TIME: Almanac 1993/TIME Almanac 1993.iso/time/090291/0902201.000

Text File | 1992-08-28 | 5.4 KB | 113 lines

                                                                                BUSINESS, Page 59

FINANCE

Salvaging Salomon Brothers


A white knight and his new team fight to keep "Solly" afloat
despite a tide of client desertions

By THOMAS MCCARROLL -- With reporting by Elaine Shannon/Washington


    When billionaire financier Warren Buffett announced he
was assuming the chairmanship of Salomon Brothers on an interim
basis last week, he stepped into a morass that threatened to
grow worse for the 81-year-old Wall Street firm before it got
better. In fact, Buffett's salvage job began even before he was
able to warm his new seat. The Treasury Department, in an
attempt to restore confidence in the market, barred Salomon from
bidding at further auctions. In a series of telephone calls with
vacationing Treasury Secretary Nicholas Brady, Buffett
successfully lobbied for leniency. Salomon was permitted to
trade, but for its own account only, not on behalf of clients.
The decision was more than symbolic, since Salomon, one of only
40 firms designated as primary dealers in T-bonds and T-bills,
directly and indirectly counts on government securities for
about 25% of its business. The firm participated in last week's
auction under the watchful eye of Treasury officials.

    Buffett, who owns 16% of Salomon's preferred stock and a
legendary reputation for his investing, if not his
investment-banking, savvy, assumed Solly's chairmanship after
the board forced chairman John Gutfreund and two other top
executives to step down. Buffett immediately brought in Deryck
C. Maughan, 43, who until recently ran Salomon's Asian
operations from Tokyo, and jettisoned two bond traders.
Executives admitted that the firm had violated the rules that
prohibit any one bidder from buying more than 35% of a single
issue at a Treasury auction, and that they had skirted
regulations barring a firm from submitting bids in its
customers' names without their authorization in order to
conceal such illegal efforts to influence the market.

    For decades, the government securities market has been
considered the world's safest haven for investors. Unlike stocks
and bonds, both of which were plagued by a series of
insider-trading cases during the 1980s, the $2.2 trillion market
for Treasury instruments was thought to be too big to rig. The
Salomon scandal shook that conventional wisdom and aroused
suspicion that other firms might be playing similar games.
Consequently, an intimidating array of investigations by the
Federal Reserve Bank, the Justice Department, the Securities and
Exchange Commission -- where enforcement director William
McLucas is personally heading the inquiry -- and the New York
Stock Exchange were launched. Next month Representative Edward
Markey, who heads a subcommittee that oversees Treasury-bond
trading, will hold hearings on the Salomon scandal.

    The SEC is seeking detailed information from all dealers,
brokerages and commercial banks authorized to trade Treasuries,
as well as from individual bond traders employed at those firms.
The Treasury Department is re-examining the records of every
auction since 1986, a total of more than 200, searching for
evidence of collusion with customers to violate the 35% rule.
Industry analysts expect only minor infractions to turn up.
Still, says Howard Sirota, a New York City securities attorney,
"this proves that the market isn't quite as pristine and squeaky
clean as its participants would have us believe."

    Salomon's more urgent problem is customer defections,
which threaten the firm's liquidity. The World Bank and at least
two state treasuries and four state pension funds said they
would all stop buying Treasury bonds through Salomon until
questions about auction violations are resolved. The British
Treasury is also considering sanctions against the investment
house. More desertions are expected.

    Salomon already faces about a dozen lawsuits filed by
investors who charge they either overpaid for securities because
of artificially inflated prices or were paid less interest
income because of deflated yields. In anticipation of financial
damages arising out of litigation, the firm is setting aside
reserves that almost certainly will exceed its profits, which
have totaled $451 million so far this year. To head off a
liquidity crisis, the investment house triggered its emergency
financing plan, which calls for a shift from short-term IOU's
to secured loans that pay higher rates.

    Buffett's internal reforms, announced shortly after he and
Maughan took up their posts, could cost Salomon some of its
high-flying bond traders, who could bolt from the firm once they
receive this year's bonuses. If individual bonuses are decoupled
from the performance of business units in order to eliminate
the motivation for overly aggressive trading, some traders may
jump ship. Says a former Salomon trader: "People who have had
deals like that know they can get them someplace else."

    Despite the desertions and a plunge in stock price of more
than a third since the scandal broke, few are counting Solly
out. The firm still maintains substantial resources and a loyal
following. Says Samuel Hayes III, a finance professor at Harvard
University: "Salomon will emerge from this episode, bloodied and
bruised, but just as potent a force on Wall Street."