC to the extent provided by law.
       J. Aron & Company is authorized by the Federal Energy Regulatory Commission to sell wholesale physical power at market-based rates. As a FERC-authorized power marketer, J. Aron & Company is subject to regulation under the Federal Power Act and FERC regulations.

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       In addition, as a result of our interests in electric power generation facilities, we are subject to extensive and evolving energy, environmental and other governmental laws and regulations, as discussed under “Risk Factors — Our power generation interests subject us to the risks associated with owning power generation facilities” in Part I, Item 1A of the Annual Report on Form 10-K.
       Our U.S. insurance subsidiaries are subject to state insurance regulation in the states in which they are domiciled and in the other states in which they are licensed. A number of our other businesses, including our lending and mortgage businesses, require us to obtain licenses and adhere to applicable regulations in the states in which we conduct these businesses.
       The USA PATRIOT Act of 2001 contains anti-money laundering and financial transparency laws and mandates the implementation of various new regulations applicable to broker-dealers and other financial services companies, including standards for verifying client identification at account opening, and obligations to monitor client transactions and report suspicious activities. Through these and other provisions, the USA PATRIOT Act of 2001 seeks to promote the identification of parties that may be involved in terrorism or money laundering. Anti-money laundering laws outside the United States contain some similar provisions. The obligation of financial institutions, including Goldman Sachs, to identify their clients, to watch for and report suspicious transactions, to respond to requests for information by regulatory authorities and law enforcement agencies, and to share information with other financial institutions, has required the implementation and maintenance of internal practices, procedures and controls that have increased, and may continue to increase, our costs, and any failure with respect to our programs in this area could subject us to substantial liability and regulatory fines.
Regulation Outside the United States
       Goldman Sachs provides investment services in and from the United Kingdom under the regulation of the Financial Services Authority (FSA). Goldman Sachs International (GSI), our regulated U.K. broker-dealer, is subject to the capital requirements of the FSA. As of November 2006, GSI was in compliance with the FSA capital requirements. Other subsidiaries, including Goldman Sachs International Bank, are also regulated by the FSA.
       Various Goldman Sachs entities are regulated by the banking and regulatory authorities of the other European countries in which Goldman Sachs operates, including, among others, the Federal Financial Supervisory Authority (BaFin) and the Bundesbank in Germany, Banque de France and the Autorité des Marchés Financiers in France, Banca d’Italia and the Commissione Nazionale per le Società e la Borsa (CONSOB) in Italy, the Federal Financial Markets Service in Russia and the Swiss Federal Banking Commission. Goldman Sachs entities are also regulated by the European securities, derivatives and commodities exchanges of which they are members.
       The investment services that are subject to oversight by the FSA and other European regulators are regulated in accordance with European Union directives requiring, among other things, compliance with certain capital adequacy standards, customer protection requirements and conduct of business rules. These standards, requirements and rules are similarly implemented, under the same directives, throughout the European Union and are broadly comparable in scope and purpose to the regulatory capital and customer protection requirements imposed under the SEC and CFTC rules. Some European Union directives also permit local regulation in each jurisdiction, including those in which we operate, to be more restrictive than the requirements of such directives and these local requirements can result in certain competitive disadvantages to Goldman Sachs.
       The European Union’s Markets in Financial Instruments Directive (Directive 2004/39/EC) will affect several of our subsidiaries by imposing detailed pan-European requirements in areas such as internal organization (including conflict management, outsourcing and recordkeeping), best execution, real-time disclosure of completed transactions in shares, quoting obligations for internalized client orders in shares, transaction reporting to regulators, client classification and documentation, and

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regulation of investment services related to commodity derivatives. European Union member states were required to adopt national laws, regulations and administrative provisions complying with the directive by January 31, 2007 and must apply these laws, regulations and provisions by November 1, 2007. The United Kingdom has met the adopting deadline and is expected to meet the deadline for applying the laws and regulations. Therefore, we anticipate that we will be subject to substantial new requirements beginning November 1, 2007, which could lead to business disruptions or require us to change certain of our business practices. Certain other member states have not yet adopted the required laws and regulations and may not meet the November 1, 2007 deadline for applying them. While we are preparing for compliance with the implementing laws and regulations, we remain subject to continuing regulatory uncertainty concerning the national implementing laws and regulations.
       Goldman Sachs Japan Co., Ltd. (GSJCL), our regulated Japanese broker-dealer, is subject to the capital requirements of Japan’s Financial Services Agency. As of November 2006, GSJCL was in compliance with its capital adequacy requirements. GSJCL is also regulated by the Tokyo Stock Exchange, the Osaka Securities Exchange, the Tokyo Financial Exchange, the Japan Securities Dealers Association, the Tokyo Commodity Exchange and the Ministry of Economy, Trade and Industry in Japan. Prior to October 1, 2006, Goldman Sachs (Japan) Ltd., the predecessor to GSJCL, was our primary regulated subsidiary based in Japan.
       Also in Asia, the Securities and Futures Commission in Hong Kong, the Monetary Authority of Singapore, the China Securities Regulatory Commission and the Korean Financial Supervisory Service, among others, regulate various of our subsidiaries and also have capital standards and other requirements comparable to the rules of the SEC.
       Various Goldman Sachs entities are regulated by the banking and regulatory authorities of other non-U.S. countries in which Goldman Sachs operates, including, among others, Brazil, India and Dubai. In addition, certain of our insurance subsidiaries are regulated by the Bermuda Registrar of Companies.
Regulations Applicable in and Outside the United States
       The U.S. and non-U.S. government agencies, regulatory bodies and self-regulatory organizations, as well as state securities commissions in the United States, are empowered to conduct administrative proceedings that can result in censure, fine, the issuance of cease and desist orders, or the suspension or expulsion of a broker-dealer or its directors, officers or employees. From time to time, our subsidiaries have been subject to investigations and proceedings, and sanctions have been imposed for infractions of various regulations relating to our activities, none of which has had a material adverse effect on us or our businesses.
       In 2004, the Basel Committee on Banking Supervision issued the Basel II capital standards, which are designed to promote enhanced risk management practices among large, international financial services firms by aligning regulatory capital requirements more closely with the underlying risks faced by these firms. Under the currently proposed time schedule, GSI, as well as our other subsidiaries in the United Kingdom and elsewhere in Europe, would become subject to the Basel II requirements on January 1, 2008. The Consolidated Supervised Entity rules described above under “— Regulation in the United States,” which provide for group-wide supervision, are consistent with Basel II. Complying with these new standards has required us to develop and apply new and sophisticated measurement techniques to determine our regulatory capital adequacy. As an increasing number of financial institutions become subject to Basel II, new interpretations may arise, and harmonization among regulators could then impact the regulatory capital requirements under which we operate as a Consolidated Supervised Entity, as well as the requirements for some of our regulated subsidiaries.
       Our specialist businesses are subject to extensive regulation by a number of securities exchanges. The rules of these exchanges generally require our specialists to maintain orderly

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markets in the securities in which they are specialists. These requirements, in turn, may require us to commit significant amounts of capital to our specialist businesses.
       The research areas of investment banks have been and remain the subject of regulatory scrutiny. The SEC, NYSE and NASD have adopted rules imposing restrictions on the interaction between equity research analysts and investment banking personnel at member securities firms. Various non-U.S. jurisdictions have imposed both substantive and disclosure-based requirements with respect to research and may impose additional regulations. In 2003, GS&Co. agreed to a global settlement with certain federal and state securities regulators and self-regulatory organizations to resolve investigations into equity research analysts’ alleged conflicts of interest. The global settlement includes certain restrictions and undertakings that have imposed additional costs and limitations on the conduct of our businesses, including restrictions on the interaction between research and investment banking departments.
       In connection with the research settlement, we have also subscribed to a voluntary initiative imposing restrictions on the allocation of shares in initial public offerings to executives and directors of public companies. The FSA in the United Kingdom has imposed requirements on the conduct of the allocation process in equity and fixed income securities offerings (including initial public offerings and secondary distributions). The SEC, NYSE and NASD have proposed rules that would further affect the manner in which securities are distributed and allocated in registered public offerings. We cannot fully predict the practical effect that these proposed requirements will have on our business, and the SEC, NYSE, NASD and non-U.S. regulators, such as the FSA, may adopt additional and more stringent rules with respect to offering procedures and the management of conflicts of interest in the future.
       Our investment management businesses are subject to significant regulation in numerous jurisdictions around the world relating to, among other things, the safeguarding of client assets and our management of client funds.
       As discussed above, many of our subsidiaries are subject to regulatory capital requirements in jurisdictions throughout the world. Subsidiaries not subject to separate regulation may hold capital to satisfy local tax guidelines, rating agency requirements or internal policies, including policies concerning the minimum amount of capital a subsidiary should hold based upon its underlying risk.
       Certain of our businesses are subject to compliance with regulations enacted by U.S. federal and state governments, the European Union or other jurisdictions and/or enacted by various regulatory organizations or exchanges relating to the privacy of client information, and any failure to comply with these regulations could expose us to liability and/or reputational damage.
Item 1A.     Risk Factors
       We face a variety of risks that are substantial and inherent in our businesses, including market, liquidity, credit, operational, legal and regulatory risks. The following are some of the more important factors that could affect our businesses.
Our businesses may be adversely affected by conditions in the global financial markets and economic conditions generally.
       Our business, by its nature, does not produce predictable earnings. While we have achieved record earnings per common share in each of our last three fiscal years, reflecting a favorable trading and investing environment and an increase in investment banking activity, an adverse change in these market conditions may adversely affect our results of operations.
       Our businesses are materially affected by conditions in the global financial markets and economic conditions generally, and these conditions may change suddenly and dramatically. A favorable business environment is generally characterized by, among other factors, high global gross domestic product growth, stable geopolitical conditions, transparent and efficient capital markets, low

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inflation, high business and investor confidence, and strong business earnings. Unfavorable or uncertain economic and market conditions, which can be caused by outbreaks of hostilities or other geopolitical instability, declines in business confidence, increases in inflation, corporate, political or other scandals that reduce investor confidence in capital markets, natural disasters or pandemics or a combination of these or other factors, have adversely affected, and may in the future adversely affect, our business and profitability in many ways, including the following:
  •  We have been operating in a low interest rate market for the past several years. Increasing or high interest rates and/or widening credit spreads, especially if such changes are rapid, may create a less favorable environment for certain of our businesses.
 
  •  We have been committing increasing amounts of capital in many of our businesses and generally maintain large trading, specialist and investing positions. Market fluctuations and volatility may adversely affect the value of those positions, including, but not limited to, our interest rate and credit products, currency, commodity and equity positions, and our merchant banking investments, or may reduce our willingness to enter into new transactions. From time to time, we have incurred significant trading losses in periods of market turbulence. Conversely, certain of our trading businesses depend on market volatility to provide trading and arbitrage opportunities, and decreases in volatility may reduce these opportunities and adversely affect the results of these businesses.
 
  •  Industry-wide declines in the size and number of underwritings and mergers and acquisitions may have an adverse effect on our revenues and, because we may be unable to reduce expenses correspondingly, our profit margins. In particular, because a significant portion of our investment banking revenues are derived from our participation in large transactions, a decrease in the number of large transactions due to uncertain or unfavorable market conditions may adversely affect our investment banking business.
 
  •  Pricing and other competitive pressures have continued, even as the volume and number of investment banking transactions have increased. In addition, the trend in the underwriting business toward multiple book runners and co-managers handling transactions, where previously there would have been a single book runner, has adversely affected our business and reduced our revenues.
 
  •  Reductions in the level of the equity markets or increases in interest rates tend to reduce the value of our clients’ portfolios, which in turn may reduce the fees we earn for managing assets. Increases in interest rates or attractive conditions in other investments could cause our clients to transfer their assets out of our funds or other products. Even in the absence of uncertain or unfavorable economic or market conditions, investment performance by our asset management business below the performance of benchmarks or competitors could result in a decline in assets under management and in the incentive and management fees we receive as well as reputational damage that might make it more difficult to attract new investors.
 
  •  Concentration of risk increases the potential for significant losses in our market-making, proprietary trading and investing, block trading, merchant banking, underwriting and lending businesses. This risk may increase to the extent we expand our proprietary trading and investing businesses or commit capital to facilitate customer-driven business. For example, in recent years large blocks of securities have increasingly been sold in block trades rather than on a marketed basis, which increases the risk that Goldman Sachs may be unable to resell the purchased securities at favorable prices and may incur significant losses as a result. Moreover, because of concentration of risk, we may suffer losses even when economic and market conditions are generally favorable for others in the industry. We also regularly enter into large transactions as part of our trading businesses. The number and size of such transactions may affect our results of operations in a given period.

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  •  The volume of transactions that we execute for our clients and as a specialist or market maker may decline, which would reduce the revenues we receive from commissions and spreads. In addition, competitive pressures and other industry factors, including the increasing use by our clients of low-cost electronic trading, could cause a reduction in commissions and spreads. In our specialist businesses, we are obligated by stock exchange rules to maintain an orderly market, including by purchasing shares in a declining market. This may result in trading losses and an increased need for liquidity. Weakness in global equity markets and the trading of securities in multiple markets and on multiple exchanges could adversely impact our trading businesses and impair the value of our goodwill and identifiable intangible assets. In addition, competitive pressures have been particularly intense in the context of block trades.
 
  •  The emergence of a pandemic or other widespread health emergency, or concerns over the possibility of such an emergency, could create economic and financial disruptions in emerging markets and other areas throughout the world, and could lead to operational difficulties (including travel limitations) that could impair our ability to manage our businesses around the world. In addition, unforeseen or catastrophic events, including health emergencies, terrorist attacks or natural disasters, could expose our insurance subsidiaries to significant losses.
We may incur losses as a result of ineffective risk management processes and strategies.
       We seek to monitor and control our risk exposure through a variety of separate but complementary financial, credit, operational, compliance and legal reporting systems. Our trading risk management process seeks to balance our ability to profit from trading positions with our exposure to potential losses. While we employ a broad and diversified set of risk monitoring and risk mitigation techniques, those techniques and the judgments that accompany their application cannot anticipate every economic and financial outcome or the specifics and timing of such outcomes. Thus, we may, in the course of our activities, incur losses.
       The models that we use to assess and control our risk exposures reflect assumptions about the degrees of correlation or lack thereof among prices of various asset classes or other market indicators, and in times of market stress or other unforeseen circumstances previously uncorrelated indicators may become correlated, or conversely previously correlated indicators may move in different directions. In the past, these types of market movements have at times limited the effectiveness of our hedging strategies and have caused us to incur significant losses, and they may do so in the future.
       Market volatility has been relatively low in recent years. An increase in volatility would increase our measured risk, which might cause us to reduce our proprietary positions or to reduce certain of our business activities. In such circumstances, we may not be able to reduce our positions or our exposure in a timely, cost-effective way or in a manner sufficient to offset the increase in measured risk.
       For a further discussion of our risk management policies and procedures, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Risk Management” in Part II, Item 7 of the Annual Report on Form 10-K.
Our liquidity and businesses may be adversely affected by an inability to access the debt capital markets or to sell assets, by a reduction in our credit ratings or by an inability of The Goldman Sachs Group, Inc. to access funds from its subsidiaries.
       Liquidity is essential to our businesses. Our liquidity could be impaired by an inability to access secured and/or unsecured debt markets, an inability to sell assets or unforeseen outflows of cash or collateral. This situation may arise due to circumstances that we may be unable to control, such as a general market disruption or an operational problem that affects third parties or us. The financial

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instruments that we hold and the contracts to which we are a party are increasingly complex, as we employ structured products to benefit our clients and ourselves, and these complex structured products often do not have readily available markets to access in times of liquidity stress. Growth of our proprietary investing activities may lead to situations where the holdings from these activities represent a significant portion of specific markets, which could restrict liquidity for our positions. Further, our ability to sell assets may be impaired if other market participants are seeking to sell similar assets at the same time.
       Our credit ratings are important to our liquidity. A reduction in our credit ratings could adversely affect our liquidity and competitive position, increase our borrowing costs, limit our access to the capital markets or trigger our obligations under certain bilateral provisions in some of our trading and collateralized financing contracts. Under these provisions, counterparties could be permitted to terminate contracts with Goldman Sachs or require us to post additional collateral. Termination of our trading and collateralized financing contracts could cause us to sustain losses and impair our liquidity by requiring us to find other sources of financing or to make significant cash payments or securities movements.
       The Goldman Sachs Group, Inc. is a holding company and, therefore, depends on dividends, distributions and other payments from its subsidiaries to fund dividend payments and to fund all payments on its obligations, including debt obligations. Many of our subsidiaries, including GS&Co., are subject to laws that authorize regulatory bodies to block or reduce the flow of funds from those subsidiaries to The Goldman Sachs Group, Inc. Regulatory action of that kind could impede access to funds that The Goldman Sachs Group, Inc. needs to make payments on obligations, including debt obligations, or dividend payments.
Our businesses, profitability and liquidity may be adversely affected by a deterioration in the credit quality of, or defaults by, third parties who owe us money, securities or other assets.
       We are exposed to the risk that third parties that owe us money, securities or other assets will not perform their obligations. These parties may default on their obligations to us due to bankruptcy, lack of liquidity, operational failure or other reasons. We are also subject to the risk that our rights against third parties may not be enforceable in all circumstances. In addition, a deterioration in the credit quality of third parties whose securities or obligations we hold could result in losses and/or adversely affect our ability to rehypothecate or otherwise use those securities or obligations for liquidity purposes. A significant downgrade in the credit ratings of our counterparties could also have a negative impact on our results. The amount and duration of our credit exposures have been increasing over the past several years, as has the breadth of the entities to which we have credit exposures. As a clearing member firm, we finance our client positions, and we could be held responsible for the defaults or misconduct of our clients. In addition, we have experienced, due to competitive factors, pressure to extend and price credit at levels that may not always fully compensate us for the risks we take. In particular, corporate clients sometimes seek to require credit commitments from us in connection with investment banking and other assignments. While our activities expose us to many different industries and counterparties, we routinely execute a high volume of transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment funds and other institutional clients, resulting in significant credit concentration with respect to this industry. In the ordinary course of business, we may also be subject to a concentration of credit risk to a particular counterparty, borrower or issuer.
       Although we regularly review credit exposures to specific clients and counterparties and to specific industries, countries and regions that we believe may present credit concerns, default risk may arise from events or circumstances that are difficult to detect or foresee. In addition, concerns about, or a default by, one institution could lead to significant liquidity problems, losses or defaults by other institutions, which in turn could adversely affect Goldman Sachs.

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We face enhanced risks as new business initiatives lead us to transact with a broader array of clients, with new asset classes and in new markets.
       A number of our recent and planned business initiatives and expansions of existing businesses may bring us into contact, directly or indirectly, with individuals and entities that are not within our traditional client base and with new asset classes and new markets. For example, we have begun providing loans to small and mid-sized businesses, increased our exposure to subprime mortgages and are transacting business and investing in new emerging markets. In addition, we are increasingly offering complex structured products and alternative investments to a wider investor base, both directly and through third-party distribution channels. Furthermore, a number of our businesses, including our proprietary investing and merchant banking activities, cause us to directly or indirectly own interests in, or otherwise become affiliated with the ownership and operation of, public services, such as airports, toll roads, shipping ports and electric power generation facilities, both within and outside the United States. These business activities expose us to new and enhanced risks, including reputational concerns arising from dealing with less sophisticated counterparties and investors, greater regulatory scrutiny of these activities, increased credit-related and operational risks, risks arising from accidents or acts of terrorism, and reputational concerns with the manner in which these assets are being operated or held.
Derivative transactions may expose us to unexpected risk and potential losses.
       We are party to a large number of derivative transactions, including credit derivatives, that require that we deliver to the counterparty the underlying security, loan or other obligation in order to receive payment. In a number of cases, we do not hold the underlying security, loan or other obligation and may have difficulty obtaining, or be unable to obtain, the underlying security, loan or other obligation through the physical settlement of other transactions. As a result, we are subject to the risk that we may not be able to obtain the security, loan or other obligation within the required contractual time frame for delivery. This could cause us to forfeit the payments due to us under these contracts or result in settlement delays with the attendant credit and operational risk as well as increased costs to the firm.
       Derivative contracts and other transactions entered into with third parties are not always confirmed by the counterparties on a timely basis. While the transaction remains unconfirmed, we are subject to heightened credit and operational risk and in the event of a default may find it more difficult to enforce the contract.
A failure in our operational systems or infrastructure, or those of third parties, could impair our liquidity, disrupt our businesses, damage our reputation and cause losses.
       Shortcomings or failures in our internal processes, people or systems could lead to impairment of our liquidity, financial loss, disruption of our businesses, liability to clients, regulatory intervention or reputational damage. Our businesses are highly dependent on our ability to process, on a daily basis, a large number of transactions, many of which are highly complex, across numerous and diverse markets in many currencies. These transactions often must adhere to client-specific guidelines, as well as legal and regulatory standards. Our financial, accounting, data processing or other operating systems and facilities may fail to operate properly or become disabled as a result of events that are wholly or partially beyond our control, adversely affecting our ability to process these transactions. The inability of our systems to accommodate an increasing volume of transactions could also constrain our ability to expand our businesses.
       We also face the risk of operational failure or termination of any of the clearing agents, exchanges, clearing houses or other financial intermediaries we use to facilitate our securities transactions, and as our interconnectivity with our clients grows, we will increasingly face the risk of operational failure with respect to our clients’ systems. In recent years, there has been significant consolidation among clearing agents, exchanges and clearing houses, which has increased our

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exposure to operational failure or termination of the particular financial intermediaries that we use and could affect our ability to find adequate and cost-effective alternatives in the event of any such failure or termination. Any such failure or termination could adversely affect our ability to effect transactions, service our clients and manage our exposure to risk.
       Despite the contingency plans and facilities we have in place, our ability to conduct business may be adversely impacted by a disruption in the infrastructure that supports our businesses and the communities in which we are located. This may include a disruption involving electrical, communications, transportation or other services used by Goldman Sachs or third parties with which we conduct business. These disruptions may occur, for example, as a result of events that affect only the buildings of Goldman Sachs or such third parties, or as a result of events with a broader impact globally, regionally or in the cities where those buildings are located. Nearly all of our employees in our primary locations, including New York, London, Frankfurt, Hong Kong, Tokyo and Bangalore, work in close proximity to one another, in one or more buildings. If a disruption occurs in one location and our employees in that location are unable to occupy our offices or communicate with or travel to other locations, our ability to service and interact with our clients may suffer, and we may not be able to successfully implement contingency plans that depend on communication or travel.
       Our operations rely on the secure processing, storage and transmission of confidential and other information in our computer systems and networks. Although we take protective measures and endeavor to modify them as circumstances warrant, our computer systems, software and networks may be vulnerable to unauthorized access, computer viruses or other malicious code and other events that could have a security impact. If one or more of such events occur, this potentially could jeopardize our or our clients’ or counterparties’ confidential and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our, our clients’, our counterparties’ or third parties’ operations, which could result in significant losses or reputational damage. We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are either not insured against or not fully covered through any insurance maintained by us.
       We routinely transmit and receive personal, confidential and proprietary information by email and other electronic means. We have discussed and worked with clients and counterparties to develop secure transmission capabilities, but we do not have in place secure capabilities for all of our clients and counterparties. An interception or mishandling of personal, confidential or proprietary information being sent to or received from a client or counterparty could result in legal liability, regulatory action and reputational harm. We are exposed to similar risks arising from the interception of personal, confidential or proprietary information sent to or received from, or the misuse or mishandling of personal, confidential or proprietary information by, vendors, service providers and other third parties who may receive such information from us, and our efforts to ensure that these third parties have appropriate controls in place may not be successful.
Conflicts of interest are increasing and a failure to appropriately deal with conflicts of interest could adversely affect our businesses.
       Our reputation is one of our most important assets. As we have expanded the scope of our businesses and our client base, we increasingly have to address potential conflicts of interest, including situations where our services to a particular client or our own proprietary investments or other interests conflict, or are perceived to conflict, with the interests of another client, as well as situations where one or more of our businesses have access to material non-public information that may not be shared with other businesses within the firm.
       The SEC, the NASD, other federal and state regulators and regulators outside the United States, including in the United Kingdom and Japan, have announced their intention to increase their

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scrutiny of potential conflicts of interest, including through detailed examinations of specific transactions. There have been recent public reports that the Department of Justice is conducting an investigation regarding joint participation by certain private equity firms and other financial institutions in certain leveraged buyouts, referred to as “club deals.” In addition, certain complaints filed against firms other than Goldman Sachs allege the violation of antitrust laws arising from their “club deal” arrangements. A number of class action complaints have also been filed in connection with certain specific “club deal” transactions which name the relevant “club deal” participants among the defendants, including Goldman Sachs affiliates in several cases, and generally allege that the transactions constitute a breach of fiduciary duty by the target company and that the “club” participants aided and abetted such breach. We may become subject to further litigation or regulatory scrutiny in the future in this regard.
       We have extensive procedures and controls that are designed to address conflicts of interest, including those designed to prevent the improper sharing of information among our businesses. However, appropriately dealing with conflicts of interest is complex and difficult, and our reputation could be damaged and the willingness of clients to enter into transactions in which such a conflict might arise may be affected if we fail, or appear to fail, to deal appropriately with conflicts of interest. In addition, potential or perceived conflicts could give rise to litigation or enforcement actions.
Our businesses and those of our clients are subject to extensive and pervasive regulation around the world.
       Goldman Sachs, as a participant in the financial services industry, is subject to extensive regulation in jurisdictions around the world. We face the risk of significant intervention by regulatory authorities in all jurisdictions in which we conduct our businesses. Among other things, we could be fined, prohibited from engaging in some of our business activities or subject to limitations or conditions on our business activities.
       New laws or regulations or changes in enforcement of existing laws or regulations applicable to our businesses or those of our clients may also adversely affect our businesses. Regulatory changes could lead to business disruptions, could require us to change certain of our business practices and could expose us to additional costs and liabilities as well as reputational harm. For a discussion of the extensive regulation to which our businesses are subject, see “Business — Regulation” in Part I, Item 1 of the Annual Report on Form 10-K.
       Firms in the financial services industry have been operating in a difficult regulatory environment. The industry has experienced increased scrutiny from a variety of regulators, both within and outside the United States. Penalties and fines sought by regulatory authorities have increased substantially over the last several years, and certain regulators have been more likely in recent years to commence enforcement actions. For example, regulators, both within and outside the United States, continue to scrutinize complex, structured finance transactions and have brought enforcement actions against a number of financial institutions in connection with such transactions. We seek to create innovative solutions to address our clients’ needs, and we have entered into, and continue to enter into, structured transactions with clients.
       This environment has led some of our clients to be less willing to engage in transactions that may carry a risk of increased scrutiny by regulators and has created uncertainty with respect to a number of transactions that had historically been entered into by financial services firms, including our firm, and that were generally believed to be permissible and appropriate. This environment also has led us and our competitors to modify transaction structures and, in some cases, to limit or cease our execution of some types of transactions. While we have policies and procedures in place that are intended to ensure that the transactions we enter into are appropriately reviewed and comply with applicable laws and regulations, it is possible that certain transactions could give rise to litigation or enforcement actions or that the regulatory scrutiny of, and litigation in connection with, transactions

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will make our clients less willing to enter into these transactions with us, and will adversely affect our business.
Substantial legal liability or significant regulatory action against Goldman Sachs could have material adverse financial effects or cause significant reputational harm to Goldman Sachs, which in turn could seriously harm our business prospects.
       We face significant legal risks in our businesses, and the volume of claims and amount of damages and penalties claimed in litigation and regulatory proceedings against financial institutions remain high. See “Legal Proceedings” in Part I, Item 3 of the Annual Report on Form 10-K for a discussion of certain legal proceedings in which we are involved.
       For example, federal and state authorities and other regulatory entities, including the NASD, have made informational requests regarding market timing, late trading and other activities broadly across all of the major fund companies and broker-dealers, including Goldman Sachs. While we believe that we have in place reasonable measures to detect and deter disruptive and abusive trading practices and comply with applicable legal and regulatory requirements, we cannot predict the course that these inquiries and areas of focus may take or the impact that any new laws or regulations governing mutual funds may have on our businesses.
       Also, in March 2004, certain NYSE specialist firms, including our specialist unit, agreed to a settlement with the SEC and NYSE to resolve charges that the firms violated certain federal securities laws and NYSE rules in connection with their activities as NYSE specialists during the years 1999 through 2003. The settlement did not resolve the related civil actions discussed under “Legal Proceedings — Specialist Matters” in Part I, Item 3 of the Annual Report on Form 10-K, or potential regulatory charges against individuals. In addition, we have received requests for information from regional stock exchanges and options exchanges regarding specialist activities. As a result of the settlement and any related developments, other investigations or any new laws or regulations governing specialists, our specialist businesses may be adversely affected and the value of our goodwill and identifiable intangible assets related to these businesses may be impaired.
       There have been a number of highly publicized cases involving fraud or other misconduct by employees in the financial services industry in recent years, and we run the risk that employee misconduct could occur. It is not always possible to deter or prevent employee misconduct and the precautions we take to prevent and detect this activity may not be effective in all cases.
The financial services industry is highly competitive.
       The financial services industry — and all of our businesses — are intensely competitive, and we expect them to remain so. We compete on the basis of a number of factors, including transaction execution, our products and services, innovation, reputation and price. We believe that we will continue to experience pricing pressures in the future as some of our competitors seek to increase market share by reducing prices. Over time, there has been substantial consolidation and convergence among companies in the financial services industry. U.S. federal legislation, which significantly expanded the activities permissible for firms affiliated with a U.S. bank, has accelerated this consolidation and further increased competition. This trend toward consolidation and convergence has significantly increased the capital base and geographic reach of our competitors. This trend has also hastened the globalization of the securities and other financial services markets. As a result, we have had to commit capital to support our international operations and to execute large global transactions. As our business expands into new business areas and new geographical regions, we will face competitors with more experience and more established relationships with clients, regulators and industry participants in the relevant market, which could adversely affect our ability to expand.

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The growth of electronic trading and the introduction of new technology may adversely affect our business and may increase competition.
       Technology is fundamental to our business and our industry. The growth of electronic trading and the introduction of new technologies is changing our businesses and presenting us with new challenges. Securities, futures and options transactions are increasingly occurring electronically, both on our own systems and through other alternative trading systems, and it appears that the trend toward alternative trading systems will continue and probably accelerate. Some of these alternative trading systems compete with our trading businesses, including our specialist businesses, and we may experience continued competitive pressures in these and other areas. In addition, the increased use by our clients of low-cost electronic trading systems and direct electronic access to trading markets could cause a reduction in commissions and spreads. The NYSE’s adoption of its hybrid market for trading securities may increase pressure on our Equities business as customers execute more of their NYSE-related trades electronically. We have invested significant resources into the development of electronic trading systems and expect to continue to do so, but there is no assurance that the revenues generated by these systems will yield an adequate return on our investment, particularly given the relatively lower commissions arising from electronic trades.
Our businesses may be adversely affected if we are unable to hire and retain qualified employees.
       Competition from within the financial services industry and from businesses outside the financial services industry, such as hedge funds, private equity funds and venture capital funds, for qualified employees is intense, particularly in emerging markets. Our performance is largely dependent on the talents and efforts of highly skilled individuals; therefore, our continued ability to compete effectively in our businesses and to expand into new business areas depends on our ability to attract new employees and to retain and motivate our existing employees. In addition, current and future laws (including laws relating to immigration and outsourcing) may restrict our ability to move responsibilities or personnel from one jurisdiction to another. This may impact our ability to take advantage of business opportunities or potential efficiencies.
Our power generation interests subject us to the risks associated with owning power generation facilities.
       The operation of our power generation facilities may be disrupted for many reasons, many of which are outside our control, including the breakdown or failure of power generation equipment, transmission lines or other equipment or processes, and performance below expected levels of output or efficiency. In addition, these facilities could be adversely affected by the failure of any of third-party suppliers or service providers to perform their contractual obligations, including the failure to obtain raw materials necessary for operation at reasonable prices. Market conditions or other factors could cause a failure to satisfy or obtain waivers under agreements with third parties, including lenders and utilities, which impose significant obligations on our subsidiaries that own such facilities. The occurrence of any of such events may prevent the affected facilities from performing under applicable power sales agreements, may impair their operations or financial results and may result in litigation or other reputational harm.
       Our power generation facilities are subject to extensive and evolving federal, state and local energy, environmental and other governmental laws and regulations, including environmental laws and regulations relating to, among others, air quality, water quality, waste management, natural resources, site remediation and health and safety. In the past several years, intensified scrutiny of the energy market by federal, state and local authorities and the public has resulted in increased regulatory and legal proceedings involving companies engaged in electric power generation. In addition, we may incur substantial costs in complying with current or future laws and regulations relating to power generation, including having to commit significant capital toward environmental monitoring, installation of pollution control equipment, payment of emission fees, and application for,

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and holding of, permits and licenses at our power generation facilities. In certain instances, compliance with applicable laws and regulations may require us to cease or curtail operations of one or more of our power generation facilities. Our power generation facilities are also subject to the risk of unforeseen or catastrophic events, including terrorist attacks, natural disasters or other hostile or catastrophic events. We may not have insurance against these risks or other risks, including environmental risks, that such facilities face, and, in cases in which we do have insurance, the insurance proceeds may be inadequate to cover our losses. Our overall businesses and reputation may be adversely affected by legal and regulatory proceedings, particularly those related to the environmental matters, arising out of our power generation business, as well as by the occurrence of unforeseen or catastrophic events.
In conducting our businesses around the world, we are subject to political, economic, legal, operational and other risks that are inherent in operating in many countries.
       In conducting our businesses and maintaining and supporting our global operations, we are subject to risks of possible nationalization, expropriation, price controls, capital controls, exchange controls and other restrictive governmental actions, as well as the outbreak of hostilities. In many countries, the laws and regulations applicable to the securities and financial services industries are uncertain and evolving, and it may be difficult for us to determine the exact requirements of local laws in every market. Our inability to remain in compliance with local laws in a particular market could have a significant and negative effect not only on our businesses in that market but also on our reputation generally. We are also subject to the enhanced risk that transactions we structure might not be legally enforceable in all cases.
       Our businesses and operations are increasingly involved in emerging markets throughout the world, and we expect this trend to continue. In the last several years, various emerging market countries have experienced severe economic and financial disruptions, including significant devaluations of their currencies, capital and currency exchange controls, and low or negative growth rates in their economies. The possible effects of any of these conditions include an adverse impact on our businesses and increased volatility in financial markets generally.
Item 1B. Unresolved Staff Comments
       There are no material unresolved written comments that were received from the SEC staff 180 days or more before the end of our fiscal year relating to our periodic or current reports under the Securities Exchange Act of 1934.
Item 2. Properties
       Our principal executive offices are located at 85 Broad Street, New York, New York, and comprise approximately one million rentable square feet of leased space, pursuant to a lease agreement expiring in June 2008 (with options to renew for up to 20 additional years). We also occupy over 680,000 rentable square feet at One New York Plaza under lease agreements expiring primarily in 2009 (with options to renew for up to five additional years), and we lease space at various other locations in the New York metropolitan area. In total, we lease approximately 3.9 million rentable square feet in the New York metropolitan area.
       In August 2005, we leased from Battery Park City Authority a parcel of land in lower Manhattan, pursuant to a ground lease. We are currently constructing a 2.1 million gross-square-foot office building on the site that will serve as our world headquarters. Under the lease, Battery Park City Authority holds title to all improvements, including the office building, subject to Goldman Sachs’ right of exclusive possession and use for the 64-year duration of the lease.
       Under the terms of the ground lease, we are required to make a lump-sum ground rent payment of $161 million by June 2007 and to make additional periodic payments during the term of the lease. We are obligated under the ground lease to construct the office building by 2011 (subject

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to extensions in the case of force majeure) in accordance with certain pre-approved design standards. Construction began on the building in November 2005, and we expect initial occupancy of the building by 2009. The building is projected to cost between $2.3 billion and $2.5 billion, including acquisition, development, fitout and furnishings, financing and other related costs.
       We are receiving a number of benefits from the City and State of New York based on our agreement to construct our world headquarters in lower Manhattan. These benefits are subject to recoupment or recapture if we do not proceed in accordance with our agreements with the City and State of New York.
       We own an office building at 30 Hudson Street in Jersey City, New Jersey, which includes approximately 1.6 million gross square feet of office space, and we own over 300,000 square feet of additional space spread among three locations in New York and New Jersey. We have additional offices in the U.S. and elsewhere in the Americas, which together comprise approximately 2.3 million rentable square feet of leased space.
       In Europe, the Middle East and Africa, we have offices that total approximately 2.0 million rentable square feet. Our European headquarters is located in London at Peterborough Court, pursuant to a lease expiring in 2026. In total, we lease approximately 1.6 million rentable square feet in London through various leases, relating to various properties.
       In Asia, we have offices that total approximately 1.2 million rentable square feet. Our headquarters in this region are in Tokyo, at the Roppongi Hills Mori Tower, and in Hong Kong, at the Cheung Kong Center. In Tokyo, we currently lease approximately 390,000 rentable square feet through a lease that will expire in 2018. In Hong Kong, we currently lease approximately 220,000 rentable square feet under lease agreements, the majority of which will expire in fiscal 2012.
       Our occupancy expenses include costs associated with office space held in excess of our current requirements. This excess space, the cost of which is charged to earnings as incurred, is being held for potential growth or to replace currently occupied space that we may exit in the future. We regularly evaluate our current and future space capacity in relation to current and projected staffing levels. We may incur exit costs in 2007 and thereafter to the extent we (i) reduce our space capacity or (ii) commit to, or occupy, new properties in the locations in which we operate and, consequently, dispose of existing space that had been held for potential growth. These exit costs may be material to our results of operations in a given period.
Item 3. Legal Proceedings
       We are involved in a number of judicial, regulatory and arbitration proceedings (including those described below) concerning matters arising in connection with the conduct of our businesses. We believe, based on currently available information, that the results of such proceedings, in the aggregate, will not have a material adverse effect on our financial condition, but might be material to our operating results for any particular period, depending, in part, upon the operating results for such period. Given the range of litigation and investigations presently under way, our litigation expenses can be expected to remain high.
IPO Process Matters
       The Goldman Sachs Group, Inc. and Goldman, Sachs & Co. are among the numerous financial services companies that have been named as defendants in a variety of lawsuits alleging improprieties in the process by which those companies participated in the underwriting of public offerings in recent years.
       Certain purported class actions have been brought in the U.S. District Court for the Southern District of New York, beginning on November 3, 1998, by purchasers of securities in public offerings as well as certain purported issuers of such offerings, that allege that the defendants have conspired to fix at 7% the discount that underwriting syndicates receive from issuers of shares in certain

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offerings in violation of federal antitrust laws. On March 15, 1999, the purchaser plaintiffs filed a consolidated amended complaint seeking treble damages as well as injunctive relief. The defendants moved to dismiss the consolidated amended complaint on April 29, 1999. On February 9, 2001, the federal district court granted with prejudice the defendants’ motion to dismiss the claims asserted by the purchasers of securities on the ground that they lacked antitrust standing. The plaintiffs in those actions appealed, and by a decision dated December 13, 2002, the U.S. Court of Appeals for the Second Circuit vacated the dismissal on the ground that the lower court had engaged in improper fact-finding on the motion and remanded for consideration of other potential bases for dismissal. On September 28, 2001, the defendants moved to dismiss the complaints filed by the issuer plaintiffs on statute of limitations grounds. On September 25, 2002, the federal district court denied the underwriter defendants’ motion to dismiss. On March 26, 2003, defendants moved to dismiss the claims asserted by both the issuers and the purchasers of securities on preemption grounds, but the motion was denied on June 27, 2003. On June 24, 2003, defendants filed a motion to dismiss the claims asserted by the purchasers of securities on standing grounds, and on February 24, 2004, the district court granted the motion to dismiss as to the purchasers’ damages claims. Plaintiffs in both actions moved for class certification on September 16, 2004 and for summary judgment on November 16, 2005, and by a decision dated April 18, 2006, the district court denied class certification with respect to the damages claims asserted by the issuers of securities. The issuer plaintiffs have petitioned the U.S. Court of Appeals for the Second Circuit to review that certification decision on an interlocutory basis, and the petition was granted on August 1, 2006.
       Goldman, Sachs & Co. is one of numerous financial services firms that have been named as defendants in purported class actions filed beginning on March 9, 2001 in the U.S. District Court for the Southern District of New York by purchasers of securities in public offerings, who claim that the defendants engaged in a conspiracy to “tie” allocations in certain offerings to higher customer brokerage commission rates as well as purchase orders in the aftermarket, in violation of federal antitrust laws. The plaintiffs filed a consolidated amended complaint on January 2, 2002 seeking treble damages as well as injunctive relief. The defendants moved to dismiss the consolidated amended complaint on May 24, 2002, and the motion was granted by a decision dated November 3, 2003. Plaintiffs appealed, and by a decision dated September 28, 2005, the U.S. Court of Appeals for the Second Circuit reversed and remanded the action. On March 8, 2006, the underwriter defendants filed a petition for certiorari with the U.S. Supreme Court seeking review of the appellate decision, and the petition was granted by order dated December 7, 2006. Goldman, Sachs & Co. has also, together with other underwriters in certain offerings as well as the issuers and certain of their officers and directors, been named as a defendant in a number of related lawsuits alleging, among other things, that the prospectuses for the offerings violated the federal securities laws by failing to disclose the existence of the alleged “tying” arrangements and that the alleged arrangements resulted in market manipulation. On July 1, 2002, the underwriter defendants moved to dismiss those complaints. By an opinion and order dated February 19, 2003, the federal district court denied the motion to dismiss in all material respects relating to the underwriter defendants. By a decision dated October 13, 2004, the federal district court generally granted plaintiffs’ motion for class certification in six “focus cases.” The underwriter defendants petitioned the U.S. Court of Appeals for the Second Circuit to review that certification decision on an interlocutory basis, and the appellate court agreed to review the decision by order dated June 30, 2005. On December 5, 2006, the Second Circuit reversed the district court’s order granting class certification and remanded; plaintiffs sought rehearing and rehearing en banc on January 5, 2007. On June 10, 2004, plaintiffs entered into a definitive settlement agreement with respect to their claims against the issuer defendants and the issuers’ present or former officers and directors named in the lawsuits. On June 14, 2004, those parties jointly moved for approval of the proposed settlement, and the district court granted preliminary approval by a decision dated February 15, 2005. On April 20, 2006, plaintiffs announced that they had entered into a definitive settlement agreement with respect to their claims against J.P. Morgan Securities, Inc. arising from lawsuits alleging that (i) the prospectuses for certain offerings violated the federal securities laws by failing to disclose the

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existence of alleged arrangements to “tie” allocations to higher customer brokerage commission rates as well as purchase orders in the aftermarket, and (ii) such alleged underlying “tying” arrangements violated federal and state antitrust laws. The settlement, pursuant to which J.P. Morgan Securities, Inc. will pay $425 million, is subject to, among other things, documentation and court approval.
       Goldman, Sachs & Co. has been named as a defendant in an action commenced on May 15, 2002 in New York Supreme Court, New York County, by an official committee of unsecured creditors on behalf of eToys, Inc., alleging that the firm intentionally underpriced eToys, Inc.’s initial public offering. The action seeks, among other things, unspecified compensatory damages resulting from the alleged lower amount of offering proceeds. On August 1, 2002, Goldman, Sachs & Co. moved to dismiss the complaint. On May 2, 2003, the court granted Goldman, Sachs & Co.’s motion to dismiss as to five of the claims; plaintiff appealed from the dismissal of the five claims, and Goldman, Sachs & Co. appealed from the denial of its motion as to the remaining claim. By a decision dated May 20, 2004, the New York Appellate Division, First Department affirmed in part and reversed in part the lower court’s ruling on the firm’s motion to dismiss, permitting all claims to proceed except the claim for fraud, as to which the appellate court granted leave to replead. The Appellate Division granted leave to appeal, and by a decision dated June 7, 2005, the New York Court of Appeals affirmed in part and reversed in part the Appellate Division’s decision, dismissing claims for breach of contract, professional malpractice and unjust enrichment, but permitting claims for breach of fiduciary duty and fraud to continue. On remand to the lower court, Goldman, Sachs & Co. moved to dismiss the claims that survived the appeal or, in the alternative, for summary judgment, but the motion was denied by a decision dated March 21, 2006.
       The Goldman Sachs Group, Inc. and certain of its affiliates have, together with various underwriters in certain offerings, received subpoenas and requests for documents and information from various governmental agencies and self-regulatory organizations in connection with investigations relating to the public offering process. Goldman Sachs has cooperated with the investigations. On January 25, 2005, in connection with an investigation by the SEC of certain allocation practices employed by Goldman, Sachs & Co. and other firms, the SEC announced a settlement pursuant to which Goldman, Sachs & Co., without admitting or denying the allegations, (i) consented to the entry of an order permanently enjoining Goldman, Sachs & Co. from violating Rule 101 of Regulation M of the Securities Exchange Act of 1934, by inducing or attempting to induce customers receiving IPO allocations to buy additional shares in the aftermarket; and (ii) agreed to pay a penalty of $40 million. In connection with effectuation of the settlement, the SEC filed a civil action against Goldman, Sachs & Co. in the U.S. District Court for the Southern District of New York on January 25, 2005, and the district court entered a final judgment on February 7, 2005 approving the settlement and granting the permanent injunctive relief.
Stock Options Litigation
       Hull Trading Co. L.L.C. and Spear, Leeds & Kellogg, L.P. (now known as Goldman Sachs Execution & Clearing, L.P.), affiliates of The Goldman Sachs Group, Inc., are among the numerous market makers in listed equity options that have been named as defendants, together with five national securities exchanges, in a purported class action brought in the U.S. District Court for the Southern District of New York on behalf of persons who purchased or sold listed equity options. The consolidated class action complaint, filed on October 4, 1999 (which consolidated certain previously pending actions and added Hull Trading Co. L.L.C. and other market makers as defendants), generally alleges that the defendants engaged in a conspiracy to preclude the multiple listing of certain equity options on the exchanges and seeks treble damages under the antitrust laws as well as injunctive relief. Certain of the parties, including Hull Trading Co. L.L.C. and Spear, Leeds & Kellogg, L.P., have entered into a stipulation of settlement, subject to court approval, which originally required Hull Trading Co. L.L.C. to pay an aggregate of $2.48 million and Spear, Leeds & Kellogg, L.P. an aggregate of $19.59 million. On February 14, 2001, the federal district court granted the

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motion of certain non-settling defendants for summary judgment. By a decision dated April 24, 2001, the district court ruled that in light of that order granting summary judgment, the court lacked jurisdiction to entertain the proposed settlement. Plaintiffs appealed, and by a decision dated January 9, 2003, the U.S. Court of Appeals for the Second Circuit affirmed the grant of summary judgment, but held that the decision did not divest the lower court of jurisdiction to entertain the proposed settlement, and remanded for further proceedings. By an Order dated March 17, 2003, the U.S. Court of Appeals denied plaintiffs’ motion for rehearing or rehearing en banc of the Court’s January 9, 2003 decision. On October 26, 2005, certain defendants, including Spear, Leeds & Kellogg, L.P. and Hull Trading Co. L.L.C., reached an agreement to modify and restate the original settlement agreement, reducing the overall settlement payments by certain market maker defendants by approximately 25% of the original amounts. By an order dated February 8, 2006, the federal district court entered an order that, among other things, preliminarily approved the proposed modified settlement. The federal district court approved the settlement by an Order dated December 4, 2006.
Iridium Securities Litigation
       Goldman, Sachs & Co. has been named as a defendant in two purported class action lawsuits commenced, beginning on May 26, 1999, in the U.S. District Court for the District of Columbia brought on behalf of purchasers of Class A common stock of Iridium World Communications, Ltd. in a January 1999 underwritten secondary offering of 7,500,000 shares of Class A common stock at a price of $33.50 per share, as well as in the secondary market. Goldman, Sachs & Co. underwrote 996,500 shares of common stock and Goldman Sachs International underwrote 320,625 shares of common stock for a total offering price of approximately $44 million.
       The defendants in the actions include Iridium, certain of its officers and directors, Motorola, Inc. (an investor in Iridium) and the lead underwriters in the offering, including Goldman, Sachs & Co. The complaints in both actions allege violations of the disclosure requirements of the federal securities laws and seek compensatory and/or rescissory damages. On May 13, 2002, plaintiffs filed a consolidated amended complaint alleging substantively identical claims as the original complaints.
On July 15, 2002, the defendants moved to dismiss the consolidated amended complaint, and by a decision dated August 31, 2004, the motion was denied. On April 15, 2005, plaintiffs moved for class certification, and the district court granted the motion, certifying two subclasses, by a decision dated January 9, 2006. On September 30, 2005, the underwriter defendants moved for summary judgment, and by a decision dated September 15, 2006, the federal district court denied the motion as to claims under Section 11 of the Securities Act of 1933, but granted summary judgment dismissing claims under Section 12(a)(2) of the Securities Act against Goldman, Sachs & Co. and all but one of the other underwriter defendants. On November 3, 2006, the underwriter defendants entered into an agreement to settle all claims against them for a settlement payment of $8.25 million. The settlement is subject to, among other things, documentation and court approval.
       On August 13, 1999, Iridium World Communications, Ltd. filed for protection under the U.S. bankruptcy laws.
World Online Litigation
       Several lawsuits have been commenced in the Netherlands courts based on alleged misstatements and omissions relating to the initial public offering of World Online in March 2000. Goldman Sachs and ABN AMRO Rothschild served as joint global coordinators of the approximately 2.9 billion offering. Goldman Sachs International underwrote 20,268,846 shares and Goldman, Sachs & Co. underwrote 6,756,282 shares for a total offering price of approximately 1.16 billion.
       On September 11, 2000, several Dutch World Online shareholders as well as a Dutch entity purporting to represent the interests of certain World Online shareholders commenced a proceeding in Amsterdam District Court against “ABN AMRO Bank N.V., also acting under the name of ABN AMRO Rothschild,” alleging misrepresentations and omissions relating to the initial public offering of

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World Online. The lawsuit seeks, among other things, the return of the purchase price of the shares purchased by the plaintiffs or unspecified damages. By a decision dated May 7, 2003, the court held that the claims failed and dismissed the complaint. The plaintiffs appealed, and by a decision dated October 7, 2004, the Amsterdam Court of Appeal affirmed dismissal of the complaint.
       In March 2001, a Dutch shareholders association initiated legal proceedings in Amsterdam District Court in connection with the World Online offering. Goldman Sachs International is named as a defendant in the writ served on its Dutch attorneys on March 14, 2001. The amount of damages sought is not specified in the writ. Goldman Sachs International filed its Statement of Defense on January 16, 2002 and a rejoinder on January 14, 2003. By a decision dated December 17, 2003, the court rejected the claims against Goldman Sachs International, but found World Online liable in an amount to be determined. On March 12, 2004, the Dutch shareholders association appealed from the dismissal of their claims against Goldman Sachs International. Oral hearings took place on November 13, 2006.
Owens Corning Bondholder Litigation
       Goldman, Sachs & Co. has been named as a defendant in a purported class action filed on April 27, 2001 in the U.S. District Court for the District of Massachusetts arising from a 1998 offering by Owens Corning of two series of its notes. The defendants include certain of Owens Corning’s officers and directors and the underwriters for the offering (including Goldman, Sachs & Co., which was the lead manager in the offering). The offering included a total of $550 million principal amount of notes, of which Goldman, Sachs & Co. underwrote $275 million.
       The lawsuit, brought by certain institutional purchasers of the notes, alleges that the prospectus issued in connection with the offering was false and misleading in violation of the disclosure requirements of the federal securities laws. The plaintiffs are seeking, among other things, unspecified damages. The underwriter defendants moved to dismiss the complaint on November 14, 2001. By a decision dated August 26, 2002, the federal district court denied the underwriter defendants’ motion to dismiss, and by a decision dated March 9, 2004, granted plaintiffs’ motion for class certification. On November 4, 2005, the underwriter defendants reached an agreement in principle to settle all claims against them for an aggregate payment of $8.25 million, of which Goldman, Sachs & Co. will contribute approximately $2.5 million. Subsequently, on September 22, 2006, the remaining defendants advised the Court that they had entered into a separate settlement agreement in principle. All settlements remain subject to, among other things, documentation and court approval.
       On October 5, 2000, Owens Corning filed for protection under the U.S. bankruptcy laws.
Research Independence Matters
       The Goldman Sachs Group, Inc. and its affiliates, together with other financial services firms, have received requests for information from various governmental agencies and self-regulatory organizations in connection with their review of research independence issues. Goldman Sachs has cooperated with the requests. See “Business — Regulation — Regulations Applicable in and Outside the United States” in Part I, Item 1 of the Annual Report on Form 10-K for a discussion of our global research settlement.
       Goldman, Sachs & Co. is one of several investment firms that have been named as defendants in substantively identical purported class actions filed in the U.S. District Court for the Southern District of New York alleging violations of the federal securities laws in connection with research coverage of certain issuers and seeking compensatory damages. In one such action, relating to coverage of RSL Communications, Inc. commenced on July 5, 2003, Goldman, Sachs & Co. moved to dismiss the complaint on January 13, 2004, and the motion was denied by a decision dated May 21, 2004. On November 9, 2004, plaintiffs moved for class certification, and the district court granted the motion by a decision dated July 27, 2005. Defendants petitioned the U.S. Court of

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Appeals for the Second Circuit to review that certification decision on an interlocutory basis. The appellate court, by an order dated December 22, 2005, denied the petition in part and otherwise held the petition in abeyance for consideration by the panel assigned to review the certification decision in the action described under “IPO Process Matters” above, and, by an order dated January 26, 2007, granted the petition, vacated the district court’s class certification and remanded for reconsideration in light of the appellate court’s certification decision in such action. Goldman, Sachs & Co. is also a defendant in several actions relating to research coverage of Exodus Communications, Inc. that commenced beginning in May 2003. The actions were consolidated, and on March 15, 2004, Goldman, Sachs & Co. moved to dismiss, and the motion was granted with leave to replead on April 17, 2006. Plaintiff filed a second amended complaint on May 17, 2006. On July 7, 2006, defendants moved to dismiss the second amended complaint.
       A purported shareholder derivative action was filed in New York Supreme Court, New York County on June 13, 2003 against The Goldman Sachs Group, Inc. and its board of directors, which, as amended, alleges that the directors breached their fiduciary duties in connection with the firm’s research as well as the firm’s IPO allocations practices. An amended complaint was filed on March 3, 2004, which was further amended on June 14, 2005.
       The Goldman Sachs Group, Inc., Goldman, Sachs & Co. and Henry M. Paulson, Jr., the former Chairman and Chief Executive Officer of The Goldman Sachs Group, Inc., have been named as defendants in a purported class action filed originally on July 18, 2003 in the U.S. District Court for the District of Nevada on behalf of purchasers of The Goldman Sachs Group, Inc. stock from July 1, 1999 through May 7, 2002. The complaint alleges that defendants breached their fiduciary duties and violated the federal securities laws in connection with the firm’s research activities. The complaint seeks, among other things, unspecified compensatory damages and/or rescission. The action was transferred on consent to the U.S. District Court for the Southern District of New York, defendants moved to dismiss the amended complaint on August 30, 2004, and the district court granted the motion with leave to amend by order dated February 17, 2005. Plaintiffs filed a second amended complaint on February 25, 2005, and defendants filed a motion to dismiss on March 24, 2005. In a decision dated September 29, 2006, the federal district court granted Mr. Paulson’s motion to dismiss with leave to replead but otherwise denied the motion.
Enron Litigation Matters
       Goldman Sachs affiliates are defendants in certain actions arising relating to Enron Corp., which filed for protection under the U.S. bankruptcy laws on December 2, 2001.
       Goldman, Sachs & Co. and co-managing underwriters have been named as defendants in certain purported securities class and individual actions commenced beginning on December 14, 2001 in the U.S. District Court for the Southern District of Texas and California Superior Court brought by purchasers of $222,500,000 of Exchangeable Notes of Enron Corp. in August 1999. The notes were mandatorily exchangeable in 2002 into shares of Enron Oil & Gas Company held by Enron Corp. or their cash equivalent. The complaints also name as defendants The Goldman Sachs Group, Inc. as well as certain past and present officers and directors of Enron Corp. and the company’s outside accounting firm. The complaints generally allege violations of the disclosure requirements of the federal securities laws and/or state law, and seek compensatory damages. Goldman, Sachs & Co. underwrote $111,250,000 principal amount of the notes. The Goldman Sachs Group, Inc. and Goldman, Sachs & Co. moved to dismiss the class action complaint in the Texas federal court on March 15, 2004, and by a decision dated December 5, 2005, the motion was granted as to The Goldman Sachs Group, Inc. but denied as to Goldman, Sachs & Co. One of the plaintiffs moved for class certification on August 11, 2006. Goldman, Sachs & Co. moved for judgment on the pleadings against one plaintiff on August 21, 2006, and against all plaintiffs on October 11, 2006. Plaintiffs in various consolidated actions relating to Enron entered into a

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settlement with Banc of America Securities LLC on July 2, 2004 and with Citigroup, Inc. on June 10, 2005, including with respect to claims relating to the Exchangeable Notes offering, as to which affiliates of those settling defendants were two of the three underwriters (together with Goldman, Sachs & Co.). The settling parties have yet to announce what portion of the settlement will apply to the Exchangeable Notes offering.
       Several funds which allegedly sustained investment losses of approximately $125 million in connection with secondary market purchases of the Exchangeable Notes as well as Zero Coupon Convertible Notes of Enron Corp. commenced an action in the U.S. District Court for the Southern District of New York on January 16, 2002. As amended, the lawsuit names as defendants the underwriters of the August 1999 offering and the company’s outside accounting firm, and alleges violations of the disclosure requirements of the federal securities laws, fraud and misrepresentation. By an Order dated June 24, 2002, the Judicial Panel on Multidistrict Litigation entered an order transferring that action to the Texas federal district court for purposes of coordinated or consolidated pretrial proceedings with other matters relating to Enron Corp. On March 20, 2002, Goldman, Sachs & Co. moved to dismiss the complaint. By a decision dated December 10, 2003, the motion was granted in part and denied in part. Goldman, Sachs & Co. sought clarification and reconsideration of the decision, and on June 13, 2005, the federal district court granted Goldman, Sachs & Co.’s motion for reconsideration and provided for further briefing on Goldman, Sachs & Co.’s motion to dismiss. On August 18, 2006, the funds moved for leave to file a second amended complaint, and the district court granted the motion on January 22, 2007.
       The Goldman Sachs Group, Inc. and Goldman, Sachs & Co. have been named as defendants in two substantively identical purported class actions filed on June 5, 2003 in Oregon Circuit Court, Multnomah County, on behalf of former shareholders of Portland General Corporation. The complaints generally allege that defendants breached their fiduciary duties in connection with Portland General’s 1997 merger with Enron Corp., in respect of which Goldman, Sachs & Co. acted as financial advisor to Portland General. The defendants also include Arthur Andersen, LLP, Andersen-U.S., and certain former officers and directors of Portland General. The complaints seek unspecified compensatory damages. In July 2003, defendants removed the actions to the U.S. District Court for the District of Oregon, and the actions were transferred by the Judicial Panel on Multidistrict Litigation to the U.S. District Court for the Southern District of Texas for coordinated proceedings with other actions relating to Enron Corp. On February 25, 2004, The Goldman Sachs Group, Inc. and Goldman, Sachs & Co. moved to dismiss the action, and on August 5, 2004, the federal district court granted the motion to dismiss and denied plaintiffs’ motion to remand the actions to state court. On October 14, 2004, plaintiffs moved for reconsideration, and on November 10, 2004, the motion was denied. On August 28, 2006, the other defendants entered into a stipulation dismissing all remaining claims, but judgment has yet to be entered.
       Goldman, Sachs & Co. is among numerous defendants in two substantively identical actions filed in the U.S. Bankruptcy Court for the Southern District of New York beginning in November 2003 seeking to recover as fraudulent transfers and/or preferences payments made by Enron Corp. in repurchasing its commercial paper shortly before its bankruptcy filing. Goldman, Sachs & Co., which had acted as a commercial paper dealer for Enron Corp., resold to Enron Corp. approximately $30 million of commercial paper as principal, and as an agent facilitated Enron Corp.’s repurchase of additional commercial paper from various customers who have also been named as defendants. Goldman, Sachs & Co. moved to dismiss the complaints on February 19, 2004, but the bankruptcy court denied the motion as well as similar motions by other defendants by a decision dated June 15, 2005. On August 1, 2005, various defendants including Goldman, Sachs & Co. petitioned to have the denial of their motion to dismiss reviewed by the U.S. District Court for the Southern District of New York.

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Exodus Securities Litigation
       By an amended complaint dated July 11, 2002, Goldman, Sachs & Co. and the other lead underwriters for the February 2001 offering of 13,000,000 shares of common stock and $575,000,000 of 51/4% convertible subordinated notes of Exodus Communications, Inc. were added as defendants in a purported class action pending in the U.S. District Court for the Northern District of California. The complaint, which also names as defendants certain officers and directors of Exodus Communications, Inc., alleges violations of the disclosure requirements of the federal securities laws and seeks compensatory damages. On October 23, 2002, the underwriter defendants moved to dismiss the complaint. By a decision dated August 19, 2003, the district court granted the defendants’ motion to dismiss with leave to replead, and the plaintiffs filed a third amended complaint on January 15, 2004. On March 12, 2004, the underwriter defendants moved to dismiss the third amended complaint, and by a decision dated August 5, 2005, the district court denied the motion. The underwriter defendants moved for reconsideration and clarification on August 30, 2005, but the motion was denied by an order dated September 12, 2005. By a decision dated June 2, 2006, the district court granted summary judgment dismissing the complaint on the grounds that the plaintiff’s purchases of Exodus securities were not traceable. On May 5, 2006 and May 19, 2006, two new putative plaintiffs filed motions to intervene, respectively, those motions were denied by a decision dated August 14, 2006, and a motion by the putative intervenors to vacate the resulting judgment was denied by a decision dated October 26, 2006. Plaintiffs filed an appeal on November 27, 2006, and the underwriter defendants cross-appealed on December 11, 2006 to the extent that certain earlier grounds for dismissal had been rejected by the district court. Goldman, Sachs & Co. underwrote 5,200,000 shares of common stock for a total offering price of approximately $96,200,000, and $230,000,000 principal amount of the notes.
       On September 26, 2001, Exodus Communications, Inc. filed for protection under the U.S. bankruptcy laws.
Montana Power Litigation
       Goldman, Sachs & Co. and The Goldman Sachs Group, Inc. have been named as defendants in a purported class action commenced originally on October 1, 2001 in Montana District Court, Second Judicial District on behalf of former shareholders of Montana Power Company. The complaint generally alleges that Montana Power Company violated Montana law by failing to procure shareholder approval of certain corporate strategies and transactions, that the company’s board breached its fiduciary duties in pursuing those strategies and transactions, and that Goldman, Sachs & Co. aided and abetted the board’s breaches and rendered negligent advice in its role as financial advisor to the company. The complaint seeks, among other things, compensatory damages. In addition to Goldman, Sachs & Co. and The Goldman Sachs Group, Inc., the defendants include Montana Power Company, certain of its officers and directors, an outside law firm for the Montana Power Company, and certain companies that purchased assets from Montana Power Company and its affiliates. The Montana state court denied motions to dismiss by a decision dated August 1, 2002. On July 18, 2003, following the bankruptcies of certain defendants in the action, defendants removed the action to federal court, the U.S. District Court for the District of Montana, Butte Division.
       On October 26, 2004, a creditors committee of Touch America Holdings, Inc. brought an action against Goldman, Sachs & Co., The Goldman Sachs Group, Inc., and a former outside law firm for Montana Power Company in Montana District Court, Second Judicial District. The complaint asserts that Touch America Holdings, Inc. is the successor to Montana Power Corporation and alleges substantially the same claims as in the purported class action. Defendants removed the action to federal court on November 19, 2004. On January 14, 2005, defendants moved to dismiss the complaint, but the motion was denied by a decision dated June 10, 2005.

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Global Crossing and Asia Global Crossing Securities Litigation
       Goldman, Sachs & Co. has been named as a defendant in a consolidated class action lawsuit in the U.S. District Court for the Southern District of New York relating to various securities offerings by Global Crossing, Ltd. and Asia Global Crossing Ltd. in which Goldman, Sachs & Co. acted as an underwriter. The claims had originally been asserted in separate actions, reflected in an amended complaint filed on January 28, 2003 as to Global Crossing, Ltd. and in a complaint filed on November 8, 2002 as to Asia Global Crossing Ltd., but the claims were consolidated into a single amended complaint on August 11, 2003, which was further amended on March 22, 2004 (including to drop The Goldman Sachs Group, Inc. as a defendant). The consolidated action includes claims relating to Global Crossing, Ltd.’s concurrent April 2000 offerings of 43 million shares of common stock at $33 per share and 4.6 million shares of 63/4% cumulative preferred stock at $250 per share, as well as Asia Global Crossing Ltd.’s October 2000 initial public offering of 68,500,000 shares of common stock at a price of $7 per share. Goldman, Sachs & Co. acted as a co-lead underwriter of both Global Crossing, Ltd. offerings, underwriting 12.9 million shares of common stock and 1,840,000 shares of convertible preferred stock for a total offering price of approximately $886 million. Goldman, Sachs & Co. underwrote 20,670,000 shares of common stock in the Asia Global Crossing Ltd. offering for a total offering price of approximately $145 million. The claims assert violations of the disclosure requirements of the federal securities laws as to such offerings and seek compensatory and/or rescissory damages. In addition to the lead and other underwriters in the offerings, the defendants as to such claims originally included certain officers and directors of Global Crossing, Ltd. and Asia Global Crossing Ltd. as well as the companies’ former outside auditors.
       On April 21, 2003, the underwriter defendants as to the Global Crossing, Ltd. offerings moved to dismiss the claims relating to such offerings; the motion was denied in significant part by a decision dated December 18, 2003. On July 23, 2004, the underwriter defendants as to the Asia Global Crossing Ltd. offering moved to dismiss the claims relating to that offering. On March 1, 2005, plaintiffs entered into a definitive settlement agreement with Citigroup, Inc. and certain related parties, including as to claims asserted against such parties in respect of the various offerings in which Goldman, Sachs & Co. participated for a total payment of $75 million. The various officer and director defendants as well as the former auditors had separately entered into settlement agreements earlier. On March 23, 2006, the remaining underwriter defendants (including Goldman, Sachs & Co.) agreed in principle to settle all claims for a payment of $82.5 million (of which Goldman, Sachs & Co. contributed approximately one-half), those underwriter defendants entered into a definitive settlement agreement on July 24, 2006, and that settlement was approved by the federal district court on October 27, 2006.
       Global Crossing, Ltd. filed for protection under the U.S. bankruptcy laws on January 28, 2002, and Asia Global Crossing Ltd. filed for such protection on November 17, 2002.
Adelphia Communications Fraudulent Conveyance Litigations
       Goldman, Sachs & Co. is among numerous entities named as defendants in two adversary proceedings commenced in the U.S. Bankruptcy Court for the Southern District of New York, one on July 6, 2003 by a creditors committee, and the second on or about July 31, 2003 by an equity committee of Adelphia Communications, Inc. The nearly identical complaints seek, among other things, to recover, as fraudulent conveyances, payments made allegedly by Adelphia Communications, Inc. and its affiliates to certain brokerage firms, including approximately $62.9 million allegedly paid to Goldman, Sachs & Co., in respect of margin calls made in the ordinary course of business on accounts owned by members of the family that formerly controlled Adelphia Communications, Inc.

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Specialist Matters
       Spear, Leeds & Kellogg Specialists LLC (SLKS) and certain affiliates have received requests for information from various governmental agencies and self-regulatory organizations as part of an industry-wide investigation relating to activities of floor specialists in recent years. Goldman Sachs has cooperated with the requests.
       On March 30, 2004, a final global settlement with the SEC and the NYSE was announced covering certain activities during the years 1999 through 2003 of certain specialist firms on the NYSE, including SLKS. Without admitting or denying the allegations, SLKS and the other specialist firms entered into settlements to resolve these SEC and NYSE investigations of the firms with respect to those activities. The SLKS settlement involves, among other things, (i) findings by the SEC and the NYSE that SLKS violated certain federal securities laws and NYSE rules, and in some cases failed to supervise certain individual specialists, in connection with trades that allegedly disadvantaged customer orders, (ii) a cease and desist order against SLKS, (iii) a censure of SLKS, (iv) SLKS’ agreement to pay an aggregate of $45.3 million in disgorgement and a penalty to be used to compensate customers, (v) certain undertakings with respect to SLKS’ systems and procedures, and (vi) SLKS’ retention of an independent consultant to review and evaluate certain of SLKS’ compliance systems, policies and procedures. Comparable findings were made and sanctions imposed in the settlements with other specialist firms. The settlement did not resolve the related private civil actions against SLKS and other firms or regulatory investigations involving individuals or conduct on other exchanges.
       SLKS, Spear, Leeds & Kellogg, L.P. and The Goldman Sachs Group, Inc. are among numerous defendants named in purported class actions brought beginning in October 2003 on behalf of investors in the U.S. District Court for the Southern District of New York alleging violations of the federal securities laws and state common law in connection with NYSE floor specialist activities. The actions seek unspecified compensatory damages, restitution and disgorgement on behalf of purchasers and sellers of unspecified securities between October 17, 1998 and October 15, 2003. Plaintiffs filed a consolidated amended complaint on September 16, 2004, defendants moved to dismiss the amended complaint on November 16, 2004, and the motion was granted in part and denied in part by a decision dated December 13, 2005.
Treasury Matters
       On September 4, 2003, the SEC announced that Goldman, Sachs & Co. had settled an administrative proceeding arising from certain trading in U.S. Treasury bonds over an approximately eight-minute period after Goldman, Sachs & Co. received an October 31, 2001 telephone call from a Washington, D.C.-based political consultant concerning a forthcoming Treasury refunding announcement. The administrative complaint alleged that Goldman, Sachs & Co. (i) violated Section 15(c)(1) and Rule 15c1-2 of the Securities Exchange Act of 1934 as a result of the trading and (ii) violated Section 15(f) of the Securities Exchange Act of 1934 by failing to maintain policies and procedures specifically addressed to the possible misuse of information obtained by consultants from confidential government sources. Without admitting or denying the allegations, Goldman, Sachs & Co. consented to the entry of an order that, among other things, (i) censured Goldman, Sachs & Co.; (ii) directed Goldman, Sachs & Co. to cease and desist from committing or causing any violations of Section 15(c)(1)(A) and (C) and 15(f) of, and Rule 15c1-2 under, the Securities Exchange Act of 1934; (iii) ordered Goldman, Sachs & Co. to pay disgorgement and prejudgment interest in the amount of $1,742,642, and a civil monetary penalty of $5 million; and (iv) directed Goldman, Sachs & Co. to conduct a review of its policies and procedures and adopt, implement and maintain policies and procedures consistent with the order and that review. Goldman, Sachs & Co. also undertook to pay $2,562,740 in disgorgement and interest relating to certain trading in U.S. Treasury bond futures during the same eight-minute period.

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       Goldman, Sachs & Co. has been named as a defendant in a purported class action filed on March 10, 2004 in the U.S. District Court for the Northern District of Illinois on behalf of holders of short positions in 30-year U.S. Treasury futures and options on the morning of October 31, 2001. The complaint alleges that the firm purchased 30-year bonds and futures prior to the Treasury’s refunding announcement that morning based on non-public information about that announcement, and that such purchases increased the costs of covering such short positions. The complaint also names as defendants the Washington, D.C.-based political consultant who allegedly was the source of the information, a former Goldman, Sachs & Co. economist who allegedly received the information, and another company and one of its employees who also allegedly received and traded on the information prior to its public announcement. The complaint alleges violations of the federal commodities and antitrust laws, as well as Illinois statutory and common law, and seeks, among other things, unspecified damages including treble damages under the antitrust laws. On June 28, 2004, Goldman, Sachs & Co. moved to dismiss the complaint, and by a decision dated March 28, 2005, the district court dismissed the antitrust and Illinois state law claims but permitted the federal commodities law claims to proceed. On December 20, 2006, plaintiff moved for class certification.
Mutual Fund Matters
       Goldman, Sachs & Co. and certain mutual fund affiliates have received subpoenas and requests for information from various governmental agencies and self-regulatory organizations including the SEC as part of the industry-wide investigation relating to the practices of mutual funds and their customers. Goldman, Sachs & Co. and its affiliates have cooperated with such requests.
       The Goldman Sachs Group, Inc., Goldman, Sachs & Co. and various asset management affiliates and employees have been named as defendants in several putative consolidated class and derivative actions commenced in the U.S. District Court for the Southern District of New York beginning in April 2004 by purported shareholders of certain Goldman Sachs mutual funds. The consolidated complaint also names as nominal defendants certain of the Goldman Sachs family of mutual funds. The cases are brought on behalf of all persons or entities that held shares in these mutual funds between April 2, 1999 and January 9, 2004, and allege violations of the Investment Company Act of 1940, the Investment Advisers Act of 1940 and common law breaches of fiduciary duty. The complaint alleges, among other things, that Goldman Sachs charged the mutual funds improper Rule 12b-1 fees, paid excessive brokerage commissions and made other undisclosed payments to brokers in exchange for selling shares of the mutual funds, and made untrue statements of material fact in registration statements and reports filed pursuant to the Investment Company Act. The complaint further alleges that the funds’ trustees, officers and directors breached their fiduciary duties by, among other things, failing to prevent such violations. The complaint seeks compensatory and punitive damages; rescission of the funds’ investment advisory agreements with Goldman Sachs and recovery of fees paid; an accounting of all fund-related fees, commissions and other payments; restitution of all unlawfully or discriminatorily-obtained fees and charges; and costs and expenses incurred in connection with these lawsuits. Defendants moved to dismiss the complaint on May 2, 2005, and the motion was granted by a Memorandum and Order dated January 13, 2006, and plaintiffs appealed on February 22, 2006. On March 31, 2006, plaintiffs withdrew their appeal from active consideration but may reactivate the appeal within 15 days after entry of a mandate in an appeal involving other parties but similar issues, or not later than March 30, 2007.

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Refco Securities Litigation
       Goldman, Sachs & Co. and the other lead underwriters for the August 2005 initial public offering of 26,500,000 shares of common stock of Refco Inc. are among the defendants in various putative class actions filed in the U.S. District Court for the Southern District of New York beginning in October 2005 by Refco Inc. investors in response to certain publicly reported events that culminated in the October 17, 2005 filing by Refco Inc. and certain affiliates for protection under U.S. bankruptcy laws. The actions, which have been consolidated, allege violations of the disclosure requirements of the federal securities laws and seek compensatory damages. In addition to the underwriters, the consolidated complaint names as defendants Refco Inc. and certain of its affiliates, certain officers and directors of Refco Inc., Thomas H. Lee Partners, L.P. (which held a majority of Refco Inc.’s equity through certain funds it manages), Grant Thornton (Refco Inc.’s outside auditor), and BAWAG P.S.K. Bank fur Arbeit und Wirtschaft und Osterreichische Postsparkasse Aktiengesellschaft (BAWAG). On September 8, 2006, lead plaintiffs filed a motion for preliminary approval of a proposed settlement with BAWAG, and various defendants (including the underwriters) have objected to certain terms of the settlement. By a decision dated January 9, 2007, the district court denied preliminary approval of the settlement, based on such objection. Goldman, Sachs & Co. underwrote 5,639,200 shares of common stock at a price of $22 per share for a total offering price of approximately $124 million.
       A purported shareholder derivative action was filed in the U.S. District Court for the Southern District of New York on November 2, 2005 on behalf of The Goldman Sachs Group, Inc. against certain of its officers and directors. The complaint alleges that the individual defendants breached their fiduciary duties by failing to ensure that adequate due diligence was conducted in connection with the Refco Inc. initial public offering.
       Goldman, Sachs & Co. has, together with other underwriters of the Refco Inc. initial public offering, received requests for information from various governmental agencies and self-regulatory organizations. Goldman, Sachs & Co. is cooperating with those requests.
Short-Selling Litigation
       The Goldman Sachs Group, Inc., Goldman, Sachs & Co. and Goldman Sachs Execution & Clearing, L.P. are among the numerous financial services firms that have been named as defendants in a purported class action filed on April 12, 2006 in the U.S. District Court for the Southern District of New York by customers who engaged in short-selling transactions in equity securities since April 12, 2000. The amended complaint generally alleges that the customers were charged fees in connection with the short sales but that the applicable securities were not necessarily borrowed to effect delivery, resulting in failed deliveries, and that the defendants conspired to set a minimum threshold borrowing rate for securities designated as hard to borrow. The complaint asserts a claim under the federal antitrust laws, as well as claims under the New York Business Law and common law, and seeks treble damages as well as injunctive relief.

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Fannie Mae Litigation
       Goldman, Sachs & Co. was added as a defendant in an amended complaint filed on August 14, 2006 in a purported class action, and The Goldman Sachs Group, Inc. and Goldman, Sachs & Co. were added as defendants in an amended complaint filed on September 1, 2006 in a separate shareholder derivative action, both pending in the U.S. District Court for the District of Columbia. The complaints’ allegations generally arise from allegations concerning Fannie Mae’s accounting practices and, insofar as they relate to the Goldman Sachs defendants, assert violations of the federal securities laws and common law in connection with certain Fannie Mae-sponsored REMIC transactions that were allegedly arranged by Goldman, Sachs & Co. The other defendants include Fannie Mae, certain of its past and present officers and directors, accountants and other financial services firms. On November 28, 2006, the plaintiffs in the derivative action voluntarily dismissed the Goldman Sachs defendants without prejudice, subject to an agreement to toll the statute of limitations. Goldman, Sachs & Co. moved to dismiss the class action claims on November 13, 2006.
Item 4. Submission of Matters to a Vote of Security Holders
       There were no matters submitted to a vote of security holders during the fourth quarter of our fiscal year ended November 24, 2006.

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EXECUTIVE OFFICERS OF THE GOLDMAN SACHS GROUP, INC.
       Set forth below are the name, age, present title, principal occupation and certain biographical information for our executive officers as of February 1, 2007, all of whom have been appointed by and serve at the pleasure of our board of directors.
Lloyd C. Blankfein, 52
       Mr. Blankfein has been our Chairman and Chief Executive Officer since June 2006, and a director since April 2003. Previously, he had been our President and Chief Operating Officer since January 2004. Prior to that, from April 2002 until January 2004, he was a Vice Chairman of Goldman Sachs, with management responsibility for Goldman Sachs’ Fixed Income, Currency and Commodities Division (FICC) and Equities Division. Prior to becoming a Vice Chairman, he had served as co-head of FICC since its formation in 1997. From 1994 to 1997, he headed or co-headed the Currency and Commodities Division. Mr. Blankfein is not on the board of any public company other than Goldman Sachs. He is affiliated with certain non-profit organizations, including as a member of the Harvard University Committee on University Resources, the Advisory Board of the Tsinghua University School of Economics and Management and the Governing Board of the Indian School of Business, an overseer of the Weill Medical College of Cornell University, and a director of the Partnership for New York City, Catalyst and The Robin Hood Foundation.
Alan M. Cohen, 56
       Mr. Cohen has been an Executive Vice President of Goldman Sachs and our Global Head of Compliance since February 2004. From 1991 until January 2004, he was a partner in the law firm of O’Melveny & Myers LLP. Mr. Cohen is also a board member of the Chelsea Piers Scholarship Fund, a non-profit organization.
Gary D. Cohn, 46
       Mr. Cohn has been our President and Co-Chief Operating Officer and a director since June 2006. Previously, he had been the co-head of Goldman Sachs’ global securities businesses since January 2004. He also had been the co-head of Equities since 2003 and the co-head of FICC since September 2002. From March 2002 to September 2002, he served as co-chief operating officer of FICC. Prior to that, beginning in 1999, Mr. Cohn managed the FICC macro businesses. From 1996 to 1999, he was the global head of Goldman Sachs’ commodities business. Mr. Cohn is not on the board of any public company other than Goldman Sachs. He is affiliated with certain non-profit organizations, including as a member of the Treasury Borrowing Advisory Committee of the Securities Industry and Financial Markets Association and as a trustee of the Gilmour Academy, the NYU Child Study Center, the NYU Hospital, the NYU Medical School, the Harlem Children’s Zone, Columbia Grammar and Preparatory School and American University.
Edward C. Forst, 46
       Mr. Forst has been an Executive Vice President of Goldman Sachs and our Chief Administrative Officer since February 2004. Prior to that, he was our Chief of Staff for FICC from November 2003 to February 2004 (after having served in that position earlier from July 2000 to March 2002), our Chief of Staff for the Equities Division from August 2003 to February 2004, and co-head of Global Credit Markets in FICC from March 2002 to August 2003. Prior to July 2000, Mr. Forst served as co-head of our Global Bank Debt business. Mr. Forst serves as Co-Chair of the Securities Industry and Financial Markets Association. He also serves as a trustee of the Woods Hole Oceanographic Institution, a non-profit organization, and as Co-Chair of the Harvard University Committee on Student Excellence and Opportunity.

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Kevin W. Kennedy, 58
       Mr. Kennedy has been our Executive Vice President — Human Capital Management since December 2001. From 1999 until 2001, he served as a member of the Executive Office. From 1994 to 1999, he served as head of the Americas Group, in the Investment Banking Division, and, from 1988 to 1994, as head of Corporate Finance. Mr. Kennedy is a life trustee and a former Chairman of the Board of Hamilton College, a Managing Director and Secretary and Treasurer of the Board of the Metropolitan Opera, a trustee of the New York Public Library, a member of the Board of Directors of the Wallace Foundation and an honorary trustee of the Chewonki Foundation.
Gregory K. Palm, 58
       Mr. Palm has been an Executive Vice President of Goldman Sachs since May 1999, and our General Counsel and head or co-head of the Legal Department since May 1992.
Esta E. Stecher, 49
       Ms. Stecher has been an Executive Vice President of Goldman Sachs and our General Counsel and co-head of the Legal Department since December 2000. From 1994 to 2000, she was head of the firm’s Tax Department, over which she continues to have senior oversight responsibility. She is also a trustee of Columbia University.
David A. Viniar, 51
       Mr. Viniar has been an Executive Vice President of Goldman Sachs and our Chief Financial Officer since May 1999. He has been the head of Operations, Technology, Finance and Services Division since December 2002. He was head of the Finance Division and co-head of Credit Risk Management and Advisory and Firmwide Risk from December 2001 to December 2002. Mr. Viniar was co-head of Operations, Finance and Resources from March 1999 to December 2001. He was Chief Financial Officer of The Goldman Sachs Group, L.P. from March 1999 to May 1999. From July 1998 until March 1999, he was Deputy Chief Financial Officer and from 1994 until July 1998, he was head of Finance, with responsibility for Controllers and Treasury. From 1992 to 1994, he was head of Treasury and prior to that was in the Structured Finance Department of Investment Banking. He also serves on the Board of Trustees of Union College.
John S. Weinberg, 49
       Mr. Weinberg has been a Vice Chairman of Goldman Sachs since June 2006. He has been co-head of Goldman Sachs’ Investment Banking Division since December 2002. From January 2002 to December 2002, he was co-head of the Investment Banking Division in the Americas. Prior to that, he served as co-head of the Investment Banking Services Department since 1997. He is affiliated with certain non-profit organizations, including as a board member at the New York-Presbyterian Hospital, The Steppingstone Foundation, the Greenwich Country Day School and Community Anti-Drug Coalitions of America.
Jon Winkelried, 47
       Mr. Winkelried has been our President and Co-Chief Operating Officer and a director since June 2006. Previously, he had been the co-head of Goldman Sachs’ Investment Banking Division since January 2005. From 2000 to 2005, he was co-head of FICC. From 1999 to 2000, he was head of FICC in Europe. From 1995 to 1999, he was responsible for Goldman Sachs’ leveraged finance business. Mr. Winkelried is not on the board of any public company other than Goldman Sachs. He is also a trustee of the University of Chicago.

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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
       The principal market on which our common stock is traded is the NYSE. Information relating to the high and low sales prices per share of our common stock, as reported by the Consolidated Tape Association, for each full quarterly period during fiscal 2005 and 2006 is set forth under the heading “Supplemental Financial Information — Common Stock Price Range” in Part II, Item 8 of the Annual Report on Form 10-K. As of January 26, 2007, there were 6,804 holders of record of our common stock.
       During fiscal 2005 and 2006, dividends of $0.25 per share of common stock were declared on December 15, 2004, March 16, 2005, June 15, 2005, September 19, 2005 and December 14, 2005, and dividends of $0.35 per share of common stock were declared on March 13, 2006, June 12, 2006 and September 11, 2006. The holders of our common stock share proportionately on a per share basis in all dividends and other distributions on common stock declared by our board of directors.
       The declaration of dividends by Goldman Sachs is subject to the discretion of our board of directors. Our board of directors will take into account such matters as general business conditions, our financial results, capital requirements, contractual, legal and regulatory restrictions on the payment of dividends by us to our shareholders or by our subsidiaries to us, the effect on our debt ratings and such other factors as our board of directors may deem relevant. See “Business — Regulation” in Part I, Item 1 of the Annual Report on Form 10-K for a discussion of potential regulatory limitations on our receipt of funds from our regulated subsidiaries.
       The table below sets forth the information with respect to purchases made by or on behalf of The Goldman Sachs Group, Inc. or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934), of our common stock during the fourth quarter of our fiscal year ended November 24, 2006.
                                                 
                        Total Number of       Maximum Number
        Total       Average       Shares Purchased       of Shares That May
        Number       Price       as Part of Publicly       Yet Be Purchased
        of Shares       Paid per       Announced Plans       Under the Plans or
Period       Purchased (2)       Share       or Programs (3)       Programs (3)
                                 
Month #1
(August 26, 2006 to
September 29, 2006)
        7,109,500         $ 165.99           7,109,500           66,231,884  
Month #2
(September 30, 2006 to
October 27, 2006)
        11,668,000         $ 179.68           11,668,000           54,563,884  
Month #3
(October 28, 2006 to
November 24, 2006)
        1,994,971         $ 188.26           1,994,971           52,568,913  
                                             
Total (1)
        20,772,471         $ 175.82           20,772,471              
                                             
 
 
  (1)  Goldman Sachs generally does not repurchase shares of its common stock as part of the repurchase program during self-imposed “black-out” periods, which run from the last two weeks of a fiscal quarter through and including the date of the earnings release for such quarter.
 
  (2)  No shares were purchased other than through our publicly announced repurchase program during the fourth quarter of our fiscal year ended November 24, 2006.
 
  (3)  On March 21, 2000, we announced that our board of directors had approved a repurchase program, pursuant to which up to 15 million shares of our common stock may be repurchased. This repurchase program was increased by an aggregate of 220 million shares by resolutions of our board of directors adopted on June 18, 2001, March 18, 2002, November 20, 2002, January 30, 2004, January 25, 2005, September 16, 2005 and September 11, 2006. We use our repurchase program to help maintain the appropriate level of common equity and to substantially offset

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  increases in share count over time resulting from employee share-based compensation. The repurchase program is effected primarily through regular open-market purchases and is influenced by our overall capital position (the comparison of our capital requirements to our current level of available capital), general market conditions and the prevailing price and trading volumes of our common stock. The total remaining authorization under the repurchase program was 39,890,613 shares as of January 26, 2007. The repurchase program has no set expiration or termination date.
 
       Information relating to compensation plans under which equity securities of the Registrant are authorized for issuance is set forth in Part III, Item 12 of the Annual Report on Form 10-K.
Item 6. Selected Financial Data
       The Selected Financial Data table is set forth under Part II, Item 8 of the Annual Report on Form 10-K.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
INDEX
         
    Page
    No.
     
 
    48  
 
    49  
 
    51  
 
    52  
 
    56  
 
    56  
 
    61  
 
    64  
 
    64  
 
    65  
 
    72  
 
    79  
 
    79  
 
    80  
 
    86  
 
    88  
 
    88  
 
    90  
 
    94  
 
    95  
 
    97  
 
    104  
 
    104  

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Introduction
       Goldman Sachs is a leading global investment banking, securities and investment management firm that provides a wide range of services worldwide to a substantial and diversified client base that includes corporations, financial institutions, governments and high-net-worth individuals.
       Our activities are divided into three segments:
  •  Investment Banking. We provide a broad range of investment banking services to a diverse group of corporations, financial institutions, investment funds, governments and individuals.
 
  •  Trading and Principal Investments. We facilitate client transactions with a diverse group of corporations, financial institutions, investment funds, governments and individuals and take proprietary positions through market making in, trading of and investing in fixed income and equity products, currencies, commodities and derivatives on these products. In addition, we engage in specialist and market-making activities on equities and options exchanges and we clear client transactions on major stock, options and futures exchanges worldwide. In connection with our merchant banking and other investing activities, we make principal investments directly and through funds that we raise and manage.
 
  •  Asset Management and Securities Services. We provide investment advisory and financial planning services and offer investment products (primarily through separate accounts and funds) across all major asset classes to a diverse group of institutions and individuals worldwide and provide prime brokerage services, financing services and securities lending services to institutional clients, including hedge funds, mutual funds, pension funds and foundations, and to high-net-worth individuals worldwide.
       Unless specifically stated otherwise, all references to 2006, 2005 and 2004 refer to our fiscal years ended, or the dates, as the context requires, November 24, 2006, November 25, 2005 and November 26, 2004, respectively.
       When we use the terms “Goldman Sachs,” “we,” “us” and “our,” we mean The Goldman Sachs Group, Inc. (Group Inc.), a Delaware corporation, and its consolidated subsidiaries. References herein to the Annual Report on Form 10-K are to our Annual Report on Form 10-K for the fiscal year ended November 24, 2006.
       In this discussion, we have included statements that may constitute “forward-looking statements” within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not historical facts but instead represent only our beliefs regarding future events, many of which, by their nature, are inherently uncertain and outside our control. These statements may relate to our future plans and objectives, among other things. By identifying these statements for you in this manner, we are alerting you to the possibility that our actual results may differ, possibly materially, from the anticipated results indicated in these forward-looking statements. Important factors that could cause our results to differ, possibly materially, from those indicated in the forward-looking statements include, among others, those discussed below under “— Certain Risk Factors That May Affect Our Business” as well as “Risk Factors” in Part I, Item 1A of the Annual Report on Form 10-K and “Cautionary Statement Pursuant to the Private Securities Litigation Reform Act of 1995” in Part I, Item 1 of the Annual Report on Form 10-K.

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Executive Overview
       Our diluted earnings per common share were $19.69 for 2006, compared with $11.21 for 2005. Return on average tangible common shareholders’ equity (1) was 39.8% and return on average common shareholders’ equity was 32.8%. Excluding non-cash expenses of $637 million related to the accounting for certain share-based awards under SFAS No. 123-R (2), diluted earnings per common share for the year were $20.57 (2), return on average tangible common shareholders’ equity (1) was 41.8% (2) and return on average common shareholders’ equity was 34.4% (2).
       In 2006, we generated record diluted earnings per common share, which exceeded the prior year record results by 76%. Each of our three segments achieved record results. The increase in Trading and Principal Investments reflected significantly higher net revenues in Fixed Income, Currency and Commodities (FICC), Equities and Principal Investments. The increase in FICC reflected particularly strong performances across all major businesses. During 2006, FICC operated in an environment characterized by strong customer-driven activity and favorable market opportunities. The increase in Equities primarily reflected significantly higher net revenues in our customer franchise business. During 2006, Equities operated in a favorable environment characterized by strong customer-driven activity, generally higher equity prices and favorable market opportunities, although volatility levels were generally low. In FICC and Equities, as a result of the favorable trading and investing opportunities for our clients and ourselves, we increased our market risk, particularly in equity products, to capitalize on these opportunities. We grew our balance sheet as needed to support these opportunities as well as to support increased activity in Securities Services. The increase in Principal Investments reflected a significant gain related to our investment in the ordinary shares of Industrial and Commercial Bank of China Limited (ICBC) and higher gains and overrides from other principal investments, partially offset by a smaller, but still significant, gain related to our investment in the convertible preferred stock of Sumitomo Mitsui Financial Group, Inc. (SMFG). The increase in Investment Banking was due to significantly higher net revenues in Underwriting and Financial Advisory, as we benefited from strong client activity levels, reflecting favorable equity and financing markets, strong CEO confidence and growth in financial sponsor activity. The increase in Asset Management and Securities Services was primarily due to higher assets under management and significantly higher incentive fees, as well as significantly higher global customer balances in Securities Services. Assets under management increased $144 billion or 27% to a record $676 billion, including net asset inflows of $94 billion during 2006.
       Looking forward to 2007, our investment banking backlog at the end of 2006 was at its highest level since 2000 (3). In addition to potential growth in the businesses and geographic areas in which we currently operate, the expansion of the economies of China, India, Russia and Brazil, as well as those of the Middle East offer new opportunities for us to increase our presence in those markets. In Investment Banking, there is growth potential to broaden our client base by providing strategic and financing advice and capital to middle-market companies. We also see opportunities to advise governments and investors on the sale and purchase of public infrastructure assets. In addition, we are building a private banking capability as part of our strategy to provide a full-range of services to our private wealth management clients.
       Though we generated record operating results in 2006, our business, by its nature, does not produce predictable earnings. Our results in any given period can be materially affected by conditions in global financial markets and economic conditions generally. For a further discussion of the factors that may affect our future operating results, see “— Certain Risk Factors That May Affect Our Business” below as well as “Risk Factors” in Part I, Item 1A of the Annual Report on Form 10-K.
 
(1)  Return on average tangible common shareholders’ equity is computed by dividing net earnings applicable to common shareholders by average monthly tangible common shareholders’ equity. See “— Results of Operations — Financial Overview” below for further information regarding our calculation of return on average tangible common shareholders’ equity.

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(2)  Statement of Financial Accounting Standards (SFAS) No. 123-R, “Share-Based Payment,” focuses primarily on accounting for transactions in which an entity obtains employee services in exchange for share-based payments. In the first quarter of 2006, we adopted SFAS No. 123-R, which requires that share-based awards held by employees that were retirement-eligible, including those subject to non-compete agreements, be expensed in the year of grant. In addition to expensing current year awards, prior year awards must continue to be amortized over the relevant service period. Therefore, our compensation and benefits expenses in 2006 included (and, to a lesser extent, 2007 and 2008 will include) both amortization of prior year share-based awards held by employees that were retirement-eligible on the date of adoption of SFAS No. 123-R and new awards granted to those employees. We believe that presenting our results excluding the impact of the continued amortization of these prior year share-based awards increases the comparability of period-to-period operating results and allows for a more meaningful representation of the relationship of current period compensation to net revenues.
 
The following tables set forth a reconciliation of diluted earnings per common share, common shareholders’ equity and net earnings applicable to common shareholders, as reported, to these items excluding the impact of the continued amortization of these prior year share-based awards held by employees that were retirement-eligible on the date of adoption of SFAS No. 123-R:
         
    Year Ended
    November 2006
     
Diluted earnings per common share
  $ 19.69  
Impact of the continued amortization of prior year share-based awards, net of tax
    0.88  
         
Diluted earnings per common share, excluding the impact of the continued amortization of prior year share-based awards
  $ 20.57  
         
         
    Average for the
    Year Ended
    November 2006
     
    (in millions)
Total shareholders’ equity
  $ 31,048  
Preferred stock
    (2,400 )
         
Common shareholders’ equity
    28,648  
Impact of the continued amortization of prior year share-based awards, net of tax
    (122 )
         
Common shareholders’ equity, excluding the impact of the continued amortization of prior year share-based awards
    28,526  
Goodwill and identifiable intangible assets, excluding power contracts (see footnote 1 above)
    (5,013 )
         
Tangible common shareholders’ equity (see footnote 1 above), excluding the impact of the continued amortization of prior year share-based awards
  $ 23,513  
         
         
    Year Ended
    November 2006
     
    (in millions)
Net earnings applicable to common shareholders
  $ 9,398  
Impact of the continued amortization of prior year share-based awards, net of tax
    421  
         
Net earnings applicable to common shareholders, excluding the impact of the continued amortization of prior year share-based awards
  $ 9,819  
         
(3)  Our investment banking backlog represents an estimate of our future net revenues from investment banking transactions where we believe that future revenue realization is more likely than not.

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Business Environment
       As an investment banking, securities and investment management firm, our businesses are materially affected by conditions in the financial markets and economic conditions generally, both in the United States and elsewhere around the world. A favorable business environment is generally characterized by, among other factors, high global gross domestic product growth, stable geopolitical conditions, transparent and efficient capital markets, low inflation, high business and investor confidence and strong business earnings. These factors provide a positive climate for our investment banking activities, for many of our trading businesses and for wealth creation, which contributes to growth in our asset management business. Although global short-term interest rates rose to modest levels and yield curves continued to flatten in 2006, economic conditions remained favorable, as global equity prices generally rose, core inflation was broadly contained and corporate activity strengthened. For a further discussion of how market conditions can affect our businesses, see “— Certain Risk Factors That May Affect Our Business” below as well as “Risk Factors” in Part I, Item 1A of the Annual Report on Form 10-K. A further discussion of the business environment in 2006 is set forth below.
       Global. After solid economic growth in 2005, the global economy grew at a strong pace in 2006, particularly during the first half of the year. However, during the second half of the year, economic growth in the United States and Japan showed some signs of deceleration, while the pace of growth in the Eurozone economy appeared to strengthen. Corporate activity was very strong, as mergers and acquisitions and equity and debt underwriting volumes increased significantly compared with 2005. The U.S. Federal Reserve continued to raise rates in the first half of the year, increasing its federal funds target rate by a total of 125 basis points. Despite the increase in short-term rates, fixed income markets were favorable as long-term bond yields remained low and the credit environment remained strong. Oil prices remained high throughout the year, despite declining during our fourth quarter, but this did not appear to materially affect consumer spending or global growth. In the currency markets, the U.S. dollar weakened against most major currencies, as well as against such emerging market currencies as the Brazilian real, Chinese yuan and Korean won.
       United States. The U.S. economy grew at a strong pace during the year as financial conditions remained supportive of economic activity. Real gross domestic product rose by 3.4% in the 2006 calendar year, driven principally by strength in the industrial sector, solid consumer expenditure growth and a strong labor market. This growth occurred despite a decline in the housing market and residential investment. After slowing modestly in the beginning of 2006, the rate of inflation increased, particularly in the second quarter, as energy prices rose significantly. Measures of core inflation also accelerated, although they eased towards the end of the calendar year. In response to the strong economic growth and rising inflation, the U.S. Federal Reserve raised its federal funds target rate by 25 basis points in each of its meetings in 2006 through June, bringing the rate to 5.25%. However, the Federal Reserve kept rates unchanged for the remainder of the year as the pace of growth moderated, reflecting a decline in the U.S. housing market and the delayed effects of higher interest rates and energy prices. Despite the rise in short-term interest rates, the 10-year U.S. Treasury note yield ended the year only 12 basis points higher at 4.55%. The Dow Jones Industrial Average, S&P 500 Index and NASDAQ Composite Index increased by 12%, 10% and 9%, respectively, during our fiscal year.
       Europe. The pace of economic growth in Europe accelerated as real gross domestic product in the Eurozone economy grew by approximately 2.7% in the 2006 calendar year. Despite a higher Euro, economic conditions in the Eurozone countries improved throughout the year, and consumer sentiment began to improve as a result of lower unemployment levels and higher domestic demand. After leaving rates unchanged for over two years, the European Central Bank raised interest rates by a total of 125 basis points during our 2006 fiscal year, bringing its policy rate to 3.25%. In the United Kingdom, real gross domestic product growth accelerated to approximately 2.7% in the 2006 calendar year, primarily reflecting strong investment spending. The Bank of England increased interest rates by 50 basis points to 5.00%, after having reduced rates by 25 basis points in 2005.

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Long-term bond yields in both the Eurozone and the United Kingdom ended our fiscal year modestly higher. Reflecting the improvement in economic growth, European equity markets increased significantly during our fiscal year.
       Asia. Japan’s economy grew at a relatively strong pace for the second year in a row, with real gross domestic product increasing by approximately 2.2% in the 2006 calendar year. The recovery in private investment and domestic demand continued to drive much of the improvement in the first part of the year, while exports drove real gross domestic product growth toward the end of the calendar year. The unemployment rate fell to 4.2% in 2006 from 4.4% in calendar 2005. The Bank of Japan ended its zero interest rate policy, which had been in place since early 2001, and raised the target overnight call rate by 25 basis points during our fiscal year. The yield on 10-year Japanese government bonds increased slightly, ending our fiscal year up 17 basis points. Despite slightly higher short- and long-term interest rates, financial conditions remained supportive of economic activity. The yen appreciated slightly against the U.S. dollar, but declined against most other major currencies, while the Nikkei 225 Index increased 6% during our fiscal year.
       Elsewhere in Asia, China’s real gross domestic product growth remained robust, with growth particularly reliant on net exports, as demonstrated by China’s large current account surplus. China continued to allow its currency to appreciate modestly, with evidence of acceleration during the second half of the calendar year, ending our fiscal year nearly 3% higher against the U.S. dollar. Other currencies in the region also strengthened against the U.S. dollar, including the Korean won, Philippine peso and the Taiwan dollar. Growth in India also remained strong, which, together with China, supported growth throughout the region. Equity markets across the region generally rose, with markets in China, India, Hong Kong, South Korea and Taiwan all posting significant gains during our fiscal year.
Certain Risk Factors That May Affect Our Business
       We face a variety of risks that are substantial and inherent in our businesses, including market, liquidity, credit, operational, legal and regulatory risks. For a discussion of how management seeks to manage some of these risks, see “— Risk Management” below. A summary of the more important factors that could affect our business follows below. For a further discussion of these and other important factors that could affect our business, see “Risk Factors” in Part I, Item 1A of the Annual Report on Form 10-K.
       Market Conditions and Market Risk. Our businesses are materially affected by conditions in the global financial markets and economic conditions generally, and these conditions may change suddenly and dramatically. A favorable business environment is generally characterized by, among other factors, high global gross domestic product growth, stable geopolitical conditions, transparent and efficient capital markets, low inflation, high business and investor confidence and strong business earnings. Unfavorable or uncertain economic and market conditions, which can be caused by outbreaks of hostilities or other geopolitical instability, declines in business confidence, increases in inflation, corporate, political or other scandals that reduce investor confidence in capital markets, natural disasters or pandemics or a combination of these or other factors, have adversely affected, and may in the future adversely affect, our business and profitability in many ways, including the following:
  •  We have been operating in a low interest rate market for the past several years. Increasing or high interest rates and/or widening credit spreads, especially if such changes are rapid, may create a less favorable environment for certain of our businesses.
 
  •  We have been committing increasing amounts of capital in many of our businesses and generally maintain large trading, specialist and investing positions. Market fluctuations and volatility may adversely affect the value of those positions, including, but not limited to, our interest rate and credit products, currency, commodity and equity positions and our merchant banking investments, or may reduce our willingness to enter into new transactions. From time

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  to time, we have incurred significant trading losses in periods of market turbulence. Conversely, certain of our trading businesses depend on market volatility to provide trading and arbitrage opportunities, and decreases in volatility may reduce these opportunities and adversely affect the results of these businesses.
 
  •  Industry-wide declines in the size and number of underwritings and mergers and acquisitions may have an adverse effect on our revenues and, because we may be unable to reduce expenses correspondingly, our profit margins. In particular, because a significant portion of our investment banking revenues are derived from our participation in large transactions, a decrease in the number of large transactions due to uncertain or unfavorable market conditions may adversely affect our investment banking business.
 
  •  Pricing and other competitive pressures have continued, even as the volume and number of investment banking transactions have increased. In addition, the trend in the underwriting business toward multiple book runners and co-managers handling transactions, where previously there would have been a single book runner, has adversely affected our business and reduced our revenues.
 
  •  Reductions in the level of the equity markets or increases in interest rates tend to reduce the value of our clients’ portfolios, which in turn may reduce the fees we earn for managing assets. Increases in interest rates or attractive conditions in other investments could cause our clients to transfer their assets out of our funds or other products. Even in the absence of uncertain or unfavorable economic or market conditions, investment performance by our asset management business below the performance of benchmarks or competitors could result in a decline in assets under management and in the incentive and management fees we receive as well as reputational damage that might make it more difficult to attract new investors.
 
  •  Concentration of risk increases the potential for significant losses in our market-making, proprietary trading and investing, block trading, merchant banking, underwriting and lending businesses. This risk may increase to the extent we expand our proprietary trading and investing businesses or commit capital to facilitate customer-driven business. For example, in recent years large blocks of securities have increasingly been sold in block trades rather than on a marketed basis, which increases the risk that Goldman Sachs may be unable to resell the purchased securities at favorable prices and may incur significant losses as a result. Moreover, because of concentration of risk, we may suffer losses even when economic and market conditions are generally favorable for others in the industry. We also regularly enter into large transactions as part of our trading businesses. The number and size of such transactions may affect our results of operations in a given period.
 
  •  The volume of transactions that we execute for our clients and as a specialist or market maker may decline, which would reduce the revenues we receive from commissions and spreads. In addition, competitive pressures and other industry factors, including the increasing use by our clients of low-cost electronic trading, could cause a reduction in commissions and spreads. In our specialist businesses, we are obligated by stock exchange rules to maintain an orderly market, including by purchasing shares in a declining market. This may result in trading losses and an increased need for liquidity. Weakness in global equity markets and the trading of securities in multiple markets and on multiple exchanges could adversely impact our trading businesses and impair the value of our goodwill and identifiable intangible assets. In addition, competitive pressures have been particularly intense in the context of block trades. For a further discussion of our goodwill and identifiable intangible assets, see “— Critical Accounting Policies — Goodwill and Identifiable Intangible Assets” below.

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  •  While we employ a broad and diversified set of risk monitoring and risk mitigation techniques, those techniques and the judgments that accompany their application cannot anticipate every economic and financial outcome or the specifics and timing of such outcomes. Thus, we may, in the course of our activities, incur losses.
 
  •  Market volatility has been relatively low in recent years. An increase in volatility would increase our measured risk, which might cause us to reduce our proprietary positions or to reduce certain of our business activities. In such circumstances, we may not be able to reduce our positions or our exposure in a timely, cost-effective way or in a manner sufficient to offset the increase in measured risk.
       Liquidity Risk. Liquidity is essential to our businesses. Our liquidity could be impaired by an inability to access secured and/or unsecured debt markets, an inability to access funds from our subsidiaries, an inability to sell assets or unforeseen outflows of cash or collateral. This situation may arise due to circumstances that we are unable to control, such as a general market disruption or an operational problem that affects third parties or us. The financial instruments that we hold and the contracts to which we are a party are increasingly complex, as we employ structured products to benefit our clients and ourselves, and these complex structured products often do not have readily available markets to access in times of liquidity stress. Growth of our proprietary investing activities may lead to situations where the holdings from these activities represent a significant portion of specific markets, which could restrict liquidity for our positions. Further, our ability to sell assets may be impaired if other market participants are seeking to sell similar assets at the same time.
       Our credit ratings are important to our liquidity. A reduction in our credit ratings could adversely affect our liquidity and competitive position, increase our borrowing costs, limit our access to the capital markets or trigger our obligations under certain bilateral provisions in some of our trading and collateralized financing contracts. Under these provisions, counterparties could be permitted to terminate contracts with Goldman Sachs or require us to post additional collateral. Termination of our trading and collateralized financing contracts could cause us to sustain losses and impair our liquidity by requiring us to find other sources of financing or to make significant cash payments or securities movements. For a discussion of the potential impact on Goldman Sachs of a reduction in our credit ratings, see “— Liquidity and Funding Risk — Credit Ratings” below.
       Credit Risk. We are exposed to the risk that third parties that owe us money, securities or other assets will not perform their obligations. These parties may default on their obligations to us due to bankruptcy, lack of liquidity, operational failure or other reasons. We are also subject to the risk that our rights against third parties may not be enforceable in all circumstances. In addition, a deterioration in the credit quality of third parties whose securities or obligations we hold could result in losses and/or adversely affect our ability to rehypothecate or otherwise use those securities or obligations for liquidity purposes. A significant downgrade in the credit ratings of our counterparties could also have a negative impact on our results. The amount and duration of our credit exposures have been increasing over the past several years, as has the breadth of the entities to which we have credit exposures. As a clearing member firm, we finance our client positions, and we could be held responsible for the defaults or misconduct of our clients. In addition, we have experienced, due to competitive factors, pressure to extend and price credit at levels that may not always fully compensate us for the risks we take. In particular, corporate clients sometimes seek to require credit commitments from us in connection with investment banking and other assignments. Although we regularly review credit exposures to specific clients and counterparties and to specific industries, countries and regions that we believe may present credit concerns, default risk may arise from events or circumstances that are difficult to detect or foresee, particularly as new business initiatives lead us to transact with a broader array of clients, with new asset classes and in new markets. In addition, concerns about, or a default by, one institution could lead to significant liquidity problems, losses or defaults by other institutions, which in turn could adversely affect Goldman Sachs.

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       Operational Risk. Shortcomings or failures in our internal processes, people or systems, or external events could lead to impairment of our liquidity, financial loss, disruption of our businesses, liability to clients, regulatory intervention or reputational damage. For example, our businesses are highly dependent on our ability to process, on a daily basis, a large number of transactions across numerous and diverse markets in many currencies. The transactions we process have become increasingly complex and often must adhere to client-specific guidelines, as well as legal and regulatory standards. Despite the contingency plans and facilities we have in place, our ability to conduct business may be adversely impacted by a disruption in the infrastructure that supports our businesses and the communities in which we are located. This may include a disruption involving electrical, communications, transportation or other services used by Goldman Sachs or third parties with which we conduct business.
       Legal and Regulatory Risk. We are subject to extensive and evolving regulation in jurisdictions around the world. Substantial legal liability or a significant regulatory action against Goldman Sachs could have material adverse financial effects or cause significant reputational harm to Goldman Sachs, which in turn could seriously harm our business prospects. Firms in the financial services industry have been operating in a difficult regulatory environment. We face significant legal risks in our businesses, and the volume of claims and amount of damages and penalties claimed in litigation and regulatory proceedings against financial institutions remain high. For a discussion of how we account for our legal and regulatory exposures, see “— Use of Estimates” below.

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Critical Accounting Policies
Fair Value
       The use of fair value to measure our financial instruments, with related unrealized gains or losses generally recognized immediately in our results of operations, is fundamental to our financial statements and is our most critical accounting policy. 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.
       In determining fair value, we separate our financial instruments into three categories — cash (i.e., nonderivative) trading instruments, derivative contracts and principal investments (included within the Principal Investments component of our Trading and Principal Investments segment), as set forth in the following table:
Financial Instruments by Category
(in millions)
                                 
    As of November
     
    2006   2005
         
        Financial       Financial
    Financial   Instruments Sold,   Financial   Instruments Sold,
    Instruments   But Not Yet   Instruments   But Not Yet
    Owned, At   Purchased, At   Owned, At   Purchased, At
    Fair Value   Fair Value   Fair Value   Fair Value
                 
Cash trading instruments
  $ 247,031   (1)   $ 87,244     $ 210,042     $ 89,735  
Derivative contracts
    67,543       65,496       58,532       57,829  
Principal investments
    13,962   (2)     3,065  (3)     6,526   (2)     1,507  (3)
                                 
Total
  $ 328,536     $ 155,805     $ 275,100     $ 149,071  
                                 
 
 
  (1)  Includes securities held by our bank and insurance subsidiaries, which are accounted for as “available-for-sale” (AFS) under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” The following table sets forth the types of AFS securities and their maturity profile:
                                         
    As of November 2006
     
    Under       10 Years    
    One Year   1 - 5 Years   5 - 10 Years   or Greater   Total
                     
    (in millions)
Mortgage-backed and other federal agency securities
  $ 2,374     $ 1,031     $ 146     $ 111     $ 3,662  
Investment-grade corporate bonds
    23       1,403       42       51       1,519  
Collateralized debt obligations
    192       4,199             121       4,512  
Other debt securities
    115       31       52       54       252  
                                         
Total
  $ 2,704     $ 6,664     $ 240     $ 337     $ 9,945  
                                         
  (2)  Excludes assets related to consolidated merchant banking funds of $6.03 billion and $1.93 billion as of November 2006 and November 2005, respectively, for which Goldman Sachs is not at risk.
 
  (3)  Represents an economic hedge on the unrestricted shares of common stock underlying our investment in the convertible preferred stock of SMFG. For a further discussion of our investment in SMFG, see “— Principal Investments” below.

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       Cash Trading Instruments. The following table sets forth the valuation of our cash trading instruments by level of price transparency:
Cash Trading Instruments by Price Transparency
(in millions)
                                 
    As of November
     
    2006   2005
         
        Financial       Financial
    Financial   Instruments Sold,   Financial   Instruments Sold,
    Instruments   But Not Yet   Instruments   But Not Yet
    Owned, At   Purchased, At   Owned, At   Purchased, At
    Fair Value   Fair Value   Fair Value   Fair Value
                 
Quoted prices or alternative pricing sources with reasonable price transparency
  $ 231,012     $ 87,110     $ 198,233     $ 89,565  
Little or no price transparency
    16,019       134       11,809       170  
                                 
Total
  $ 247,031     $ 87,244     $ 210,042     $ 89,735  
                                 
 
 
       Fair values of our cash trading instruments are generally obtained from quoted market prices in active markets, broker or dealer price quotations, or alternative pricing sources with reasonable levels of price transparency. The types of instruments valued in this manner include U.S. government and agency securities, other sovereign government obligations, liquid mortgage products, investment-grade and high-yield corporate bonds, listed equities, money market securities, state, municipal and provincial obligations, and physical commodities.
       Certain cash trading instruments trade infrequently and have little or no price transparency. Such instruments include certain corporate bank loans, mortgage whole loans and distressed debt. We value these instruments initially at cost and generally do not adjust valuations unless there is substantive evidence supporting a change in the value of the underlying instrument or valuation assumptions (such as similar market transactions, changes in financial ratios or changes in the credit ratings of the underlying companies). Where there is evidence supporting a change in the value, we use valuation methodologies such as the present value of known or estimated cash flows.
       Cash trading instruments we own (long positions) are marked to bid prices, and instruments we have sold but not yet purchased (short positions) are marked to offer prices. In certain circumstances, such as for positions that are illiquid or have transfer restrictions, the fair value reflects liquidity valuation adjustments based on market evidence or predetermined policies. For certain highly illiquid positions, management’s estimates are used to determine these liquidity valuation adjustments. See “— Recent Accounting Developments” below for a discussion of the impact of SFAS No. 157, “Fair Value Measurements” on the valuation of financial instruments.

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       Derivative Contracts. Derivative contracts consist of exchange-traded and over-the-counter (OTC) derivatives. The following table sets forth the fair value of our exchange-traded and OTC derivative assets and liabilities:
Derivative Assets and Liabilities
(in millions)
                                 
    As of November
     
    2006   2005
         
    Assets   Liabilities   Assets   Liabilities
                 
Exchange-traded derivatives
  $ 14,407     $ 13,851     $ 10,869     $ 9,083  
OTC derivatives
    53,136       51,645       47,663       48,746  
                                 
Total
  $ 67,543  (1)   $ 65,496   (2)   $ 58,532   (1)   $ 57,829   (2)
                                 
 
 
  (1)  Net of cash received pursuant to credit support agreements of $24.06 billion and $22.61 billion as of November 2006 and November 2005, respectively.
 
  (2)  Net of cash paid pursuant to credit support agreements of $16.00 billion and $16.10 billion as of November 2006 and November 2005, respectively.
 
       Fair values of our exchange-traded derivatives are generally determined from quoted market prices. OTC derivatives are valued using valuation models. We use a variety of valuation models including the present value of known or estimated cash flows and option-pricing models. The valuation models that we use to derive the fair values of our OTC derivatives require inputs including contractual terms, market prices, yield curves, credit curves, measures of volatility, prepayment rates and correlations of such inputs. The selection of a model to value an OTC derivative depends upon the contractual terms of, and specific risks inherent in, the instrument as well as the availability of pricing information in the market. We generally use similar models to value similar instruments. Where possible, we verify the values produced by our pricing models to market transactions. For OTC derivatives that trade in liquid markets, such as generic forwards, swaps and options, model selection does not involve significant judgment because market prices are readily available. For OTC derivatives that trade in less liquid markets, model selection requires more judgment because such instruments tend to be more complex and pricing information is less available in these markets. Price transparency is inherently more limited for more complex structures because they often combine one or more product types, requiring additional inputs such as correlations and volatilities. As markets continue to develop and more pricing information becomes available, we continue to review and refine the models that we use.
       At the inception of an OTC derivative contract (day one), we value the contract at the model value if we can verify all of the significant model inputs to observable market data and verify the model to market transactions. When appropriate, valuations are adjusted to reflect various factors such as liquidity, bid/offer spreads and credit considerations. These adjustments are generally based on market evidence or predetermined policies. In certain circumstances, such as for highly illiquid positions, management’s estimates are used to determine these adjustments.
       Where we cannot verify all of the significant model inputs to observable market data and verify the model to market transactions, we value the contract at the transaction price at inception and, consequently, record no day one gain or loss in accordance with Emerging Issues Task Force (EITF) Issue No. 02-3, “Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities.”
       Following day one, we adjust the inputs to our valuation models only to the extent that changes in these inputs can be verified by similar market transactions, third-party pricing services and/or broker quotes, or can be derived from other substantive evidence such as empirical market data. In circumstances where we cannot verify the model to market transactions, it is possible that a different valuation model could produce a materially different estimate of fair value. See “— Recent Accounting Developments” below for a discussion of the impact of SFAS No. 157 on the valuation of financial instruments.

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       The following tables set forth the fair values of our OTC derivative assets and liabilities by product and by remaining contractual maturity:
OTC Derivatives
(in millions)
                                                 
    As of November 2006
Assets    
    0 - 6   6 - 12   1 - 5   5 - 10   10 Years    
Contract Type   Months   Months   Years   Years   or Greater   Total
                         
Interest rates (1)
  $ 2,432     $ 1,706     $ 5,617     $ 5,217     $ 6,201     $ 21,173  
Currencies
    5,578       943       3,103       1,669       966       12,259  
Commodities
    3,892       1,215       5,836       1,258       231       12,432  
Equities
    1,430       1,134       1,329       2,144       1,235       7,272  
                                                 
Total
  $ 13,332     $ 4,998     $ 15,885     $ 10,288     $ 8,633     $ 53,136  
                                                 
                                                 
Liabilities                        
    0 - 6   6 - 12   1 - 5   5 - 10   10 Years    
Contract Type   Months   Months   Years   Years   or Greater   Total
                         
Interest rates (1)
  $ 2,807     $ 1,242     $ 6,064     $ 3,582     $ 5,138     $ 18,833  
Currencies
    6,859       1,290       2,582       494       634       11,859  
Commodities
    3,078       658       4,253       1,643       273       9,905  
Equities
    3,235       1,682       2,615       3,239       277       11,048  
                                                 
Total
  $ 15,979     $ 4,872     $ 15,514     $ 8,958     $ 6,322     $ 51,645  
                                                 
                                                 
    As of November 2005
Assets    
    0 - 6   6 - 12   1 - 5   5 - 10   10 Years    
Contract Type   Months   Months   Years   Years   or Greater   Total
                         
Interest rates (1)
  $ 1,898     $ 467     $ 4,634     $ 5,310     $ 5,221     $ 17,530  
Currencies
    5,825       1,031       1,843       919       1,046       10,664  
Commodities
    3,772       1,369       8,130       1,374       120       14,765  
Equities
    1,168       1,171       832       1,403       130       4,704  
                                                 
Total
  $ 12,663     $ 4,038     $ 15,439     $ 9,006     $ 6,517     $ 47,663  
                                                 
                                                 
Liabilities                        
    0 - 6   6 - 12   1 - 5   5 - 10   10 Years    
Contract Type   Months   Months   Years   Years   or Greater   Total
                         
Interest rates (1)
  $ 1,956     $ 590     $ 5,327     $ 3,142     $ 4,970     $ 15,985  
Currencies
    6,295       575       3,978       436       924       12,208  
Commodities
    3,852       2,080       5,904       1,865       162       13,863  
Equities
    1,308       1,068       2,079       1,993       242       6,690  
                                                 
Total
  $ 13,411     $ 4,313     $ 17,288     $ 7,436     $ 6,298     $ 48,746  
                                                 
 
 
  (1)  Includes credit-related derivatives.
 
       We enter into certain OTC option transactions that provide us or our counterparties with the right to extend the maturity of the underlying contract. The fair value of these option contracts is not material to the aggregate fair value of our OTC derivative portfolio. In the tables above, for option contracts that require settlement by delivery of an underlying derivative instrument, the remaining contractual maturity is generally classified based upon the maturity date of the underlying derivative instrument. In those instances where the underlying instrument does not have a maturity date or either counterparty has the right to settle in cash, the remaining contractual maturity is generally based upon the option expiration date.

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       Principal Investments. The following table sets forth the carrying value of the investments included within the Principal Investments component of our Trading and Principal Investments segment. These investments consist of private investments, investments in the convertible preferred stock of SMFG and the ordinary shares of ICBC, and other public investments:
Principal Investments
(in millions)
                                                 
    As of November
     
    2006   2005
         
    Corporate   Real Estate   Total   Corporate   Real Estate   Total
                         
Private
  $ 2,741     $ 555     $ 3,296     $ 1,538     $ 716     $ 2,254  
Public
    934       33       967       185       29       214  
                                                 
Subtotal (1)
    3,675       588       4,263       1,723       745       2,468  
SMFG convertible
preferred stock (2) (3)
    4,505             4,505       4,058             4,058  
ICBC ordinary shares (4)
    5,194             5,194                    
                                                 
Total
  $ 13,374     $ 588     $ 13,962     $ 5,781     $ 745     $ 6,526  
                                                 
 
 
  (1)  Excludes assets related to consolidated merchant banking funds of $6.03 billion and $1.93 billion as of November 2006 and November 2005, respectively, for which Goldman Sachs is not at risk.
 
  (2)  The fair value of our Japanese yen-denominated investment in the convertible preferred stock of SMFG includes the effect of foreign exchange revaluation. We mitigate our economic exposure to exchange rate movements on our investment in SMFG by borrowing Japanese yen. Foreign exchange revaluation on the investment and the related borrowing are generally equal and offsetting. For example, if the Japanese yen appreciates against the U.S. dollar, the U.S. dollar carrying value of our SMFG investment will increase and the U.S. dollar carrying value of the related borrowing will also increase by an amount that is generally equal and offsetting.
 
  (3)  Excludes an economic hedge on the unrestricted shares of common stock underlying our investment in the convertible preferred stock of SMFG. The fair value of this hedge was $3.07 billion and $1.51 billion as of November 2006 and November 2005, respectively, and is reflected in “Financial instruments sold, but not yet purchased, at fair value” in the consolidated statements of financial condition. For a further discussion of the restrictions on our ability to hedge or sell the common stock underlying our investment in SMFG, see below.
 
  (4)  Includes interests of $3.28 billion as of November 2006 held by investment funds managed by Goldman Sachs. The fair value of our investment in the ordinary shares of ICBC, which trade on The Stock Exchange of Hong Kong, includes the effect of foreign exchange revaluation.
 
       Our private principal investments, by their nature, have little or no price transparency. Such investments are initially carried at cost as an approximation of fair value. Adjustments to carrying value are made if there are third-party transactions evidencing a change in value. Downward adjustments are also made, in the absence of third-party transactions, if we determine that the expected realizable value of the investment is less than the carrying value. In reaching that determination, we consider many factors including, but not limited to, the operating cash flows and financial performance of the companies or properties relative to budgets or projections, trends within sectors and/or regions, underlying business models, expected exit timing and strategy, and any specific rights or terms associated with the investment, such as conversion features and liquidation preferences. See “— Recent Accounting Developments” below for a discussion of the impact of SFAS No. 157 on the valuation of financial instruments.
       Our public principal investments, which tend to be large, concentrated holdings that result from initial public offerings or other corporate transactions, are valued using quoted market prices less a liquidity valuation adjustment based on predetermined written policies.

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       Our investment in the convertible preferred stock of SMFG is carried at fair value, which is derived from a model that incorporates SMFG’s common stock price and credit spreads, the impact of nontransferability and illiquidity, and downside protection on the conversion strike price. The fair value of our investment is particularly sensitive to movements in the SMFG common stock price. As a result of downside protection on the conversion strike price, the relationship between changes in the fair value of our investment and changes in SMFG’s common stock price would be nonlinear for a significant decline in the SMFG common stock price. During the year, the fair value of our investment (excluding the economic hedge on the unrestricted shares of common stock) increased 8% (expressed in Japanese yen), reflecting the impact of passage of time in respect of the transfer restrictions on the underlying common stock.
       Our investment in the convertible preferred stock of SMFG is generally nontransferable without the consent of SMFG, but is freely convertible into SMFG common stock. As of November 2006, we had hedged two-thirds of the common stock underlying our investment in SMFG. Restrictions on our ability to hedge or sell the remaining shares will lapse on February 7, 2007. As of November 2006, the conversion price was ¥318,800, subject to downward adjustment if the price of SMFG common stock at the time of conversion is less than the conversion price (subject to a floor of ¥105,100).
       Our investment in the ordinary shares of ICBC is carried at fair value using quoted market prices less a liquidity valuation adjustment. The ordinary shares acquired from ICBC are subject to transfer restrictions that, among other things, prohibit any sale, disposition or other transfer until April 28, 2009. From April 28, 2009 to October 20, 2009, we may transfer up to 50% of the aggregate ordinary shares of ICBC that we owned as of October 20, 2006. We may transfer the remaining shares after October 20, 2009. A portion of our interest is held by investment funds managed by Goldman Sachs.
       Controls Over Valuation of Financial Instruments. A control infrastructure, independent of the trading and investing functions, is fundamental to ensuring that our financial instruments are appropriately valued and that fair value measurements are reliable. This is particularly important in valuing instruments with lower levels of price transparency.
       We employ an oversight structure that includes appropriate segregation of duties. Senior management, independent of the trading functions, is responsible for the oversight of control and valuation policies and for reporting the results of these policies to our Audit Committee. We seek to maintain the necessary resources to ensure that control functions are performed to the highest standards. We employ procedures for the approval of new transaction types and markets, price verification, review of daily profit and loss, and review of valuation models by personnel with appropriate technical knowledge of relevant products and markets. These procedures are performed by personnel independent of the revenue-producing units. For trading and principal investments with little or no price transparency, we employ, where possible, procedures that include comparisons with similar observable positions, analysis of actual to projected cash flows, comparisons with subsequent sales and discussions with senior business leaders. For a further discussion of how we manage the risks inherent in our trading and principal investing businesses, see “— Risk Management” below.
Goodwill and Identifiable Intangible Assets
       As a result of our acquisitions, principally SLK LLC (SLK) in 2000, The Ayco Company, L.P. (Ayco) in 2003, Cogentrix Energy, Inc. (Cogentrix) in 2004, National Energy & Gas Transmission, Inc. (NEGT) in 2005 and the acquisition of the variable annuity and variable life insurance business of The Hanover Insurance Group, Inc. (formerly Allmerica Financial Corporation) in 2006, we have acquired goodwill and identifiable intangible assets. Goodwill is the cost of acquired companies in excess of the fair value of net assets, including identifiable intangible assets, at the acquisition date.

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       Goodwill. We test the goodwill in each of our operating segments for impairment at least annually in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” by comparing the estimated fair value of each operating segment with its estimated net book value. We derive the fair value of each of our operating segments primarily based on price-earnings multiples. We derive the net book value of our operating segments by estimating the amount of shareholders’ equity required to support the activities of each operating segment. Our last annual impairment test was performed during our 2006 fourth quarter and no impairment was identified.
       The following table sets forth the carrying value of our goodwill by operating segment:
Goodwill by Operating Segment
(in millions)
                   
    As of November
     
    2006   2005
         
Investment Banking
               
 
Financial Advisory
  $     $  
 
Underwriting
    125       125  
Trading and Principal Investments
               
 
FICC
    136       91  
 
Equities (1)
    2,381       2,390  
 
Principal Investments
    4       1  
Asset Management and Securities Services
               
 
Asset Management (2)
    421       424  
 
Securities Services
    117       117  
                 
Total
  $ 3,184     $ 3,148  
                 
 
 
  (1)  Primarily related to SLK.
 
  (2)  Primarily related to Ayco.
 
       Identifiable Intangible Assets. We amortize our identifiable intangible assets over their estimated useful lives in accordance with SFAS No. 142, and test for potential impairment whenever events or changes in circumstances suggest that an asset’s or asset group’s carrying value may not be fully recoverable in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” An impairment loss, calculated as the difference between the estimated fair value and the carrying value of an asset or asset group, is recognized if the sum of the estimated undiscounted cash flows relating to the asset or asset group is less than the corresponding carrying value.

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       The following table sets forth the carrying value and range of remaining useful lives of our identifiable intangible assets by major asset class:
Identifiable Intangible Assets by Asset Class
($ in millions)
                     
    As of November
     
    2006   2005
         
        Range of Remaining    
    Carrying   Useful Lives   Carrying
    Value   (in years)   Value
             
Customer lists (1)
  $ 737     5 – 19   $ 777  
Power contracts (2)
    667     2 – 22     481  
New York Stock Exchange (NYSE) specialist rights
    542       15 (5)     580  
Insurance-related assets (3)
    362     7      
Exchange-traded fund (ETF) specialist rights
    105     21     111  
Other (4)
    89     1 – 7     106  
                     
Total
  $ 2,502         $ 2,055  
                     
 
 
  (1)  Primarily includes our clearance and execution and NASDAQ customer lists related to SLK and financial counseling customer lists related to Ayco.
 
  (2)  Primarily relates to above-market power contracts of consolidated power generation facilities related to Cogentrix and NEGT. Substantially all of these power contracts have been pledged to counterparties in connection with our secured financings. The increase in the carrying value of power contracts in 2006 was due to a restructuring of certain contracts, which resulted in the consolidation of the associated power generation facilities that had been previously accounted for under the equity method.
 
  (3)  Consists of the value of business acquired (VOBA) and deferred acquisition costs (DAC). VOBA represents the present value of estimated future gross profits of the variable annuity and variable life insurance business acquired in 2006. DAC results from commissions paid by Goldman Sachs to the primary insurer (ceding company) on life and annuity reinsurance agreements as compensation to place the business with us and to cover the ceding company’s acquisition expenses. VOBA and DAC are amortized over the estimated life of the underlying contracts based on estimated gross profits, and amortization is adjusted based on actual experience. The seven year useful life represents the weighted average remaining amortization period of the underlying contracts (certain of which extend for approximately 30 years).
 
  (4)  Primarily includes technology-related and other assets related to SLK.
 
  (5)  During the first quarter of 2006, we reduced the estimated useful lives of our NYSE specialist rights from 22-24 years to 16 years. This change was due to higher than expected attrition in acquired NYSE specialist rights, primarily from mergers and delistings.
 
       A prolonged period of weakness in global equity markets and the trading of securities in multiple markets and on multiple exchanges could adversely impact our businesses and impair the value of our goodwill and/or identifiable intangible assets. In addition, certain events could indicate a potential impairment of our identifiable intangible assets, including (i) changes in market structure that could adversely affect our specialist businesses, (ii) an adverse action or assessment by a regulator, (iii) a default event under a power contract or physical damage or other adverse events impacting the underlying power generation facilities, or (iv) adverse actual experience on the contracts in our variable annuity and variable life insurance business.

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Use of Estimates
       The use of generally accepted accounting principles requires management to make certain estimates. In addition to the estimates we make in connection with fair value measurements and the accounting for goodwill and identifiable intangible assets, the use of estimates is also important in determining provisions for potential losses that may arise from litigation and regulatory proceedings and tax audits.
       We estimate and provide for potential losses that may arise out of litigation and regulatory proceedings and tax audits to the extent that such losses are probable and can be estimated, in accordance with SFAS No. 5, “Accounting for Contingencies.” Significant judgment is required in making these estimates and our final liabilities may ultimately be materially different. Our total liability in respect of litigation and regulatory proceedings is determined on a case-by-case basis and represents an estimate of probable losses after considering, among other factors, the progress of each case or proceeding, our experience and the experience of others in similar cases or proceedings, and the opinions and views of legal counsel. Given the inherent difficulty of predicting the outcome of our litigation and regulatory matters, particularly in cases or proceedings in which substantial or indeterminate damages or fines are sought, we cannot estimate losses or ranges of losses for cases or proceedings where there is only a reasonable possibility that a loss may be incurred. See “— Legal Proceedings” in Part I, Item 3 of the Annual Report on Form 10-K, for information on our judicial, regulatory and arbitration proceedings.
Results of Operations
       The composition of our net revenues has varied over time as financial markets and the scope of our operations have changed. The composition of net revenues can also vary over the shorter term due to fluctuations in U.S. and global economic and market conditions. For a further discussion of the impact of economic and market conditions on our results of operations, see “— Certain Risk Factors That May Affect Our Business” above, and “Risk Factors” in Part I, Item 1A of the Annual Report on Form 10-K.

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Financial Overview
       The following table sets forth an overview of our financial results:
Financial Overview
($ in millions, except per share amounts)
                         
    Year Ended November
     
    2006   2005   2004
             
Net revenues (1)
  $ 37,665     $ 25,238     $ 20,951  
Pre-tax earnings
    14,560       8,273       6,676  
Net earnings
    9,537       5,626       4,553  
Net earnings applicable to common shareholders
    9,398       5,609       4,553  
Diluted earnings per common share
    19.69       11.21       8.92  
Return on average common shareholders’ equity (2)
    32.8 %     21.8 %     19.8 %
Return on average tangible common shareholders’ equity (3)
    39.8 %     26.7 %     25.2 %
 
 
  (1)  Beginning in the fourth quarter of 2006, “Cost of power generation” in the consolidated statements of earnings was reclassified to operating expenses. “Cost of power generation” was previously reported as a reduction to revenues. Prior periods have been reclassified to conform to the current presentation, with no impact to our reported net earnings.
  (2)   Return on average common shareholders’ equity is computed by dividing net earnings applicable to common shareholders by average monthly common shareholders’ equity.
  (3)  Tangible common shareholders’ equity equals total shareholders’ equity less preferred stock, goodwill and identifiable intangible assets, excluding power contracts. In 2006, we amended our calculation of tangible common shareholders’ equity. We no longer deduct identifiable intangible assets associated with power contracts from total shareholders’ equity because, unlike other intangible assets, less than 50% of these assets are supported by common shareholders’ equity. Prior periods have been adjusted to conform to the current presentation.
  We believe that return on average tangible common shareholders’ equity is meaningful because it measures the performance of businesses consistently, whether they were acquired or developed internally. Return on average tangible common shareholders’ equity is computed by dividing net earnings applicable to common shareholders by average monthly tangible common shareholders’ equity.
 
  The following table sets forth a reconciliation of average total shareholders’ equity to average tangible common shareholders’ equity:
                         
    Average for the
    Year Ended November
     
    2006   2005   2004
             
    (in millions)
Total shareholders’ equity
  $ 31,048     $ 26,264     $ 22,975  
Preferred stock
    (2,400 )     (538 )      
                         
Common shareholders’ equity
  $ 28,648     $ 25,726     $ 22,975  
Goodwill and identifiable intangible assets, excluding power contracts
    (5,013 )     (4,737 )     (4,918 )
                         
Tangible common shareholders’ equity
  $ 23,635     $ 20,989     $ 18,057  
                         

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  Net Revenues
       2006 versus 2005. Our net revenues were $37.67 billion in 2006, an increase of 49% compared with 2005, reflecting significantly higher net revenues in Trading and Principal Investments, Investment Banking, and Asset Management and Securities Services. The increase in Trading and Principal Investments reflected significantly higher net revenues in FICC, Equities and Principal Investments. The increase in FICC reflected particularly strong performances across all major businesses. During 2006, FICC operated in an environment characterized by strong customer-driven activity and favorable market opportunities. In addition, corporate credit spreads tightened, the yield curve flattened and volatility levels were generally low in interest rate and currency markets. The increase in Equities primarily reflected significantly higher net revenues in our customer franchise business. During 2006, Equities operated in a favorable environment characterized by strong customer-driven activity, generally higher equity prices and favorable market opportunities, although volatility levels were generally low. The increase in Principal Investments reflected a significant gain related to our investment in the ordinary shares of ICBC and higher gains and overrides from other principal investments, partially offset by a smaller, but still significant, gain related to our investment in the convertible preferred stock of SMFG. The increase in Investment Banking was due to significantly higher net revenues in Underwriting and Financial Advisory, as we benefited from strong client activity levels, reflecting favorable equity and financing markets, strong CEO confidence and growth in financial sponsor activity. The increase in Asset Management and Securities Services was primarily due to higher assets under management and significantly higher incentive fees, as well as significantly higher global customer balances in Securities Services. Assets under management increased $144 billion or 27% to a record $676 billion, including net asset inflows of $94 billion during 2006.
       2005 versus 2004. Our net revenues were $25.24 billion in 2005, an increase of 20% compared with 2004, reflecting strong growth in Trading and Principal Investments and Asset Management and Securities Services as well as higher net revenues in Investment Banking. The increase in Trading and Principal Investments reflected significantly higher net revenues in FICC, as all major businesses performed well. During 2005, FICC operated in an environment generally characterized by strong customer-driven activity, tight, but volatile, credit spreads, higher energy prices and a flatter yield curve. Net revenues in Equities also improved significantly compared with the prior year, reflecting strong performance across the business. Equities operated in an environment characterized by generally higher equity prices, improved customer-driven activity and continued low levels of market volatility. Net revenues in our Principal Investments business also increased significantly, primarily reflecting a gain on our investment in the convertible preferred stock of SMFG as well as gains from real estate principal investments. The strong net revenue growth in Asset Management and Securities Services primarily reflected higher assets under management and higher customer balances in Securities Services. The increase in Investment Banking net revenues was due to significantly higher net revenues in debt underwriting and improved results in Financial Advisory, primarily reflecting an increase in industry-wide corporate activity, partially offset by lower net revenues in equity underwriting.

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  Operating Expenses
       Our operating expenses are primarily influenced by compensation, headcount and levels of business activity. A substantial portion of our compensation expense represents discretionary bonuses which are significantly impacted by, among other factors, the level of net revenues, prevailing labor markets, business mix and the structure of our share-based compensation programs. For 2006, our ratio of compensation and benefits to net revenues was 43.7%. Excluding non-cash expenses of $637 million related to the continued amortization of prior year share-based awards held by employees that were retirement-eligible on the date of adoption of SFAS No. 123-R, our ratio of compensation and benefits to net revenues was 42.0% (1).
 
(1)  Our ratio of compensation and benefits to net revenues, excluding the impact of the continued amortization of these share-based awards, is computed by dividing compensation and benefits, excluding the impact of the continued amortization of these prior year share-based awards held by employees that were retirement-eligible on the date of adoption of SFAS No. 123-R, by net revenues. We believe that presenting the ratio of compensation and benefits to net revenues excluding the impact of the continued amortization of these awards enhances the comparability of period-to-period compensation and benefits and allows for a more meaningful representation of the relationship of current period compensation to net revenues. The following table sets forth the reconciliation of the ratio of compensation and benefits to net revenues, as reported, to the ratio of compensation and benefits to net revenues excluding the impact of the continued amortization of these prior year share-based awards:
         
    Year Ended
    November 2006
     
    ($ in millions)
Compensation and benefits
  $ 16,457  
Impact of the continued amortization of prior year share-based awards
    (637 )
         
Compensation and benefits, excluding the impact of the continued amortization of prior year share-based awards
  $ 15,820  
         
Net revenues
  $ 37,665  
Ratio of compensation and benefits to net revenues, excluding the impact of the continued amortization of prior year share-based awards
    42.0%  

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       The following table sets forth our operating expenses and number of employees:
Operating Expenses and Employees
($ in millions)
                         
    Year Ended November
     
    2006   2005   2004
             
Compensation and benefits (1) (2)
  $ 16,457     $ 11,758     $ 9,681  
 
Brokerage, clearing, exchange and distribution fees (3)
    1,985       1,416       1,172  
Market development
    492       378       374  
Communications and technology
    544       490       461  
Depreciation and amortization
    521       501       499  
Amortization of identifiable intangible assets
    173       124       125  
Occupancy
    850       728       646  
Professional fees
    545       475       338  
Cost of power generation (2)
    406       386       372  
Other expenses (3)
    1,132       709       607  
                         
Total non-compensation expenses
    6,648       5,207       4,594  
                         
Total operating expenses
  $ 23,105     $ 16,965     $ 14,275  
                         
 
Employees at year end (4) (5)
    26,467       23,623       21,736  
 
 
  (1)  Compensation and benefits includes $259 million, $137 million and $19 million for the years ended November 2006, November 2005 and November 2004, respectively, attributable to consolidated entities held for investment purposes. Consolidated entities held for investment purposes are entities that are held strictly for capital appreciation, have a defined exit strategy and are engaged in activities that are not closely related to our principal businesses.
 
  (2)  Beginning in the fourth quarter of 2006, “Cost of power generation” in the consolidated statements of earnings was reclassified to operating expenses. “Cost of power generation” was previously reported as a reduction to revenues. Compensation and benefits includes direct employee costs associated with our consolidated power generation facilities and cost of power generation includes the other direct costs associated with these power generation facilities and related contractual assets. Prior periods have been reclassified to conform to the current presentation, with no impact to our reported net earnings. This reclassification increased operating expenses as follows:
                         
    Year Ended
    November
     
    2006   2005   2004
             
    (in millions)
Compensation and benefits
  $ 78     $ 70     $ 29  
Cost of power generation
    406       386       372  
                         
Total
  $ 484     $ 456     $ 401  
                         
  (3)  Beginning in the fourth quarter of 2006, third party research and brokerage fees and asset management sales and distribution fees were reclassified from “Other expenses” to “Brokerage, clearing, exchange and distribution fees” in the consolidated statements of earnings. Prior periods have been reclassified to conform to the current presentation.
 
  (4)  Excludes 3,868, 7,382 and 485 employees as of November 2006, November 2005 and November 2004, respectively, of consolidated entities held for investment purposes (see footnote 1 above).
 
  (5)  Includes 1,326 employees as of November 2006 of Goldman Sachs’ consolidated property management and loan servicing subsidiaries. November 2005 and November 2004 have been adjusted to conform to the current presentation and include 1,198 and 1,014 employees, respectively.

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       The following table sets forth non-compensation expenses of consolidated entities held for investment purposes and our remaining non-compensation expenses by line item:
Non-Compensation Expenses
(in millions)
                         
    Year Ended November
     
    2006   2005   2004
             
Non-compensation expenses of consolidated investments (1)
  $ 501     $ 265     $ 21  
Non-compensation expenses excluding consolidated investments
                       
Brokerage, clearing, exchange and distribution fees (2)
    1,985       1,416       1,172  
Market development
    461       361       374  
Communications and technology
    537       487       461  
Depreciation and amortization
    444       467       499  
Amortization of identifiable intangible assets
    169       124       125  
Occupancy
    738       674       646  
Professional fees
    534       468       338  
Cost of power generation (3)
    406       386       372  
Other expenses (2)
    873       559       586  
                         
Subtotal
    6,147       4,942       4,573  
                         
Total non-compensation expenses, as reported
  $ 6,648     $ 5,207     $ 4,594  
                         
 
 
  (1)  Consolidated entities held for investment purposes are entities that are held strictly for capital appreciation, have a defined exit strategy and are engaged in activities that are not closely related to our principal businesses. For example, these investments include consolidated entities that hold real estate assets, such as golf courses and hotels in Asia, but exclude investments in entities that primarily hold financial assets. We believe that it is meaningful to review non-compensation expenses excluding expenses related to these consolidated entities in order to evaluate trends in non-compensation expenses related to our principal business activities. Revenues related to such entities are included in “Trading and principal investments” in the consolidated statements of earnings.
 
  (2)  Beginning in the fourth quarter of 2006, third party research and brokerage fees and asset management sales and distribution fees were reclassified from “Other expenses” to “Brokerage, clearing, exchange and distribution fees” in the consolidated statements of earnings. Prior periods have been reclassified to conform to the current presentation.
 
  (3)  Beginning in the fourth quarter of 2006, “Cost of power generation” in the consolidated statements of earnings was reclassified to operating expenses. “Cost of power generation” was previously reported as a reduction to revenues. Prior periods have been reclassified to conform to the current presentation, with no impact to our reported net earnings.

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       2006 versus 2005. Operating expenses were $23.11 billion for 2006, 36% higher than 2005. Compensation and benefits expenses of $16.46 billion increased 40% compared with 2005, primarily reflecting increased discretionary compensation due to higher net revenues, and increased levels of employment. The ratio of compensation and benefits to net revenues for 2006 was 43.7% (1) compared with 46.6% (1) for 2005. This lower ratio primarily reflected our strong net revenues in 2006. Employment levels increased 12% compared with November 2005.
       In the first quarter of 2006, we adopted SFAS No. 123-R, which requires that share-based awards granted to retirement-eligible employees be expensed in the year of grant. In addition to expensing current year awards, prior year awards must continue to be amortized over the relevant service period. Therefore, our compensation and benefits in 2006 included (and, to a lesser extent, 2007 and 2008 will include) both amortization of prior year share-based awards held by employees that were retirement-eligible on the date of adoption of SFAS No. 123-R and new awards granted to those employees.
       Compensation and benefits expenses in 2006 included $637 million in continued amortization of prior year awards held by employees that were retirement-eligible on the date of adoption of SFAS No. 123-R. This amount represents the majority of the expense to be recognized with respect to these awards.
       Non-compensation expenses of $6.65 billion for 2006 increased 28% compared with 2005. Excluding non-compensation expenses related to consolidated entities held for investment purposes, non-compensation expenses were 24% higher than 2005, primarily due to higher brokerage, clearing, exchange and distribution fees in Equities and FICC, and increased other expenses, primarily due to costs related to our insurance business, which was acquired in 2006. In addition, market development costs and professional fees were higher, reflecting increased levels of business activity, and occupancy expenses increased, primarily reflecting new office space and higher facility expenses.
       2005 versus 2004. Operating expenses were $16.97 billion for 2005, 19% above 2004. Compensation and benefits expenses of $11.76 billion increased 21% compared with 2004, resulting from higher discretionary compensation, reflecting higher net revenues, and increased levels of employment. The ratio of compensation and benefits to net revenues for 2005 was 46.6%(1) compared with 46.2% (1) for 2004. Employment levels increased 9% compared with November 2004.
       Non-compensation expenses of $5.21 billion for 2005 increased 13% compared with 2004. Excluding non-compensation expenses related to consolidated entities held for investment purposes, non-compensation expenses were 8% higher than 2004, primarily due to higher brokerage, clearing, exchange and distribution fees, reflecting higher transaction volumes in FICC and Equities, and increased professional fees, reflecting higher legal and consulting fees.
       Non-compensation expenses in 2005 included $37 million of net provisions for litigation and regulatory proceedings (included in other expenses) and $36 million of real estate costs associated with the relocation of office space (included in occupancy). Non-compensation expenses in 2004 included $103 million of net provisions for litigation and regulatory proceedings, $62 million in connection with the establishment of our joint venture in China (included in market development) and $41 million of real estate exit costs associated with reductions in our office space (included in occupancy and depreciation and amortization).

 
(1)  The effect of the cost of power generation reclassification on the ratio of compensation and benefits to net revenues was to decrease the ratio by approximately 30 basis points, 60 basis points and 50 basis points for 2006, 2005 and 2004, respectively.

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  Provision for Taxes
       The effective income tax rate was 34.5% for 2006, up from 32.0% for 2005. The increase in the effective income tax rate for 2006 compared with 2005 was primarily related to a reduction in the impact of permanent benefits due to higher levels of earnings in 2006 and audit settlements in 2005. The effective income tax rate for 2005 was 32.0% compared with 31.8% for 2004. Excluding the impact of audit settlements in 2005, the effective income tax rate for 2005 would have been 33.3% (1). Excluding the impact of audit settlements, the increase in the effective income tax rate for 2005 compared with 2004 was primarily due to a lower benefit from tax credits in 2005.
       Our effective income tax rate can vary from period to period depending on, among other factors, the geographic and business mix of our earnings, the level of our tax credits and the effect of tax audits. Certain of these and other factors, including our history of pre-tax earnings, are taken into account in assessing our ability to realize our net deferred tax assets. See Note 14 to the consolidated financial statements in Part II, Item 8 of the Annual Report on Form 10-K for further information regarding our provision for taxes.
 
(1)  The effective income tax rate excluding the impact of audit settlements is calculated by dividing the provision for taxes, adjusted to exclude the impact of audit settlements, by pre-tax earnings. The impact of audit settlements decreased the effective income tax rate by 1.3% for 2005. We believe that the effective income tax rate excluding the impact of audit settlements provides a meaningful basis for period-to-period comparisons of our effective income tax rates.

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Segment Operating Results
       The following table sets forth the net revenues, operating expenses and pre-tax earnings of our segments:
Segment Operating Results
(in millions)
                             
        Year Ended November
         
        2006   2005   2004
                 
Investment Banking
  Net revenues   $ 5,629     $ 3,671     $ 3,374  
    Operating expenses     4,062       3,258       2,973  
                             
    Pre-tax earnings   $ 1,567     $ 413     $ 401  
                             
 
Trading and Principal
  Net revenues (1)   $ 25,562     $ 16,818     $ 13,728  
Investments
  Operating expenses (1)     14,962       10,600       8,688  
                             
    Pre-tax earnings   $ 10,600     $ 6,218     $ 5,040  
                             
 
Asset Management and
  Net revenues   $ 6,474     $ 4,749     $ 3,849  
Securities Services
  Operating expenses     4,036       3,070       2,430  
                             
    Pre-tax earnings   $ 2,438     $ 1,679     $ 1,419  
                             
 
Total
  Net revenues (1)   $ 37,665     $ 25,238     $ 20,951  
    Operating expenses (1) (2)     23,105       16,965       14,275  
                             
    Pre-tax earnings   $ 14,560     $ 8,273     $ 6,676  
                             
 
 
  (1)  Beginning in the fourth quarter of 2006, “Cost of power generation” in the consolidated statements of earnings was reclassified to operating expenses. “Cost of power generation” was previously reported as a reduction to revenues. Prior periods have been reclassified to conform to the current presentation, with no impact to our reported pre-tax earnings.
 
  (2)  Includes the following expenses that have not been allocated to our segments: (i) net provisions for a number of litigation and regulatory proceedings of $45 million, $37 million and $103 million for the years ended November 2006, November 2005 and November 2004, respectively; (ii) $62 million in connection with the establishment of our joint venture in China for the year ended November 2004; and (iii) the amortization of employee initial public offering awards, net of forfeitures, of $19 million for the year ended November 2004.
 
       Net revenues in our segments include allocations of interest income and interest expense to specific securities, commodities and other positions in relation to the cash generated by, or funding requirements of, such underlying positions. See Note 16 to the consolidated financial statements in Part II, Item 8 of the Annual Report on Form 10-K for further information regarding our segments.
       The cost drivers of Goldman Sachs taken as a whole — compensation, headcount and levels of business activity — are broadly similar in each of our business segments. Compensation and benefits expenses within our segments reflect, among other factors, the overall performance of Goldman Sachs as well as the performance of individual business units. Consequently, pre-tax margins in one segment of our business may be significantly affected by the performance of our other business segments. A discussion of segment operating results follows.

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  Investment Banking
       Our Investment Banking segment is divided into two components:
  •  Financial Advisory. Financial Advisory includes advisory assignments with respect to mergers and acquisitions, divestitures, corporate defense activities, restructurings and spin-offs.
 
  •  Underwriting. Underwriting includes public offerings and private placements of a wide range of securities and other financial instruments.
       The following table sets forth the operating results of our Investment Banking segment:
Investment Banking Operating Results
(in millions)
                           
    Year Ended November
     
    2006   2005   2004
             
Financial Advisory
  $ 2,580     $ 1,905     $ 1,737  
 
  Equity underwriting
    1,365       704       819  
 
  Debt underwriting
    1,684       1,062       818  
                         
Total Underwriting
    3,049       1,766       1,637  
                         
Total net revenues
    5,629       3,671       3,374  
Operating expenses
    4,062       3,258       2,973  
                         
Pre-tax earnings
  $ 1,567     $ 413     $ 401  
                         
 
       The following table sets forth our financial advisory and underwriting transaction volumes:
Goldman Sachs Global Investment Banking Volumes (1)
(in billions)
                         
    Year Ended November
     
    2006   2005   2004
             
Announced mergers and acquisitions
  $ 1,112     $ 807     $ 395  
Completed mergers and acquisitions
    858       588       503  
Equity and equity-related offerings (2)
    76       49       54  
Debt offerings (3)
    302       270       236  
 
 
  (1)  Source: Thomson Financial. Announced and completed mergers and acquisitions volumes are based on full credit to each of the advisors in a transaction. Equity and equity-related offerings and debt offerings are based on full credit for single book managers and equal credit for joint book managers. Transaction volumes may not be indicative of net revenues in a given period.
 
  (2)  Includes public common stock offerings, convertible offerings, rights offerings and Rule 144A issues.
 
  (3)  Includes non-convertible preferred stock, mortgage-backed securities, asset-backed securities and taxable municipal debt. Includes publicly registered and Rule 144A issues.
 
       2006 versus 2005. Net revenues in Investment Banking of $5.63 billion for 2006 increased 53% compared with 2005. Net revenues in Financial Advisory of $2.58 billion increased 35% compared with 2005, primarily reflecting strong growth in industry-wide completed mergers and acquisitions. Net revenues in our Underwriting business of $3.05 billion increased 73% compared with 2005. Net revenues were significantly higher in equity underwriting, reflecting increased client

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activity. Net revenues were also significantly higher in debt underwriting, primarily due to a significant increase in leveraged finance activity and, to a lesser extent, an increase in investment-grade activity. Our investment banking backlog at the end of 2006 was at its highest level since 2000. (1)
       Operating expenses of $4.06 billion for 2006 increased 25% compared with 2005, substantially all of which was due to increased compensation and benefits expenses resulting from higher levels of discretionary compensation. Pre-tax earnings were $1.57 billion in 2006 compared with $413 million in 2005.
       2005 versus 2004. Net revenues in Investment Banking of $3.67 billion for 2005 increased 9% compared with 2004. Net revenues in Financial Advisory of $1.91 billion increased 10% compared with 2004, primarily reflecting an increase in industry-wide completed mergers and acquisitions. Net revenues in our Underwriting business of $1.77 billion increased 8% compared with 2004, reflecting higher net revenues in debt underwriting, primarily due to an increase in leveraged finance and mortgage activity, partially offset by lower net revenues in equity underwriting. Our investment banking backlog at the end of 2005 was significantly higher than at the end of 2004. (1)
       Operating expenses of $3.26 billion for 2005 increased 10% compared with 2004, primarily due to increased compensation and benefits expenses resulting from higher levels of discretionary compensation and increased amortization expense related to prior year equity awards. In addition, professional fees were higher, principally due to increased legal and consulting fees. Pre-tax earnings of $413 million in 2005 increased 3% compared with 2004.
Trading and Principal Investments
       Our Trading and Principal Investments segment is divided into three components:
  •  FICC. We make markets in and trade interest rate and credit products, mortgage-related securities and loan products, currencies and commodities, structure and enter into a wide variety of derivative transactions and engage in proprietary trading and investing.
 
  •  Equities. We make markets in, trade and act as a specialist for equities and equity-related products, structure and enter into equity derivative transactions and engage in proprietary trading and insurance activities. We also execute and clear client transactions on major stock, options and futures exchanges worldwide.
 
  •  Principal Investments. We make real estate and corporate principal investments, including our investments in the convertible preferred stock of SMFG and the ordinary shares of ICBC. We generate net revenues from returns on these investments and from the increased share of the income and gains derived from our merchant banking funds when the return on a fund’s investments, over the life of the fund, exceeds certain threshold returns (overrides).
       Substantially all of our inventory is marked-to-market daily and, therefore, its value and our net revenues are subject to fluctuations based on market movements. In addition, net revenues derived from our principal investments in privately held concerns and in real estate may fluctuate significantly depending on the revaluation or sale of these investments in any given period. We also regularly enter into large transactions as part of our trading businesses. The number and size of such transactions may affect our results of operations in a given period.
       Net revenues from Principal Investments do not include management fees generated from our merchant banking funds. These management fees are included in the net revenues of the Asset Management and Securities Services segment.
 
(1)  Our investment banking backlog represents an estimate of our future net revenues from investment banking transactions where we believe that future revenue realization is more likely than not.

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       The following table sets forth the operating results of our Trading and Principal Investments segment:
Trading and Principal Investments Operating Results
(in millions)
                             
    Year Ended November
     
    2006   2005   2004
             
FICC (1)
  $ 14,262     $ 8,940     $ 7,723  
 
Equities trading
    4,965       2,675       1,969  
 
Equities commissions
    3,518       2,975       2,704  
                         
Total Equities
    8,483       5,650       4,673  
 
SMFG
    527       1,475       771  
 
ICBC
    937              
 
Gross gains
    1,534       767       855  
 
Gross losses (2)
    (585 )     (198 )     (399 )
                         
   
Net other corporate and real estate investments
    949       569       456  
 
Overrides
    404       184       105  
                         
Total Principal Investments
    2,817       2,228       1,332  
                         
Total net revenues (1)
    25,562       16,818       13,728  
Operating expenses (1)
    14,962       10,600       8,688  
                         
Pre-tax earnings
  $ 10,600     $ 6,218     $ 5,040  
                         
 
 
  (1)  Beginning in the fourth quarter of 2006, “Cost of power generation” in the consolidated statements of earnings was reclassified to operating expenses. “Cost of power generation” was previously reported as a reduction to revenues. Prior periods have been reclassified to conform to the current presentation, with no impact to our reported pre-tax earnings.
 
  (2)  A substantial portion relates to interest expense on our principal investments.
 
       2006 versus 2005. Net revenues in Trading and Principal Investments of $25.56 billion for 2006 increased 52% compared with 2005. Net revenues in FICC of $14.26 billion increased 60% compared with 2005, primarily due to significantly higher net revenues in credit products (which includes distressed investing) and commodities. In addition, net revenues were higher in interest rate products, currencies and mortgages. During 2006, the business operated in an environment characterized by strong customer-driven activity and favorable market opportunities. In addition, corporate credit spreads tightened, the yield curve flattened and volatility levels were generally low in interest rate and currency markets. Net revenues in Equities of $8.48 billion increased 50% compared with 2005, primarily reflecting significantly higher net revenues in derivatives, across all regions, as well as higher net revenues in shares. The increase also reflected the contribution from our insurance business, which was acquired in 2006. In addition, principal strategies performed well, although net revenues were lower than a particularly strong 2005. During 2006, Equities operated in a favorable environment characterized by strong customer-driven activity, generally higher equity prices and favorable market opportunities, although volatility levels were generally low. Principal Investments recorded net revenues of $2.82 billion, reflecting a $937 million gain related to our investment in the ordinary shares of ICBC, a $527 million gain related to our investment in the convertible preferred stock of SMFG and $1.35 billion in gains and overrides from other principal investments.

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       Operating expenses of $14.96 billion for 2006 increased 41% compared with 2005, due to increased compensation and benefits expenses, primarily resulting from higher levels of discretionary compensation due to higher net revenues and increased levels of employment, as well as higher non-compensation expenses. Excluding non-compensation expenses related to consolidated entities held for investment purposes, the increase in non-compensation expenses was primarily due to higher brokerage, clearing, exchange and distribution fees, in Equities and FICC, and increased other expenses, primarily due to costs related to our insurance business, which was acquired in 2006, and higher levels of business activity. In addition, professional fees were higher, due to increased legal and consulting fees. Pre-tax earnings of $10.60 billion in 2006 increased 70% compared with 2005.
       2005 versus 2004. Net revenues in Trading and Principal Investments of $16.82 billion for 2005 increased 23% compared with 2004. Net revenues in FICC of $8.94 billion increased 16% compared with 2004, primarily reflecting significantly higher net revenues in credit products (which includes distressed investing) and, to a lesser extent, interest rate products and currencies. Net revenues in commodities and mortgages were strong, but essentially unchanged compared with 2004. During 2005, FICC operated in an environment generally characterized by strong customer-driven activity, tight, but volatile, credit spreads, higher energy prices and a flatter yield curve. Net revenues in Equities of $5.65 billion increased 21% compared with 2004, reflecting significantly higher net revenues in our customer franchise and principal strategies businesses. The increase in our customer franchise business reflected improved results in derivatives and shares, particularly in Europe and Asia, as well as in convertibles. In addition, results in principal strategies reflected strength across all regions. During 2005, Equities operated in an environment characterized by generally higher equity prices, improved customer-driven activity and continued low levels of market volatility. Principal Investments recorded net revenues of $2.23 billion, due to a $1.48 billion gain related to our investment in the convertible preferred stock of SMFG and $753 million in gains and overrides from other corporate and, to a lesser extent, real estate principal investments.
       Operating expenses of $10.60 billion for 2005 increased 22% compared with 2004, primarily due to increased compensation and benefits expenses, reflecting higher discretionary compensation and increased levels of employment and, to a lesser extent, higher non-compensation expenses related to consolidated entities held for investment purposes. Excluding non-compensation expenses related to consolidated entities held for investment purposes, the increase in non-compensation expenses was primarily attributable to higher brokerage, clearing, exchange and distribution fees, principally due to increased transaction volumes in FICC and Equities, and higher professional fees, due to increased legal and consulting fees. Pre-tax earnings of $6.22 billion in 2005 increased 23% compared with 2004.
  Asset Management and Securities Services
       Our Asset Management and Securities Services segment is divided into two components:
  •  Asset Management. Asset Management provides investment advisory and financial planning services and offers investment products (primarily through separate accounts and funds) across all major asset classes to a diverse group of institutions and individuals worldwide and primarily generates revenues in the form of management and incentive fees.
 
  •  Securities Services. Securities Services provides prime brokerage services, financing services and securities lending services to institutional clients, including hedge funds, mutual funds, pension funds and foundations, and to high-net-worth individuals worldwide, and generates revenues primarily in the form of interest rate spreads or fees.

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       Assets under management typically generate fees as a percentage of asset value. In certain circumstances, we are also entitled to receive incentive fees based on a percentage of a fund’s return or when the return on assets under management exceeds specified benchmark returns or other performance targets. Incentive fees are recognized when the performance period ends and they are no longer subject to adjustment. We have numerous incentive fee arrangements, many of which have annual performance periods that end on December 31. For that reason, incentive fees have been seasonally weighted to our first quarter. Based on investment performance in calendar 2006, our incentive fees will be significantly lower in fiscal 2007 than they were in fiscal 2006.
       The following table sets forth the operating results of our Asset Management and Securities Services segment:
Asset Management and Securities Services Operating Results
(in millions)
                           
    Year Ended November
     
    2006   2005   2004
             
 
Management and other fees
  $ 3,332     $ 2,629     $ 2,219  
 
Incentive fees
    962       327       334  
                         
Total Asset Management
    4,294       2,956       2,553  
Securities Services
    2,180       1,793       1,296  
                         
Total net revenues
    6,474       4,749       3,849  
Operating expenses
    4,036       3,070       2,430  
                         
Pre-tax earnings
  $ 2,438     $ 1,679     $ 1,419  
                         
 
       Assets under management include our mutual funds, alternative investment funds and separately managed accounts for institutional and individual investors. Substantially all assets under management are valued as of calendar month end.
       The following table sets forth our assets under management by asset class:
Assets Under Management by Asset Class (1)
(in billions)
                         
    As of November 30
     
    2006   2005   2004
             
Alternative investments (2)
  $ 145     $ 110     $ 95  
Equity
    215       167       133  
Fixed income
    198       154       134  
                         
Total non-money market assets
    558       431       362  
Money markets
    118       101       90  
                         
Total assets under management
  $ 676     $ 532     $ 452  
                         
 
 
  (1)  In the first quarter of 2006, we changed the methodology for classifying certain non-money market assets. The changes were made primarily to reclassify certain assets allocated to external investment managers out of alternative investment assets and to reclassify currency funds into alternative investment assets. The changes did not impact total assets under management and prior periods have been reclassified to conform to the current presentation.
 
  (2)  Primarily includes hedge funds, private equity, real estate, currencies, commodities and asset allocation strategies.

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       The following table sets forth a summary of the changes in our assets under management:
Changes in Assets Under Management
(in billions)
                           
    Year Ended November 30
     
    2006   2005   2004
             
Balance, beginning of year
  $ 532     $ 452     $ 373  
 
Net asset inflows/ (outflows)
                       
 
Alternative investments
    32       11       27  
 
Equity
    16       25       13  
 
Fixed income
    29       16       11  
                         
Total non-money market net asset inflows/ (outflows)
    77       52       51  
 
Money markets
    17   (1)     11       1  
                         
Total net asset inflows/ (outflows)
    94   (2)     63       52  
 
Net market appreciation/ (depreciation)
    50       17       27  
                         
Balance, end of year
  $ 676     $ 532     $ 452  
                         
 
 
  (1)  Net of $8 billion transferred from assets under management to interest-bearing deposits at Goldman Sachs Bank USA, a wholly owned subsidiary of Group Inc. These deposits are not included in assets under management.
 
  (2)  Includes $3 billion of net asset inflows in connection with our December 30, 2005 acquisition of the variable annuity and variable life insurance business of The Hanover Insurance Group, Inc.
 
       2006 versus 2005. Net revenues in Asset Management and Securities Services of $6.47 billion for 2006 increased 36% compared with 2005. Asset Management net revenues of $4.29 billion increased 45% compared with 2005, reflecting significantly higher management and other fees, principally due to strong growth in assets under management, and significantly higher incentive fees. During the year, assets under management increased $144 billion or 27% to $676 billion, reflecting non-money market net asset inflows of $77 billion, spread across all asset classes, money market net asset inflows of $17 billion (1), and market appreciation of $50 billion, primarily in equity and fixed income assets. Securities Services net revenues of $2.18 billion increased 22% compared with 2005, as our prime brokerage business continued to generate strong results, primarily reflecting significantly higher global customer balances in securities lending and margin lending.
       Operating expenses of $4.04 billion for 2006 increased 31% compared with 2005, primarily due to increased compensation and benefits expenses, resulting from higher levels of discretionary compensation due to higher net revenues, and increased levels of employment. Non-compensation expenses also increased, primarily due to higher distribution fees (included in brokerage, clearing, exchange and distribution fees). In addition, market development costs were higher, reflecting increased levels of business activity. Pre-tax earnings of $2.44 billion increased 45% compared with 2005.
 
(1)  Net of $8 billion transferred from assets under management to interest-bearing deposits at Goldman Sachs Bank USA, a wholly owned subsidiary of Group Inc. These deposits are not included in assets under management.

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       2005 versus 2004. Net revenues in Asset Management and Securities Services of $4.75 billion for 2005 increased 23% compared with 2004. Asset Management net revenues of $2.96 billion increased 16% compared with 2004, primarily due to higher management fees, driven by growth in assets under management. During 2005, assets under management increased 18% to $532 billion, reflecting net asset inflows of $63 billion across all asset classes as well as market appreciation of $17 billion, primarily in equity assets. Securities Services net revenues of $1.79 billion for 2005 increased 38% compared with 2004, primarily reflecting significantly higher global customer balances in securities lending and margin lending.
       Operating expenses of $3.07 billion for 2005 increased 26% compared with 2004, primarily due to increased compensation and benefits expenses resulting from higher discretionary compensation and increased levels of employment. Other expenses also increased and professional fees were higher, principally due to increased consulting and legal fees. Pre-tax earnings of $1.68 billion increased 18% compared with 2004.
Geographic Data
       For a summary of the net revenues and pre-tax earnings of Goldman Sachs by geographic region, see Note 16 to the consolidated financial statements in Part II, Item 8 of the Annual Report on Form 10-K.
Off-Balance-Sheet Arrangements
       We have various types of off-balance-sheet arrangements that we enter into in the ordinary course of business. Our involvement in these arrangements can take many different forms, including purchasing or retaining residual and other interests in mortgage-backed and other asset-backed securitization vehicles; holding senior and subordinated debt, interests in limited and general partnerships, and preferred and common stock in other nonconsolidated vehicles; entering into interest rate, foreign currency, equity, commodity and credit derivatives, including total return swaps; entering into operating leases; and providing guarantees, indemnifications, loan commitments, letters of credit, representations and warranties.
       We enter into these arrangements for a variety of business purposes, primarily related to the securitization of commercial and residential mortgages, home equity and auto loans, government and corporate bonds, and other types of financial assets. Other reasons for entering into these arrangements include underwriting client securitization transactions; providing secondary market liquidity; making investments in performing and nonperforming debt, equity, real estate and other assets; providing investors with credit-linked and asset-repackaged notes; and receiving or providing letters of credit to satisfy margin requirements and to facilitate the clearance and settlement process.
       We engage in transactions with variable interest entities (VIEs) and qualifying special-purpose entities (QSPEs). Such vehicles are critical to the functioning of several significant investor markets, including the mortgage-backed and other 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. Our financial interests in, and derivative transactions with, such nonconsolidated entities are accounted for at fair value, in the same manner as our other financial instruments, except in cases where we apply the equity method of accounting.

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       The following table sets forth where a discussion of these and other off-balance-sheet arrangements may be found in Part II, Items 7 and 8 of the Annual Report on Form 10-K:
     
Type of Off-Balance-Sheet Arrangement   Disclosure in Annual Report on Form 10-K
 
Retained interests or contingent interests in assets transferred by us to nonconsolidated entities   See Note 3 to the consolidated financial statements in Part II, Item 8 of the Annual Report on Form 10-K.
 
Leases, letters of credit, and loans and other commitments   See “— Contractual Obligations and Commitments” below and Note 6 to the consolidated financial statements in Part II, Item 8 of the Annual Report on Form 10-K.
 
Guarantees   See Note 6 to the consolidated financial statements in Part II, Item 8 of the Annual Report on Form 10-K.
 
Other obligations, including contingent obligations, arising out of variable interests we have in nonconsolidated entities   See Note 3 to the consolidated financial statements in Part II, Item 8 of the Annual Report on Form 10-K.
 
Derivative contracts   See “— Critical Accounting Policies” above and “—Risk Management” below and Note 3 to the consolidated financial statements in Part II, Item 8 of the Annual Report on Form 10-K.
 
       In addition, see Note 2 to the consolidated financial statements in Part II, Item 8 of the Annual Report on Form 10-K for a discussion of our consolidation policies.
Equity Capital
       The level and composition of our equity capital are principally determined by our consolidated regulatory capital requirements, subsidiary capital requirements and rating agency guidelines. The equity capital we hold may also be influenced by the business environment, conditions in the financial markets and an assessment of potential future losses during an extremely adverse business and market environment. As of November 2006, our total shareholders’ equity was $35.79 billion (consisting of common shareholders’ equity of $32.69 billion and preferred stock of $3.10 billion) compared with total shareholders’ equity of $28.00 billion as of November 2005 (consisting of common shareholders’ equity of $26.25 billion and preferred stock of $1.75 billion). In addition to total shareholders’ equity, we consider the $2.75 billion of junior subordinated debt issued to a trust (see below) part of our equity capital, as it qualifies as capital for regulatory and certain rating agency purposes.
Consolidated Regulatory Capital Requirements
       During 2005, Goldman Sachs became regulated by the U.S. Securities and Exchange Commission (SEC) as a Consolidated Supervised Entity (CSE). As such, Goldman Sachs is subject to group-wide supervision and examination by the SEC and to minimum capital adequacy standards on a consolidated basis. Minimum capital adequacy standards are principally driven by the amount of our market risk, credit risk and operational risk as calculated by methodologies approved by the SEC. Eligible sources of regulatory capital include common equity and certain types of preferred stock, debt and hybrid instruments, including our junior subordinated debt issued to a trust. The recognition of preferred stock, debt and hybrid instruments as regulatory capital is subject to limitations. Goldman Sachs was in compliance with the CSE capital adequacy standards as of November 2006 and November 2005.

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Subsidiary Capital Requirements
       Many of our principal subsidiaries are subject to separate regulation and capital requirements in the United States and/or elsewhere. Goldman, Sachs & Co. and Goldman Sachs Execution & Clearing, L.P. are registered U.S. broker-dealers and futures commissions merchants, and their primary regulators include the SEC, the Commodity Futures Trading Commission, the Chicago Board of Trade, the NYSE, the National Association of Securities Dealers, Inc. and the National Futures Association. Goldman Sachs International, our regulated U.K. broker-dealer, is subject to regulation primarily by the U.K.’s Financial Services Authority. Goldman Sachs Japan Co., Ltd. (GSJCL), our regulated Japanese broker-dealer, is subject to regulation by Japan’s Financial Services Agency. Prior to October 1, 2006, Goldman Sachs (Japan) Ltd. (GSJL), the predecessor to GSJCL, was our primary regulated subsidiary based in Japan. Several other subsidiaries of Goldman Sachs are regulated by securities, investment advisory, banking, and other regulators and authorities around the world, such as the Federal Financial Supervisory Authority (BaFin) and the Bundesbank in Germany, Banque de France and the Autorité des Marchés Financiers in France, Banca d’Italia and the Commissione Nazionale per le Società e la Borsa (CONSOB) in Italy, the Swiss Federal Banking Commission, the Securities and Futures Commission in Hong Kong, the Monetary Authority of Singapore and the China Securities Regulatory Commission. Goldman Sachs Bank USA (GS Bank), a wholly owned industrial bank, is regulated by the Federal Deposit Insurance Corporation and the State of Utah Department of Financial Institutions and is subject to minimum capital requirements. As of November 2006 and November 2005, these subsidiaries were in compliance with their local capital requirements.
       As discussed above, many of our subsidiaries are subject to regulatory capital requirements in jurisdictions throughout the world. Subsidiaries not subject to separate regulation may hold capital to satisfy local tax guidelines, rating agency requirements or internal policies, including policies concerning the minimum amount of capital a subsidiary should hold based upon its underlying risk. For a discussion of our potential inability to access funds from our subsidiaries, see
“— Liquidity and Funding Risk — Conservative Liability Structure” below.
       Equity investments in subsidiaries are generally funded with parent company equity capital. As of November 2006, Group Inc.’s equity investment in subsidiaries was $32.58 billion compared with its total shareholders’ equity of $35.79 billion.
       Our capital invested in non-U.S. subsidiaries is generally exposed to foreign exchange risk, substantially all of which is managed primarily through the use of derivative contracts. In addition, we generally manage the non-trading exposure to foreign exchange risk that arises from transactions denominated in currencies other than the transacting entity’s functional currency.
       See Note 15 to the consolidated financial statements in Part II, Item 8 of the Annual Report on Form 10-K for further information regarding our regulated subsidiaries.

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Rating Agency Guidelines
       The credit rating agencies assign credit ratings to the obligations of The Goldman Sachs Group, Inc., which directly issues or guarantees substantially all of Goldman Sachs’ senior unsecured obligations. The level and composition of our equity capital are among the many factors considered in determining our credit ratings. Each agency has its own definition of eligible capital and methodology for evaluating capital adequacy, and assessments are generally based on a combination of factors rather than a single calculation. See “— Liquidity and Funding Risk — Credit Ratings” below for further information regarding our credit ratings.
Equity Capital Management
       Our objective is to maintain a sufficient level and optimize the composition of our equity capital. We manage our capital through repurchases of our common stock and issuances of preferred stock, junior subordinated debt issued to a trust and subordinated debt.
       Share Repurchase Program. We use our share repurchase program to help maintain the appropriate level of common equity and to substantially offset increases in share count over time resulting from employee share-based compensation. The repurchase program is effected primarily through regular open-market purchases and is influenced by our overall capital position (the comparison of our capital requirements to our available capital), general market conditions and the prevailing price and trading volumes of our common stock.
       The following table sets forth the level of share repurchases for the years ended November 2006 and November 2005:
                 
    As of November
     
    2006   2005
         
    (in millions, except per
    share amounts)
Number of shares repurchased
    50.23       63.73  
Total cost
  $ 7,817     $ 7,108  
Average cost per share
  $ 155.64     $ 111.57  
 
       As of November 2006, we were authorized to repurchase up to 52.6 million additional shares of common stock pursuant to our repurchase program. For additional information on our repurchase program, see “— Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” in Part II, Item 5 of the Annual Report on Form 10-K.

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       Preferred Stock. During 2006, Goldman Sachs issued 54,000 shares of perpetual Floating Rate Non-Cumulative Preferred Stock, Series D. As of November 2006, Goldman Sachs had 124,000 shares of perpetual non-cumulative preferred stock outstanding in four series as set forth in the following table:
Preferred Stock by Series
                                     
    Shares   Shares       Earliest   Redemption Value
Series   Issued   Authorized   Dividend Rate   Redemption Date   (in millions)
                     
  A       30,000       50,000     3 month LIBOR + 0.75%,
with floor of 3.75% per annum
  April 25, 2010   $ 750  
  B       32,000       50,000     6.20% per annum   October 31, 2010     800  
  C       8,000       25,000     3 month LIBOR + 0.75%,
with floor of 4% per annum
  October 31, 2010     200  
  D       54,000       60,000     3 month LIBOR + 0.67%,
with floor of 4% per annum
  May 24, 2011     1,350  
                                   
          124,000       185,000             $ 3,100  
                                   
 
       Each share of preferred stock has a par value of $0.01, has a liquidation preference of $25,000, is represented by 1,000 depositary shares and is redeemable at our option at a redemption price equal to $25,000 plus declared and unpaid dividends. Dividends on each series of preferred stock, if declared, are payable quarterly in arrears. Our ability to declare or pay dividends on, or purchase, redeem or otherwise acquire, our common stock is subject to certain restrictions in the event that we fail to pay or set aside full dividends on our preferred stock for the latest completed dividend period. All preferred stock also has a preference over our common stock upon liquidation.
       Junior Subordinated Debt Issued to a Trust. As of November 2006, we had outstanding junior subordinated debt issued to a trust of $2.75 billion, included in “Unsecured long-term borrowings” on the consolidated statements of financial condition. The inherent characteristics of these securities, including the long-term nature of the securities, our ability to defer coupon interest for up to ten consecutive semiannual periods and the subordinated nature of the obligations in our capital structure, are such that they qualify as regulatory capital for CSE purposes, and thus, are part of our equity capital.
       Subordinated Debt. Although not part of our shareholders’ equity, subordinated debt may be used to meet a portion of our consolidated minimum capital requirements as a CSE. As of November 2006, we had outstanding subordinated debt of $4.67 billion.

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Capital Ratios and Metrics
       The following table sets forth information on our assets, shareholders’ equity, leverage ratios and book value per common share:
                 
    As of November
     
    2006   2005
         
    ($ in millions, except per
    share amounts)
Total assets
  $ 838,201     $ 706,804  
Adjusted assets (1)
    541,033       466,500  
Total shareholders’ equity
    35,786       28,002  
Tangible equity capital (2)
    33,517       26,030  
Leverage ratio (3)
    23.4 x     25.2 x
Adjusted leverage ratio (4)
    16.1 x     17.9 x
Debt to equity ratio (5)
    3.4 x     3.0 x
Common shareholders’ equity
    32,686       26,252  
Tangible common shareholders’ equity (6)
    27,667       21,530  
Book value per common share (7)
  $ 72.62     $ 57.02  
Tangible book value per common share (8)
    61.47       46.76  
 
 
  (1)  Adjusted assets excludes (i) low-risk collateralized assets generally associated with our matched book and securities lending businesses (which we calculate by adding our securities borrowed and financial instruments purchased under agreements to resell, and then subtracting our nonderivative short positions), (ii) cash and securities we segregate for regulatory and other purposes and (iii) goodwill and identifiable intangible assets, excluding power contracts. In 2006, we amended our calculation of adjusted assets. We no longer deduct identifiable intangible assets associated with power contracts from total assets. We amended our calculation in order to be consistent with the calculation of tangible equity capital and the adjusted leverage ratio (see footnote 2 below). Prior periods have been adjusted to conform to the current presentation.

The following table sets forth a reconciliation of total assets to adjusted assets:
                     
        As of November
         
        2006   2005
             
        (in millions)
Total assets   $ 838,201     $ 706,804  
Deduct:
 
Securities borrowed
    (219,342 )     (191,800 )
   
Financial instruments purchased under agreements to resell
    (82,126 )     (83,619 )
Add:
 
Financial instruments sold, but not yet purchased, at fair value
    155,805       149,071  
   
Less derivative liabilities
    (65,496 )     (57,829 )
                     
   
Subtotal
    90,309       91,242  
Deduct:
 
Cash and securities segregated for regulatory and other purposes
    (80,990 )     (51,405 )
   
Goodwill and identifiable intangible assets, excluding power contracts
    (5,019 )     (4,722 )
                     
Adjusted assets   $ 541,033     $ 466,500  
                     
  (2)  Tangible equity capital equals total shareholders’ equity and junior subordinated debt issued to a trust less goodwill and identifiable intangible assets, excluding power contracts. In 2006, we amended our calculation of tangible equity capital. We no longer deduct identifiable intangible assets associated with power contracts from total shareholders’ equity because, unlike other intangible assets, less than 50% of these assets are supported by common shareholders’ equity. Prior periods have been adjusted to conform to the current presentation. We consider junior subordinated debt issued to a trust to be a component of our tangible equity capital base due to the inherent characteristics of these securities, including the long-term nature of the securities, our ability to defer coupon interest for up to ten consecutive semiannual periods and the subordinated nature of the obligations in our capital structure.

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  The following table sets forth the reconciliation of total shareholders’ equity to tangible equity capital:
                     
        As of November
         
        2006   2005
             
        (in millions)
Total shareholders’ equity   $ 35,786     $ 28,002  
Add:
 
Junior subordinated debt issued to a trust
    2,750       2,750  
Deduct:
 
Goodwill and identifiable intangible assets, excluding power contracts
    (5,019 )     (4,722 )
                     
Tangible equity capital   $ 33,517     $ 26,030  
                     
  (3)  Leverage ratio equals total assets divided by total shareholders’ equity.
 
  (4)  Adjusted leverage ratio equals adjusted assets divided by tangible equity capital. We believe that the adjusted leverage ratio is a more meaningful measure of our capital adequacy than the leverage ratio because it excludes certain low-risk collateralized assets that are generally supported with little or no capital and reflects the tangible equity capital deployed in our businesses.
 
  (5)  Debt to equity ratio equals unsecured long-term borrowings divided by total shareholders’ equity.
 
  (6)  Tangible common shareholders’ equity equals total shareholders’ equity less preferred stock, goodwill and identifiable intangible assets, excluding power contracts. In 2006, we amended our calculation of tangible common shareholders’ equity. We no longer deduct identifiable intangible assets associated with power contracts from total shareholders’ equity because, unlike other intangible assets, less than 50% of these assets are supported by common shareholders’ equity. Prior periods have been adjusted to conform to the current presentation.

The following table sets forth a reconciliation of total shareholders’ equity to tangible common shareholders’ equity:
                     
        As of November
         
        2006   2005
             
        (in millions)
Total shareholders’ equity   $ 35,786     $ 28,002  
Deduct:
 
Preferred stock
    (3,100 )     (1,750 )
                     
Common shareholders’ equity     32,686       26,252  
Deduct:
 
Goodwill and identifiable intangible assets, excluding power contracts
    (5,019 )     (4,722 )
                     
Tangible common shareholders’ equity   $ 27,667     $ 21,530  
                     
  (7)  Book value per common share is based on common shares outstanding, including restricted stock units granted to employees with no future service requirements, of 450.1 million and 460.4 million as of November 2006 and November 2005, respectively.
 
  (8)  Tangible book value per common share is computed by dividing tangible common shareholders’ equity by the number of common shares outstanding, including restricted stock units granted to employees with no future service requirements.

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Contractual Obligations and Commitments
       Goldman Sachs has contractual obligations to make future payments related to our unsecured long-term borrowings, secured long-term financings, long-term noncancelable lease agreements and purchase obligations and has commitments under a variety of commercial arrangements.
       The following table sets forth our contractual obligations by fiscal maturity date as of November 2006:
Contractual Obligations
(in millions)
                                     
        2008 -   2010 -   2012 -    
    2007   2009   2011   Thereafter   Total
                     
Unsecured long-term borrowings (1)(2)(3)
  $     $ 33,262     $ 20,043     $ 69,537     $122,842
Secured long-term financings (1)(2)(4)
          6,412       6,999       12,723     26,134
Minimum rental payments
    564       758       535       2,195     4,052
Purchase obligations (5)
    1,448       535       18       18     2,019
 
 
  (1)  Obligations maturing within one year of our financial statement date or redeemable within one year of our financial statement date at the option of the holder are excluded from this table and are treated as short-term obligations. See Note 3 to the consolidated financial statements in Part II, Item 8 of the Annual Report on Form 10-K for further information regarding our secured financings.
 
  (2)  Obligations that are repayable prior to maturity at the option of Goldman Sachs are reflected at their contractual maturity dates. Obligations that are redeemable prior to maturity at the option of the holder are reflected at the dates such options become exercisable.
 
  (3)  Includes $7.25 billion of hybrid financial instruments accounted for at fair value under SFAS No. 155 as of November 2006.
 
  (4)  Included in “Other secured financings” in the consolidated statements of financial condition.
 
  (5)  Primarily includes construction-related obligations.
 
       As of November 2006, our unsecured long-term borrowings were $122.84 billion and consisted principally of senior borrowings with maturities extending to 2036. See Note 5 to the consolidated financial statements in Part II, Item 8 of the Annual Report on Form 10-K for further information regarding our unsecured long-term borrowings.
       As of November 2006, our future minimum rental payments, net of minimum sublease rentals, under noncancelable leases were $4.05 billion. These lease commitments, principally for office space, expire on various dates through 2069. Certain agreements are subject to periodic escalation provisions for increases in real estate taxes and other charges. See Note 6 to the consolidated financial statements in Part II, Item 8 of the Annual Report on Form 10-K for further information regarding our leases.
       Our occupancy expenses include costs associated with office space held in excess of our current requirements. This excess space, the cost of which is charged to earnings as incurred, is being held for potential growth or to replace currently occupied space that we may exit in the future. We regularly evaluate our current and future space capacity in relation to current and projected staffing levels. We may incur exit costs in 2007 and thereafter to the extent we (i) reduce our space capacity or (ii) commit to, or occupy, new properties in the locations in which we operate and, consequently, dispose of existing space that had been held for potential growth. These exit costs may be material to our results of operations in a given period.
       As of November 2006 and November 2005, we had construction-related obligations of $1.63 billion and $579 million, respectively, including purchase obligations of $1.07 billion and

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$481 million, respectively, related to the development of wind energy projects. Construction-related obligations also include outstanding purchase obligations of $500 million and $47 million as of November 2006 and November 2005, respectively, related to our new world headquarters in New York City, which is expected to cost between $2.3 billion and $2.5 billion.
       The following table sets forth our commitments as of November 2006:
Commitments
(in millions)
                                             
    Commitment Amount by Fiscal Period of Expiration
     
        2008 -   2010 -   2012 -    
    2007   2009   2011   Thereafter   Total
                     
Commitments to extend credit
                                       
 
William Street program
  $ 1,540     $ 2,664     $ 13,442     $ 1,185     $ 18,831  
 
Other commercial lending:
                                       
   
Investment-grade
    4,606       1,463       1,535             7,604  
   
Non-investment-grade
    2,437       11,999       30,415       12,166       57,017  
 
Warehouse financing
    15,488       1,538                   17,026  
                                         
Total commitments to extend credit
    24,071       17,664       45,392       13,351       100,478  
Forward starting resale and securities borrowing agreements
    18,285                         18,285  
Forward starting repurchase and securities lending agreements
    17,148                         17,148  
Commitments under letters of credit issued by banks to counterparties
    5,714       4       1       15       5,734  
Merchant banking commitments
    4,058       457       487       1,353       6,355  
Underwriting commitments
    2,620                         2,620  
Other investment commitments
    356       1,201       143       182       1,882  
                                         
Total
  $ 72,252     $ 19,326     $ 46,023     $ 14,901     $ 152,502  
                                         
 
       Our commitments to extend credit are agreements to lend to counterparties that have fixed termination dates and are contingent on the satisfaction of all conditions to borrowing set forth in the contract. In connection with our lending activities, we had outstanding commitments to extend credit of $100.48 billion as of November 2006 compared with $61.12 billion as of November 2005. Since these commitments may expire unused or be reduced or cancelled at the counterparty’s request, the total commitment amount does not necessarily reflect the actual future cash flow requirements. Our commercial lending commitments outside the William Street credit extension program are generally extended in connection with contingent acquisition financing and other types of corporate lending. We may seek to reduce our credit risk on these commitments by syndicating all or substantial portions of commitments to other investors. In addition, commitments that are extended for contingent acquisition financing are often short-term in nature, as borrowers often replace them with other funding sources.
       Substantially all of the commitments provided under the William Street credit extension program are to investment-grade corporate borrowers. Commitments under the program are primarily extended by William Street Commitment Corporation (Commitment Corp.), a consolidated wholly owned subsidiary of Group Inc. whose assets and liabilities are legally separated from other assets

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and liabilities of Goldman Sachs, and, to a lesser extent, by William Street Credit Corporation, another consolidated wholly owned subsidiary of Group Inc. A majority of the commitments extended by Commitment Corp. are supported by funding raised by William Street Funding Corporation (Funding Corp.), another consolidated wholly owned subsidiary of Group Inc. whose assets and liabilities are also legally separated from other assets and liabilities of Goldman Sachs. With respect to substantially all of the William Street commitments, SMFG provides us with credit loss protection that is generally limited to 95% of the first loss we realize on approved loan commitments, up to a maximum of $1.00 billion. In addition, subject to the satisfaction of certain conditions, upon our request, SMFG will provide protection for 70% of the second loss on such commitments, up to a maximum of $1.13 billion. We also use other financial instruments to mitigate credit risks related to certain William Street commitments not covered by SMFG.
       Our commitments to extend credit also include financing for the warehousing of financial assets to be securitized, primarily in connection with collateralized debt obligations (CDOs) and mortgage securitizations, which are expected to be repaid from the proceeds of the related securitizations for which we may or may not act as underwriter. These arrangements are secured by the warehoused assets, primarily consisting of mortgage-backed and other asset-backed securities, residential and commercial mortgages and corporate debt instruments.
       See Note 6 to the consolidated financial statements in Part II, Item 8 of the Annual Report on Form 10-K for further information regarding our commitments, contingencies and guarantees.
Risk Management
       Management believes that effective risk management is of primary importance to the success of Goldman Sachs. Accordingly, we have a comprehensive risk management process to monitor, evaluate and manage the principal risks we assume in conducting our activities. These risks include market, credit, liquidity, operational, legal and reputational exposures.
Risk Management Structure
       We seek to monitor and control our risk exposure through a variety of separate but complementary financial, credit, operational, compliance and legal reporting systems. In addition, a number of committees are responsible for monitoring risk exposures and for general oversight of our risk management process, as described further below. These committees (including their subcommittees), meet regularly and consist of senior members of both our revenue-producing units and departments that are independent of our revenue-producing units.
       Segregation of duties and management oversight are fundamental elements of our risk management process. In addition to the committees described below, functions that are independent of the revenue-producing units, such as Compliance, Finance, Legal, Management Controls (Internal Audit) and Operations, perform risk management functions, which include monitoring, analyzing and evaluating risk.
       Management Committee. All risk control functions ultimately report to our Management Committee. Through both direct and delegated authority, the Management Committee approves all of our operating activities, trading risk parameters and customer review guidelines.
       Risk Committees. The Firmwide Risk Committee reviews the activities of existing businesses, approves new businesses and products, approves firmwide and divisional market risk limits, reviews business unit market risk limits, approves market risk limits for selected sovereign markets and business units, approves sovereign credit risk limits and credit risk limits by ratings group, and reviews scenario analyses based on abnormal or “catastrophic” market movements.

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       The Divisional Risk Committee sets market risk limits for our trading activities subject to overall firmwide risk limits, based on a number of measures, including Value-at-Risk (VaR), stress tests and scenario analyses. Several other committees oversee various risk, valuation, operational, credit and business practice issues related to our asset management business.
       Business unit risk limits are established by the various risk committees and may be further allocated by the business unit managers to individual trading desks. Trading desk managers have the first line of responsibility for managing risk within prescribed limits. These managers have in-depth knowledge of the primary sources of risk in their respective markets and the instruments available to hedge their exposures.
       Market risk limits are monitored by the Finance Division and are reviewed regularly by the appropriate risk committee. Limit violations are reported to the appropriate risk committee and business unit managers and addressed, as necessary. Credit risk limits are also monitored by the Finance Division and reviewed by the appropriate risk committee.
       Business Practices Committee. The Business Practices Committee assists senior management in its oversight of compliance, legal and operational risks and related reputational concerns, such as potential conflicts of interest. The Business Practices Committee also reviews Goldman Sachs’ business practices, policies, and procedures for consistency with our business principles. The Business Practices Committee reviews these areas and makes recommendations for improvements as necessary to mitigate potential risks and assist in achieving adherence to our business principles.
       Firmwide Capital Committee. The Firmwide Capital Committee reviews and approves transactions involving commitments of our capital. Such capital commitments include, but are not limited to, extensions of credit, alternative liquidity commitments, certain bond underwritings and certain distressed debt and principal finance activities. The Firmwide Capital Committee is also responsible for establishing business and reputational standards for capital commitments and ensuring that they are maintained on a global basis.
       Commitments Committee. The Commitments Committee reviews and approves underwriting and distribution activities, primarily with respect to offerings of equity and equity-related securities, and sets and maintains policies and procedures designed to ensure that legal, reputational, regulatory and business standards are maintained in conjunction with these activities. In addition to reviewing specific transactions, the Commitments Committee periodically conducts strategic reviews of industry sectors and products and establishes policies in connection with transaction practices.
       Credit Policy Committee. The Credit Policy Committee establishes and reviews broad credit policies and parameters that are implemented by the Credit Department.
       Finance Committee. The Finance Committee establishes and oversees our liquidity policies, sets certain inventory position limits and has oversight responsibility for liquidity risk, the size and composition of our balance sheet and capital base, and our credit ratings. The Finance Committee regularly reviews our funding position and capitalization and makes adjustments in light of current events, risks and exposures.
       New Products Committee. The New Products Committee, under the oversight of the Firmwide Risk Committee, is responsible for reviewing and approving new products and businesses globally.
       Operational Risk Committee. The Operational Risk Committee provides oversight of the ongoing development and implementation of our operational risk policies, framework and methodologies, and monitors the effectiveness of operational risk management.
       Structured Products Committee. The Structured Products Committee reviews and approves structured product transactions entered into with our clients that raise legal, regulatory, tax or accounting issues or present reputational risk to Goldman Sachs.

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Market Risk
       The potential for changes in the market value of our trading and investing positions is referred to as market risk. Such positions result from market-making, specialist, proprietary trading and investing, and underwriting activities.
       Categories of market risk include exposures to interest rates, equity prices, currency rates and commodity prices. A description of each market risk category is set forth below:
  •  Interest rate risks primarily result from exposures to changes in the level, slope and curvature of the yield curve, the volatility of interest rates, mortgage prepayment speeds and credit spreads.
 
  •  Equity price risks result from exposures to changes in prices and volatilities of individual equities, equity baskets and equity indices.
 
  •  Currency rate risks result from exposures to changes in spot prices, forward prices and volatilities of currency rates.
 
  •  Commodity price risks result from exposures to changes in spot prices, forward prices and volatilities of commodities, such as electricity, natural gas, crude oil, petroleum products, and precious and base metals.
       We seek to manage these risks by diversifying exposures, controlling position sizes and establishing economic hedges in related securities or derivatives. For example, we may hedge a portfolio of common stocks by taking an offsetting position in a related equity-index futures contract. The ability to manage an exposure may, however, be limited by adverse changes in the liquidity of the security or the related hedge instrument and in the correlation of price movements between the security and related hedge instrument.
       In addition to applying business judgment, senior management uses a number of quantitative tools to manage our exposure to market risk for our long and short financial instruments. These tools include:
  •  risk limits based on a summary measure of market risk exposure referred to as VaR;
 
  •  scenario analyses, stress tests and other analytical tools that measure the potential effects on our trading net revenues of various market events, including, but not limited to, a large widening of credit spreads, a substantial decline in equity markets and significant moves in selected emerging markets; and
 
  •  inventory position limits for selected business units.
VaR
       VaR is the potential loss in value of Goldman Sachs’ trading positions due to adverse market movements over a defined time horizon with a specified confidence level.
       For the VaR numbers reported below, a one-day time horizon and a 95% confidence level were used. This means that there is a 1 in 20 chance that daily trading net revenues will fall below the expected daily trading net revenues by an amount at least as large as the reported VaR. Thus, shortfalls from expected trading net revenues on a single trading day greater than the reported VaR would be anticipated to occur, on average, about once a month. Shortfalls on a single day can exceed reported VaR by significant amounts. Shortfalls can also accumulate over a longer time horizon such as a number of consecutive trading days.
       The modeling of the risk characteristics of our trading positions involves a number of assumptions and approximations. While management believes that these assumptions and approximations are reasonable, there is no standard methodology for estimating VaR, and different assumptions and/or approximations could produce materially different VaR estimates.

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       We use historical data to estimate our VaR and, to better reflect current asset volatilities, we generally weight historical data to give greater importance to more recent observations. Given its reliance on historical data, VaR is most effective in estimating risk exposures in markets in which there are no sudden fundamental changes or shifts in market conditions. An inherent limitation of VaR is that the distribution of past changes in market risk factors may not produce accurate predictions of future market risk. Different VaR methodologies and distributional assumptions could produce a materially different VaR. Moreover, VaR calculated for a one-day time horizon does not fully capture the market risk of positions that cannot be liquidated or offset with hedges within one day. Changes in VaR between reporting periods are generally due to changes in levels of exposure, volatilities and/or correlations among asset classes.
       The following tables set forth the daily VaR:
Average Daily VaR (1)
(in millions)
                         
    Year Ended November
     
Risk Categories   2006   2005   2004
             
Interest rates
  $ 49     $ 37     $ 36  
Equity prices
    72       34       32  
Currency rates
    21       17       20  
Commodity prices
    30       26       20  
Diversification effect (2)
    (71 )     (44 )     (41 )
                         
Total
  $ 101     $ 70     $ 67  
                         
 
 
  (1)  Beginning in the first quarter of 2006, we excluded from our calculation of VaR certain equity positions generally due to their transfer restrictions or illiquidity. The effect of excluding these positions was not material to prior periods and, accordingly, such periods have not been adjusted. For a further discussion of the market risk associated with these positions, see “— Other Market Risk Measures” below.
 
  (2)  Equals the difference between total VaR and the sum of the VaRs for the four risk categories. This effect arises because the four market risk categories are not perfectly correlated.
 
       Our average daily VaR increased to $101 million in 2006 from $70 million in 2005. We increased our level of exposure across all risk categories, particularly equity prices and interest rates.
       Our average daily VaR increased to $70 million in 2005 from $67 million in 2004. The increase was primarily due to higher levels of exposure to commodity prices, equity prices and interest rates, partially offset by reduced exposures to currency rates, as well as reduced volatilities, particularly in interest rate and equity assets.

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Daily VaR (1)
(in millions)
                                 
        Year Ended
    As of November   November 2006
         
Risk Categories   2006   2005   High   Low
                 
Interest rates
  $ 51     $ 45     $ 68     $ 35  
Equity prices
    84       54       106       49  
Currency rates
    15       10       47       9  
Commodity prices
    21       18       49       17  
Diversification effect (2)
    (52 )     (44 )                
                             
Total
  $ 119     $ 83     $ 135     $ 73  
                             
 
 
  (1)  Beginning in the first quarter of 2006, we excluded from our calculation of VaR certain equity positions generally due to their transfer restrictions or illiquidity. The effect of excluding these positions was not material to prior periods and, accordingly, such periods have not been adjusted. For a further discussion of the market risk associated with these positions, see “— Other Market Risk Measures” below.
 
  (2)  Equals the difference between total VaR and the sum of the VaRs for the four risk categories. This effect arises because the four market risk categories are not perfectly correlated.
 
 
       Our daily VaR increased to $119 million as of November 2006 from $83 million as of November 2005. We increased our level of exposure across all risk categories, particularly equity prices.
       The following chart presents our daily VaR during 2006:
(DAILY VaR GRAPH)

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  Trading Net Revenues Distribution
       Substantially all of our inventory positions are marked-to-market on a daily basis and changes are recorded in net revenues. The following chart sets forth the frequency distribution of our daily trading net revenues for substantially all inventory positions included in VaR for the year ended November 2006:
(DAILY TRADING NET REVENUE GRAPH)
 
 
  (1)  Beginning in the fourth quarter of 2006, we excluded daily net revenues from our insurance business and our power generation facilities from this chart. Amounts for the full year have been adjusted accordingly.
 
       As part of our overall risk control process, daily trading net revenues are compared with VaR calculated as of the end of the prior business day. Trading losses incurred on a single day exceeded our 95% one-day VaR on three occasions during 2006.
  Other Market Risk Measures
       Certain portfolios and individual positions are not included in VaR, where VaR is not the most appropriate measure of risk (e.g., due to transfer restrictions and/or illiquidity). The market risk related to our investments in the convertible preferred stock of SMFG and the ordinary shares of ICBC is measured by estimating the potential reduction in net revenues associated with a 10% decline in the SMFG common stock price and a 10% decline in the ICBC ordinary share price, respectively. The market risk related to the remaining positions is measured by estimating the potential reduction in net revenues associated with a 10% decline in asset values.
       The sensitivity analyses for equity and debt positions in our trading portfolio and equity, debt (primarily mezzanine instruments) and real estate positions in our non-trading portfolio are measured by the impact of a decline in the asset values (including the impact of leverage in the underlying investments for real estate positions in our non-trading portfolio) of such positions. The fair values of the underlying positions may be sensitive to changes in a number of factors, including, but not limited to, the financial performance of the companies or properties relative to budgets or projections, the projected timing and amount of future cash flows, discount rates, trends within sectors and/or regions, underlying business models and equity prices.

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       The sensitivity analysis of our investment in the convertible preferred stock of SMFG, net of the economic hedge on the unrestricted shares of common stock underlying a portion of our investment, is measured by the impact of a decline in the SMFG common stock price. This sensitivity should not be extrapolated to a significant decline in the SMFG common stock price, as the relationship between the fair value of our investment and the SMFG common stock price would be nonlinear due to downside protection on the conversion stock price.
       The sensitivity analysis of our investment in the ordinary shares of ICBC excludes interests held by investment funds managed by Goldman Sachs.
       The following table sets forth market risk for positions not included in VaR. These measures do not reflect diversification benefits across asset categories and, given the differing likelihood of such events occurring, these measures have not been aggregated:
                       
        10% Sensitivity Measure
         
        Amount as of   Amount as of
Asset Categories   10% Sensitivity Measure   November 2006    November 2005 (1)
             
        (in millions)
Trading Risk (2)
                   
 
Equity
  Underlying asset value   $ 377     $ 127  
 
Debt
  Underlying asset value     725       634  
Non-trading Risk
                   
 
SMFG
          SMFG common stock price     140       262  
 
ICBC
       ICBC ordinary share price     191       N/A  
 
Other Equity
  Underlying asset value     390       172  
 
Debt
  Underlying asset value     199       63  
 
Real Estate (3)
  Underlying asset value     341       145  
 
 
  (1)  Beginning in the first quarter of 2006, we excluded from our calculation of VaR certain equity positions generally due to their transfer restrictions or illiquidity. The effect of excluding these positions from VaR was not material to prior periods and, accordingly, VaR for such periods has not been adjusted. We have calculated the 10% sensitivity measure for these equity positions (i.e., Trading Risk— Equity) as of November 2005 to provide a period-to-period comparison. To the extent that other market risk measures in the above table were affected, such measures have been adjusted to conform to the current presentation.
 
  (2)  In addition to the positions in these portfolios, which are accounted for at fair value, we make investments accounted for under the equity method and we also make direct investments in real estate, both of which are included in “Other assets” in the consolidated statements of financial condition. Direct investments in real estate are accounted for at cost less accumulated depreciation. See Note 10 to the consolidated financial statements in Part II, Item 8 of the Annual Report on Form 10-K for information on “Other assets.”
 
  (3)  Relates to interests in our real estate investment funds.
 
       During 2006, the market risk for equity positions in our trading portfolio increased due to new investments as well as an increase in the fair value of the portfolio. The increase in market risk in 2006 for debt positions in our trading portfolio and debt, real estate and other equity positions in our non-trading portfolio was primarily due to new investments.
       The decrease in market risk in 2006 for SMFG was primarily due to the impact of additional hedging with respect to the second one-third installment of unrestricted shares underlying our investment, partially offset by the increase in the fair value of our investment due to the passage of time in respect of the transfer restrictions on the underlying common stock.
Credit Risk
       Credit risk represents the loss that we would incur if a counterparty or an issuer of securities or other instruments we hold fails to perform under its contractual obligations to us, or upon a deterioration in the credit quality of third parties whose securities or other instruments, including OTC

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derivatives, we hold. Our exposure to credit risk principally arises through our trading, investing and financing activities. To reduce our credit exposures, we seek to enter into netting agreements with counterparties that permit us to offset receivables and payables with such counterparties. In addition, we attempt to further reduce credit risk with certain counterparties by (i) entering into agreements that enable us to obtain collateral from a counterparty on an upfront or contingent basis, (ii) seeking third-party guarantees of the counterparty’s obligations, and/or (iii) transferring our credit risk to third parties using credit derivatives and/or other structures and techniques.
       To measure and manage our credit exposures, we use a variety of tools, including credit limits referenced to both current exposure and potential exposure. Potential exposure is generally based on projected worst-case market movements over the life of a transaction. In addition, as part of our market risk management process, for positions measured by changes in credit spreads, we use VaR and other sensitivity measures. To supplement our primary credit exposure measures, we also use scenario analyses, such as credit spread widening scenarios, stress tests and other quantitative tools.
       Our global credit management systems monitor credit exposure to individual counterparties and on an aggregate basis to counterparties and their affiliates. These systems also provide management, including the Firmwide Risk and Credit Policy Committees, with information regarding credit risk by product, industry sector, country and region.
       While our activities expose us to many different industries and counterparties, we routinely execute a high volume of transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment funds and other institutional clients, resulting in significant credit concentration with respect to this industry. In the ordinary course of business, we may also be subject to a concentration of credit risk to a particular counterparty, borrower or issuer.
       As of both November 2006 and November 2005, we held U.S. government and federal agency obligations that represented 6% and 7% of our total assets, respectively. In addition, most of our financial instruments purchased under agreements to resell as well as some derivatives are collateralized by U.S. government, federal agency and other sovereign obligations. As of November 2006 and November 2005, we did not have credit exposure to any other counterparty that exceeded 5% of our total assets. However, over the past several years, the amount and duration of our credit exposures have been increasing, due to, among other factors, the growth of our lending and OTC derivative activities and market evolution towards longer dated transactions. A further discussion of our derivative activities follows below.
  Credit Risk on Derivatives
       Derivative contracts are instruments, such as futures, forwards, swaps or option contracts, that derive their value from underlying assets, indices, reference rates or a combination of these factors. Derivative instruments may be privately negotiated contracts, which are often referred to as OTC derivatives, or they may be listed and traded on an exchange.
       Substantially all of our derivative transactions are entered into to facilitate client transactions, to take proprietary positions or as a means of risk management. In addition to derivative transactions entered into for trading purposes, we enter into derivative contracts to manage currency exposure on our net investment in non-U.S. operations and to manage the interest rate and currency exposure on our long-term borrowings and certain short-term borrowings.
       Derivatives are used in many of our businesses, and we believe that the associated market risk can only be understood relative to all of the underlying assets or risks being hedged, or as part of a broader trading strategy. Accordingly, the market risk of derivative positions is managed together with our nonderivative positions.
       Fair values of our derivative contracts are reflected net of cash paid or received pursuant to credit support agreements and are reported on a net-by-counterparty basis in our consolidated

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statements of financial condition when management believes a legal right of setoff exists under an enforceable netting agreement. For an OTC derivative, our credit exposure is directly with our counterparty and continues until the maturity or termination of such contract.
       The following table sets forth the distribution, by credit rating, of substantially all of our exposure with respect to OTC derivatives as of November 2006 and November 2005, after taking into consideration the effect of netting agreements. The categories shown reflect our internally determined public rating agency equivalents:
Over-the-Counter Derivative Credit Exposure
($ in millions)
                                         
        As of
    As of November 2006   November 2005
         
        Exposure   Percentage of   Percentage of
        Collateral   Net of   Total Exposure   Total Exposure
Credit Rating Equivalent   Exposure (1)   Held   Collateral   Net of Collateral   Net of Collateral
                     
AAA/Aaa
  $ 5,185     $ 514     $ 4,671       12 %     12 %
AA/Aa2
    12,499       1,447       11,052       29       22  
A/A2
    16,039       4,810       11,229       29       28  
BBB/Baa2
    8,616       2,964       5,652       15       21  
BB/Ba2 or lower
    8,906       3,760       5,146       13       15  
Unrated
    1,891       954       937       2       2  
                                         
Total
  $ 53,136     $ 14,449     $ 38,687       100 %     100 %
                                         
 
 
  (1)  Net of cash received pursuant to credit support agreements of $24.06 billion.
 
       The following tables set forth our OTC derivative credit exposure, net of collateral, by remaining contractual maturity:
Exposure Net of Collateral
(in millions)
                                                 
    0 - 6   6 - 12   1 - 5   5 - 10   10 Years    
Credit Rating Equivalent   Months   Months   Years   Years   or Greater   Total (1)
                         
AAA/Aaa
  $ 1,011     $ 116     $ 1,263     $ 1,002     $ 1,279     $ 4,671  
AA/Aa2
    2,204       1,496       2,521       2,834       1,997       11,052  
A/A2
    3,850       1,304       3,094       1,867       1,114       11,229  
BBB/Baa2
    1,480       660       2,478       247       787       5,652  
BB/Ba2 or lower
    1,729       451       1,550       581       835       5,146  
Unrated
    477       348       5       52       55       937  
                                                 
Total
  $ 10,751     $ 4,375     $ 10,911     $ 6,583     $ 6,067     $ 38,687  
                                                 
                                                 
    0 - 6   6 - 12   1 - 5   5 - 10   10 Years    
Contract Type   Months   Months   Years   Years   or Greater   Total (1)
                         
Interest rates (2)
  $ 2,300     $ 1,524     $ 3,720     $ 3,802     $ 3,753     $ 15,099  
Currencies
    4,418       882       2,521       1,186       946       9,953  
Commodities
    3,469       992       3,898       585       231       9,175  
Equities
    564       977       772       1,010       1,137       4,460  
             </