Salomon Receives Penalty, Reprieve : Scandal: U.S. at first bans Wall Street giant from bidding on Treasury bonds. But punishment is eased after plea by firm’s chairman, ouster of more executives.

The Treasury Department on Sunday announced unprecedented punishment for Salomon Bros., suspending the giant Wall Street firm from auctions of Treasury bonds and notes. Just hours later, though, the government partly backed down.

The punishment, which analysts said could have had dire consequences for Salomon, was eased after billionaire investor Warren E. Buffett, named Sunday as interim chairman and chief executive of the scandal-plagued firm, made urgent phone calls to Treasury Secretary Nicholas F. Brady. Buffett said he assured Brady that stringent new control procedures would be put in place at the firm.

After the phone calls, Treasury said it will let Salomon continue bidding to buy securities for the firm’s own account. But it suspended the firm’s right to make bids on behalf of customers.

The government’s move against Salomon was prompted by the firm’s admission over the past 10 days of serious wrongdoing in Treasury auctions, and disclosure that top Salomon executives knew about the violations for months before alerting regulators. Renowned for its trading prowess, Salomon was one of the biggest buyers at Treasury auctions and probably the most powerful player in the $2.2-trillion market for government securities.

As expected, Salomon Chairman and Chief Executive John H. Gutfreund and President Thomas W. Strauss resigned Sunday and gave up their seats on Salomon’s board. A vice chairman, legendary Wall Street trader John W. Meriwether, also quit. And Buffett said he fired managing directors Paul Mozer and Tom Murphy, who had been suspended. The two were in direct charge of Salomon’s government securities department.

In one of several revelations in a long press conference Sunday afternoon, Buffett said there had been a “cover-up” at Salomon in which it appeared some executives had altered documents to hide the firm’s wrongdoing. He said there was no evidence that Gutfreund, Strauss or Meriwether had participated in the cover-up.

But Buffett described the three men’s failure to alert regulators promptly after they had learned of the wrongdoing as “inexplicable and inexcusable.”

The Salomon scandal marks the first allegations of major wrongdoing in the Treasury market, which the government depends on to finance the national debt at the lowest possible cost to taxpayers. But the Salomon affair follows years of major financial scandals, including the manipulation of the junk bond market by Drexel Burnham Lambert, the savings and loan debacle and more recently scandals involving the largest financial institutions in Japan and the sprawling Bank of Credit & Commerce International. Senior regulators and banking officials say that collectively, the spreading scandals may undermine confidence in the global financial markets, with unpredictable consequences.

Despite the partial and possibly temporary reprieve granted by the Treasury on Sunday, Buffett faces a daunting job in persuading regulators not to punish the firm severely. The firm has said it also may face criminal and civil prosecution by the Justice Department and the Securities and Exchange Commission.

Buffett said he has heard from government “authorities that they are quite upset about what has taken place in the past.” Buffett said the firm could still lose its valued designation as one of 40 primary dealers of government securities, firms authorized to trade securities directly with the Federal Reserve.

Buffett said the firm must move quickly to reestablish its reputation for integrity, and cooperate completely with regulators if it wants to remain a primary dealer.

Buffett also must seek to rebuild Salomon’s formidable reputation--and stem defections by big clients--without the aid of expert traders like Gutfreund and Meriwether, who built the firm. He said he had no doubt, however, that it can be done.

Buffett, chairman of Omaha-based Berkshire Hathaway Inc., controls about $700 million of Salomon’s stock and was on the firm’s board. He has no experience running a Wall Street firm. On Sunday he named Deryck C. Maughan, 43, as chief operating officer, with responsibility for running the firm on a day-to-day basis. Maughan, a British citizen and former official of the British treasury department, is a vice chairman of Salomon. He just returned from Tokyo where he was head of Salomon’s Asian operations.

Maughan is an investment banker in a firm where bond traders have long been king. He acknowledged he faces a tough job in taking over. “I’m not an American and I’m not a trader,” he said.

Buffett said the decision to take over as interim chairman came about on Friday, after he “volunteered” in telephone conversations with Gutfreund and Strauss. He said the two executives had already made up their minds to resign. “I had no interest in doing it,” Buffett said, and denied exerting any pressure. But he added, “It needed to be done. Probably I was the logical person to do it.”

Suspension of the right to participate in Treasury auctions would have severely curtailed one of Salomon’s main businesses. The firm regularly buys billions of dollars worth of securities in individual auctions and then resells them to a range of customers. Losing the right to bid altogether might have caused the firm to shrivel or founder as customers moved elsewhere.

The suspension of the right to bid on behalf of customers, although less severe, is still expected to hurt. “If (clients) want to go to the Treasury auction, they’re going to have to submit bids through another firm,” Buffett said.

But only a relatively small proportion of Salomon’s buying in the auctions consists of bids handled for customers. The firm will lose some revenue, but makes most of its money in reselling--often only minutes or hours later--the securities it bought for its own account. Salomon will still be permitted to do this.

In a statement, the Treasury said it decided to rescind the harsher penalty because of the changes in management at Salomon and the firm’s “plans to address management and administrative problems that surfaced last week.” The Treasury said “it welcomes these important steps,” and said Secretary Brady “expressed high regard for Mr. Buffett.”

Salomon’s violations included covertly buying more securities than allowed for individual firms in the auctions. Salomon several times bought more than the 35% maximum allowed by law.

The move was characterized by government securities experts as an attempt to corner the market and “squeeze” other firms that had already made commitments to sell the securities to clients. These other firms were forced to buy some of the securities from Salomon at markups instead of directly from the Treasury.

Salomon also admitted making bids in the name of customers even though the customers had not authorized the bids.

In another possibly significant disclosure, Buffett said the respected Wall Street law firm Wachtell Lipton Rosen & Katz had been called in on “July 6 or 8” to conduct an internal investigation for Salomon. Salomon has admitted that its executives knew of at least one incident of wrongdoing as early as April 27, and presumably Wachtell lawyers learned of possible serious wrongdoing shortly after beginning the investigation. But Buffett and Maughan said they did not know if Wachtell had made any efforts to get the firm to notify regulators before top executives finally did so on Aug. 9.

The only Wachtell partner who could be reached Sunday, Leonard M. Rosen, said he was not involved in the investigation and declined to comment.

Buffett said top management first learned of misdeeds on April 27 when Mozer showed Meriwether a copy of a letter the Treasury department had sent to a Salomon client. The letter raised questions about a possible unauthorized bid in a February auction of five-year notes. “John Meriwether on seeing (the letter) immediately knew he had a problem,” Buffett said.

Over the next 48 hours Strauss and Gutfreund met with Meriwether to discuss the letter, but no one informed the government, Buffett said. “I said to John Meriwether: ‘Did anyone tell you it was your job to report it?’ John says no and I believe him,” Buffett said.

Meriwether, 44, was a ferociously competitive trader who personified Salomon’s aggressive corporate culture. Buffett acknowledged that one of his main jobs will be to change that culture, which he said contributed to the wrongdoing, at times encouraging traders to work perilously close to the bounds of legal behavior.

Buffett and Maughan said they would emphasize “moral” as well as legal behavior. Buffett vowed to fire anyone who did not get the message.

In addition to investigations by at least four government agencies, the firm said it has been named as a defendant in three lawsuits. Buffett said he did not know how much money, if any, the firm made because of its wrongdoing, or whether the government and taxpayers actually lost money because of the manipulations.

Oswald Johnston in Washington contributed to this story.