NEWS ANALYSIS : Salomon Fights to Restore Gleam to Tarnished Image
If recent history is a guide, there is a shortened life expectancy for Wall Street brokerage firms that get into trouble with the law.
E. F. Hutton & Co. was forced to merge with Shearson Lehman Bros. in 1987 after a chain of events set in motion by a mammoth check-kiting scandal that broke two years earlier. Drexel Burnham Lambert collapsed less than a year after it pleaded guilty in 1989 to six felony counts of securities fraud.
Like frenzied emergency room physicians, the damage control team at Salomon Bros. is scurrying to resuscitate the firm’s critically injured reputation. But on Wall Street, where business is built on trust, reputations are hard to revive.
“The essence of trading with other people is honesty and a feeling that the other side will honor its commitments,” said Marshall Blume, professor of financial management at the University of Pennsylvania’s Wharton School. “Certainly, once a firm has a tarnished reputation, it’s hard to maintain business.”
Salomon was learning that lesson this week, although signs were that the firm is pulling through a series of grave repercussions from its admission of extensive wrongdoing in government-run auctions of Treasury notes and bonds.
Perhaps the most critical moment came Thursday when rumors swept Wall Street that the firm faced a cash-flow crisis. The rumors were fueled by the fact that several holders of Salomon’s commercial paper--short term IOUs--including the California state treasury, would not roll over their Salomon commercial paper when they came due or were looking to sell the paper they held.
In fact, Salomon has put into effect a well thought-out contingency plan that during the next couple of months should enable it to raise the day-to-day financing needed to operate a giant Wall Street firm. It has about $7 billion in securities available that can be pledged to obtain alternative financing.
But, Salomon still faces enormous hurdles, including criminal and civil investigations, lawsuits, defections by customers and a round of congressional inquiries.
In its swift action to replace senior management and publicly confess its sins, Salomon showed that it had learned from the Drexel debacle. For many months after it came under investigation, Drexel, the former junk bond powerhouse, denied that it had done anything wrong.
As a criminal investigation of securities fraud and market manipulation at Drexel progressed, damaging disclosures continuously trickled out. Public attention remained fixed on Drexel, and prosecutors repeatedly upped the stakes. The firm was finally forced to plead guilty to six felony counts. Less than a year later, Drexel was in bankruptcy court, its brokerage permanently shut down.
“I think Drexel proves that the stonewall approach doesn’t work,” said Harvey Pitt, a prominent Washington securities lawyer.
Many former Drexel executives now concur. “If the principals had owned up to it earlier, the firm probably would still be around,” one said.
Although top Salomon executives knew about wrongdoing for several months without notifying regulators, once the wrongdoing became public, the firm moved like lightning. Chairman John H. Gutfreund and two other top executives resigned almost immediately. Warren E. Buffett, perhaps the most revered man in corporate America, swiftly took the helm. Immediately, he imposed rigid new internal controls. The firm threw open its books to investigators, vowing to cooperate completely. On Friday, Donald M. Feuerstein, Salomon’s chief legal officer, quit after Buffett asked for his resignation.
Even with that approach, however, Salomon is not getting an easy ride. The arrival of Buffett, the billionaire chairman of Berkshire Hathaway Inc. who is considered a pillar of integrity, wasn’t enough to stem a wave of defections and censures by prominent Salomon clients.
The World Bank, the California Public Employees’ Retirement System and Connecticut’s state employee pension fund were among the big customers that publicly announced suspension of business with the firm. Government investigations widened. Through much of the week, Salomon’s stock seemed like a go-cart without the brakes to stop a frightening trip downhill. On Friday, however, Salomon stock rose $1.125 to close at $23.75.
Clients and regulators were angered by the admission that Salomon repeated the same kind of wrongdoing--covertly buying more than the allowed 35% share of securities in Treasury auctions and making bids in the names of customers who hadn’t authorized them--even after Gutfreund and other top executives learned of earlier violations in April.
Although Salomon may have learned lessons about damage control from what happened at Drexel, some note that Salomon evidently hadn’t learned the most important moral of all.
“When they were doing this (wrongdoing), they obviously weren’t learning any lessons from Drexel,” said a prominent Washington defense lawyer who had a role in the Drexel case. “How the hell could they have done something that stupid in the light of all these Drexel disclosures? There’s a paper trail a mile long when you oversubscribe in a Treasury auction.”
Even before the scandal broke, Salomon was laboring to overcome damage to its reputation inflicted by two best-sellers about Wall Street. One, “Liar’s Poker,” by Michael Lewis, had portrayed Salomon as a firm that wasn’t above harming customers in efforts to secure profits for itself. The other, “Barbarians at the Gate,” by Bryan Burrough and John Helyar, made the firm out as a bumbler in investment banking.
To be sure, there were some strongly encouraging signs for Salomon this week. A great many other important clients said that, at least for now, they will stand by Salomon, including the Teachers Insurance & Annuity Assn.-College Retirement Equities Fund, the nation’s largest pension fund.
In a show of loyalty, or in an effort to keep competition healthy on Wall Street, many other customers increased the business they do with Salomon above normal levels to help out the firm. There is still strong speculation that if Salomon were to get into a real liquidity crisis, the Federal Reserve or other government agencies might intervene to save it.
As a result, the betting at the moment is that Salomon will recover.
Nevertheless, some of Salomon’s mainstream customers wonder whether the tight new controls that Buffett has imposed might undermine what had made Salomon a preeminent firm: its reputation as the most aggressive trader on the Street. Although widely disliked, Gutfreund had built Salomon into a powerhouse and set the tone for its macho trading culture.
“Now it remains to be seen if Salomon is merely a shadow of Gutfreund,” said an executive at another Wall Street firm. “They’re going to have to prove themselves.”
Stanley Arkin, a leading New York white-collar crime defense lawyer, said many customers will be comforted knowing that Salomon is playing squarely by the rules and the government is watching it closely. But, Arkin noted darkly, it is also true that “many people who engage in commercial transactions don’t like to do so under the mantle of somebody who is being scrutinized too carefully.”
