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Salomon Inc. is a diversified trading and financial services holding company led by its flagship subsidiary, Salomon Brothers Inc., one of Wall Street's leading securities houses and a worldwide operator through its offices in London, Tokyo, and Hong Kong. The parent company also engages in commodities trading and petroleum refining through its subsidiaries Phibro Energy USA, Inc., Phibro Division of Salomon Inc., and Phibro Energy Production, Inc., a joint venture with Russia. This slightly unusual combination of businesses is the result of the 1981 purchase of Salomon Brothers, then a private partnership, by the commodities company Phibro Corporation. The resulting company was named Phibro-Salomon until 1986, when the firm assumed the name Salomon Inc.
Salomon Brothers may not be Wall Street's most famous name, but this reflects more than anything else the firm's long and continued absence from the retail end of the securities business. Institutional investors and companies in search of an underwriter don't need pithy advertising slogans to catch their attention. Throughout its history, Salomon has worked primarily in the two businesses it knows best--wholesale securities trading and underwriting--and used them to rise from modest beginnings to a position of prominence in the financial community by the 1970s. The firm continued to prosper until a 1991 scandal involving U.S. treasury bonds tarnished the company's reputation and its aftermath threatened to relegate Salomon to second-tier status on Wall Street.
Salomon Brothers was founded in New York City in 1910 when Arthur, Herbert, and Percy Salomon broke away from their father Ferdinand's money-brokerage operation and went into business for themselves. They took with them a $5,000 stake and their father's clerk, Ben Levy, and opened a small office on Broadway near Wall Street. Later that year, they became Salomon Brothers & Hutzler when they brought broker Morton Hutzler into the firm for the sake of his seat on the New York Stock Exchange.
During its infancy, Salomon concentrated on money brokerage, an obscure Wall Street specialty that consisted of arranging loans for securities brokers and trading bonds for institutional clients. The partners branched out into underwriting in 1915 by participating in a $15 million offering of short-term Argentine notes. But expansion of its underwriting activities was limited: underwriting was dominated at the time by a select group of old-line firms. Reputation and connections were essential to building a clientele, and the Salomons had neither.
Salomon Brothers' big break came when the United States entered World War I. The Liberty Loan Act of 1917 unleashed a flood of government securities that needed someone to take them to market; since social connections were not necessary to getting business, Salomon entered the lucrative government-bond market. The firm's expansion continued through the boom years of the 1920s. By 1930, Salomon had opened branches in Boston, Chicago, Philadelphia, Minneapolis, and Cleveland and employed a staff of more than 30 traders and salespeople.
The 1920s are remembered most for the big bull market in stocks, but Salomon entered the equities business tentatively, even then dealing only wholesale. As a result, the firm made little money in the bull market, but also escaped serious damage in the market crash in 1929. Arthur Salomon, in fact, had decreed in 1927 that all of his company's margin accounts be terminated.
The eldest and most forceful personality among the three Salomons, Arthur was without question the firm's dominant partner. A shrewd player of the financial game and a hard worker who held few interests beyond Wall Street, he became known, according to Salomon historian Robert Sobel, "as one of the very few individuals who could see J. P. Morgan without an appointment." His death in 1928 left a power vacuum that was not filled until his nephew William became managing partner 35 years later.
In addition to coping with the Great Depression, Salomon had to deal with an internal struggle in the 1930s centering around Herbert, who considered himself Arthur's natural heir. Herbert was the youngest brother, but Percy was too retiring by nature to assume leadership. Herbert, however, lacked Arthur's savoir-faire and failed to earn the confidence of many partners, who found a reluctant leader for their opposition in Ben Levy. The general slump in the bond market increased tensions within the firm, squeezing its profits and forcing it to lay off traders.
The one bright spot in the decade for Salomon came at the end of the capital strike of 1933--35, when the establishment investment banks protested the Roosevelt administration's formation of the Securities and Exchange Commission by refusing to bring new issues to market. In 1935 both the government and the banks were looking for a face-saving end to the moratorium, but Salomon, still an outsider, decided to end it on its own by underwriting a bond issue for Swift & Company, the meat packer. This was the first new debt issue to come to market under the new SEC rules and, though it brought the Salomon name into the spotlight, it caused resentment among the old-line underwriters that would last into the 1950s.
The firm concentrated on government bonds during World War II but did not find them as great a boon as in 1917. After the war, Salomon's power vacuum persisted and the firm lacked strategic direction as a result. Nonetheless, individual departments prospered when left to their own devices. In 1951 Herbert died and Rudolf Smutny became the dominant figure in the firm, becoming senior partner in 1955. Smutny's abrasive manner and questionable business decisions led to his ouster the next year. Percy Salomon's son William, aided by Ben Levy, spearheaded the coup.
William's coming of age in the family business solved the leadership problem that had existed since Arthur's death. William gradually accumulated influence at the firm in the years after Smutny's departure and was named managing partner in 1963. He guided Salomon through a massive expansion marked not by rapid diversification but by an aggressive, no-guts-no-glory approach to fields in which it was already established. According to journalist Paul Hoffman, William once boasted, "We'll bid for almost anything, and we take many baths."
In 1960 the firm moved to shore up a major weakness by starting its own research department, hiring economist Sidney Homer away from Scudder, Stevens & Clark to head it. Two years later, Homer was joined by Henry Kaufman, whose extraordinary ability to forecast interest rates would earn him the nickname "Dr. Gloom" on Wall Street.
In 1962 Salomon pulled a major coup by underwriting an AT&T offering worth $218 million, even though the financial markets were paralyzed at the time by the Cuban Missile Crisis. Also in the autumn of that year, the firm formed, with Blyth, Merrill Lynch, and Lehman Brothers, a group that became known as "the fearsome foursome." This association tried to break the establishment firms' stranglehold on the underwriting business by putting together syndicates that sought to outbid them on major utility-bond issues throughout the decade. Between 1962 and 1964, Salomon more than tripled its underwriting business, from $276 million to $873 million.
Salomon finally began to diversify its activities in the mid-1960s when, aided by the new computer technology on Wall Street, it expanded its block-trading activity on the New York Stock Exchange. In 1965 the firm bought seats on exchanges in Boston, Philadelphia, Washington, and Baltimore and on the Pacific Stock Exchange in Los Angeles. Salomon took advantage of an opportunity created by depressed stock prices in 1969 to expand its merger-and-acquisition activity, forging, among others, the Pepsi-ICI merger and Esmark's acquisition of Playtex. In 1971 the firm opened its first overseas office, in London, and the next year another in Hong Kong; in 1980 it opened a third in Tokyo.
In 1970 the firm finally dropped Morton Hutzler's name (Hutzler had retired in 1929) to mark a new era in Salomon's history. In 1971 the SEC began the process of deregulating brokerage commissions. Fees earned on the largest block trades were the first to be cut loose. Salomon responded by slashing its commission rate 50 percent. When rate structures ended in April 1972, Salomon and archrival Goldman, Sachs led the way in conducting the first major block trades. Soon, however, sluggish stock market conditions made block trading less lucrative, and in 1973 Salomon posted its first money-losing year since 1956.
In 1975 the firm participated in one of the year's major stories when New York City found itself unable to meet its financial obligations and appealed to the state and federal governments for aid. William Simon, a former Salomon partner who was treasury secretary in the Ford administration at the time, said that Washington might organize a "punitive" bailout package to discourage other cities from doing the same in the future. New York state, for its part, formed the Municipal Assistance Corporation (MAC) to generate funds for the city. Salomon, along with Morgan Guaranty Trust, led the syndicate that marketed MAC debt offerings. Salomon also helped underwrite two more major bailouts before the decade was through, for the Government Employee Insurance Company in 1976 and Chrysler Corporation in 1979.
Having transformed Salomon into the second-largest underwriter and the largest private brokerage house in the United States, William Salomon retired in 1978 and was succeeded as CEO by John Gutfreund. Described by Business Week as "shrewd, supremely intelligent, cosmopolitan yet street-fighter tough" and as a member of Manhattan high society who would "host extravagant parties straight out of The Great Gatsby," Gutfreund had studied literature at Oberlin College and considered teaching English before joining Salomon in 1953. He became a partner in 1963 at the age of 34 and became William Salomon's heir apparent when Simon left to join the federal government in 1972.
Under Gutfreund, Salomon participated in the leveraged-buyout boom of the 1980s, including Xerox's acquisition of Crum & Foster, Texaco's controversial acquisition of Getty Oil, and the mergers between Santa Fe Industries and Southern Pacific and Gulf Oil and Standard Oil of California. The firm was also retained as an adviser by AT&T when the telecommunications giant underwent the largest corporate breakup in United States history. However, the core of Salomon's business remained underwriting and bond trading, as it had been for seven decades. By 1985 Salomon's underwriting business generated 22 percent of all the money raised by American corporations through new issues, while Salomon's high-volume, low-margin approach to the bond business had made it the largest dealer of U.S. government securities.
A seminal event in Salomon's history occurred in 1981, when the company was acquired by Phibro Corporation, a commodities firm. The new entity was known as Phibro-Salomon Inc. until 1986, when Salomon gained control and changed the name of the parent company to Salomon Inc. The merger gave Phibro the diversification it desired and gave Salomon the operating capital it needed for further expansion. But many partners were not pleased by the prospect of becoming salaried employees whose profits would belong to Phibro management and not themselves. William Salomon also expressed displeasure that retired partners received nothing out of the merger deal while general partners like Gutfreund and merger-and-acquisition specialist J. Ira Harris received bonuses of over $10 million. "I would have thought that those of us who had been here 40 years deserved to share in the gain," he told Business Week. He and his successor rarely spoke after the merger.
The flight of individual investors that followed the stock market crash of 1987 did not hit Salomon as hard as it did retail-oriented houses like PaineWebber and Merrill Lynch. In fact, it closed out the year as the largest underwriter in the country, and the second-largest in the world after sponsoring $40.3 billion worth of new issues. But Salomon had also announced significant retrenchment plans prior to the crash and laid off 800 employees. Changes in the tax laws and rising interest rates in the first half of 1987 caused a slump in the bond market, seriously affecting Salomon's main business, and competition from Japanese firms further cut into profits. Although the firm could boast of co-managing Conrail's $1.7 billion stock offering (the largest initial public stock offering in history), it also lost $79 million in a post-crash underwriting for British Petroleum and was nearly left with a $100 million loss when Southland Corporation decided to postpone a junk-bond offering in November of that year.
To cope with the slow securities markets, many Wall Street firms turned to merchant banking and junk bonds for revenue. Thanks in part to lower stock prices, mergers and acquisitions increased in 1988. But Salomon, which had always specialized in trading and was plagued by weakness in its merchant-banking division (Salomon's reputation was tarnished by its involvement with two leveraged buyout failures--TVX in 1987 and Revco in 1988) was slow to diversify, and its financial performance suffered. Its underwriting business also suffered, and in 1988 Merrill Lynch overtook Salomon as the nation's top underwriter. Gutfreund came under substantial external and internal criticism for a lack of strategic direction, causing financial journalists to refer to him as "embattled" throughout 1988 and into 1989. Key personnel began to leave, and rumors circulated that Salomon would take itself private or be taken over. One bright spot, however, was its office in Japan, which was headed by Derek C. Maughan. Salomon's Tokyo office was, according to Business Week, "Tokyo's largest and most successful foreign brokerage." Given Japan's notoriously clubby business atmosphere, Salomon's success was particularly impressive.
Although it had missed out on the junk bond heyday of the 1980s, Salomon began to succeed in this arena in the early 1990s after the collapse of junk bond pioneer Drexel Burnham Lambert Inc. in February 1990. Drexel's demise left a hole in the secondary market for junk bonds which Salomon was quick to fill. The firm hired several prominent former employees of Drexel, and then purchased for $1 million a critical Drexel junk bond database which contained important information on more than 3,000 issues. These moves enabled Salomon to quickly become a leader in the junk bond market; by March 1991 it had built a $1 billion trading inventory in junk bonds, an impressive increase from its December 1990 level of $400 million. It managed or co-managed such major underwritings as the refinancing of $1.5 billion in RJR Nabisco debt. This expansion of its junk bond business helped Salomon post record pretax earnings of $500 million in the first quarter of 1991, on revenues of $1.2 billion.
The very next quarter, however, saw the beginning of a major scandal that nearly brought Salomon to the same end as Drexel. Treasury rules for auctions of U.S. issues of notes and bonds stipulated that no one purchaser could bid for more than 35 percent of the entire auction offering. Salomon, however, could--and often did--bid for itself, up to 35 percent, and as a broker for one or more clients, up to 35 percent for each client. Salomon circumvented these rules in the May 1991 auction of two-year Treasury notes by submitting false bids in the names of two of its clients, in addition to a 35-percent bid in its own name. When these submissions won the auction, Salomon then entered into its computer fake "sales" from its clients to Salomon. As a result, Salomon controlled $10.6 billion of the total $11.3 billion auction, putting it in a very strong position to squeeze dealers who had taken positions in the when-issued market for the May auction. Salomon could consequently charge higher-than-expected prices to these dealers and make huge profits. Martin Mayer claimed in Nightmare on Wall Street that this is precisely what happened.
In part because one of the two Salomon clients whose name the firm used in the May auction submitted a legitimate bid of its own which raised its total bid over 35 percent, the Treasury initiated an investigation. After the probe uncovered in detail what happened in May, found previous instances of similar false bids, and discovered that top officials at Salomon--including Gutfreund--had been told of one of the earlier infractions but had done nothing about it, major changes rippled through the company. In August the famed investor Warren E. Buffett, who was Salomon's largest shareholder with a $700 million stake, took over as Salomon CEO and chairman from Gutfreund, who resigned, as did Thomas Strauss, president of Salomon Inc.; John Meriwether, vice-chairman and supervisor of all of Salomon's proprietary bond trading; and Donald Feuerstein, the firm's general counsel. Paul Mozer, the head government bonds trader and the person who made the false bids, and Thomas Murphy, Mozer's assistant, were fired. Had Buffett not stepped in to take over, observers have speculated that Salomon would have gone under.
Eventually, the following year, the Securities and Exchange Commission imposed $290 million in fines and damages on Salomon for violations of securities laws, the second-largest such fine ever, behind only a $600 million judgment against Drexel. The company was also suspended from its position as primary dealer at treasury auctions for a two-month period. Buffett staved off more severe penalties by fully revealing the company's actions and taking steps to prevent recurrences. Buffett also propped up the financial structure of the company--damaged by the difficulty in gaining credit following the revelation of the scandal--by selling some of Salomon's assets. Also in 1992, Buffett installed Maughan, the former head of Salomon's Tokyo office, as chairman of Salomon Brothers and Robert E. Denham, his long-time attorney, as chairman of Salomon Inc. Buffett remained on the Salomon board of directors and continued to be substantially involved in the company's operation.
The new management had seemed to weather the scandal's aftermath on the basis of two impressive years during which the company returned to its roots in securities trading to great success. In 1992 Salomon posted $550 million in net income on $1.06 billion in pretax earnings, and in 1993 $827 million on $1.47 billion in pretax earnings. The 1994 results--a $399 million net loss on a pretax loss of $831 million--however, pointed to several weaknesses at Salomon and pressure from an increasingly competitive market. Business Week contended that Salomon suffered from weak management at the hands of Maughan, who had never been a trader. Key personnel left Salomon because of a new compensation plan implemented in 1993 that cut traders' bonuses for the benefit of shareholders. Perhaps most importantly, Salomon management had failed to define a clear vision for the company's future. As a result, industry observers, who predicted a mid-1990s shakeout on Wall Street based on an overabundance of traders and underwriters, speculated that Salomon would need to remake itself again in order to survive another crisis--the possibilities included an emphasis on investment banking, a return to a primarily fixed-income trading orientation, or a merger with or acquisition by a commercial bank. It seemed unlikely that Salomon would ever return to its position near the top of Wall Street that it held during the 1980s.
Principal Subsidiaries: Phibro Division of Salomon Inc.; Phibro Energy Production, Inc.; Phibro Energy USA, Inc.; Salomon Brothers Inc.
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