Alot of things must go right to perpetuate a massive fraud. It certainly did for Tino De Angelis and his salad oil swindle in the early 1960s.
How does someone commit fraud with salad oil, you ask? Tino started Allied, a vegetable oil refining business with the goal of becoming the industry leader. He needed growth to achieve that end. So, he borrowed money in a unique way.
Tino used Allied’s existing inventory as collateral for loans. Tanks full of soybean and cottonseed oil were pledged to secure loans. The initial loans came from exporters. Banks, brokerage firms, and more eventually became willing lenders because the warehousing receipts tied to Allied’s inventory carried the name American Express.
Tino scheme was simple. He only needed people to believe the vegetable oil existed, so he created that illusion. He built a network of over 70 tanks that allowed him to pump contents from one tank into another while inspectors checked the contents of a third.
And the contents? A few tanks held petroleum, gasoline, soap stock, and sludge. The majority held salt water…with a thin layer of oil floating on top. In the end, 1.85 billion pounds of inventory was unaccounted for!
When the scandal went public in November 1963, nobody believed that almost two billion pounds of vegetable oil, secured against loans, would vanish. Yet, it did.
Dozens of companies were hit. A handful were bankrupted. Others were forced into merges. American Express’ stock suffered from the exposure and the company eventually settled the claims for its involvement in all it.
The lessons from the swindle begin with greed but end with a unique opportunity.
Beware the Incentives
When a man is measured only by a balance sheet, the system breeds a pursuit of a dollar by any means and thus may destroy ethics.
The way commodity warehousing works is the warehousing company charges a fee to manage inventory used as collateral in loans. A warehousing receipt for the inventory is issued, and given to the lender, which ensures the collateral is accounted for in its inventory. The system works on the belief that the receipt is accurate and the inventory exists.
When Donald Miller took charge of American Express Field Warehousing (AEFW) the American Express subsidiary had lost money for over a decade, since its inception in 1944. His job depended on making the subsidiary profitable.
Miller’s unlucky break came in 1957. Tino presented Miller with an opportunity to work with Allied. Never mind, that Tino had a prior history of bankrupting a company, suspected fraud, and tax evasion. A deal was made. Allied became AEFW’s biggest account and made the subsidiary profitable within a year.
And if Allied’s business was so profitable for AEFW, how profitable was it for the banks issuing loans? Banks, at the time, charged Allied in excess of 10% interest on collateralized loans.
Finally, there was the young partners at trading firms like Ira Haupt & Company and others. Allied traded futures to protect against changes in commodity prices. Or so they claimed. The partners at the trading firms saw dollar signs. The commodity exchanges did too.
Of course, the expanse of the swindle extended even further but the incentive to make money explains why most people got into business with someone with such a long questionable history.
A Little Ignorance Goes a Long Way
A recurring theme throughout the scandal is how little the victims understood Allied’s business or the commodity business in general. That ignorance helped Tino expand the scandal to a ridiculous size.
For example, Miller admitted to not understanding how Allied’s business worked right from the start. Partners at Ira Haupt were new to futures trading and its general partners were oblivious to the extent of what was going on up to the end.
Tino’s fraud worked because of the complete ignorance of the commodities market. At its peak, warehouse receipts against Allied’s inventory equaled the total supply of soybean and cottonseed oil in the US based on Census Bureau data. Factor in oil from futures contracts, and total holdings exceeded what the US exported in a year.
If anyone at AEFW had a basic understanding of the size of the market Allied played in, or just read Census Bureau data, they would have realized that Allied’s inventory claims were bogus.
The same can be said of all the other companies that dealt with Allied from bankers to brokers to exporters to exchanges. At least one person, amongst all of them, should have understood Allied’s business.
That said, Tino strategy offered some protection from knowledge. He spread around warehouse receipts so broadly that 51 companies held receipts against Allied inventory in the end. Those companies had no idea how many receipts existed. Diversification became a defense against intelligence.
Faith in American Express
We didn’t deal with this Tino character. We dealt with American Express. — Jakob Isbrandtsen, President of Isbrandtsen & Co., lender to Allied.
It never entered our minds that the warehouse receipts were invalid. We felt we were quite solvent. — Haupt partner
“So long as the oil exists, we’re fine,” was said or inferred often. The bankers said it. The brokers said it. The exporters said it. Even American Express said it.
Sure, multiple inspections were made on the tanks to ensure the oil existed. Yet, the inspections were riddled with errors. Inspectors relied on Allied employees to “help” with the inspections. Early reports and audits with questionable results, like water in the tanks, were explained away by Tino. Numerous warning signs were ignored.
Everything hinged on the belief that the warehouse receipts were legit, and the oil existed. American Express said it existed, so everyone believed it to be true.
The American Express brand carried far more weight, than Tino ever could. The deception depended on faith in the brand.
Opportunity in the Fallout
American Express was the preeminent leader in travelers’ checks. Banks and businesses around the world accepted their checks without question. American Express was good for it.
At least one person noticed the slide in American Express’ shares as a possible temporary hiccup.
Our Partnership has recently purchased approximately 70,000 shares of American Express stock. This purchase was made after extensive investigation among Travelers Cheque users, bank tellers, bank officers, credit card establishments, card holders and competitors in these various lines of endeavor. All confirmed that American Express’ competitive vigor and preeminent trade position had not been damaged by the salad oil problem. — Warren Buffett, letter to Howard Clark, President of American Express
Warren Buffett believed the company’s integrity and trust, with over 100 years of history behind it, wouldn’t suffer from the scandal. His investigation showed that. In fact, he believed the company’s primary business would continue growing as it did before the scandal.
It is our feeling that three or four years from now this problem may well have added to the stature of the company in establishing standards of financial integrity and responsibility which are far beyond those of the normal commercial enterprise…
The typhoon will pass, and I think history will show that the ship has continued to make real progress.
The decision by American Express to settle with creditors turned out to be a public relations win. Three years later, the stock was above its pre-scandal price.
The scandal knocked American Express down but it’s reputation and financial strength stopped it from being knocked out.
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