Thursday, June 02, 2011

Munger’s Revenge, Part II: The Elephant in the Room



  It’s only 9:00 a.m. on a quiet Saturday morning, but the Qwest Center in Omaha, Nebraska is full, almost literally to the rafters, and the most widely-attended financial gathering in the world is already underway.
 36,000 Berkshire Hathaway shareholders, company managers, Wall Street analysts and reporters have descended on Omaha for the weekend, and half are here in the main Qwest Center arena, half  are in other parts of the complex watching along on jumbo screens.  While 36,000 sounds like a lot, and it is a lot, it’s still less than last year’s meeting: the first and only time in our records that Berkshire’s attendance has dropped.
 I suspect this has a lot to do with the Elephant in the Room—i.e. the David Sokol Affair, which has not only caused much in the way of “I told you so”-type commentary from the somewhat secret club of Warren Buffett Loathers (which is bigger than you might think), but even a lot of head-scratching and “What was he thinking?” from the bigger, public club of investors and non-investors who pretty much view everything Buffett does and says as being The Word.
 Headcount and Elephant aside, what all 36,000 of us are watching is the hour-long movie that traditionally kicks off the proceedings an hour before the start of the main event: six hours of questions-and-answers with Buffett and his longtime business partner, Berkshire vice-chairman Charlie Munger.

As usual, this year’s movie has a rousing mix of fast-paced TV commercials from Berkshire companies such as Dairy Queen and Geico, clips from previous Berkshire gatherings, as well as slick new bits, including a preview of “Too Big to Fail,” a new movie from Andrew Ross Sorkin’s excellent book about the sub-prime financial crisis, in which Warren Buffett played a behind-the-scenes role.
 (Unfortunately, Buffett is portrayed by Ed Asner—Mary Tyler Moore’s old TV boss—and Asner looks and sounds more like Mary Tyler Moore’s old TV boss than he looks and sounds like Warren Buffett.)
 But for now, all eyes are focused on what comes next: grainy, 20 year-old footage of a man giving testimony before a Congressional committee.

“Mr. Chairman, I thank you for the opportunity to appear before this subcommittee. I would like to start by apologizing for the acts that have brought us here.”
 So begins the centerpiece of the Berkshire movie—a brief, riveting video clip of Warren Buffett testifying in the midst of a financial scandal, in which bond traders at Salomon Brothers were caught trying to corner the U.S.Treasury market.
 For reasons lost to the history, Buffett was testifying before the “Subcommittee on Telecommunications and Finance of the Energy and Commerce Committee of the U.S. House of Representatives,” and he might as well have been testifying before  “Subcommittee on Getting TV Cameras into a Room and Looking Serious While We’re Actually Thinking We Would Kill for a Scotch and Soda Right Now,” for all the good Congressional testimony has ever done the U.S. Financial System.
 In any event, Buffett continues his testimony in his gruff, familiar voice (his hair blacker but his eyebrows just as bushy as now), and the words carry a familiar sense of moral rectitude Buffett has been projecting for the better part of his near-50 years as CEO of Berkshire Hathaway:
 “The nation has a right to expect its rules and laws to be obeyed.  And at Salomon, certain of these were broken. Almost all of Salomon’s 8,000 employees regret this as deeply as I do. And I apologize on their behalf as well as mine.”

Though now a mere footnote in the history of 20th Century finance, the Salomon Brothers scandal was a whopper in its day, and only the great exertions of Buffett and Munger saved the company from prosecution and ruin…and, of course, protected Berkshire’s investment in the firm.
 The reason Buffett’s solemn, straightforward testimony is shown to the Berkshire shareholders and managers here at the meeting every year is this: to reinforce the message that, above all things, Buffett wants to protect Berkshire’s reputation, even at the expense of profits.
 Buffett describes his new mandate for Salomon’s people
 “After they first obey all rules, I then want employees to ask themselves whether they are willing to have any contemplated act appear the next day on the front page of their local paper, to be read by their spouses, children, and friends…
 “If they follow this test they need not fear my other message to them: Lose money for the firm, and I will be understanding; lose a shred of reputation for the firm, and I will be ruthless.”
 Those words, spoken 20 years ago, carry a special meaning at this meeting, thanks to a press release that stunned Wall Street and many of the people in this arena.

The press release that stopped Wall Street in its tracks and left investors around the world in a state of disbelief and wonder went across the wires on March 30, 2011, one month before the Berkshire meeting.
“This press release will be unusual,” it began.  “First, I will write it as if it were a letter. Second, it will contain two sets of facts, both about Dave Sokol, Chairman of several Berkshire subsidiaries….”
 The author was Warren Buffett, investment legend and “Oracle of Omaha,” and what followed, in 14 short paragraphs of Buffett’s characteristically clear, straightforward style, was the announcement of the abrupt and unexpected resignation of David Sokol following what seemed, to most professionals reading the news, to be shockingly inappropriate behavior.
 Sokol had been the longtime chairman of Berkshire’s hugely profitable MidAmerican Energy utility and was widely perceived to be first in line to succeed Warren Buffett himself at the helm of Berkshire Hathaway, and what he had done, Buffett disclosed, was this: he traded in shares of Lubrizol for himself while lobbying Buffett to buy the chemical company for Berkshire, without disclosing his trades until after the $10 billion deal was announced.
 Not only did Sokol make a personal profit of some $3 million based on the figures in Buffett’s letter, he made Warren Buffett look foolish.
 After all, trading for your own account while working on behalf of another company, whether for a profit of three dollars or $3 million, is called “front-running” on Wall Street, and it is one of the first things even a summer intern learns never—ever—to do.
 Sokol, of course, was no summer intern. He was a veteran, not merely of boardrooms but also of the ways of Wall Street. He also ran MidAmerican Energy, one of the largest Berkshire businesses, and he was quite well paid for doing so—close to $90 million on cash compensation plus another $145 million in stock-related proceeds over the course of his decade-long career with Berkshire.
 Why would Sokol risk that position, not to mention the prestige of being considered a potential successor to Warren Buffett as CEO of the greatest financial success story of our times, by doing something so tawdry?
 Buffett offered no answers in his March 30 press release, but neither did he display any of the “ruthlessness” he had promised Congress 20 years ago.  In fact, he appeared to dismiss what Sokol did, as others had, writing:
 “Neither Dave nor I feel his Lubrizol purchases were in any way unlawful.”
 For all the good Warren Buffett has done for his shareholders over the years—and growing Berkshire’s stock price from $15 a share to over $100,000 a share is only part of what has drawn 36,000 shareholders to Omaha this weekend—it is that press release that is one everyone’s mind here this morning.

In fact, once the movie ends and the lights go up, the first question of this meeting will be long, a stinging rebuke to the Oracle of Omaha from a Berkshire shareholder that winds up with, “Why did you handle this matter so inadequately?”

(To be continued...)


Jeff Matthews
Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”
(eBooks on Investing, 2011)    Available now at Amazon.com


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The content contained in this blog represents only the opinions of Mr. Matthews.   Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.  This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever.  Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored.  The content herein is intended solely for the entertainment of the reader, and the author.

5 comments:

Anonymous said...

I may be wrong, but it seems to me that accepting Sokol's resignation, thus ending his tenure at Berkshire, could be construed as ruthless. Public flogging simply isn't done anymore, so that leaves termination or taking away his cell phone for a month as Warren's options.

Anonymous said...

@Jeff,

Does being a Buffett groupie, such as yourself, add any value at all?

If you were an analyst working for me, I'd fire you.

Jeff Matthews said...

Anonymous #1: I disagree. Accepting a resignation, and repeating the statement that it was not related to the Lubrizol affair, is not at all ruthless.

Anonymous #2: I find this enjoyably amusing. The writer has clearly not read "Secrets in Plain Sight," the first and only book to analyze both sides of Buffett's record.

JM

Anonymous said...

Jeff,

I understand your reaction to Anon #2, clearly not a long time reader. I will say however that your first two posts are light on substance, especially since the meeting happened weeks ago and there are many transcriptions and reviews out there. Understandable if this is part of a new book intro or something, but could you beef it up a little next time?
Thanks, I really do appreciate your blog.

Jeff Matthews said...

Anon #3: You are right, and we're getting there. Apologies for the dryness thus far, but there's a serious issue at the bottom of this, and we're trying to tee it up without the "Tastes Great/Less Filling" kind of yammering that's already been out there.

Much appreciated,

JM