U.S. Punishes Salomon, Rescinds Harsh Penalty
The government on Sunday punished Salomon Bros. by curtailing the Wall Street giant’s right to bid on Treasury bonds and notes, but it rescinded a much harsher penalty just hours after announcing it.
The Treasury first completely barred Salomon from Treasury auctions, an unprecedented and potentially devastating ban for a firm which routinely makes billion-dollar bids for Treasury securities.
But the Treasury backed down after billionaire investor Warren E. Buffett, named Sunday as Salomon’s interim chairman and chief executive, urgently phoned Treasury Secretary Nicholas F. Brady.
The Treasury then said it would let Salomon continue bidding on securities for the firm’s own account. But it suspended Salomon’s right to bid on behalf of customers.
The government actions were 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.
But Buffett described their failure to alert regulators promptly after learning 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.
According to Buffett, he managed to reverse the stiffer ban on Salomon by telling Brady the firm would suffer badly, and by giving assurances that stringent new controls on the firm’s securities trading would be imposed.
But despite the partial and possibly temporary reprieve granted by the Treasury on Sunday, Buffett faces a daunting task 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.
Salomon has long been known for its freewheeling style, and the 44-year-old Meriwether, a ferociously competitive trader, personified the firm’s aggressive corporate culture. Buffett acknowledged that one of his main jobs will be changing that culture, which he said contributed to the wrongdoing, at times encouraging traders to tread perilously close to the bounds of legal behavior.
Buffett added that he would emphasize “moral” as well as legal behavior, and vowed to fire anyone who did not get the message.
He also said he had read “Liar’s Poker,” Michael Lewis’ irreverent account of his stint as a Salomon bond salesman. The book portrayed the firm as bent on making money even if it meant seriously harming its own customers. Said Buffett: “I just want to make sure there isn’t a second edition.”
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 Salomon 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.
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.
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..
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. 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.
BACKGROUND
To finance the national debt, the government borrows money from the public by issuing bonds, notes and bills. Forty brokerages are allowed to buy the securities wholesale from the government at auctions. Those firms can turn around and sell the securities for a profit in the secondary market. Salomon Bros., the brokerage of Salomon Inc., bought more than its 35% limit of U.S. Treasury securities. By doing so, Salomon could control enough of the market to charge high prices when reselling the securities. The firm bought more than its share by submitting bids under customers’ names without their authorization.
Staff writer Oswald Johnston in Washington contributed to this story.
