When the investor Warren Buffett finds a worthwhile investment, he rarely lacks commitment. Many of his holdings, either in the days of his old investment partnership or at his firm Berkshire Hathaway, are large relative to the total portfolio’s size. At odds with others’ guiding rules, Buffett has often eschewed diversification, at least when he believed he’s found a good company. One of his largest investments is in American Express. What brought Buffett to American Express was rather curious. It was not only the company’s earnings and growth prospects that drew his attention but also a scandal, a scandal involving fraud, bankruptcies, and salad oil.
Salad Oil Scandal
At the center of the salad oil scandal was the Allied Crude Oil Refining Corporation. A firm trading not in petroleum oil but in soybean and cottonseed oil. The American company was based in Bayonne, New Jersey and led by Anthony De Angelis, who had leased old petroleum tanks and converted them to hold foodstuffs.
In 1963, the company became increasingly involved in commodities markets. It speculated in futures contracts on soybean and cottonseed oil, agreements to buy or sell these commodities at a later date. The company was usually a buyer, and a large one, lifting prices higher. Allied Crude traded in these commodities on the New York Produce Exchange, where it controlled as much as 90% of all cottonseed contracts, and at the Chicago Board of Trade, where it held 30% of all open soybean oil trades. Individual brokers handled only a portion of this trading so the true extent of the company’s buying only became apparent to all as this saga came to a conclusion.
De Angelis may have been trying to control the market in these commodities or may have been speculating that prices would rise following a trade deal between the United States and the Soviet Union. Whatever the reasoning, futures prices rose sharply on Allied Crude’s buying. In the end, the trade negotiations had stalled and prices fell. Allied Crude’s trades fell apart.
Borrowing
The impact of the company’s speculation was widened by virtue of its borrowing. The company financed its trading by borrowing heavily from banks and brokers. These loans were secured by warehouse receipts for salad oils owned by Allied Crude. Warehouse receipts are issued by the storage firm as evidence of the goods kept with it. They suggested that 937 million pounds of soybean and cottonseed oil supposedly existed, worth over $80 million. These physical holdings of salad oils, allegedly filling over 100 tanks, turned out to be fraudulent.
Some tanks at the Bayonne property had false chambers installed under the sampling holes and only these chambers were filled with oil; the rest of the structures contained only seawater or watered-down oil. Allied Crude’s actual holdings of salad oils were less than 100 million pounds. De Angelis’s fraud seemed like a virtuous (or perhaps vicious) cycle; futures buying lifted prices for the commodities, increasing the value of his company’s false inventories, allowing it to borrow more money with which to lift prices higher. It did not work out. Allied Crude was being investigated by the Commodity Exchange Authority, a predecessor to the Commodity Futures Trading Commission, when it filed for bankruptcy on November 19, 1963.
Effects
Allied Crude’s failure was not a contained matter. Bunge Corporation, a large agricultural commodities firm, was a lender to Allied Crude. Bank of America, Bankers Trust, Brown Brothers Harriman, and Chase Manhattan Bank were all caught up in the scandal as well. These were just some of the 51 institutions that lost money in the salad oil scandal of 1963.
Together, creditors to the fraudulent scheme were left with $150 million in worthless claims against the company. The New York Produce Exchange, the venue of much of the firm’s antics suspended further trading in cottonseed oil futures. A few years later, it would leave the commodities trading field altogether. On the same day as the bankruptcy, November 19, the New York Stock Exchange announced it was investigating the capital position of two member firms with exposure to Allied Crude. Exposure to the firm was extensive and, for some unfortunate parties, was deep as well.
Brokerage firms issued margin calls, or demands for more collateral, to Allied Crude that the company was unable to fulfill. At least one brokerage firm, Ira Haupt & Co, was forced to liquidate in the aftermath of the scandal. Another firm, J. R. Williston & Beane, was forced to merge with a competitor after being suspended by the New York Stock Exchange after no longer meeting the exchange’s net capital requirements. The New York Stock Exchange even used its own funds to prevent losses to the brokers’ customers, preventing them from being swept up in a bankruptcy.
American Express
Even American Express was involved and to a particularly agonizing extent. The company’s warehousing subsidiary, American Express Warehousing Company, Ltd., was among those most ensnared in the salad oil scandal. The company offered warehousing services to Allied Crude through tanks it subleased from De Angelis’s firm itself. It also hired employees from Allied Crude to run the warehouses. Though seemingly a strange arrangement, Allied Crude got the reputable American Express name on its phony warehouse receipts and American Express got a new client.
Such arrangements were common in the ‘field warehousing’ industry at the time. Out of it, Allied Crude obtained warehouse receipts to make it seem as though the company had kept some of its fictitious inventories with American Express Warehousing, supposedly verified by American Express. In the case of tanks earmarked for Bunge Corporation though, instead of finding four full tanks of oil, inspectors found two empty tanks, one tank half-full, and a fourth tank filled only with watered-down soybean oil.
The American Express Warehousing receipts gave Allied Crude seemingly legitimate collateral for loans but this proved not to be the case. The ire of creditors was therefore directed at American Express as well. De Angelis not only had his associates hired as field agents of American Express but continued to pay them in order to pull off the fraud, extracting from them overstated inventory measures. These were not petty bribes; he paid them well, even more than what they would already earn from American Express in ordinary wages. The company did not manage to stop this.
The results of the fraud seemed dire for American Express; they had issued far more warehouse receipts than permitted by inventories that actually existed. True, there were receipts in the picture which the company contended were forgeries but some of them represented genuine failures of the company to accurately reflect the oils it stored for Allied Crude. The amount of fictitious salad oil kept at the Bayonne tanks would have been twice the stocks government reports showed to be in existence in the whole country. By the end of the year, American Express Warehousing would file for bankruptcy reorganization. It was one of twenty firms bankrupted as a result of the fraud.
For the parent company, it was an embarrassment as well as a loss. An anonymous tipster had alerted the company of Allied Crude’s fraud back in 1960. It had also turned out that its own investigator into the matter had found, in 1960, that De Angelis already had indictments and more than a million dollars in tax liens chained to him. The indictments also related to falsifying company inventories at a past firm and De Angelis was suspected of bribing a government inspector. The American Express investigator suspected ties to organized crime.
As one of the worst performing units at the company, the closure of American Express Warehousing had been discussed for years. The parent firm had set a $500,000 profit target on its warehousing unit which typically ran losses. Its managers were likely under pressure to improve profitability and did not want to lose Allied Crude, a large client, by investigating the matter more closely. In any case, American Express did not take action and the scandal unraveled three years later, by which point the fraud had grown far larger.
Warren Buffett
American Express’s stock fell 50% in the months after the salad oil scandal. Shareholders were worried of personal losses in excess of the stock’s value; American Express was one of the last major public companies not to be organized as a limited liability firm. A certain Warren Buffett was buying though and the holding went on to make up almost one-third of the now-famous investor’s portfolio.
Upon investing in American Express, Buffett did not demand board representation or replace management. He even asked that the company use its resources to compensate the parties defrauded in the salad oil scandal. The amount at stake would not be meaningful to the future of the company and its image could improve with such a move, even though its legal basis for fighting any payment may have been reasonably strong. The company eventually reached a settlement with claimants of losses related to the scandal at a cost of ‘just’ $32 million. By comparison, the drop in the company’s market value after the scandal was nearly four times greater, at $125 million.
In time, Buffett and others found that the scandal had not tarnished the company’s brand. This was of critical importance for a financial institution serving ordinary people through its travelers check business and now a new credit card product as well. Perhaps the indirect role of American Express in the scandal, more that of a seriously mistaken victim than a perpetrator, and the fact that the scandal broke in the week of President Kennedy’s assassination had both cushioned the blow. By 1967, the American Express investment had turned out to be very profitable for Buffett’s investment partnership. His involvement with the company was at least partially owed to a salad oil trading scandal.
Lesson
The salad oil scandal of 1963 had many victims, some of which saw their demise at the hands of Anthony De Angelis and others merely wounded. American Express lost millions and saw its share price fall in half. To Warren Buffett, the crisis presented an opportunity though. Finding that the cost of the scandal was minor in comparison to the lost market value and believing the reputation of the company remained intact, he made his investment. It turned out well for the famous investor and American Express continues to be one of his largest holdings almost sixty years on. Crises, especially the largest among them, bring the greatest opportunities.
More from the Tontine Coffee-House
Read about another venue hosting De Angelis’s fraud, the New York Produce Exchange. Also learn about Warren Buffett’s mentor Benjamin Graham. Lastly, consider subscribing to this blog’s newsletter here.
Further Reading
1. Gramm, Jeff. “Warren Buffett and American Express: The Great Salad Oil Swindle.” Dear Chairman – Boardroom Battles and the Rise of Shareholder Activism, Harper Business, 2016.
2. “The Great Vegetable‐Oil Mystery; Scandal, Now One Year Old, Remains a Financial Maze.” New York Times, 15 Nov. 1964.
3. “The Vanishing Salad Oil: A $100 Million Mystery.” New York Times, 6 Jan. 1964, p. 97.
4. Woolf, Emile. “The Astonishing Story of the Salad Oil Swindle.” Accountancy, June 1976, pp. 78–83.
Paul Ochman