Buffett’s manifesto generated a groundswell of support from people outside Salomon, many of whom hoped that it might—finally—bring some reasonableness to Wall Street’s pay scales. Inside Salomon it was a different story. The employees felt they were being made to take the fall for Mozer, and they deeply resented Buffett’s going public. The day the ad ran, Gary Goldstein, a headhunter, got a torrent of calls from Salomon executives who were, indeed, quite willing to have their loyalty priced.
What’s more, the size of the cuts—amid a record year on Wall Street—stunned them. Maughan slashed bonuses for 70 percent of Salomon’s managers.46 Investment bankers were shaved by an average of 25 percent, with some taking cuts of as much as $500,000. In addition, Buffett and Maughan laid off eighty professionals and two hundred support staff.47
Quite quickly, sentiment toward Buffett soured. People were grateful to him for saving Salomon. Now they’d had enough of him. They thought he was pandering to the regulators and blamed him for putting Gutfreund out in the cold. A veteran analyst said, “Some of us who have been here a long time felt a certain affection—a strong one—for John Gutfreund. Warren was a savior. You know how you feel about saviors. You love ’em but you also resent them.”
Of Gutfreund’s barons, none had been more protected than Stanley Shopkorn, Salomon’s head stock trader. Gutfreund used to smoke cigars in Shopkorn’s office while the heavyset, be jeweled horse player traded stocks. On Wall Street, Shopkorn’s reputation for trading big positions and playing his hunches had given him a certain aura.
However, the equities department, which he ran, was a poor performer. Buffett, totally unmoved by Shopkorn’s Runyonesque charm, ordered him to sell a couple of losing stocks and to quit his speculations. Shopkorn resigned.
His departure triggered a wave of defections in equities. After the group’s paltry bonuses were announced, Bruce Hackett, Shopkorn’s replacement, got on the squawk box and hollered to his troops, “I’m mad as hell. I leave it to you to figure out why.” Buffett’s rush to remake the firm seemed to have opened a trapdoor in Salomon’s attic, through which all of the demons accumulated over the past decade were suddenly tumbling forth.
The fourth quarter of 1991 was a disaster. Salomon’s share of stock underwritings collapsed from 8 percent before the scandal to 2 percent. The timing was awful. Wall Street was doing a record business in underwritings and bonuses were up all over the Street. But at Salomon, the salesmen and analysts had nothing to pitch, and the bankers had no deals. So they left.
“Warren doesn’t realize how easy it is for people to leave—he thought he was so goddam smart,” a departing banker fumed, reclining in the leather-backed chair of a men’s club. “He’s running it like a stock. He doesn’t care about the people.”
Warming to his subject, the banker continued, “Do you think his entire record could go on the front page? He’d have to be almost inhuman. A saint or something.”
In January 1992, Buffett faced a crisis. Tom Hanley, the banking analyst previously enthralled by Buffett’s team spirit, threatened to defect to First Boston unless his pay was doubled to $2 million. Hanley had used similar ploys to extract raises in the past (including a 40 percent hike in 1991). Though a prima donna, Hanley was a valued analyst, and influential in winning business from banks. Buffett let him go.
Four other analysts left the same week. It touched off a panic. The cream was gone; now rivals were threatening to pick the department clean. At Maughan’s urging, Buffett backpedaled a bit and guaranteed bonuses for six younger analysts. It was the first time he had blinked.
Meanwhile, Buffett and Maughan were trying to design a system that would link bonuses in each group to the group’s return on capital. This was not so easy. Salomon had never bothered to calculate how much capital each of its various units was using. To Buffett, it was a fatal oversight.
Rather strange, frankly, to me, to think of having a business that employs close to $4 billion of equity capital and not knowing exactly who is using what.48
In the midst of the battle over bonuses, Jack Byrne’s son Patrick, a doctoral student in economics and philosophy at Stanford, stopped off to see Buffett, and the two had a long chat about motivation. Buffett encouraged young Byrne to question the dogma of his textbooks. People—at least some people—he maintained, were not the purely economic creatures depicted by economists. They could also be motivated by loyalty.
To put it mildly, this was less than obvious on Wall Street. People became investment bankers to make money. If you didn’t pay them they would leave. Nick Brady, himself a former investment banker, thought Buffett was out of his element: “It’s like running an opera. You’re dealing with people with big egos, with prima donnas. I don’t think he understood the business completely.”49
Many shared this view, some adding the twist that Buffett was putting on his Midwestern morals for public relations purposes. Yet their criticism betrayed a level of discomfort that Wall Street had always felt with Buffett. Rub the critics deeply enough and they, too, were uneasy about their profession’s pay and overall behavior. The CEO of a major, nonpublic Wall Street competitor sarcastically remarked that Buffett “came in as Mr. Clean, the open-eyed boy from Omaha.”
The guy was anything but. He’s a canny, shrewd operator. But his attempt to rationalize pay was naïve. [Then a nervous giggle.] Some—a lot of it made sense. I agree, the compensation isn’t rational. I’d hate for my pay to be on a public proxy. [Another giggle.] He was quite right—you’ve got to run it like a business.
As Howie had predicted, people who had been waiting for the chance to take a shot at his father came out of the woodwork. Business Week, citing “lemons” such as Wells Fargo and Salomon (and omitting Coca-Cola), asserted early in 1992 that Buffett had lost his touch as an investor.50 Three weeks later, Business Week decided that Buffett had also blown the job at Salomon. While acknowledging that he had, in fact, saved it, the magazine slammed him for “a series of mistakes.” He had embittered employees, backtracked on pay, killed the firm’s taste for risk, and, interestingly, was lacking in “leadership and trust.”51
Some of the criticism was intensely personal. A Wall Street Journal profile played up Buffett’s mistress and implied that his folksy image was something of a fraud.52 In this revisionist view, Buffett crafted his annual letters so as to deflect “tough questions”; he levitated his stock by manipulating his image; he owed his success to his nonpareil circle of contacts. The Journal, quoting Michael Price, a competing money manager, saw Buffett as “one of the biggest invisible market operators going, big arbitrages and all, getting better market information than anybody—and all people see is this homespun, down-to-earth guy.”
Buffett, who had been used to the press fawning over him, “was really upset” by the article, according to Peter, who added, “I was with him. He was obsessed with it.” Buffett wrote a letter to the Journal contesting numerous points in the article, but he was typically unwilling to show his hurt publicly and insisted that the letter not be published.
Next, Michael Lewis, the author of Liar’s Poker, smeared Buffett in The New Republic.53 In “Saint Warren: Wall Street’s Fallen Angel,” Lewis charged Buffett with a series of investing and ethical flaws so all-encompassing that an unknowing subscriber might have supposed that he was reading of one of the century’s great swindlers—and one of its great failures, to boot. Lewis took the Efficient Market Theory as gospel and dismissed Buffett’s career as a run of lucky coin flips. That aside, “Fallen Angel” was rife with actual errors.*
Buffett was livid over the Lewis piece. Morey Bernstein, the author of The Search for Bridey Murphy and a Ben Graham devotee who had known Buffett casually, wrote Buffett a sympathetic note, damning Lewis’s article, apparently in profane terms. Buffett—ever careful with words—responded: “Morey—Thanks for the empathy re the Michael Lewis piece. He is everything you say he is.”54
The interesting question is, what was Lewis’s gripe wit
h Buffett? There is a clue in Liar’s Poker, and it reflects on Wall Street’s discomfort with Buffett as well. In the book, Lewis, describing his life as a young bond salesman, seems to celebrate his unloading of $86 million of unwanted Olympia & York bonds on a gullible client. Yet he admits to a hint of embarrassment over it. He has stuck his “best customer,” and one who trusted him, with bonds that Lewis “probably wouldn’t touch with a barge pole”—save for the “glory” that will redound to him at Salomon.
I knew it was awful. But I feel much worse about it now than I did at the time.55
Now, the conclusion of his essay on Buffett:
You can frighten people into behaving themselves for a while. But in the long run he’s wrong.… Thus we arrive at what might be called Buffett’s Dilemma: the choice between doing good and making money.
In fact, it was Lewis who had made that choice. Buffett, under extremely trying circumstances, was attempting to do both. Buffett’s repeated exhortation—“Good profits simply are not inconsistent with good behavior”56—was a challenge to Lewis’s (and other cynics’) rationalizations.
By the time of Lewis’s piece, mid-February 1992, Salomon was in limbo. The stock had recovered to 30. Customers such as the World Bank and state pension funds had returned. The management had been overhauled, and Buffett was spending most of his time in Omaha.
But Salomon’s corporate business continued to bleed. Morale was suffering from speculation that Salomon was losing its core viability, and by rumors that Buffett was planning to return the firm to its bond-trader “roots” and close up everything else, such as its investment bank. One hundred employees defected in February alone. Of those who had been on the payroll in August, a third of the people in equities and a fourth of the bankers were gone.57 Even Denis Bovin, who had been Buffett’s banker in his first dealing with Salomon, in the early seventies, and who had been a fan of Buffett’s personally, jumped to Bear Stearns.
As painful as such betrayals were, Buffett relentlessly insisted that Salomon was on track. When the dust settled, he maintained, Salomon would be stronger, in all areas, than ever. No one on the staff saw him waver, even in the slightest. This was Buffett’s essential virtue—the courage to stick to his course. Don Howard, the chief financial officer, said, “He conveyed to me that every problem was surmountable.”
Inwardly, it was killing him. Perhaps the most stressful aspect was that Buffett was not used to working with people who were not personally loyal to him. “It’s agony,” Munger said that spring. “It’s just bloody murder. Salomon is losing key employees even as we speak.” For as long as the Treasury case remained open, there was scant hope of stemming the tide.
IV—First Love
It had dawned on Buffett that the government was punishing Salomon by making it wait. He pleaded with the Treasury to bring the case to a head, though he was careful as always not to pressure anyone. “Take your shots,” he would say. “We just don’t want to bleed to death while you’re making up your mind.”58
The Justice Department and the SEC were demanding that Salomon plead to a felony and pay $400 million in fines. Gary Naftalis, Salomon’s criminal lawyer, considered that to be shockingly stiff. Kidder Peabody, which Naftalis had defended in the 1980s, had paid only $25 million, and had not been charged with a crime, after Martin Siegel, its star deal-maker, had confessed to pervasive insider trading. All the government had on Salomon was phony bidding. (The more serious charge of manipulating the market in the squeeze had been dropped for lack of evidence.)
The boyish-looking Naftalis even kidded government lawyers about the case’s seeming smallness, remarking, “What baby died over this?”
An assistant U.S. attorney replied, “You lied to the government. That’s worse than insider trading.”
The decision was up to Otto G. Obermaier, the U.S. attorney in Manhattan. Unlike his predecessor, Rudolph Giuliani, who had handcuffed investment bankers in daylight, Obermaier was a legal scholar and thought to be dovish. But prosecutors live in a world of deterrents. Obermaier wanted a guilty plea.
As Naftalis and the U.S. attorney’s office began to negotiate, Naftalis realized that Buffett had presented him with a subtle weapon. In August, Buffett had promised to cooperate. In the government’s view, he had kept his word. If Obermaier were to prosecute Salomon now, Naftalis argued, Buffett’s openness would be seen as naïve. In effect, the prosecution would then deter not future crimes but future cooperation. Buffett had made his own behavior—not Mozer’s or Gutfreund’s—the issue in the case.
In April, as the case was nearing a climax, Naftalis played his ace. He, Denham, and attorney Ron Olson brought Buffett to the U.S. attorney’s office, a squat, brownish building by the federal courthouse, for a meeting with Obermaier. As this was to be Buffett’s show, the lawyers held their tongues.
Buffett began unassumingly, giving Obermaier a sense of his career.59 He didn’t argue the case, and yet, like a country lawyer who may defend a man accused of murder by pointing out the upstanding nature of his client’s family, he was arguing it all the same. He sketched in the milestones in his relationship with Salomon—how it had once raised money for Berkshire, how it had continued to be his broker ever since, how Gutfreund had bailed out GEICO. In Buffett’s experience, Salomon was a proud firm, of which his own twenty-year tie to it was emblematic. Though not belittling the moral and financial depths to which Salomon had fallen at the hour of Gutfreund’s desperate call to him, Buffett argued that, in both senses, the firm had recovered. “The firm is totally different than it was in August,” Buffett insisted.
Obermaier asked just one question: how long would Buffett be around?
Now, Buffett talked about his philosophy of investing for the long term—of treating his companies like partners—as he had done in his early years and right through the rip-roaring eighties. He hadn’t just sucked the blood out; he had stuck with them. And now and in the future he would be on Salomon’s board, invested in the company and watching over it. As on the Sunday when he had pleaded with Brady—as in the entire Salomon episode—Buffett presented the case in personal terms.
Obermaier would insist that the facts were sufficient to indict.60 Nonetheless, in May he announced that he would not bring charges. Concurrently, the various federal agencies announced a civil settlement with Salomon. To a man, the top officials had been personally won over. Powell, the assistant Treasury secretary, said, “I think every Salomon shareholder should have a little picture of Warren Buffett by their night table.”61
The settlement cost Salomon $290 million (including $100 million set aside for private suits)—then the second-largest penalty ever levied against a U.S. securities firm.
The final SEC complaint detailed ten “extremely serious” bidding violations. Breeden gravely noted that he had issued four hundred subpoenas and taken thirty thousand pages of testimony to ferret them out. Yet the SEC had done more to prove Salomon’s integrity than its guilt. Its exhaustive probe had turned up no evidence of affirmative wrongdoing other than that by Mozer—the full extent of which Salomon had uncovered and disclosed itself.
In June, Buffett stepped down from the chairman’s post he had held for nine months. The stock was at 335⅝—25 percent higher than in August 1991. Buffett stunned the Street by picking Bob Denham, his tightlipped lawyer, to succeed him.
The bland, soft-spoken Texan was a Wall Street outsider whose loyalty was to Buffett, and whose mission would be to preserve Buffett’s reforms. Deryck Maughan would continue to run the business, but the power behind the throne was unchanged; it would be Buffett himself.
Having ridden into Salomon with fanfare, Buffett slipped away with none. Merely a note, scribbled by Bill McIntosh:
“I’m with Salomon” has always been said with pride, and thanks to you it will be for many years to come.
Buffett bought more stock in Salomon, raising Berkshire’s stake in it to 20 percent. After rising to 50, the stock fell sharply after Buffett’s
purchase, but it remained above its high for the period that he had been chairman.
The Treasury market underwent modest reform. The Fed retained Salomon as one of its primary dealers, but post-scandal changes diluted the club’s importance. The wooden box at the Fed went the way of the horse and buggy.
Paul Mozer admitted that he had lied to the Treasury. He served four months in a low-security jail, paid $1.1 million in various fines, and was permanently banned from the securities business.
The SEC brought an action against Gutfreund for failing to supervise Mozer. He settled for a $100,000 fine and a stipulation that he would not run another securities firm. In exile, he grew bitter at what he considered his unjust railroading and at the loss of his social standing. His friendship with Buffett dissolved. In an ugly aftermath, Gutfreund brought a claim against Salomon for money and stock he said he was owed in severance, options, and bonuses—an amount that swelled with Salomon’s rising share price to $55 million. In an effort to hash it out, Gutfreund met Buffett and Munger, in California, and lost his temper with them.62 An arbitration panel ruled against Gutfreund—leaving him with zero.
Gutfreund was commonly depicted as a managerial giant with an ethical flaw. Ironically, that was doubly off the mark. He was an upright but weak manager who built little of enduring value for stockholders. His procrastination over Mozer was simply one more management failure.
Salomon recouped some, though not all, of its market share in underwritings and rebuilt its staff. Though the swagger was gone, it made gains in investment banking and reestablished itself as a player in worldwide markets.
In the two years following the scandal, Salomon had record profits. Then, during the tumultuous bond market of 1994, it suffered wrenching losses. It was increasingly apparent that some of the damage from the scandal had lingered. The best of Meriwether’s former traders, including the talented Eric Rosenfeld, defected to join Meriwether in a new arbitrage venture. Salomon’s own arbitrage group was decimated. And, after a couple of years of sanity in the payroll, bonuses again exploded out of control, forcing Buffett to eat humble pie and again overhaul the compensation system—triggering a new round of defections. Salomon eventually returned to profitability, but as an investment for Buffett it was distinctly mediocre. In sum, the jury remained out on Buffett’s decision to rebuild the entire firm and to entrust it to a colorless administrator such as Maughan, rather than return Salomon to its bond trader “roots,” which had always been its strength. Moreover, Buffett had yet to answer Tisch’s question: who, if anyone, could replace Gutfreund as Salomon’s “risk-taker”?
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