The Great Salad Oil Swindle of 1963 was a defining event in the career of Warren Buffett. The victim of the fraud was American Express. The perpetrator was Allied Crude Vegetable Oil Refining Co. along with its founder, Anthony “Tino” De Angelis. For Warren Buffett, it presented a rare opportunity to invest in a profitable business at a significantly depressed valuation.
A subsidiary of American Express was specializing in the busines of field warehousing. This entailed providing loans to businesses against colletaral in physical inventories. The company also provided receipts that Allied would use to get loans from other financial institutions.
In 1963, though an anonymous tip, American Express discovered that it had been conned by Allied. The oil containers that Allied was using turned out to be filled mostly with seawater. The small volume of salad oil naturally floated on top of the water and the fraud had thus gone undetected when the containers had been inspected.
The discovery of the fraud created both confusion and uncertainty. It was not apparent who would eventually have to foot the bill. Since American Express had vouched for Allied’s inventory, it was unsure if the company would be held responsible for the damages. Allied had, in total, received loans against collaterals from fifty-one other financial institutions.
The company was supposed to have $150 million in vegetable oil as collateral but only had inventories worth $6 million. After the discovery, the share price of American Express fell by more than 50%.
American Express was already on Buffett’s radar as he was particularly impressed with the company’s core traveller checks business. He quietly amassed a 5% stake in American Express amid the scandal for $20 million.
American Express eventually settled all claims for a total amount of XXX million. Not all shareholders agreed with this policy and sued AMEX. At that point, Buffett had to step in and use his weight as a large shareholder to nudge the deal forward.
In his eyes, the core value of American Express as a financial intermediary was trust. In his mind, the reputation damage of not paying out would hurt the long term prospects of the franchise more than the cost of settling the collaterals.
Once it was apparent that the situation was manageable and that the underlying business was unaffected, the AMEX stock started to recover. AMEX was a big position for the Buffett Partnership at once the stock started to appreciate it grew to 40% of the total portfolio. As Buffett was proven right, he started exited the AMEX position. It had taken five years to play out.
On January 24, 1968, Buffett wrote to his shareholders: “Last year I referred to one investment which substantially outperformed the general market in 1964, 1965 and 1966 and because of its size (the largest proportion we have ever had in anything – we hit our 40% limit) had a very material impact on our overall results and, even more so, this category. This excellent performance continued throughout 1967 and a large portion of total gain was again accounted for by this single security. Our holdings of this security have been very substantially reduced and we have nothing in this group remotely approaching the size or potential which formerly existed in this investment.”
He had paid the equivalent of $0.94 per share for the stock and sold in the $5 range.