Deal for Spear Leeds Lifts Goldman Shares to Record Close

Goldman Sachs Group on Monday took another giant leap to bolster its stock trading operations, and investors gave the move a hearty endorsement--sending Goldman shares to a record close.

Financial stocks in general rallied, despite a down day for much of Wall Street.

Goldman said it will pay $6.5 billion in stock and cash to buy Spear, Leeds & Kellogg, a 69-year-old partnership that is the top specialist firm on the New York Stock Exchange and the No. 3 market maker on Nasdaq.

Goldman also will pay $900 million in Goldman stock to retain Spear Leeds employees.

The deal makes Goldman, now the biggest underwriter of new stock sales, also the largest market middleman.

The purchase demonstrates the importance to securities firms of beefing up trading businesses, as commission revenue declines and competition from online brokers rises. Earlier this year, Merrill Lynch & Co. bought market-making firm Herzog Heine Geduld Inc. for about $1 billion.

“This is a very important strategy in terms of putting us in the center of the capital markets,” said Henry Paulson, Goldman’s chief executive, in a conference call. “This will give us market knowledge that we would have in many respects if we had a broad retail presence.”

Investors seemed to agree: Goldman shares (ticker symbol: GS) soared $7.75 to close at $132, a record high close on the NYSE. The stock is up 40% year-to-date.

Other brokerage shares also rallied, anticipating more consolidation in the business. Merrill Lynch (MER) gained $2.50 to $71.50, Morgan Stanley Dean Witter (MWD) rose $3.88 to $109.38 and Lehman Bros. surged $11.94 to $160.

But shares of LaBranche & Co. (LAB), another specialist firm, fell $4.75 to $29.75--perhaps on disappointment it wasn’t picked by Goldman.

The decision by Spear Leeds, controlled by Peter Kellogg and his family, to sell now may reflect concern about having adequate capital to compete against electronic rivals and make a market in more stocks. The link to Goldman would also enable Spear Leeds to expand more quickly in Europe and Asia, Paulson said.

The combined firm would trade 8% of Nasdaq volume, making a market in about 6,400 Nasdaq stocks. It would trade 500 securities on the Big Board, as well as 200 stocks and 300 options on Amex.

Although trading firms are often shunned by investors because of volatile earnings, Paulson called Spear Leeds a profit machine that would smooth out Goldman’s results. He said the firm has earned money every month for the last nine years, and that clearing--settling trades for other firms for a fee--is its biggest profit center.

“It doesn’t make a difference whether the market is going up or going down,” he said. “What’s important is the volume.”

The move suggests Goldman is hedging its bet on the future of markets: Last year the firm called for a central electronic trading system that could lead to the demise of Big Board specialists--an idea it has since dropped. The Spear Leeds purchase “positions us regardless of how the structure of the equity markets evolves,” Paulson said.