From the Leadership Development Cabinet

Inaction Can be as Dangerous as Bad Action
by Aly Gonenne, Class of 2004

In the early 1990's, John Gutfreund, ex-CEO of Salomon Inc, received one of the stiffest penalties yet issued by the Securities and Exchange Commission. In addition to receiving a $100,000 fine and being denied his stock options and retirement benefits, Gutfreund was banned for life from serving as a chairman or CEO of a securities firm. Despite receiving these stiff penalties, Gutfreund should receive some credit for preventing Salomon Inc. from going the same route as Andersen or Enron. Although he had allowed himself to be led by the company's culture instead of recognizing and adopting change, in a final leadership decision Gutfreund ultimately did what was best for the company.

Four stories illustrate how Gutfreund's demise began:
1. Many of Gutfreund's corporate decisions were made in private. Instead of bringing them before the executive committee of 14 senior managing directors, Gutfreund commonly informed his executives of his decisions well after they had been made.
2. He recognized that his most talented bond traders were prima donnas but refused to reign in their unrestrained behavior. In fact, Gutfreund was himself a part of this behavior. According to company myth, at one point he walked up to John Meriwether, a vice-chairman of Salomon Inc. and whispered, "One hand, one million dollars, no tears." (Translation: for an insignificant bluffing game, the loser would pay the winner $1 million with no whining allowed.) Meriwether, either out of bravado or disbelief, responded by raising the stakes to $10 million.
3. In early 1991, Gutfreund learned from Meriwether that bond trader Paul Mozer (a managing director) had illegally bid for US Treasury bonds on behalf of a customer but without the customer's knowledge. In doing so, Mozer willingly violated a federal ruling that the government had instituted to block him. Instead of taking the necessary strong disciplinary action, Gutfreund hid this knowledge from the other managing directors. Mozer was equally unconcerned.
4. In April 1991, Mozer violated the federal ruling a second time by buying nearly all of the T-bills offered by the government in an open bid. Other banks who were shut from the market complained, and the SEC began to investigate Salomon's actions in secret. Gutfreund knew about the violation in early May and yet did not share his knowledge with either the government or his managing directors for over three months.

By early August, Gutfreund finally realized that the stakes of the game had risen too high and started to talk with the federal government. But it was too late: on August 15, the Wall Street Journal headline blared "Top Salomon Officials Knew About Illegal Bid." During the first few hours of trading, Salomon was flooded by holders of Salomon debt securities, demanding that Salomon buy them back. After spending $700 million to repurchase its own notes in three hours, Salmon suspended trading in its own securities in for the remainder of the week.

Fortunately, throughout his reign as CEO of Salomon, Gutfreund had been in constant communication with Warren Buffet, Salomon's largest stakeholder and one of his most trusted allies. In turn, Buffet understood that Gutfreund had always placed the welfare of the client in front of the firm's interest. So when Gutfreund called Buffet on August 16 at 7:45A.M. to offer Buffet the job as CEO, Buffet responded quickly. By noon that day, Gutfreund announced to his employees, "Warren is the CEO."

Gutfreund's last decision as CEO certainly saved the company from complete collapse. On the 18th, just as the board was about to confirm Gutfreund's resignation and approve Buffet as the replacement, a treasury official called to warn that the government would announce in just minutes that Salomon was suspended from bidding at Treasury auctions. Buffet quickly placed a call to the Secretary of the Treasury, warning of a domino effect in the bond trading industry, and threatening to leave Salomon if the Secretary insisted upon immediate action. The government scaled back its penalties to a point where Buffet believed the firm could survive, and he accepted promotion to interim CEO for an annual salary of $1.

Just as an antibiotic aggressively attacks an infection, Buffet's actions during the following months to repair the infected culture were aggressive and systemic. Eight days after becoming CEO, Buffet sent a clear message to the employees of Salomon: "We want people Ä to get rich through the firm and not off the firmÄIf you lose reputation for the firm, I will be ruthless." Ignoring the pleas of corporate lawyers, Buffet put his own reputation on the line and revealed Salomon's transgressions to the federal government completely. His bold action quickened the federal investigation, won the government's trust, and prevented Salomon from receiving an estimated $400 million in government fines.

After consulting the remaining senior managing directors, Buffet tapped Deryck Maugham for the leadership of Salomon Brothers and Robert Denham for Salmon Inc. The effect was immediate: "'Mr. Integrity' Is Promoted to Top Post" ran the headline in the Wall Street Journal in reference to Maugham. In turn, Maugham continued what Buffet had started to reshape the corporate culture, starting by ousting a vice chairman whose brash, narcissistic personality was out of step with Salomon's need for inclusive leadership. Maugham formed a compliance committee, naming Buffet as its head, and moved its members onto the trading floor. Through similar actions, Maugham and Denham brought back Salomon Inc. back to respectability and relatively full financial health before Salomon Inc was acquired in 1997 for $9 billion by the Travelers Group.

Note: most of the research for this article came from a book entitled "The Leadership Moment," by Michael Useem. Available in the Ford library at Fuqua or at most public libraries, "The Leadership Moment" contains vignettes of other leaders and lessons learned from their actions and is well worth a read.

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