Becoming Berkshire: 1963 - The American Express Salad Oil Swindle
Issue 5 | 1963
Welcome to Issue Number 5 of Becoming Berkshire, as we look at the fascinating story of the American Express salad oil scandal almost bringing down the New York Stock Exchange (“NYSE”). We also get to witness the beginning of the evolution of Buffett’s investment ideology as he is starting to be influenced by Charlie Munger.
American Express
American Express AXP 0.00%↑ (“AMEX”) is a globally integrated payments company that provides customers with access to products, insights, and experiences in over 100 countries and provides over a trillion dollars in total network volume. The $130 billion dollar company did over $52 billion in revenue and $7 billion in net income in 2022. However, American Express was not always the blue-chip powerhouse you know today. In 1963, the Company found itself in the middle of a soybean oil scandal with liabilities large enough to force liquidation on the entire company.
American Express, which started as a parcel delivery company in the middle of the 19th century, was, by the start of the 20th century, a financial institution of considerable size. American Express, which started as a parcel delivery company in the middle of the 19th century, was, by the start of the 20th century, a financial institution of considerable size.1 The original company was founded on March 18, 1850, by consolidating three companies active in the express transport of goods, valuables, and spices between New York City and Buffalo, New York, and points in the Midwest. In 1903, it had capital and surplus of about $28 million, exceeded only among banks by the National City Bank of New York, and $4.5 million higher than that of the second largest bank.2
After World War II, AMEX established a small, separately incorporated subsidiary engaged in field warehousing. Clients would store inventories in warehouses controlled by American Express Warehousing (“AEW”), which would then issue warehouse receipts guaranteeing that the inventory was in the warehouse. The client would post these as collateral for borrowing. The business never made or lost much money, and by the early 1960s, AMEX had decided to sell it. However, fate intervened. During the early 1960s, AEW established a very profitable relationship with one particular client, Anthony “Tiny” DeAngelis, who controlled several companies, the most important of which was Allied Crude Vegetable Oil.3
Anthony “Tiny” DeAngelis
Tino De Angelis was no stranger to nefarious business dealings; before the Salad Oil Scandal, he was involved in a financial scheme with the National School Lunch Act.
De Angelis had learned that government programs were a way to make easy money, so he started the Allied Crude Vegetable Oil Refining Co. in 1955 to take advantage of the U.S. Government’s Food for Peace program—the program aimed to sell surplus goods to Europe at low prices. Initially, De Angelis sold massive quantities of shortening and other vegetable oil products to Europe, and when this worked, he expanded into cotton and soybeans.4 De Angelis was using the soybean oil as collateral to borrow from 51 banks, as he figured nobody would verify the amount stored in tanks. The tanks sat in a Bayonne, New Jersey, warehouse managed by American Express Warehousing.5 AEW issued warehouse receipts: docuetments that certified how much oil was in a tank and could be bought and sold.6 American Express stood as guarantor of the quantity of oil behind those receipts. A system of pipes and valves connected the tanks, and the soybean oil could be sloshed and shunted around from one tank to another. He had enough soybean oil to fool the inspectors. 7
The Shot Heard Around the World
De Angelis then decided to corner the soybean market by using the collateral in American Express Warehouses to purchase future soybean contracts. He bet that the price of soybean oil would continue to rise, increasing the value of his future contracts. However, as all sure bets tend to do, this one went to shit; the futures market crashed; Soybean oil closed at $9.875 on Friday, November 15, and $7.775 on Tuesday, November 19, thus wiping out the entire value of De Angelis’ Loans.8
Bryan Tayor does a great job of describing the chaos that ensued:
On November 19, the Allied Crude Vegetable Oil Refining Co. filed for bankruptcy. Fifty-one companies were stuck with bad loans from Allied Crude. And looked to collect the $150 million stored in American Express Warehouses. Two of the brokerage houses whom De Angelis had used, Williston & Beane and Ira Haupt & Co. were suspended from trading by the NYSE. These brokerages’ customers became desperate because they didn’t know if they would get back the money in their accounts.
On Friday, November 22, the NYSE organized a bail out of Williston & Beane, and the firm was allowed to reopen at noon on Friday. Ira Haupt & Co. was a bigger problem. It collectively owned $450 million in securities and owed various banks over $37 million that it could not pay.
At 1:41 pm, word that JFK had been shot flashed on the floor of the New York Stock Exchange (NYSE) at 1:41 pm, and stocks began to sell off. The Dow Jones Industrials, which was recorded at hourly intervals in 1963, had been at 735.87 at 1 pm on November 22, and fell to 730.18 by 2 pm. Over the next seven minutes, the market traded 2.2 million shares and lost an additional nineteen points, erasing around $11 billion in capitalization, before NYSE officials halted trading at 2:07 pm to stop the panic selling. The market rested, and the next day, JFK’s body lay in repose at the White House.9
Unlimited Liability
When word got out that the AEW unit suffered a massive fraud to the tune of $150 million, American Express Stock sold off immediately. AEW subsequently filed for bankruptcy, and the question remained if American Express was on the hook for the $150 million. Howard Clark, CEO of AMEX, in hopes of calming the markets, assured the public the following:
American Express Company feels morally bound to do everything it can, consistent with its overall responsibilities, to see that such excess liabilities are satisfied.
Investors in publicly traded companies enjoy limited liability. That is, they are not liable to pay the firm's creditors in the event of insolvency. Until well into the 20th century, 1965 to be exact, American Express Company was organized “under the common law of the State of New York; not incorporated” (Moody’s (1964: 820). That is, there was unlimited shareholder liability for its debts as it was not a corporation with limited liability. American Express appears to have been the last publicly traded company whose shareholders did not enjoy limited liability.10
This scandal brought to the fore that AMEX had unlimited liability and made investors more concerned about its eventual failure. The stock fell from $60 to $56 1/2 on November 22. When the stock opened after Kennedy’s assassination, it fell to $49 1/2. By 1964, it had fallen to $35, with investors worried about a potential collapse of the company.
Franchise
During the early 1960s, Buffett & Munger would vacation together in California and debate the ideal approach to investing. Buffett, being a disciple of Graham, looked at businesses on what they were worth dead, not alive, cigar butts with a few puffs left. Munger favored higher-quality companies and didn’t mind paying a higher price point for those companies. However, they both seemed to agree that if the odds were right, you could afford to take some risk and make a concentrated bet.
American Express appears to be the first investment in which Buffett favored the qualitative aspects of the business more than the quantitative aspects. And I don’t think he would have concluded without the philosophical push from Munger. While investors fretted about whether the company would survive the scandal, American Express was a powerhouse with billions of dollars of its travelers’ cheques floating around the world. It was also a successful credit card business.
Buffett believed that the scandal would not tarnish the brand, so he did some good ole fashion boot on-the-ground research. Buffett visited his local Steakhouse and sat behind the register to see what customers would pay. Buffett noticed that customer after customer was paying with the American Express card, and they were unfazed by the salad oil events that unfolded. Buffett verified that the brand remained strong and its customers were loyal to American Express.
Buffett came away with two realizations:
American Express was not going insolvent
Its name was one of the largest franchises in the world. 11
“the name American Express is one of the greatest franchises in the world. Even with terrible management, it was bound to make money. American Express was last in the traveler’s check market and had to compete with the two largest banks in the country. Yet after a short time, it had over 80% of the business, and no one has been able to shake this position.” - Buffett.
Even with the issue of unlimited liability, Buffett had ice in his veins as he pulled out his baby elephant gun and invested 1/3 of the partnership assets into American Express. Buffett continued to add to his position until 1966 when the partnership spent $13 million on the position.
In his book, Buffett - the Making of an American Capitalist, Roger Lowenstein does a wonderful job documenting this momentous shift in Buffett’s investment philosophy.
“American Express did not have a margin of Safety in the Ben Graham sense of the word, and it is unthinkable that Graham would have invested in it. The Graham canon was quite clear: a stock out to be purchased on the basis of “simple and definite arthimtical resigning from statistical data.” In other words, on the basis of working capital, plant and equipment, and other tangible assets.
But Buffett saw a type of asset that eluded Graham: the franchise value of American Express’s name. For Franchise, think: a market lock. The Cardinals own the franchise for baseball in St. Louis; no there team need apply. American Express was nearly that good. Nationally, it had 80% of the traveler’s check market, and a dominant share in charge cards. In Buffett’s opinion, nothing had shaken it, and nothing could. The loyalty of its customers could not be deduced from Graham’s “simple statical data”; it did not appear on the company’s balance sheet as would a tangible asset, such as factories of a Berkshire Hatahway. Yet there was value in the franchise- in Buffett’s view, immense value.
American Express had earned record profits in each of the past 10 years. Salad oil or not, its customer were not going away, and yet the stock market was pricing the company as if they already had.”12
American Express had a competitive moat and was the type of business Charlie would call a “great business.”
In the 1967 partnership letter, Buffett wrote the following in describing the qualitative factors of security analysis:
Interestingly enough, although I consider myself to be primarily in the quantitative school (and as I write this no one has come back from recess - I may be the only one left in the class), the really sensational ideas I have had over the years have been heavily weighted toward the qualitative side where I have had a "high-probability insight". This is what causes the cash register to really sing. However, it is an infrequent occurrence, as insights usually are, and, of course, no insight is required on the quantitative side - the figures should hit you over the head with a baseball bat. So the really big money tends to be made by investors who are right on qualitative decisions but, at least in my opinion, the more sure money tends to be made on the obvious quantitative decisions.
Buffett had a “high probability insight” that American Express would survive the scandal and that the security price would eventually rise, which came to fruition a few years later as the investment soared in price.
The 1964 Annual reports show that Revenue and Net Income increased 17.7% & 11.3% respectively. The Company ended up paying $45 million to be applied towards the warehousing claims.
American Express had a market cap of around $150 million and around $75 million in book value. Two times the book value is certainly not the typical investment Buffett has made in the past, and I wonder if something else besides a great franchise caught his eye? Could this be the first time Buffett came across the importance of float? We shall save this topic for a different issue.
Weinstein, Mark Ira, Don't Leave Home Without it: Limited Liability and American Express (6/28/2006).
Grossman, Peter Z. 1987. American Express: The Unofficial History of the People Who Built the Great Financial Empire (Crown 1987).
Weinstein, Mark Ira, Don't Leave Home Without it: Limited Liability and American Express (6/28/2006).
Business Insider. "How The Salad Oil Swindle Of 1963 Nearly Crippled The NYSE."
Schroeder, Alice. The Snowball: Warren Buffett and the Business of Life, 2008, pp. 224.
Id.
Id.
Supra Note 4.
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Weinstein, Mark Ira, Don't Leave Home Without it: Limited Liability and American Express (6/28/2006).
“How Omaha Beats Wall Street”
Lowenstein, Roger. Buffett. The Making of an American Capitalist, 1995, pp. 81.
Thanks for the share! @financial interest