The Snowball

by Alice Schroeder

  He did not want this promotion; he and the other arbs wanted J.M. back. Meriwether’s office remained exactly as he had left it. The golf clubs, his ceremonial instruments of power, leaned in the corner. The cleaning crew kept the shrine well-dusted. The arbs gathered to consult the oracles of trading. They prayed for J.M.’s return. Salomon’s stock continued to slump toward the low $20s.

  As the investigation ticked along and the employees rowed like galley slaves, Buffett’s mind could not help but wander toward his main preoccupations: Berkshire Hathaway and investing. He had just bought a shoe company, H.H. Brown Shoes, and turned to his secretary at Salomon, Paula Orlowski, sending her to the library to delve into computer files in search of SEC documents on Morse Shoe, another footwear maker that had recently filed for bankruptcy.37

  Nevertheless, Salomon demanded most of his attention. Piled on top of other, earlier scandals—Ivan Boesky, Michael Milken at Drexel Burnham Lambert—the Salomon affair had fueled the perception that Wall Street was utterly corrupt. In the wake of Buffett’s performance before Congress, a raft of other brokerage firms rushed to the confessional and followed suit.38 By now, Salomon’s investigators had discovered that Mozer had bid more than thirty-five percent on eight separate occasions, submitting false customer bids or jacking up customer bids and taking the extra bonds into Salomon’s own account without informing the clients whose names had been used. On four occasions he had managed to acquire more than three-quarters of all the debt issued.39 As the witch-hunt atmosphere heightened, Buffett upped the ante. At the next board meeting, he led a discussion. Why should Salomon be paying the attorneys of John Gutfreund to stonewall us? was the thrust of his questioning.40 The directors voted, almost unanimously, to make two surprising moves. No severance pay, they said. And the firm cut off payment of legal fees for the former executives.41

  The drama now revolved around two things: the Federal Reserve’s deliberations over whether to keep Salomon as a primary dealer, and the criminal case. The Federal Reserve lacked the expedient option of temporarily suspending the firm: “It’s like executing somebody technically and then resuscitating them,” said Federal Reserve Chairman Alan Greenspan. In October, the Fed was seriously considering letting Salomon fail. Keeping it around was a decision that might be “jumped on by politicians right and left.”42

  The U.S. Attorney’s prosecutors thought they had enough evidence to indict. The criminal law makes it very difficult to defend corporations against the acts of their employees. Gary Naftalis, Salomon’s criminal lawyer, advised the firm that “Salomon plainly could be convicted” if it was indicted. For obvious reasons, everyone at the firm was desperate to get the criminal matter resolved. As long as it was hanging over the firm’s head, Salomon operated under a death threat, and customers knew as much. But Naftalis was in no hurry. He reasoned that a quick decision would probably mean indictment, whereas more time would let him lobby and persuade that Salomon did not deserve indictment; more time would let Salomon demonstrate its extraordinary willingness to cooperate; more time made it less likely that the prosecutors would indict.43

  After some three months of work dedicated to reforming the firm, Denham led Buffett, Olson, Naftalis, and Frank Barron to a secret location, chosen at U.S. Attorney Otto Obermaier’s insistence, half a mile from the prosecutor’s office at St. Andrew’s Plaza near City Hall. It was a last-ditch attempt to persuade Obermaier and his lawyers not to indict.44

  A Teutonic old-school prosecutor with a love of the law and a deep respect for the history and traditions of the U.S. Attorney’s office, Obermaier had been trying to figure out what to do with the fiasco that had landed in his lap. He recognized its unique nature. “This is no assault case on the New York subways,” he said. Indeed, he had been calling Jerry Corrigan “alarmingly often” to learn the ins and outs of the Treasury bond market: the difference between two-year notes and thirty-year bonds, the frequency of auctions, and how they were conducted.45

  Sitting in a little conference room facing Obermaier, Buffett did most of the talking. He worked very hard to convey what he had said so many times, that if the firm were indicted, it could not survive. Obermaier made comparisons, however, to a case involving Chrysler, which had survived prosecution.46 The difference between a firm that sold hard assets and a firm that bought and sold nothing more than promises on pieces of paper was initially not clear. Buffett tried to get past the image of onion-burger-tossing slobs inspired by Liar’s Poker and invoked the innocent rank-and-file who would lose their jobs if Salomon went down. He promised that he would not sell his Salomon stock anytime soon and that his people would continue to run the place. He conveyed the sweeping nature of the cultural changes taking place inside the firm. This made an impression on Obermaier, but he kept a poker face. He had many other factors to consider.47 The Salomon team went back across town with no idea whether they had succeeded or failed.

  By midwinter, Salomon’s status as a primary dealer remained unresolved. The firm still lacked the right to trade for clients, and the Treasury Department could undo the whole deal at any moment. Under threat of corporate criminal indictment, Buffett and Maughan labored to prove the firm worthy of saving. Buffett had run a full-page ad in the Wall Street Journal explaining the firm’s new standards.48

  “I said that we would have people to match our principles, rather than the reverse. But I found out that wasn’t so easy.”

  Day after day, Buffett bore down, shocked by the lavish lifestyle that was taken for granted on Wall Street. The executive dining room’s kitchen, as large as that of any restaurant in New York, was run by a head chef trained at the Culinary Institute of America and staffed by a pastry chef, a sous-chef, and a number of under-chefs. Employees could order “anything on earth they wanted” for lunch.49 In his first days in New York, Buffett received a letter from the head of another bank, inviting him to lunch so their chefs could do battle. Buffett’s idea of testing his chef’s skills was ordering a hamburger for lunch every single day.

  The frustrated chef created batch after batch of handmade potato chips. He peeled the potatoes into cylinders sized to the millimeter, sliced them gossamer-thin, and whisked them into fresh sizzling oil until crisped just so. The perfect potato chips lay heaped in a pyramid alongside the daily hamburger on Buffett’s plate. He ate them absentmindedly, daydreaming of McDonald’s french fries.

  For Buffett, the dining room symbolized the culture of Wall Street, which he found abhorrent. He had been born in an age where money was scarce and life was lived at a walking pace, and he’d arranged his own life to keep things that way. On Wall Street, money was plentiful and life was lived at whatever speed bandwidth could currently supply. People left their homes at five a.m. daily and returned at nine or ten at night. Their employers showered them with money for doing that but in return wanted every waking second of their time and supplied certain services to keep them working at a treadmill pace. Buffett as a child had been impressed by the Stock Exchange employee who rolled custom-made cigars, but now found this astonishing.

  “They had a barbershop downstairs, and they didn’t even tell me about it. They were afraid of what would happen when I found out. And they had a guy who came around and shined your shoes, and you didn’t pay him.”

  The executives of Salomon had previously felt, as one underling put it, that “God forbid they should ever lift anything but a fork.” Behavior by their new billionaire chairman that would seem normal on Main Street shocked Salomon’s employees. On the way to play bridge one night, Buffett asked his Salomon driver to stop the car. He climbed out and walked into a nearby store, then returned a few minutes later as the driver watched, mouth agape. The chairman was carrying huge bags full of ham sandwiches and Coca-Cola.50 This was the new Salomon.

  But it was the battle over pay that became the watershed. Early in the fall, Buffett had told the staff that he would be slashing $110 million from the year-end bonus pool. “Employees producing mediocre returns for their
owners should expect their pay to reflect this shortfall,” he wrote.51 That seemed simple and obvious to him. Businesses and people that were producing should be paid. Those that weren’t should not. Maughan agreed with Buffett that the culture of entitlement had to go. People were not entitled to millions just because they owned three houses and were supporting two ex-wives.52 But for once Buffett had miscalculated the limits of human nature. The formerly enriched employees, used to being showered with money on bonus day, now knew that they were about to be gouged.

  Buffett’s reasoning that employees should not take home all the spoils and the shareholders none was lost on them. Indeed, they believed the opposite, since they had been taking home the spoils for years. A decrease from last year was outrageous. They felt that Buffett was trying to transfer some of the guilt from Mozer’s misdeeds to them by making an issue out of the bonuses. They had not caused Salomon’s woes. Rather, they had stayed out of loyalty and were enduring humiliation and misery in its aftermath. They were sweeping up behind the elephant. They felt that they deserved combat pay. It wasn’t their fault that their businesses weren’t performing. How could they sell an investment-banking deal while the firm was under threat of indictment? Didn’t Buffett understand that? They were up against the fact that everybody on Wall Street knew that Buffett thought investment bankers were nothing but useless stuffed shirts with fancy cuff links. Meanwhile, despite its problems, Salomon was actually having a decent year financially. They resented being called greedy once again by an avaricious billionaire.

  The deprived traders, sales force, and bankers had to hang around until year-end, the traditional time for quitting, after individual bonuses were paid and the smaller but nevertheless multimillion-dollar deferred bonus pool was scheduled to cash out.

  When the bonus pool was divvied up around the holidays, the battle over pay reached epic scale. The top thirteen executives saw their bonuses slashed by half. As soon as the numbers were announced, Salomon’s hallways and trading floor erupted in open revolt. With budgets and bonuses gutted, traders and bankers fled. Half the equity department—home of the investment bankers—ran out the door. The rest of the trading floor went on a temporary strike.

  One day, Buffett walked a couple of blocks over to American Express to have lunch with its CEO, Jim Robinson. “Jim,” he said, “I didn’t think it was possible, but I just paid out nine hundred million dollars in bonuses.” Yet he felt that everybody, other than Maughan and one or two people he had brought in to fix the place, was mad at him.53

  “They took the money and ran. Everybody just peeled off.

  “It was just so apparent that the whole thing was being run for the employees.54 The investment bankers didn’t make any money, but they felt they were the aristocracy. And they hated the traders, partly because the traders made the money and therefore had more muscle.”

  He had just saved Salomon and had thought that that would matter to the employees. But no, “We were grateful for about five minutes,” was the verdict of one ex-employee. The fact that they wouldn’t have a job without Buffett was forgotten in the grim shadow of the Bad Bonus Day. “Warren didn’t understand how to run a people business” became the refrain among ex-employees. Salomon wasn’t the kind of place where you could just raise prices, cut overhead, and pull cash out of the business up to the parent company (although Buffett did as much of that as he could). You had to keep very smart people motivated when they had other options instead, during a time when “you were dying by a thousand cuts a day,” as Olson put it. Buffett viewed the new pay deal as a cultural litmus test: Those who left were mercenaries whom the firm could do without, and those who stayed had signed on to the kind of firm he wanted.

  Wall Street being a mercenary kind of place, little by little many of the top employees continued to drift away, carrying books of business to competitors as they departed. Buffett couldn’t sleep. “I couldn’t turn off my mind,” he says. He had spent his whole life avoiding commitments to anything where there was no escape hatch and he didn’t have total control. “I’ve always been leery of getting sucked into things. At Salomon I found myself defending things I didn’t want to defend; and then I found myself being critical of my own organization.”

  Months had passed and Obermaier was still pondering whether Salomon’s conduct was bad enough to indict. He knew “it would have been the death knell of the company.”55 In considering the phony bids, he thought it important that Mozer’s actions were motivated more by rebellion against the Treasury rules than simply to enrich Salomon. Likewise, no serious financial losses had occurred from the phony bids.56 He also weighed Buffett’s promises and the new culture.

  Together with Breeden at the SEC, he began to work on settlement talks with Salomon that would allow the firm to escape indictment. Frank Barron, the lawyer from Cravath, went down to the SEC to negotiate its share of the settlement in a meeting with Bill McLucas, Breeden’s deputy, who informed Barron the fine from the Department of Justice and the Treasury Department would be $190 million plus a $100 million restitution fund. Barron was shocked—the fine was huge for the transgressions of a single trader who had violated Treasury rules without causing serious harm to customers or the market. Why? he asked. “Well, Frank,” said McLucas, “you have to understand that it’s going to be $190 million because that’s what Richard Breeden says it’s going to be.”57

  The moment when John Meriwether had rushed into the conference room that Sunday morning, white and shaken, quoting Dick Breeden, who had called Salomon “rotten to the core, rotten to the core,” came to mind. There would be no appealing this decision. Salomon agreed to pay the extraordinary fine.

  Buffett was trying to undo the “rotten to the core” image as fast as he could. Dubbed “Jimmy Stewart” by the staff, he nixed deal after deal that he thought was too close to the line, despite the resulting internal backlash. Then another crisis erupted that almost derailed the settlement.

  Mozer made a proffer to the government to plea-bargain his case. He revealed some tax-motivated trades done by him with other traders that involved making secret side deals with other firms to guarantee the other firms against losses. The tax trades would give the prosecutors an even stronger reason to press criminal charges against the firm.

  Besides the obvious motivation of trying to save his own neck, Mozer had ample reason to harbor bitter feelings toward Salomon. Had the firm’s former leaders handled the situation properly, he still would have been fired, and he might have still been charged with fraud and be going to prison—but his name would not be splashed all over the newspapers as the man who had nearly caused the largest financial failure in history.

  During an emergency board meeting, Obermaier called Olson about the tax trades to settle things down. He said that he had decided not to scuttle the settlement over Mozer’s new revelations. Whatever this new issue was, Salomon would take that up with the IRS. The rest of the firm’s misconduct, he thought, was serious, and should “bring the corporate entity to its knees, at least for a slight genuflection,”58 but not require the death penalty.

  On May 20, Obermaier’s office called Olson to say that the government was not going to indict and had dropped all charges. The U.S. Attorney and the SEC announced a settlement with Salomon over fraud and record-keeping charges; including the $100 million restitution fund, it was in total the second largest fine in history. The settlement found no evidence of wrongdoing other than Mozer’s illegal bidding, which had been discovered by Salomon itself. Mozer was going to prison for four months, and would pay a $1.1 million fine. He was barred from the industry for life.59 Gutfreund, Meriwether, and Strauss were reprimanded for failing to supervise him, given small fines, and suspended for a few months from working in the industry.60

  Some thought Salomon got off easy compared to Drexel Burnham Lambert, which had paid $650 million and imploded after settling felony charges of stock parking and stock manipulation. But most observers were dumbstruck at the size of the f
ine for what amounted to technical violations by one employee. In fact, by acknowledging its guilt to the government so freely, some thought Salomon had given up its negotiating leverage. But what the large fine really reflected was that the firm had bungled its reporting responsibilities so badly, and had made the regulators look asleep at the switch in front of Congress. In other words, thumb-sucking and obfuscation had nearly bankrupted Salomon. Thus it was, as the well-exercised saying goes, the cover-up, not the crime.

  Three days after the announcement, Dan Cowin died of cancer. Buffett wrote out a heartfelt eulogy, meaning to deliver it himself, and asked his secretary, Paula Orlowski, to stop by his hotel room and pick it up to have it typed. But when she arrived, he met her at the door and said, with an agonized look, that he could not bring himself to speak at Cowin’s service. Instead, Susie was going to read it for him.61 Buffett went to the service. “I sat through it shaking all over the whole time,” he says.

  Then he went back to work. Salomon estimated that the $4 million profit Mozer had made from his trades had cost the firm $800 million in lost business, fines, penalties, and legal fees. The firm’s status as a primary dealer remained unresolved, although it now seemed a foregone conclusion that this would be resolved in Salomon’s favor.62 Employee defections had slowed to a trickle, and the rating agencies were starting to upgrade Salomon’s debt. Customers started coming back. As Salomon stock crept above $33, Buffett, who could not wait to return permanently to Omaha, announced that he was stepping down. Deryck Maughan took over as permanent CEO, and Buffett appointed MTO lawyer Bob Denham as chairman. When it was over, says Gladys Kaiser, “I could almost see a big sigh of relief. It was as if, almost overnight, we got Warren back.”

  In that mournful spring of 1992, as Salomon staggered to its feet, the question of how to deal with those who had nearly brought it down remained unresolved. Second only to Mozer in the public’s assessment of culpability was John Gutfreund. In the end it was he who was responsible, despite all the legal advice that reporting was not required.