Salomon Inc.
Company Overview
Salomon Inc. (Salomon Brothers) was one of Wall Street's most powerful and profitable investment banks, known for its dominance in bond trading and its intense, often controversial culture. Berkshire invested $700 million in Salomon preferred stock in 1987 to help Salomon defend against a hostile takeover bid. This investment led to one of the most dramatic corporate crisis management episodes in American business history.
Investment Story
1987: Preferred stock investment. Berkshire invested $700 million in convertible preferred Salomon stock at 9% dividend, convertible into common stock at $38 per share. The investment was intended to be a passively held financial investment, providing Salomon with defensive capital and Berkshire with a high-yield preferred return.
September 1991: The Treasury auction scandal. Paul Mozer, a senior Salomon trader, had submitted false customer bids in U.S. Treasury auction markets — a serious violation of securities law. More damaging: Salomon's senior management, including CEO John Gutfreund, had learned of the violations months earlier and failed to report them to regulators as required. When the violations became public, the scandal threatened Salomon's existence: the U.S. Treasury Department temporarily barred Salomon from participating in government bond auctions — a potentially fatal restriction for the world's largest government bond dealer.
Buffett takes over. With thousands of employees' jobs at risk and the firm facing potential collapse, Buffett agreed to become interim chairman. He flew to New York, met with Fed Chair Alan Greenspan, Treasury Secretary Nicholas Brady, and SEC Chairman Richard Breeden — convincing regulators to reverse the temporary ban in a late Sunday afternoon announcement. He then testified before the House Finance Committee and Senate Banking Committee, publicly holding himself accountable for what had happened under Salomon's management.
Buffett's statement at the Senate hearing. "Lose money for the firm, and I will be understanding; lose a shred of reputation for the firm, and I will be ruthless." This statement — delivered under oath before Congress — became his most famous formulation of the integrity standard he requires of Berkshire's operations.
1997: Resolution. Berkshire held the Salomon preferred through Salomon's subsequent merger with the Travelers Group in 1997, realizing a meaningful gain on the original investment despite the turbulent interim period.
Buffett's Own Words
Salomon Inc 9% preferred stock. This preferred is convertible after three years into Salomon common stock at $38 per share and, if not converted, will be redeemed ratably over five years beginning October 31, 1995. From most standpoints, this commitment fits into the medium-term fixed-income securities category. In addition, we have an interesting conversion possibility. We, of course, have no special insights regarding the direction or future profitability of investment banking. By their nature, the econom
Salomon Inc 9% convertible preferred. This preferred has a sinking fund that will retire it in equal annual installments from 1995 to 1999. Berkshire carries this holding at cost. For reasons discussed by Charlie on page 69, the estimated market value of our holding has improved from moderately under cost at the end of last year to moderately over cost at 1988 year end. The close association we have had with John Gutfreund, CEO of Salomon, during the past year has reinforced our admiration for him. But we
(in which we have a position through our 1987 purchase of Salomon convertible preferred), the airline industry, or the paper industry. This does not mean that we predict a negative future for these industries: we're agnostics, not atheists. Our lack of strong convictions about these businesses, however, means that we must structure our investments in them differently from what we do when we invest in a business appearing to have splendid economic characteristics. In one major respect, however, these purc
Capital Cities, Salomon, Gillette, USAir and Champion. Last year we said we had a special interest in large purchases of convertible preferreds. We still have an appetite of that kind, but it is limited since we now are close to the maximum position we feel appropriate for this category of investment. * * * * * * * * * * * * Two years ago, I told you about Harry Bottle, who in 1962 quickly cured a major business mess at the first industrial company I controlled, Dempster Mill Manufac
*The Salomon Interlude Last June, I stepped down as Interim Chairman of Salomon Inc after ten months in the job. You can tell from Berkshire's 1991- 92 results that the company didn't miss me while I was gone. But the reverse isn't true: I missed Berkshire and am delighted to be back full-time. There is no job in the world that is more fun than running Berkshire and I count myself lucky to be where I am. The Salomon post, though far from fun, was interesting and worthwhile: In Fortune's annual survey *
Investment Lessons
Integrity problems surface at the worst moment by definition. Salomon's management knew about the violations months before they became public — and failed to report them, hoping the problem would go away. It didn't. Integrity failures in financial firms almost always become crises at the worst possible moment, when market conditions or other pressures amplify the impact of disclosure. Buffett's standard — report violations immediately, regardless of competitive consequence — is the only policy consistent with long-term institutional survival.
A leader who steps into a crisis must subordinate personal interests completely. Buffett's willingness to become interim chairman — absorbing personal legal and reputational risk, spending months in New York managing a firm far outside Berkshire's usual operations, testifying before Congress about actions he didn't commit — was a genuine sacrifice. His ability to do this reflected both the depth of his relationship with regulators (who trusted him) and his commitment to protecting thousands of Salomon employees who were innocent.
Investment in financial firms requires understanding cultural risks. Salomon's culture — intense, competitive, trader-centric — was precisely the culture that enabled the violations to occur and be concealed. Buffett had invested in Salomon as a financial transaction, without deep intelligence into the firm's operating culture. The 1991 crisis taught him that culture risk in financial firms is uniquely acute: the same aggressive behavior that produces profits can produce violations, and the line between them is thinner than it appears from outside.