By Susan Antilla

Published: September 18, 1994

THE derivatives meltdown of 1994 hasn’t been much fun for any of the small investors who got caught in the whirlwind of what should have been solely a big players’ game. Just ask the buyers of short-term bond funds who have lined up to sue managements of their safe mutual funds.

Better yet, talk to the investors who would never have imagined that their ultra-safe money market funds could fall below $1 a share — breaking the buck in Wall Streetspeak.

But bad as those debacles may have been, few individuals felt the sting of derivatives as badly as those who used brokers in a Hong Kong office of Salomon Brothers Inc.

With the guidance of Salomon, customers in San Francisco, Hong Kong and Singapore purchased millions apiece in securities typically reserved for Wall Street’s professional investors: inverse floaters, mortgage pass-throughs, and collateralized mortgage obligations.

Different ways to play the housing market, these complex securities rise and fall in conjunction with interest rates. When interest rates rose in February, Salomon’s customers faced huge losses without the comfort of an image-conscious fund company that might provide a bailout.

But why did retail investors buy the risky stuff that wound up toppling Wall Street giants in the first place?

For one thing, Salomon told investors that the potentially volatile investments were safe. Marketing material sent to clients said that collateralized mortgage obligations were very liquid and that there was no market risk — a wild claim to make about a rate-sensitive investment.

Today, a half-dozen wealthy Hong Kong investors who bought the pitch are attempting to settle with Salomon after having filed with the National Association of Securities Dealers to arbitrate against the firm. (The investors have withdrawn that claim in the meantime.)

Another four in San Francisco — including one who borrowed on his credit cards to make the investment — have filed a separate arbitration complaint. And an attorney for a Singapore investor was readying yet another arbitration complaint against Salomon last week when Salomon contacted the client to suggest settlement talks.

Ray Peffer, the lawyer for the San Francisco investors, estimated that $100 million in mortgage-backed securities may have been sold to retail investors through the Hong Kong office. While not all those investors would have incurred losses, Mr. Peffer questioned whether they were appropriate investments for individuals.

Robert Baker, a spokesman for Salomon, declined comment on the Singapore investor’s complaints. We won’t divulge a client’s confidential information in order to respond to the claims of a plaintiff’s attorney, he said, referring to Jonathan Kord Lagemann, lawyer for the Singapore investor.

The complaints of the Singapore investor are of particular interest because of the timing of the trades. The investor, who requested anonymity through Mr. Lagemann, had purchased $11 million in derivatives on margin in February, and by March, was already being dunned an additional $1.2 million because the securities were under water.

But even as the Singapore investor was awaiting settlement of his trades, a Salomon executive from New York was poring over the books of the troubled Hong Kong office to better understand the firm’s liability in dozens of other problem accounts containing derivatives. Mr. Lagemann contends that the executive was thus in a position to have canceled his client’s pending trades or warn him about the risk he was taking.

The Hong Kong problem, as it has become known in the halls of Salomon’s New York headquarters, is worrisome enough that it has captured the attention of William Heyman, managing director of the Private Investment Division and a former director of market regulation for the Securities and Exchange Commission. Craig Palmer, a director in Mr. Heyman’s department, spent months in Hong Kong, accompanied for part of that period by George Garvey of Munger Tolles & Olsen, law firm for Warren Buffett, a former chairman of Salomon, and Harold Levy, a Salomon lawyer. Mr. Baker declined to make Mr. Heyman available.

Despite their efforts at fence-mending, Salomon is still worried enough about possible repercussions that it is apparently pushing to reduce what is known as counterparty risk — the risk of being stiffed by angry customers who refuse to pay their margin calls.

When the Singapore businessman wanted out of his positions, his Salomon broker suggested that he might get a better price than the one on his monthly statement by going to another brokerage firm. Morgan Stanley, in fact, found a buyer willing to pay 10 percent more than Salomon was valuing the securities. Mr. Baker said that, given the volatile markets of earlier this year, it is not surprising that there would be significant price variation. But Mr. Lagemann believes Salomon has an incentive to low-ball the value of customers’ derivatives so that it can accelerate margin calls and reduce its own financial risk as a lender to its customers.

Then again, it just may be that Salomon is so befuddled by derivatives that it simply can’t determine values. In a March 7 form letter to customers, Salomon admitted that some of the market values appearing on your statement for February 28 failed to properly factor in market declines. By April, another form letter warned clients that March’s monthly statements were a best assessment of prices, and that customers should regard prices as approximate.

Indeed, not even Mr. Palmer could get it right when he shipped off a two-page letter to the Singapore businessman on April 15, noting that based on market prices at this writing, further posting of $896,000 is necessary. A week later, Mr. Palmer would be signing a corrective letter lowering the earlier values and demanding $1.069 million from the investor. It’s tough to nail down a price when a stable, liquid investment neglects to act as the sales literature dictates.

Photo: William Heyman, a managing director for Salomon. (Alan Zale for The New York Times)