Buffett’s appearance before Congress was part of a careful strategy aimed at soothing furious clients-and breaking ties to the old regime. On Thursday, Salomon announced that Gutfreund and three other former executives tainted by the scandal would receive no severance pay, future legal expenses or compensation from the firm (chart). That decision followed Kansas Democratic Rep. Jim Slattery’s pronouncement during the hearings that “there should not be a dime spent by the firm to defend the wrongdoers … These men should be in striped suits, sweeping up Wall Street.” Buffett’s efforts haven’t yet stopped the exodus of disaffected customers: the British treasury last week announced it had fired the firm as the lead underwriter in an $8 billion sale of shares in British Telecommunications P.L.C. in the United States. The departures of customers have ominous implications, says a senior U.S. Treasury official: “If confidence goes, no institution can survive.”
In Congress, confidence was also waning in the $2.2 trillion treasuries market, the process by which the government raises money to cover the federal deficit. Four congressional committees are holding hearings on the Salomon scandal. “Dramatic changes have to be made,” says Massachusetts Democratic Rep. Edward Markey, who chaired last week’s hearing. Yet other Wall Street experts insist that the Salomon case is an aberration. They say the firm’s transgressions were quickly spotted and major reforms are likely to hamper the government’s ability to raise cash at the lowest rates. And some critics charge that lawmakers are less interested in fixing the markets than in fattening their own campaign chests. The financial-services industry is the biggest contributor to congressional elections, having kicked in $19.5 million between 1981 and 1990-much of that going to legislators who regulate their industry.
At stake is a system that favors 39 players, known as “primary dealers,” who buy bonds directly from the Treasury. In this era of computerized trading, the bidding process seems almost Dickensian: primary dealers buy bonds at regularly scheduled auctions, stuffing written bids into a wooden box at the Federal Reserve Bank of New York. To prevent one big player from cornering any one auction, the Treasury imposed regulations that prohibit a primary dealer from bidding on more than 35 percent of each issue.
Yet Mozer found numerous improper means of evading that restriction, according to documents released last week by Salomon. In the most outrageous case, Salomon revealed that the firm and its customers controlled a staggering $10.6 billion out of the $11.3 billion in bonds offered at the May 22 auction of two-year notes. Mozer improperly purchased $4.7 billion of the notes in direct bidding and through other dealers, giving the firm more than the allowed 35 percent share. In addition he bought $2 billion worth of bonds for a customer, Tiger Investments-then secretly bought back $500 million. And Mozer purchased $4.28 billion of the notes for another client, the Quantum Fund. Did Salomon collude with its clients? That’s unknown, but during the next few days many “short sellers”–dealers who promised to deliver bonds to customers at a price higher than what they expected to pay for them-were forced to buy the notes at Salomon’s stiff rates. When the dealers lost millions, they complained to the Federal Reserve. The premiums Salomon might have charged seem hardly noticeable, but even three cents on each $100 worth of bonds could yield a profit of $3 million on a $1 billion transaction.
Some congressmen suggest Salomon got caught only because it went too far over the line. The Treasury and the Fed, they say, aren’t qualified to police the market. In the hearings, Markey pointed to the $9 billion auction on Feb. 21 in which Salomon gobbled up 57 percent of the bonds by putting in an unauthorized bid for a customer, S.G. Warburg & Co. Warburg, a primary dealer, had submitted its own separate bid-which caught the eye of the Federal Reserve and Treasury. But both waited two months before requesting an explanation from Warburg. Critics charge the regulators are too cozy with dealers who help them raise billions. But others insist the Feds are on the job; Roger Altman, vice chairman of the Blackstone Group and a former top Treasury official, says, “The idea that the Federal Reserve in New York runs a good-ole-boy, sleepy, laissez-faire operation is complete baloney. "
There are some who insist that cornering the market on a single Treasury issue is a small offense. “Some dealers took a minor hit,” says Allan Meltzer, a financial-markets expert at Carnegie Mellon University, " [but] nobody believes the kind of fiddling done by Salomon cost the taxpayers a dime.” Other experts say the scandal could shake investor confidence, forcing the government to pay higher interest on its bonds to lure back bidders. Those costs would come out of the taxpayers’ pocket. Pressure is building on Capitol Hill for reform. Some lawmakers advocate beefing up the role played by the Securities and Exchange Commission, which has had minimal oversight so far. Possible changes include imposing stricter reporting requirements and lowering the bond-purchase limit at one auction from 35 percent to 25 percent. Some have proposed more radical reforms, including dissolving the primary dealers “club” and opening the bidding to all.
Whatever the solution, restoring confidence is paramount. “This injures the integrity of the market,” says Altman. “It risks the public being disaffected.” Buffett has already gone into high gear to clean up Salomon’s sullied reputation; now it’s the regulators’ turn for damage control.
John Gutfreund and top underlings-former president Thomas Strauss, former vice chairman John Meriwether, former general counsel Donald Feuerstein-are being cut loose from the firm. What they stand to lose:
The men forfeit severance pay and may lose their share of a $ 100 million deferred-pay pool. (Gutfreund isn’t part of it.) They could still end up with millions if they exercise stock options.
The four executives will have to pay for future legal costs, which could be staggering. Salomon itself may face lawsuits totaling as much as $1 billion, or one third of its net worth.
Salomon’s board says the men will no longer be paid for expenses or be provided with offices. If they continue working at Salomon’s old Manhattan headquarters, they’ll have to pay rent
