Salomon Cornered Market : With 94% Control of Treasury Issue, It Could Have Ruined Short-Sellers
Salomon Bros. revealed Wednesday that it and a handful of customers controlled a staggering 94% of the May 22 issue of Treasury notes, virtually cornering the vital market in the nation’s public debt.
Warren E. Buffett, the investment firm’s interim chairman, delivered an investigative report to Congress disclosing that Salomon, working for itself and customers, acquired $10.6 billion of the $11.3 billion in government notes available for competitive bid.
The overwhelming size of Salomon’s position--which prompted calls for stepped-up regulation of the government securities market--goes far beyond any previous admission concerning the firm’s activity in illegally dominating the May 22 auction. Earlier, the firm had said only that it bought 44% of those issues for its own account.
Buffett apologized profusely for the scandal that has shaken the Treasury securities market, which handles the financing of the massive federal debt.
“The integrity of the markets is paramount,” said Buffett, a billionaire investor and Salomon’s major shareholder, who stepped in as chairman last month to help the firm.
He pledged full cooperation with government investigators. “I absolutely believe in tough rules, tough cops and tough prosecutors,” Buffett told the finance subcommittee of the House Energy and Commerce Committee.
Salomon violated the rules barring a single firm from buying more than 35% of a security at auction. It also submitted fraudulent bids, using the names of customers without their permission. The various misdeeds took place during auctions in December, 1990, and February, April and May of this year.
The ramifications of the scandal could spread far beyond Salomon. It already has claimed the jobs of former Salomon Chairman John Gutfreund and five other top executives. The Securities and Exchange Commission has broadened its probe of Salomon to include an examination of the trading practices at all of the 39 primary dealers in government securities and many of their customers, SEC Chairman Richard C. Breeden told the House subcommittee.
More than 135 subpoenas and requests for information have been issued in the “wide-ranging probe,” Breeden said.
With Treasury debt amounting to $2.3 trillion, “the stakes are high” if the public loses faith in the honesty of the markets, Federal Reserve Board Vice Chairman David W. Mullins Jr. told the subcommittee.
Securities are issued constantly as the debt comes due and is rolled over into new issues of notes and bonds. A tiny increase of 1/100 of 1% in interest rates, prompted by nervousness, costs taxpayers more than $200 million a year in extra payments, Mullins noted.
If a single firm, such as Salomon, cornered the market in a Treasury issue, the result could be a “squeeze” on other companies that needed to obtain securities to fulfill business obligations. Short-sellers, those who arranged sales before and now needed the actual securities to deliver them to buyers, would be at Salomon’s mercy.
Paul Mozer, who directed government trading for Salomon until being fired last month, used several accounts to win almost the entire issue in the May 22 auction of two-year Treasury notes, according to the Salomon report submitted to Congress.
He submitted bids for Salomon and for two of the firm’s big customers, Tiger Investments and Quantum Fund.
Salomon often provided temporary financing for customers to buy securities. But in this case, the investments were so huge that they put the firm far over the 35% permissible limit for holdings of a single issue. Salomon itself was within the 35% limit, but it effectively controlled 94% because it supplied the funds for customers to buy the bulk of the issue.
Two days before the auction, Mozer had dinner with Tiger officials and said Salomon would be receptive to financing a purchase of notes, according to the report. But in an inquiry later, Salomon’s lawyers “expressed their doubts” that the bid on Tiger’s behalf “had been fully authorized” by Tiger’s management.
Responses from Tiger and Quantum were not included in the report.
Federal Reserve officials learned that Salomon and its customers had cornered the issue. They talked to Mozer, who agreed to make the notes available at reasonable prices to avoid financial collapses among short-seller firms, according to the Salomon report.
The SEC and the Justice Department are investigating the Salomon Bros. market activity in May and unauthorized bids in previous auctions for possible violations of securities laws.
Buffett said he welcomes severe punishment for “anyone who interferes with the market process.”
The scandal cost Salomon a lucrative contract Wednesday. The British government dismissed the firm as lead U.S. broker for an $8.5-billion issue of stock in British Telecom.
“We are the only U.S. investment bank that has played a lead role in all previous U.K. privatizations and look forward to renewing our long-standing relationship . . . in the near future,” a disappointed James Massey, chairman of Salomon Bros. Europe Ltd., said in London.
Rep. Edward Markey (D-Mass.), the subcommittee chairman, said he is determined to get congressional approval of tough new regulations for the government securities market.
“The admissions of wrongdoing at Salomon not only reveal an arrogant disdain for the law by former Salomon Bros. officials but cut right to the heart of concerns about the adequacy of regulation in the market itself,” Markey said.
Rep. John Dingell (D-Mich.), chairman of the full Energy and Commerce Committee, said the securities scandal gives him new determination to resist the expansion of bank powers sought by the Bush Administration.
“The Treasury has consistently resisted efforts to have proper regulation of banks, savings and loan associations and the Treasury securities markets,” Dingell said. Giving banks entry into new businesses, and permitting commercial and industrial firms to buy banks, would promote “wrongdoing, incompetence and rascality,” Dingell said.
Cornering the Market
Salomon Bros. used its customers to help corner the market in the May 22 issue of Treasury notes, violating the rule that says a single firm cannot acquire more than 35% of a single securities issue. Here’s how they did it, according to a Salomon report submitted to Congress on Wednesday:
* The firm bid $4.2 billion in its own name, $4.287 billion on behalf of a big customer, Quantum Fund, and $2 billion for the account of another major customer, Tiger Investments. Salomon also filed bids for other customers totaling $130 million.
* Salomon financed both the Quantum Fund and Tiger Investment purchases, thus pushing Salomon’s indirect stake in the market to 94%.
* Paul Mozer, who ran government trading for Salomon, had dinner with Tiger representatives two days before the auction and said Salomon would be receptive to financing any purchase of notes. But Salomon’s lawyers, who conducted an internal inquiry, “expressed their doubts” that the $2-billion bid on Tiger’s behalf “had been fully authorized” by Tiger’s management. Tiger’s response was not included in the report.
* Salomon and its customers submitted the highest bids and bought $10.6 billion of the $11.3 billion in notes.
