The Warren Buffett Scandal That Nearly Destroyed Wall Street

In 1991, Warren Buffett, the world's best investor and most humble billionaire, got caught up in the middle of a scandal that rocked Wall Street and nearly destroyed his personal reputation forever. U.S. Investment Bank Solomon Brothers, of which Buffett was both a director and a major shareholder, was found to have violated U.S. Securities laws.

But worse than that was the fact that the firm failed to report these breaches to the Treasury, the Federal Reserve, or the SEC, even months after knowing what had happened. When Warren made his investment in Solomon, I was, uh, one of the people, along with many, many others, who were quite amazed because he had taken a very critical tone in talking about investment bankers and about their greed. Here he was investing in one; Solomon Brothers that was known to be a member of the club.

In 1987, a few years prior to the scandal, Buffett invested $700 million in Solomon preferred shares, a great deal for the Berkshire CEO as it came with a juicy 9% dividend. But it wasn't long before things started to fall apart. Warren and Charlie went on the board, and Charlie couldn't stand what was going on there and didn't like the culture at all. Shortly after they got involved, the thing exploded.

On the 8th of August 1991, during a dinner with two executives of the Berkshire subsidiary, Buffett excused himself and rang through to John Gutfriend. Unable to get a hold of the Solomon CEO, Buffett instead spoke to Solomon president Tom Strauss and its inside lawyer Donald Furstein.

In 1991, on a terrible day in August, I got a call, and the two top officers of Solomon were on the other end, and they said that, uh, you know, we had a problem. They explained to Buffett that two of Solomon's government securities traders, including the managing director Paul Mosa, had broken the Treasury's bidding rules on more than one occasion in 1990 and 1991.

At the time, a new rule had just been implemented that a single firm like Solomon could not bid for more than 35% of the Treasury Securities being offered at a given auction. This rule, implemented to stop big behemoths like Solomon from cornering the market, was despised by Mosa and it didn't take him long to try and work his way around them.

On top of bidding for Solomon's 35%, he also, without authorization, put in separate bids for certain customers and then stuffed the Securities these bids into Solomon's own account, never telling the customers a word. Solomon admitted it exceeded the limit of trading in government bonds once by buying bonds in the name of a customer who didn't even know about the deal.

During this phone call, Buffett only got a very short version of the story. The call finished with Strauss and Furstein noting that Mosa and his colleague had been suspended and the firm was now moving to notify its regulators and put out a press release. But the call with Buffett left out one big piece of information that Charlie Munger had picked up on during a separate call with Furstein in that same week.

One part of the problem had been known since late April; four months had gone by and nothing had been said about it. Munger, not in the mood to play games, got straight to the point and asked who knew. It turns out that Mosa, believing he was about to be unmasked, had disclosed the illegal trades he made in February to his boss John Merriweather.

In late April, Merriweather immediately took the information to Strauss, Gutfriend, and Furstein to discuss what to do. Furstein acknowledged that Mosa's act was probably criminal, and the group decided that the New York Federal Reserve must be told what happened. But then silence. No action was taken. May went by, then June, then July, and nobody at the Fed, the Treasury, or the SEC was told anything.

A few days after his call with Strauss and Furstein, Buffett spoke with Charlie Munger and finally learned the truth of what had happened, with the news making the front page of the New York Times. The day Buffett learned the truth from Munger, the two insisted that the full story be disclosed to the public as soon as possible.

Later that week, the board held a meeting where a three-page admission was drafted and released. "This is NBC Nightly News. Good evening. It is the kind of scandal that rocks Wall Street and raises questions about the integrity of our financial institutions, with the giant securities firm of Solomon Brothers under investigation for improper trading of Treasury."

But although the full story was now out in the air for the world to see, unfortunately, the deceit didn't stop there. The day prior to this special meeting of directors, Gutfriend received a letter from the Federal Reserve Bank of New York saying that Solomon's bidding irregularities called into question its continuing business relationship with the Fed and pronounced the Fed deeply troubled by the failure of Solomon's management to make a timely disclosure of what it had learned about Mosa.

Then the demand: it asked for a comprehensive report within 10 days of all irregularities, violations, and oversight. Solomon knew who had occurred—a demand that ultimately fell on deaf ears. Because did Gutfriend mention this letter to Solomon's directors during that Wednesday meeting? No silence. Buffett later called this failure to act the "atom bomb moment."

He later noted, understandably, the Fed felt at this point that the directors had joined with the management in spitting in its face. Solomon Brothers is under investigation by the Treasury Department, the Federal Reserve, the SEC, and the Justice Department. But more important than the fate of the firm itself is the impact their actions could have on public trust and on the credibility of the American market worldwide.

Solomon's share price fell from $36 per share to $27. The far bigger issue for the company, though, was the eroding confidence from investors and the public. With a run on Solomon gathering momentum and news breaking that Gutfriend and Strauss had run away and resigned, confidence was falling faster than ever.

But with 8,000 hardworking Solomon employees facing unemployment if the firm went under, shareholders facing the very real possibility of being totally wiped out, and fears of contagion for the American financial system, Buffett decided to step up and try to save the situation. He did not run away and instead took the reins as interim chairman. But Solomon was not out of the woods by any stretch.

Buffett flew to New York to meet with New York Fed chairman Gerald Corrigan. However, understandably, he was none too happy with Solomon's lack of cooperation thus far. "That night, I met with a man that ran the Federal Reserve of New York who was the sheriff, in effect, and I said, you know, I've never really owed very much money before. I said, go little more each on a house, but 150 billion is a little staggering.

And I was hoping he would say, well, don't worry Warren, we'll give you a few weeks to breathe. And he said to me, prepare for any eventuality." Two days later, Buffett learned what that eventuality looked like: a death sentence. The Federal Reserve that Sunday announced that it would bar Solomon Brothers from bidding at Treasury auctions, both for its own account and for customers forever.

While this technically wouldn't topple Solomon from an economic standpoint, the loss of confidence in the business would most certainly destroy it and would send large ripple effects through Wall Street. This left Buffett with only two options: plead to the Federal Reserve to modify or rescind its ruling, or to give up then and there and call the bankruptcy lawyers.

"Earlier today, the U.S. Treasury Department announced that it had suspended Solomon Brothers from participating in the auction of new issues." It was one more jolt for scandal-scarred Wall Street. The Fed was, in fact, saying you're an evil force and we don't want you trading our bonds.

It was a huge turning point for Warren, and he believed that at that particular point, his reputation was on the line. Warren had 24 hours to make up his mind as to whether he was going to go forward or just bow out. I think at that point Solomon Brothers could have gone into bankruptcy, and Warren stepped up and took responsibility.

"Okay, at, uh, I'm Warren Buffett. I was the elected, uh, chairman of Solomon Inc. A few hours ago at a board of directors meeting." Was it necessary to step in and what is your mandate of leadership? "I think that it was necessary to step in because I would do whatever was needed to out any bit of information about what's happened in the past, and I would do everything I could to make sure that things were exactly right in the future."

With only one option that didn't include bankruptcy, Warren made the most important phone call of his entire life to Treasury Secretary Nicholas Brady. It was a do-or-die moment for Buffett; Solomon's future was on the line, and Buffett's reputation was on the line. According to Carol Loomis, Buffett's voice was cracking with emotion and strain.

Buffett made his case, telling the secretary that Solomon could not cope with the Treasury ban and that it was bringing in bankruptcy experts to prepare for a possible filing. Buffett stressed Solomon's gargantuan size and the worldwide nature of its business. He predicted that Solomon's bankruptcy would be calamitous, having a domino effect that would reach worldwide and play havoc with the financial system that subsists on the idea of prompt payments.

He signed off by saying, "Nick, this is the most important day of my life." He had pleaded his case and now he had to wait. "I had to convince the Treasury that what was done in the past was awful and stupid, and they had every right to be furious at us. But this firm employed 8,000 people that were going to go out of business unless they let us continue."

Basically, Buffett believed that there was a too-big-to-fail scenario. The term was not used then, but he believed that Solomon was too big to fail, and if Solomon went down, it would take other important parts of Wall Street with it. "We had this death knell from the Treasury, so I called the Treasury. Nick Brady was the secretary; you know, I'm fleeing for my life, and I'm sure my voice was cracking and everything else.

I said, 'Nick, this is the most important day of my life,' and that I really did feel that it was going to be a colossal disaster." He wasn't sure I was right at all. Back, he probably thought I was wrong, but he knew that I felt what I was saying. So the Treasury modified its order, and in effect, of course, it was quite an endorsement. It was huge.

At 2:30 p.m., Warren got his answer. Jerome Powell, then an assistant secretary of the Treasury, called Buffett to read a statement that the Treasury was ready to release. They had decided to lift the ban on Solomon's own accounts while the ban on bidding from customer accounts was to remain. Powell asked Buffett, "Will that do?" to which Buffett responded, "I think it will."

On Monday, the stock resumed trading, but it didn't crash as Buffett had thought it would a few days earlier. Solomon's 8,000 employees were able to come into work, and Buffett had saved the company. It saved some. Nick Brady went with Warren because he trusted him.

It shows how having a good reputation is really helpful in life. When all was said and done, Mosa spent 4 months in prison for lying to the Fed. Solomon settled for $290 million, an outcome reflecting the extraordinary cooperation Buffett decreed should be given to both regulators and the law in getting things cleaned up.

In May of 1992, Buffett went back to Omaha, and Robert Denham, a California lawyer that worked with Buffett to clean up Solomon, took over as chairman. Then later, in 1997, Solomon was purchased by Travelers Inc. for $9 billion. Berkshire's original $700 million investment was now worth $1.7 billion; far from Buffett's best-ever purchase, but arguably the most significant in Buffett's life.

And that's the story of how Solomon Brothers almost destroyed Warren Buffett's reputation. Please leave a like on the video if you did enjoy it, subscribe to see more, and I'll see you guys in the next video.