Salomon Bros., one of Wall Street's most powerful firms, said Friday that both its chairman and president will resign in an attempt to quell a burgeoning scandal over its illegal bidding in the market for U.S. Treasury securities.
The firm said that Warren E. Buffett, 60, a widely respected investor and one of the wealthiest men in America, will take over temporarily as chairman and chief executive. The move is aimed at preventing an exodus of clients and erosion of investor confidence that could threaten the firm's ability to do business. Buffett currently is a director of Salomon and controls 14% of its stock.
Salomon said in a one-page statement Friday that John H. Gutfreund, 62, chairman and chief executive, and Thomas W. Strauss, 49, president, will tender their resignations at a special meeting of Salomon's board called for Sunday.
The crisis at Salomon has shaken the financial world and raised calls for greater regulation of the government securities market, currently one of the least-regulated U.S. financial markets. Salomon is a major supplier of bidding and investment banking services to many of the world's biggest companies and to national and local governments and is the oldest dealer in Treasury bonds.
The $2.2-trillion government securities market is used to finance the national debt. Salomon's actions, which some experts said amounted to an attempt to manipulate the market, have caused concerns over the potential impact on taxpayers and individual investors.
In two public announcements within a week, the firm admitted illegal bidding in several auctions of U.S. government securities. The firm also admitted that its top executives knew about the wrongdoing for months before notifying regulators.
The firm has confirmed that a number of big institutional clients have stopped doing business with it because of the scandal.
Analysts interpreted Friday's move as an effort to mollify angry regulators and head off severe punishment. The firm has said it may face criminal prosecution and suspension, or "debarment," as a primary dealer of government securities.
Traders on Friday said that the Treasury market seemed to be taking Salomon's news in stride, with only a minor impact on bond prices. Top traders said that, although Salomon has been one of the two or three biggest buyers of government bonds and notes, its suspension probably wouldn't significantly disrupt the market. The company's stock price actually rose after the announcement.
Salomon's statement said, in remarks attributed to Gutfreund and Strauss: "We cannot allow our unfortunate mistake of not taking prompt action, when in April we learned of one unauthorized bid at a February Treasury auction, to harm the firm. We are taking this action to protect the firm, its 9,000 people and its clients."
Buffett, chairman of Berkshire Hathaway Inc., is revered on Wall Street, in part, because of his Midas touch in making highly profitable long-term investments in companies. In the 1980s he won praise for helping big companies, including Salomon, fend off hostile takeover attempts.
Many senior bond traders on Wall Street, as well as clients, seemed to turn against Salomon after its disclosure Wednesday of additional incidents in which it had violated rules limiting individual firms to buying no more than 35% of Treasury notes or bonds in government-run auctions.
Salomon also admitted making unauthorized bids in the name of clients. And it said it inadvertently bought an extra $1-billion worth of 30-year bonds in a February auction because a "practical joke" by one of its managing directors went awry. The firm said Friday that "we are not aware of any problems other than those already disclosed."
Analysts have said that it is unclear whether taxpayers were harmed by Salomon's misdeeds in the Treasury auctions. The open auctions are held to ensure that the Treasury pays the lowest possible interest rate on notes and bonds issued to finance the national debt.
But other government securities dealers have said that Salomon's actions, which enabled the firm to control the market for certain securities after the auctions were held, may have forced other firms and customers to pay more.
Experts on the $2.2-trillion market for government securities said it is by no means clear that Salomon's announcement Friday will head off serious consequences for the firm.
"They knew they had to take some fairly drastic steps," said Steven Wood, director of money market research at the Bank of America. But he said it's unlikely to prevent significant further loss of business for Salomon. "They're clearly going to lose a lot of customer business because of this, and it's going to take a long time to win that back," Wood said.
The Salomon scandal comes on top of other enormous financial disruptions in recent months and has reawakened painful memories of the Drexel Burnham Lambert junk-bond crisis of the 1980s. Many in the financial community worry that this latest problem may erode investor confidence in big firms and financial markets in general.
Recent scandals involved the Bank of Credit & Commerce International, admissions by Nomura, Japan's largest investment house, of major improprieties, and a crisis involving the giant Industrial Bank of Japan.
"Taken all together, these tend to subvert the confidence that underscored the great financial prosperity of the '80s," said Jim Grant, editor of Grant's Interest Rate Monitor.
In recent days, a number of large institutional investors, including state pension funds, have said that they were suspending doing business with Salomon. Among them is the Wisconsin Investment Board, a state pension fund. Its spokeswoman said Friday that "we have not reversed our position" despite the announcement of the resignations.
The California Public Employees Retirement System, one of the nation's biggest pension funds, said its staff will meet Monday to consider whether to limit the fund's dealings with Salomon.
Robert F. Baker Jr., Salomon's spokesman, asserted, however, that "the reaction to the management changes has been very positive among clients." He refused to give details and said he doesn't know how many clients have suspended dealings with the firm.
Neither Salomon nor the Federal Reserve Bank of New York would comment on whether federal regulators had pressured the firm to oust Gutfreund and Strauss. The New York Federal Reserve Bank oversees the 40 primary dealers of government securities.
In a statement Friday, the New York Federal Reserve Bank said it "has been closely reviewing developments at Salomon Bros." and has demanded "a written explanation of the irregularities, violations, and oversights committed by the firm."
The statement said that, because of the changes in senior management, it will allow Salomon more time to make its report. But a government official, who asked not to be identified, said the bank's decision to allow Salomon more time shouldn't be interpreted as a sign that the Fed or Treasury Department will go easier on Salomon in the wake of the resignations.
William McLucas, the Securities and Exchange Commission's enforcement chief, has publicly characterized Salomon's violations as "very serious."
Grant said Salomon "is in about as much regulatory trouble as you can get in the government bond market."
Salomon has long been considered the most powerful of the primary dealers, firms authorized to do business directly with the Fed in daily government securities transactions. But Grant and other experts said that, if Salomon is suspended as a primary dealer, the direct effect on the market for Treasury securities probably will be minimal. Many other large firms are prepared, and eager, to take up the slack.
Trading in Salomon's stock opened about five hours late on Friday because of the pending announcement. The market's initial reaction to the news was positive. Salomon's stock closed up $1 at $27.875 in trading on the New York Stock Exchange.
Analysts said that, despite the defection of clients and concerns about possible prosecution and punishment, Salomon doesn't appear to be in any immediate financial danger. The firm has had strong earnings in recent quarters, and it has an ample cushion of capital. In its statement, the firm said, "Salomon's business is excellent and we have been looking forward to a record year."
Traders reported that Salomon was taking the unusual step of buying up its own commercial paper, or short-term corporate IOUs, in the open market in a move to assuage investor anxiety.
Buffett is expected to lend his prestige to the firm, but experts said it is unlikely that he will take a major role in the day-to-day running of Salomon's affairs. He has no experience in running a large securities firm. Buffett became associated with Salomon when he came to Gutfreund's aid in 1987, buying a big chunk of the firm's stock to foil a hostile takeover attempt by Ronald O. Perelman's Revlon Inc.
Gutfreund, an often flamboyant character who oversaw the firm from a desk on Salomon's football-field-sized trading floor, has been both chairman and chief executive of Salomon since 1986.
He had been head of the firm since 1978, originally as managing partner before the company went public. Gutfreund pursued aggressive expansion of the firm, branching out into other businesses from its core franchise of bond trading. However, his efforts to turn Salomon into a major investment bank, aiding companies in mergers and acquisitions, had only limited success.
The firm lately was making a strong financial comeback, based on trading profits, after major setbacks following the October, 1987, stock market crash and defections of some of Salomon's top traders.
Salomon left unresolved the fate of John W. Meriwether, its vice chairman and a legendary trader on Wall Street. Salomon had said that Meriwether as well as Gutfreund and Strauss had known of the firm's wrongdoing in April, months before regulators were first notified on Aug. 9. In its statement Friday, Salomon said only that "the board will also consider the status of" Meriwether during its meeting on Sunday.
Salomon said it will hold a press conference shortly after the board meeting.
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