Thursday, April 14, 2011 Say It Aint So, Warren Q.

Is there a question about the right way for publicly traded companies to report financial information? A. I think the principles are cut and dried. The problem often lies in the interpretation of the principles. The basic principle is that anything, positively or negatively, that occurs inside a company or has a reasonable probability of occurring that could be viewed as impacting the information needs of an investor needs to be made public. You need to make it public to everybody at once, not just a select group, or not just dribble it out - fair, prompt and full disclosure. David Sokol, from Businesses can avoid trouble by telling truth, Sokol says, by Steve Jordon, Omaha World-Herald, March 17, 2002

A single, big mistake could wipe out a long string of successes. Warren Buffett, Chairmans Letter, Berkshire Hathaway 2006 annual report.

Odd timing. We were about to begin editing the final draft of our soon-to-be-published ebook, Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett, when the David Sokol news hit the tape, generating simultaneous emails, phone calls and instant-messages that made it impossible to focus on the task at hand. David Sokol, as everyone except perhaps a few nomads in the Empty Quarter of the Arabian Peninsula knows, is the Berkshire Hathaway executive who resigned suddenly and unexpectedly last month, shocking Wall Street in general and Berkshire Hathaway-watchers in particular. Why all the shock? Well, for one thing, Sokol was widely seen as The Successor who would someday take Warren Buffetts place as CEO of the Berkshire Hathaway family of companies. Thats a big deal, considering the fact that Warren Buffet is the most successful investor of his times (not hyperbole), and that Berkshire Hathaway, which his investment acumen created, today has more than a quarter-million employees generating close to $150 billion a year in revenues. Thats almost as big as General Electric. Unlike GE, however, Berkshires home office doesnt occupy a tree-shaded headquarters

building in a leafy Connecticut suburb on 68 acres of land with 600,000 square feet of space, dozens of sharp-elbowed Vice Presidents jostling for position, and hundreds of home-office types toiling away. No, the stingy and bureaucracy-shy Buffett runs Berkshire with the help of just 20 other professionals, in leased space on one floor in downtown Omaha, and he has been publicly discussing what hes looking for in a successor with the same thoughtful deliberation he uses when discussing stock-picks, the state of the economy, and acquisitions like the recently announced $9.2 billion Lubrizol purchase. Of course, David Sokol was never actually named Buffetts successor. Buffett likes the limelight, for one thing; for another, hell run Berkshire until he drops dead; and for a third, until that time he can always change his mind about who should succeed him. Still, so many signs pointed to Sokol over the years that Barrons once picked him as the heirapparent in a front-cover story. Whatever David Sokols true position in that horse race, last months very public disruption of Buffetts long-considered plans was surely a shock to the Oracle of Omaha himself, for Buffett thinks not in terms of months and quarters but in terms of years and decades, and he does not often see his well-made plans disruptedespecially not in such an ugly, public waywith the actions and integrity of a Berkshire All-Star, as Buffett refers to his managers, suddenly called into question.

This leads to the second, and bigger, reason for the stunned reaction to the Sokol Affair: what Sokol actually did before he resigned. What Sokol did was this: he tradedquite profitably, it appearsin shares of Lubrizol while lobbying Buffett to have Berkshire buy the company. This kind of trading-in-advance-ofsomeone-with-deeper-pockets-than-you is known as front-running on Wall Street, and it is one of the first things even a summer intern learns nevereverto do. Sokol, of course, is no summer intern. Hes a veteran, not merely of board rooms but also of the ways of Wall Street. And as the quote at the start of this piece indicates, he is quite familiar with the rules of disclosure for public companies. Indeed, Sokols first experience as president of a public company dates back to 1992, when he took the helm of an obscure but memorable outfit known as JWP (the old Jamaica Water PropertiesJamaica as in Queens, New York; not as in Bob Marley and the Wailers), where his Chief Financial Officer uncovered questionable accounting practices which Sokol admirably disclosed before submitting his resignation and moving on to the predecessor to MidAmerican Energy, even as JWP was moving on to Chapter 11. Nor is Sokol some underpaid subaltern for whom the lure of a quick buck might seem too great to pass up.

During his 2000-2010 tenure as Chairman of Berkshires MidAmerican Energy group, Sokol earned, by our calculations, total salary of $8.8 million and bonuses of $53.9 million, plus a $26.25 million payout thanks to MidAmericans Incremental Profit Sharing Plan. But that was not all David Sokol earned at MidAmerican, for not only did he work at MidAmerican, but Sokol was an owner of MidAmerican. Thats because Sokol, Walter Scott (a Berkshire board member) and Greg Abel (a longtime MidAmerican executive who replaced Sokol as Chairman of MidAmerican when Sokol resigned), invested alongside Berkshire to buy MidAmerican in what was, in many respects, a good old-fashioned $2.2 billion leveraged buyout. (Berkshire owned 75% of MidAmerican when the deal closed; today it owns roughly 90%.) Now, leveraged buyouts can be risky. On the other hand, they can be highly rewarding, too, as Sokols experience shows. All told, from 2000 to 2010, MidAmericans filings report he sold a total of $145.5 million in MidAmerican stock or stock-equivalents back to MidAmerican, taking his ownership as of 12/31/10 down to zero. And Sokol certainly earned his good pay, at least when measured by the gain in MidAmerican's value over the years. When the Buffett and Sokol/Scott/Abel investor group bought MidAmerican in 2000, they paid $35.05 a share. Five years later, MidAmerican paid an implied $145 per share to buy back stock from Sokol, and by 2009 the valuation had increased to what appears to be $175 per share for Sokols remaining shares. It is no wonder Buffett wrote in his March 30 letter, Berkshire is far more valuable today thanks to Sokol. And it is unlikely Buffett begrudges one dime of Sokols compensation, for Warren Buffett is, as he likes to say, A pay-for-performance kind of guy.

Yet Warren Buffett is also a Wall Street veteran. (He first visited the floor of the New York Stock Exchange when he was 10 years old.) And if anybody in the financial world knows frontrunning when he sees it, it would be Warren Buffett. This brings us to the third, and biggest, shocker of the Sokol Affair: Warren Buffetts own handling of it. The way Buffett handled it was through a press release written in the form of a letter that first praised Sokols work for Berkshire and then divulged the stunning news that Sokol had bought, then sold, and then bought shares of Lubrizol during a period of time in which Sokol was encouraging Buffett to buy Lubrizol lock, stock and barrel for Berkshire Hathawaywhich Buffett eventually would do. Buffett summed up the matter, and simultaneously tried to close the door on it, by writing, Neither Dave nor I feel his Lubrizol purchases were in any way unlawful.

To understand why this rationalization was so head-scratchingly, stop-the-presses stunning, one must understand that for a quarter-century Warren Buffett has been sending a version of the following memo to his managers (David Sokol, no doubt, included) defining what he calls Berkshires top priorityand that priority is not money: This is my biennial letter to reemphasize Berkshires top priority. The priority is that all of us continue to zealously guard Berkshires reputation. We cant be perfect but we can try to be. As Ive said in these memos for more than 25 years: We can afford to lose money even a lot of money. But we cant afford to lose reputation even a shred of reputation. We must continue to measure every act against not only what is legal but also what we would be happy to have written on the front page of a national newspaper in an article written by an unfriendly but intelligent reporter. Sometimes your associates will say Everybody else is doing it. This rationale is almost always a bad one if it is the main justification for a business action. It is totally unacceptable when evaluating a moral decision. If you see anything whose propriety or legality causes you to hesitate, be sure to give me a call. However, its very likely that if a given course of action evokes such hesitation, its too close to the line and should be abandoned. Theres plenty of money to be made in the center of the court. If its questionable whether some action is close to the line, just assume it is outside and forget it. As a corollary, let me know promptly if theres any significant bad news. I can handle bad news but I dont like to deal with it after it has festered for awhile. A reluctance to face up immediately to bad news is what turned a problem at Salomon from one that could have easily been disposed of into one that almost caused the demise of a firm with 8,000 employees. Somebody is doing something today at Berkshire that you and I would be unhappy about if we knew of it. Thats inevitable: We now employ more than 250,000 people and the chances of that number getting through the day without any bad behavior occurring is nil. But we can have a huge effect on minimizing such activities by jumping on anything immediately when there is the slightest odor of impropriety. Warren E. Buffett, July 26, 2010 (Memo to Berkshire Hathaway Managers) That letter was reprinted in the 2010 annual report that went to all Berkshire shareholders a month before the Sokol Affair exploded, and it needs no elucidation. After all, the sentiments expressed are exactly what Buffett and his long-time business partner, Charlie Munger, have been telling shareholders at his annual shareholder meetings for decades. Indeed, Munger has proven to be even more emphatic than Buffett when it comes to what constitutes appropriate conductbeing an exemplar, as he likes to say. In a speech at Harvard

Law School that still circulates on the internet, Munger once discussed the isolated example of a little old lady in the See's Candy Company, one of our subsidiaries, getting into the till: And what does she say? I never did it before, I'll never do it again. This is going to ruin my life. Please help me. . Well in the history of the See's Candy Company they always say, I never did it before, and Im never going to do it again. And we cashier them. It would be evil not to, because terrible behavior spreads. Interestingly enough, Sokol tried to throw Munger under the proverbial bus in a CNBC interview shortly after the Lubrizol trades came to light by claiming his Lubrizol tradesunreported to Berkshire shareholders until after the factwere somehow similar to Mungers longstanding and fully disclosed interest in Chinese car company BYD, in which Berkshire subsequently took a stake. (Munger, appropriately, took no part in Berkshires BYD investment processin fact it was Sokol who went to China to look at the company for Berkshire.) So what did Mungerthe man who spoke so sternly about the little old lady at Sees Candieshave to say about Sokols Lubrizol trades? He called it a glitch.

Warren Buffett was right when, explaining the kind of risk-conscious individual he was looking for to succeed him as the Chief Investment Officer at Berkshire Hathaway, he wrote this line in 2006: A single, big mistake could wipe out a long string of successes. At the time, of course, Buffett was referring to financial mistakesthe kind of mistakes that brought down Bear Stearns, and Merrill Lynch, and Fannie Mae, and so many others just a few years later. That those financial mistakes did not happen at Berkshire Hathaway during the worst financial panic since the Crash of 1929 was entirely due the rational, thoughtful, forward-looking individual at the helm of Berkshire Hathaway. Owing to that foresight, Berkshire Hathaway will continue to thrive under Warren Buffett and beyond thanks to the collection of durable companies that now make up most of Berkshires assets, even though it will never be the growth machine it was during his stock-picking years. But the reputational mistake from that single, awful line, Neither Dave nor I feel his Lubrizol purchases were in any way unlawfula line that, while factually very likely the truth, just wiped out a long string of reputation-building successesis not so easy to fix. What you are reading and hearing is from people who believedthanks to years of careful studying of what Buffett wrote in those annual letters and careful listening to what he said at those annual meetingsthat Buffett meant what he said and said what he meant. And they cannot believe what they have just read.

Friday, May 27, 2011 Berkshire 2011: Mungers Revenge Well, some things have certainly changed here in Omaha at the Berkshire Hathaway annual shareholder meeting. Most striking, the crowd seems a trifle thinner than last yearnot by a lot, and maybe not at all, but certainly the growth in attendance has stalled from the 15% compound rate of the last five years. Perhaps this is one reason Warren Buffett did not announce the attendance figures at the start of the meeting, as he has always done; the other obvious reason being that he forgot. But Buffett doesnt forget too many things, and he takes inordinate and deserved pride in the army of loyal Berkshire shareholders Whatever the reason, theres another thing thats different: the shareholders asking the questions are almost entirely Americans. Thats a big shift, coming as it does after years of a growing international presence. Two years ago, for example, 15 questions came from non-US shareholders, while last year there were six. This year theres been one shareholder from Kashmir, and thats about it. Ill ascribe this to Buffetts switch to a lottery system for determining the shareholder questions, which was intended to eliminated the spleen-venting activists that began to appear at the microphones in recent years, not to mention the Buffett Adoration Societytypes who were more interested in Buffetts view on Life, Liberty and the Pursuit of Happinessbut has had the side-effect of eliminating the European shareholders key advantage: getting up at 4 a.m. Central Standard Time to be first in line was easy for them. Of course, another thing keeping the international contingent at bay is the fact that once again, three reportersFortunes Carol Loomis, The New York Times Andrew Ross Sorkin, and CNBCs Becky Quickare alternating with shareholders. Altogether, this has kept the What Would Warren Do?-type questions to a minimum, and put the spotlight on Berkshire and its businesses, which is where it belongs. (Side note: an unusually high number of excellent questions are being posed by bright young financial analysts from the Greater Boston Area, which suggests somebody figured out how to game the lottery system anyway. Who says America has lost its competitive edge?) But of all the differences between this year and others, the happiest is that Berkshires canny and sharp-tongued Vice-Chairman, and Buffetts longtime business partner, 87 year-old Charlie Munger, is being unusually talkative. Indeed, by days end, Munger will have added his dry, acerbic commentary to all but two or three questions out of the 52 being asked. (In years past, Munger declined to answer, on average, a third of the questions.)

Ill chalk this up to the presence of all the bright young analysts asking questions about Berkshires businesses and Buffetts investing stylebut another reason might well be the recent eruption of the David Sokol Affair and the attendant sharp focus on Buffetts judgment in the matter, raising Mungers rather substantial hackles and giving him the opportunity to rise, more than once, to his longtime business partners defense. Indeed, my favorite moment thus far came when Munger practically grabbed the microphone from Buffett and But before we get to that, lets say that the one thing that hasnt changed is this: Buffett and Mungers unique determination to spend six hours answering questionssome flattering, some notwithout ducking, dodging, hesitating, or turning it over to the lawyers. Now, back to the meeting (To be continued)

Thursday, June 02, 2011 Mungers Revenge, Part II: The Elephant in the Room

Its 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, its still less than last years meeting: the first and only time in our records that Berkshires attendance has dropped. I suspect this has a lot to do with the Elephant in the Roomi.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 noninvestors 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 years 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 Sorkins excellent book about the sub-prime financial crisis, in which Warren Buffett played a behind-the-scenes role. (Unfortunately, Buffett is portrayed by Ed AsnerMary Tyler Moores old TV bossand Asner looks and sounds more like Mary Tyler Moores 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 moviea 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 Were 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 Salomons 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 ruinand, of course, protected Berkshires investment in the firm. The reason Buffetts 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 Berkshires reputation, even at the expense of profits. Buffett describes his new mandate for Salomons 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 Buffetts 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 Berkshires 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 Buffetts 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 nevereverto 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 soclose 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 yearsand growing Berkshires 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 weekendit is that press release that is one everyones 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...) Sunday, June 05, 2011 Mungers Revenge Part III: Inexplicable and Inexcusable

(With excerpts from Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett Available now at Amazon.com) Prelude: From $100 to $62 Billion in 56 Years In May 1956, seven of Warren Buffetts friends and family members invested in a partnership that would be managed by that self-assured, 25-year-old Omaha investor. They would pay him no fee or salary, but he would keep a quarter of the profits he earned for them, provided they made at least a nominal 6 percent annual return. The seven friends and family members invested $105,000. Warren Buffett himself put in a nominal $100. Thats right: one hundred dollars. Over the next 13 years, Warren Buffett grew Buffett Partnership Ltd. into a $100 million fund. Thanks mainly to his incentive fee, $25 million of the fund belonged to him. In1969 Buffett disbanded Buffett Partnership Ltd. and focused on managing its largest investment: a troublesome textile company called Berkshire Hathaway. By 2002, that company was worth nearly $200 billion, and Buffetts one-third ownership had put him on the top of the Forbes 400 list of richest human beings in the world, with a net worth of $62 billion. From $100 to $62 billion, Warren Buffetts investment legacy was secure around the world. Mixed Messages On Wall Street, however, it has been a bit more mixed. Buffetts influence among investment professionals ranges from value investors who have studied him for decades and run their own funds very much in line with Buffetts methods, to money managers who think the technologyphobic Buffett is brilliant but old-fashioned and out of step with the times. There are even some downright cynics who regard Warren Buffetts eye-popping career as a statistical fluke, consider Berkshire Hathaway to be something of a cult, and view Buffett himself as a kind of Teflon-coated master of public relations. Call the cynics jealous, if you likethere is, in fact, no person alive who can match Buffetts professional track record, and none who likely ever will. But there are some interesting contradictions between what Buffett says publicly and what he does as CEO of Berkshire Hathaway. Do as I Say, Not as I Do? During the hostile takeover boom of the 1980s, for example, such companies as International Paper and Salomon Brothers sold a special class of stock to Berkshire, solely to protect themselves from unfriendly takeovers. Warren Buffett, the implacable foe of clubby corporate boardroom behavior, was helping underperforming managers keep their companies intact and their jobs safe. And after the collapse of junk-bond king Drexel Burnham Lambert in the early 1990s, Berkshire purchased billions of dollars worth of junk bonds despite Buffetts own warnings that junk bonds were dangerous. The only time to buy these is on a day with no y in it, he liked to say. More recently, just before the crisis hit in 2008, Berkshire announced it had taken in nearly $8 billion of premiums on 94 derivative contracts, similar to those financial weapons of mass destruction Buffett had been warning about for years. The derivatives included puts on various stock market indices with a nominal exposure of more than $40 billion.

Of course, these activities proved to be quite profitable (very profitable, in the case of the RJR bonds) for Berkshires shareholders. Just because Buffett casts a dim view on a particular investment class doesnt mean he shouldnt take advantage of a profitable opportunity when it appears within his circle of competence. The Lucky Sperm Club...at Berkshire More grating, and harder to rationalize, might be the sharper moral edge Buffetts always blunt voice has taken on recentlyespecially considering his own history. Buffett criticizes hedge fund managers because they charge big incentive fees and receive favorable tax treatment compared to common folk. Yet, Buffett Partnership Ltd was structured like a hedge fund, providing Buffett with very large incentive fees and very favorable tax treatment. Buffett also criticizes efforts to reduce the inheritance tax on rich familiesthe lucky sperm club, he sniffs. Yet Buffett has, quite deliberately, made Berkshire a haven for family companies that want to keep their business and their own management intact, while avoiding the very estate taxes he wants others to pay. In fact, Buffett has advertised the tax advantage of selling to Berkshire in his own Chairmans Letter: In making acquisitions, we have a further advantage: As payment, we can offer sellers [Berkshire] stock. . An individual or a family wishing to dispose of a single fine business, but also wishing to defer personal taxes indefinitely is apt to find Berkshire stock a particularly comfortable holding. Finally, Warren Buffett himself is dodging what must surely be the biggest estate tax bill of them all by giving away all his Berkshire stock instead of selling it. Race against Time These contradictions rankle in the quieter corners of Wall Street, although certainly not on Main Street, where Buffett has, in recent years, become a very public figure known around the world. His higher public profile, of course, has a rational impetus: Buffett is engaged in a race against time to create a brand name for Berkshire that not only will attract family-owned businesses to become part of the Berkshire family but also will survive his death. The more exposure Buffett gets on CNBC and elsewheresuperficial as it may bethe better it is for Berkshire in the postBuffett era. And yet, while Buffetts passing is a certaintyhes now in his eightiesthe answer to the question of whether Berkshire Hathaway will thrive without him is not. Indeed, Berkshire shareholders got a harsh reminder of that fact thanks to the ugly end of David Sokols tenure at one of Berkshires largest and most important businesses. Buffetts handling of the abrupt resignation of David Sokolafter it was disclosed that Sokol had traded shares of Lubrizol for personal gain while Buffett was in discussion to acquire the companytriggered shock waves among many of Buffetts longtime admirers and scorn from his detractors. In that fateful March 30 press release, Warren Buffettthe very same Warren Buffett who told Congress 20 years ago, Lose money for the firm, and I will be understanding; lose a shred of reputation for the firm, and I will be ruthlessseemed to turn his back on that simple credo by writing, Neither Dave nor I feel his Lubrizol purchases were in any way unlawful. One month later, 36,000 Berkshire shareholders returned to Omaha to hear Buffett explain his own behavior.

Im Warren, Hes Charlie Omaha, Nebraska, April 30, 2011. It is 9:20 a.m., and the movie is over, the lights are up, and Warren Buffett and Charlie Munger have taken their seats at the small table onstage in the cavernous Qwest Center arena. The applause has died down, and the place goes quiet as we wait for Buffett to speak. Both men look robust, despite a combined age that is pushing 170. And they eat like teenagers: On the table in front of them, along with two microphones and the yellow legal pad Buffett will use to keep track of the questions, are two boxes, one of Sees chocolates and one of Sees peanut brittle. In between is an ice bucket with a couple of Cokes cooling off. Im Warren, hes Charlie, Buffett says into the microphone, his voice gruff, friendly, and as grandfatherly sounding as the octogenarian grandfather he happens to be. I can see and Charlie can hear, so we work well together. It is the same joke he tells every year, and it draws the same appreciative laughter it always gets. Buffett says he wants to talk about two things before taking questions: Were going to talk about earnings, and were going to talk about the David Sokol situation. Twelve Katrinas The earnings discussion is brief, but has some surprising news: Even Berkshire Hathaways vaunted insurance businesses sometimes lose money. Buffett explains that Berkshires earnings were hurt by insurance claims from the March 2011 Japanese earthquake-tsunami-nuclear meltdown, as well as the massive Christchurch, New Zealand, earthquake a month earlier. To explain why the Christchurch quakesince overshadowed by the Japanese nuclear disasterhad such an impact on Berkshire, Buffett first asks Munger what the population of New Zealand is. Id say 4 million, Munger begins, then corrects himself: No, about 5 million. (Either way, he was close: it is 4.3 million). Buffett observes that this means the Christchurch damage is the equivalent of about 12 Katrinas. That ability to put large things in vivid, clear perspective is a quick reminder of why Buffett will say, later in the day, that he would like to be remembered not as a financial genius but as a teacher. Still, it is not earthquakes and insurance losses the crowd wants to discuss, and Buffett knows it. Inexplicable and Inexcusable Id like to just comment for a few minutes on the matter of David Sokol and the purchase of Lubrizol stock, Buffett says, and the crowd gets really quiet. He starts by referring to the video clip of his Salomon Brothers testimony we all watched a half hour ago and says that what David Sokol did recalled to his mind what he said of the Salomon traders behavior at the time: It was inexplicable and inexcusable. There. For the first time since the news broke, Warren Buffett has said what everyone, deep down, expected him to say. A sense of pride, or gratitude, or reliefor all threeseems to sweep through the crowd. This is the Buffett we thought we knew. The inexcusable part, Buffett continues, is that Dave violated the [Berkshire] code of ethics, he violated our insider trading rules, and he violated the principles I lay out every two years in a direct personal letter to all of our managers.

It doesnt get much clearer than that. But still, Buffett is not done. He wants to get at the inexplicable part of what Sokol did. What is inexplicable, to Buffett, is that Sokol made no attempt to disguise the fact that he was buying the stock. Buffett describes how, in the classic insider-trading ring, People set up trusts in Luxembourg or they use neighbors or third cousins. However, Buffett says, To my knowledge, Dave did nothing like that, so he was leaving a total record as to his [Lubrizol] purchases. Furthermore, Buffett says, by way of explaining why he had no inkling what was happening under his nose, Sokol had once turned down the opportunity to make an extra $12.5 million as part of a generous, but ambitious, incentive plan offered by Buffett, insisting on splitting $25 million of the bonus plan 50/50 with his junior partner. This kind of forthrightness in years past, he says, makes Sokols recent behavior doubly inexplicable. I think 20 years from now I will not understand what causes a man to voluntarily turn away $12.5 million without getting any credit for it in the world and then, ten or so years later buy a significant amount of stock the week before he talked to me in order to make $3 million. It is not only inexplicable, Buffett says, but it is also sad: sad for Berkshire, sad for Dave. Before opening the floor to questions from reporters and shareholders, Buffett asks Charlie Munger for his thoughts on how to explain Sokols behavior. I think hubris contributes to it, Munger says flatly. Okay, lets get to work, Buffett says. And with that, the questions begin. Why Did You Handle this Matter in the Inadequate Way You Did? Carol, youre on, Buffett says. Carol Loomis, of Fortune magazine, is as good a reporter as they come. She launches straight into the question that is on everybodys mind, and she does not hold back: It is a doozy. It comes, she says, from a longtime shareholder. When you found out the details of [Sokols] stock purchases, Loomis begins, reading the question, I do not understand your reaction. Surely you realized immediately that these factswere going to damage Berkshires reputation, something you have said repeatedly you would be ruthless in protecting. Be ruthless probably would have meant your firing Sokol on the spot, the shareholder wrote, echoing the sentiment among many investors here, but you didnt do that. Instead, Buffett praised Sokols efforts over the years and declared his actions werent in any way illegal. Why, the shareholder wants to know, did you handle this matter in the inadequate way you did? Theres a pause, and then something happens that Ive never heard after a tough question of Warren Buffett: Scattered applause rumbles throughout the arena. It is clear people want an answer. And for the next 15 minutesan unprecedentedly long timeBuffett gives it, providing a detailed timeline of what happened and when it happened, as well as the nature of Sokols conversations with Buffett, all of which make Sokols behavior even more disturbing. I Plead Guilty to That Buffett, for example, says he heard not a word from Sokol about any contact with Citigroup investment bankersthe very investment bankers Sokol had contacted to help identify chemical

companies that might be attractive takeover candidates for Berkshireuntil the day the deal was announced, when a friend of Buffetts at Citigroup called. This was all news to me. Worse, Buffett says, when Sokol was then asked about his contacts with Citigroup, Dave said he thought he called a fellow there to get their phone number. Which, Buffett adds dryly, turned out to be somewhat of an understatement. The details are unsettlingnot only because of what Sokol seemed to do to cover his tracks, but also the fact that it happened on Warren Buffetts watch. Furthermore, there is a distinctly false note in Buffetts self-defense when he attempts to explain why he allowed Sokol to resign rather than firing him for cause: Buffett says it saved Berkshire some money. Still, he acknowledges the lack of ruthlessness in the press release: What I think bothers people is that there wasnt some big sense of outrage. Buffett concludes, I plead guilty to that. He turns the floor over to Munger. Not the Cleverest Press Release I think we can concede that that press release was not the cleverest press release in the history of the worlda harsh self-evaluation, coming from the supremely self-confident Munger. But I would argue that you dont want to make important decisions in anger, he says, quoting Berkshire director Tom Murphy: You can always tell a man to go to hell tomorrow if its such a good idea. The line gets a laugh, and Munger finishes with a typically rational observation. I dont think it was wrong to remember the mans virtues as well as his error. This generates applausenot enthusiastic applause, and not a great deal more than the applause that greeted the questionbut the two men have gone a long way toward clearing the air. And while the next question moves away from the Sokol affair, it is not the end of the Sokol questions. Right now, however, it is back to the business of Berkshire Hathaway. (To be continued) Friday, June 17, 2011 Mungers Revenge, Part IV: Serious Benjamins

At the Berkshire Hathaway shareholder meeting, continued Why did you handle this matter in the inadequate way you did? This, the first question of the day, is the most direct criticism ever leveled on Warren Buffett from an actual shareholder, and it is greeted not by boos and catcalls, but by applause. Buffett begins his answer by attempting to explain what he knew and when he knew itwhich turns out to be surprisingly little. To show just how little Buffett knew of what was going on, were going to arrange Buffetts Sokol comments from the meeting along the timeline provided in the Lubrizol proxy statement (in italics), as events occurred, rather than in the order in which Buffett spoke at the meeting, and contrast them with Sokols own version of events from his March 31, 2011 CNBC interview.

Sokol/Lubrizol Timeline Fall of 2010: Sokol meets with various bankers from time to time to discuss capital-raising and transaction ideas. This includes Citigroup bankers, from whom Sokol asks for more information regarding possible transactions in several industries, including the chemical industry. The Citi bankers generate a list and descriptions of 18 companies, including Lubrizol According to Sokol, I get dozens of packages from investment bankers all the time, on Hey, have you thought of some of these companies? or this and that. Furthermore, Sokol claims he already knew of Lubrizol on his own initiative. I got interested in Lubrizolfrankly I cant tell you where I first heard the namesometime last fall. I pulled their 10-K. Found what theyve been doing the past couple of years interesting. I made a decision to buy some shares. Buffett will not hear of Sokols interest in Lubrizol until January 2011. December 13, 2010: Sokol and Citigroup meet to discuss the list of companies assembled by Citigroup bankers. During the course of the meeting, Mr. Sokol said that the only company on Citis list that he found interesting was Lubrizol. When Mr. Sokol learned from Citis representatives that Citi had an investment banking relationship with Lubrizol and its ChairmanJames L. Hambrick, he asked one of the Citi representatives to inform Mr. Hambrick that he was interested in speaking with him and discussing Berkshire and Lubrizol, if Mr. Hambrick were available. Mr. Sokol also advised Citi that Berkshire Hathaway does not engage in hostile transactions, and that Mr. Hambrick should understand that if they met and nothing came of the meeting, their meeting would remain confidential. Thereafter, Citi made Lubrizol aware of these discussions This is the kind of stuff that M&A activity is made ofserious M&A activity, but Sokol plays it down on CNBC, making his focus on Lubrizol seem personal, not related to business: Now they had sent me a package earlier, with a whole number of chemical companies listed in it, again, all public information. And they wanted to sit down and see if I wanted to follow up on that. I mentioned to em when they called, I said, Listen, Im going to be in New York on the 13th, you know, lets talk. Only a couple of them even seemed to be interesting. And I had mentioned Lubrizol as one of those because it was a company Id already been looking at, and since it was on their list, I said, well, if were going to sit down, lets talk about it. Of course, anybody who knows anything about investment bankers knows that they pretty much dont even go to the bathroom without trying to figure out a way to make money on it: they are out to sell businesses. And David Sokol probably knows as much about investment bankers as any businessman on earth. Furthermore, it is reasonable to assume that the package sent by Citigroups bankers went to Sokols business address, not his personal addressas would be the case if he had been looking for personal investments. But Sokol describes the meeting as a general get-together rather than a discussion about a potential acquisition for Berkshire Hathaway:

We had a broad conversation where one of the bankers who was in the meeting said he knew the CEO of Lubrizol, and I said, Gee, if you know him well enough to set up a meeting, that would be great, Id love to meet him. Buffett knows nothing of this. December 14: Sokol buys his first Lubrizol. According to Sokol, I put an offer in, actually, to buy 50,000 shares with a limit price. He gets 2,300 shares. Buffett is still in the dark. December 17: Citigroup contacts Lubrizol CEO Hambrick and relays the substance of the conversation between Citi and Mr. Sokol on December 13. Hambrick indicated he would inform the Board of Berkshire Hathaways possible interest Later on December 17, 2010, Citi informed Mr. Sokol that Mr. Hambrick had indicated that he would discuss Berkshire Hathaways possible interest with the [Lubrizol] Board. Buffett knows none of this. December 21: Sokol sells his 2,300 Lubrizol. Tax-planning, he described it on CNBC. January 5: Sokol begins buying Lubrizol again, in size. I thought it was a good company, a company Id be happy to be invested in long-term. The stock came back down, I put an offer in to buy a hundred-thousand shares January 6: Lubrizols board has a special meeting during which Mr. Hambrick outlined Berkshire Hathaways possible interest as he understood it from his conversation with Citi. The Board engaged in an intensive and thorough discussion about Berkshire Hathaways possible interest. Lubrizols Board retains a law firm and an investment back to help it review Berkshire Hathaways possible interest in acquiring Lubrizol. Sokol buys more Lubrizol. January 7: Sokol finishes his purchase of Lubrizol, a total of 96,060 shares. Thats close to being a $10 million investmentsome serious Benjamins. He still hasnt spoken to Buffett about Lubrizol. January 10: Lubrizol holds a special Board meeting for an extensive and thorough discussion about Berkshire Hathaways possible interest. The Lubrizol Board instructs CEO Hambrick to arrange a meeting with Mr. Sokol. January 12: Citi calls Sokol to arrange a meeting. Sokol tells CNBC, The next thing that happened is, I think it was January 12th, the banker from Citibank called me and said, Hey, I think Jim Hambrick is going to give you a call to see if you want toget together for dinner. January 14: Mr. Sokol and Mr. Hambrick had a telephone conference during which they generally discussed the corporate cultures and philosophies of both Berkshire Hathaway and Lubrizol, and arranged to have an in person meeting on January 25, 2011.

January 14 or 15: Sokol finally talks to Buffett about Lubrizol. To be continued Monday, June 27, 2011 Mungers Revenge, Part V: Its a Berkshire Type Company Authors Note: we continue contrasting Warren Buffetts commentary at the April 30, 2011 annual meeting with David Sokols March 31, 2011 CNBC interview, using the Lubrizol proxy as a timeline. This entry starts on the date Sokol first spoke to Buffett about Lubrizol as a potential acquisition candidateone month after he first met with Citi bankers, discussed Lubrizol and first bought shares in that stock; one week after he finished loading up on nearly $10 million worth of that stock; and around the same time he spoke to Lubrizol CEO James Hambrick about what Hambrick appears to have logically reacted to as a takeover feeler. January 14, 2011: Sokol finally talks to Buffett. Warren Buffett: Now bear in mind his first conversation when he said he owned the stock was January 14. In between January 14 and March 14 [when the deal was announced], Dave gave no indication hed had any contact with Citigroup of any kind David Sokol: Mr. Hambrick called me on the 14th, so I either called Warren just before that call or just after it. And ah, we had a pleasant conversation. Mr. Hambrick told me about a health issue he had recently had and talked about my son, who has a similar health issue historically. [After thus diverting the issue to family health matters involving his son, presumably to dredge up sympathy among CNBC viewers, Sokol discussed the conversation with Buffett.] And then I called Warren and said, You know, theres an opportunity here either for you or I to have dinner with James. And I told Warren I purchased shares in the company. Warren Buffett: At that time when Dave called me he said nothing about contact with Citigroup or anything of the sortand I said, I dont know anything really about the company. He said, Well, take a look at it. Itmight fit Berkshire. I said How come? He said Ive owned it and its a good company. Its a Berkshire type company. And now Buffett acknowledges a mistake: And, you know, I obviously made a big mistake by not saying, Well, when did you buy it? But I think if somebody says Ive owned the stock you know it sounds to me like they didnt buy it the previous week. Indeed, it probably never crossed Buffetts mind that an employee of hisany employee would have taken down millions of dollars worth of a stock he had discussed with investment bankers, however innocently Sokol might have believed that discussion to be, particularly if (as the proxy stated) Sokol had been informed on December 17 that the companys CEO was going to discuss Berkshires possible interest with his board of directors. Nevertheless, the future of Berkshire Hathawaya conglomerate now roughly the size and scope of General Electricought not to be tied to what might or might not cross Warren Buffetts mind: the fact that Sokol could keep a lid on his Lubrizol purchases for as long as he did, whether or not he violated any laws, illustrates the problem.

Buffett, however, does not view more bureaucracy as the answer: We have 260,000 employees At Berkshire, there are presently three people that can execute trades and then there are a few other clerical people that would see what was done. If you take Berkshire at 260,000 people, you know, thats about the number of households in greater metropolitan Omaha. And as perfect as we like to think we are in Omaha, I will tell you theres lots of things going on in Omaha right now as we sit here that, you know, do not match the rules. The problem, obviously, with the Sokol thing is it hit very very high up, you know. For his part, David Sokol played down the idea that Lubrizol was even a potential acquisition target for Berkshire Hathaway at that point: And frankly, at that time, Warren was pretty cool to the idea. He says, Yeah, I know the company. Its interesting, but Im not sure it economically makes sense. But he hadnt looked at it for a while. But, you know what, why dont you go ahead and have a look and see if theres anything there. And subsequently [I] had dinner with James I believe it was the 25th. January 19: Members of Lubrizols senior management met with Citi and Evercore to discuss Mr. Hambricks upcoming meeting with Mr. Sokol. Certainly the Lubrizol team wasnt cool to the idea: they reacted as any public company would react to a potential takeover bid in the works. January 25: Mr. Sokol and Mr. Hambrick met in Cleveland, Ohio. The two executives discussed their respective backgrounds and business. Mr. Hambrick provided Mr. Sokol with an overview of Lubrizols corporate culture, philosophy and operations. Mr. Hambrick also discussed Lubrizols overall business and past and expected financial performance. Mr. Sokol indicated that he did not believe that there was any more information that Berkshire Hathaway needed at that time, but said that he would get back to Mr. Hambrick if additional meetings would be helpful. Buffett: It struck me as a business I didnt know anything about initially. You know, youre talking about petroleum additives Are there competitive moats, is there ease of entry, all that sort of thing. I did not have any understanding of that at all initially And I talked to Charlie a few days laterand Charlie says, I dont understand it either. Sokol, on CNBC: Well, just before that dinner, he [Buffett] had sent me an emailsaying, The real question iscan they sustain this margin growththat theyve had the last couple of years? That was the primary conversation then that I had with James [Hambrick]. And James offered that if Warren had an interest in continuing the discussion, hed love to come and meet Warren. And so, [I] talked to Warren the next day and from that point on I had no more conversations... At this point, CNBCs Joe Kernen interrupted Sokol: You knew at that point you had almost 100,000 shares and the wheels were starting to turn for a possible acquisition by Berkshire. At that point did that seem to you that this doesnt smell right and maybe I should sell this right now before Not at all, Sokol said. Actually I think it would have been wrong for me to do anything. Once I mentioned to Warren that James had an interest, to me then it was a Berkshire opportunity, whether Berkshire would want to do it or not was up to Berkshire

Unfortunately, Kernen didnt press the real issuethat Sokol ought to have realized that it was a Berkshire opportunity the minute he spoke to Citis investment bankers about Lubrizol back on December 13, which the Lubrizol proxy identified as the day Sokol spoke to Citis bankers and told them, according to the proxy, that Sokol was interested in speaking with the Lubrizol CEO about Berkshire and Lubrizol. January 27: Mr. Sokol responded to Mr. Hambricks offer to meet with Mr. Buffett by calling Mr. Hambrick, stating that it would be helpful for Mr. Hambrick to meet with Mr. Buffett Mr. Sokol also said that, if Mr. Buffett wanted Berkshire Hathaway to proceed with an acquisition of Lubrizol, Mr. Buffett would have a view on what Berkshire Hathaway would be willing to pay, but that Mr. Buffett would not make an offer unless Mr. Hambrick wanted him to do so. January 27: Mr. Buffettcalled Evercores Chairman and indicated that Mr. Sokols feedback on his meeting with Mr. Hambrick had been very positive and that Buffett was interested in having Berkshire Hathaway acquire the outstanding sharesif it could be done at a price that made sense to Berkshire Hathaway. Mr. Buffett also indicated that he was very interested in an opportunity to meet with Mr. Hambrick, and that, subject to the meeting, Berkshire Hathaway would be willing to make an offer at the meeting on February 8, 2011 if Lubrizol was willing to receive such an offer. February 8: Mr. Hambrick met with Mr. Buffett in Omaha, Nebraska At this meeting, Mr. Buffett responded to a question from Mr. Hamrick about price by saying that Berkshire Hathaway would like to make an offer to buy all of the outstanding shares of Company common stock for $135.00 per share in cash. Buffett: What Dave passed along to me after having that dinner with James Hambrick, and which I later confirmed in a lunch when James Hambrick came out hereI got a good understanding of industry dynamics and how the business had developed over time I looked at the question of ease of entryI decided theres probably a good size moat on this. Theyve got lots and lots of patents, but more than that they have a connection with customers I felt I had an understanding of the economics of the business I think Lubrizol will be the leading company for a very, very, very long time. And thats the conclusion I came to. March 8: Berkshire Hathaway and Lubrizol entered into the confidentiality agreement. Later that day, Munger Tolles [Berkshires law firm, and Charlie Mungers namesake] provided Jones Day [Lubrizols law firm] with initial comments on the draft merger agreement. March 14: Berkshire Hathaway and Lubrizol announced the signing of the merger through a joint press release. Buffett: On March 14, when the deal was announced in the morning, I got a call from John FreundJohn Freund works for Citi in Chicago, and hehas handled the great majority of our business in equities for decades, and Ive got a direct line to him And he called and said congratulations andthat Citis team had worked with Dave on this acquisition, and they were proud to be part of it And this was all news to me

And the next day, I had Marc Hamburg, our CFO, call Dave, and Dave readily gave him the information about when he had bought the stock and how much. So far, so good, until Hamburg asks Sokol about Citis involvement: Dave saidhe thought he called a fellow there to get their phone number, which turned out to be somewhat of an understatement. How much of an understand Buffett will find when he reads the Background to the Merger detail in the draft of the Lubrizol proxy statement March 18: Buffett receives Lubrizol proxy draft material, detailing Sokol stock purchases. Buffett: At that pointour law firm got involvedin their input to the Lubrizol lawyers as to what we had seen that was different or what we had seen that they didnt know about that we could add And I believe he [Sokol] was interviewed at least three times about both the stock purchases, the history of things withhis relationship with Citigroup, and they were assembling this information And we decided that when we got back [from Asia] we would need to have a prompt meeting of the Berkshire Board about this matter And we got back onSaturday the 26th, and on the 28th we were going to bring Charlie [Munger] into it before calling a board meeting. And then, about five or so in the afternoon a letter was delivered by Daves assistant, which really came out of the blue He said he felt he was retiring on a high point and he gave the reasons why he was retiring... I dont know whether the questioning the previous week had affected his attitude. He would say not. But in any event, we had that resignation So I drafted up a press release, which has since been the subject of at least mild criticism March 30: Berkshire Hathaway issued a press release announcing the resignation of Mr. Sokol. The press release also indicated that Mr. Sokol purchases shares of Lubrizol common stock on December 14, 2010 and on January 5, 6 and 7, 2011. Lubrizol first learned of these share purchases and Mr. Sokols resignation on March 30, 2011. Buffett: Now, in there was included the fact that Dave had no indication thatthat Lubrizol had any interest in an approach from Berkshire and that, at least according to the final Lubrizol proxy, is not the case. The Lubrizol proxy now says that Dave did know that Lubrizol had an interest on December 17. But both in the two chances he had to review it [the March 30 press release] and then when he went on CNBC on a Thursday and talked for half an hour, he made no attempt to correct any of the facts in it. Now, on Wednesday when we put out the report, we had to have a board meeting first We also deliveredwe, through our law firm, we phoned the head of enforcement division of the SEC and told them exactly the facts regarding the stock purchases and anything else that they might have cared to know. So I think we acted in that case, very very promptly So from our standpoint and my standpoint, Dave was gone, minimum severance costs, minimum chances for lawsuits about compensation due to him and we had turned over some very damning evidence, in my view, to both the public and to the SEC.

All very rational, and Warren Buffett is, if nothing else, entirely rational. However, there is the matter of being ruthless, and here is where Buffett gets defensive. To be continued Sunday, July 10, 2011 Mungers Revenge, Part VI: What Bothers People What I think bothers people is that there wasnt some big sense of outrage or something in the [press] release, and, you know, I plead guilty to that. Warren Buffett, Berkshire Hathaway shareholder meeting, April 30, 2011. The facts were complicated, and we didnt foresee appropriately the natural reaction. But I would argue that you dont want to make important decisions in anger. You want to display as much ruthlessness as your duty requires, and you do not want to add one single iota because youre angry. Charlie Munger. Thus two longtime business partners summed up their disconcertingly un-Berkshire-like handling of the David Sokol Affair in front of 36,000 Berkshire shareholders in Omaha this spring. Of the two, Charlie Munger came closer to answering the question than Warren Buffett, who used the old politicians trick of phrasing the question that he wanted to answer, rather than the one that was asked. While Buffett held nothing back about the Sokol Affair throughout the six-hour Q&A session fielding every Sokol-related question without a pause or a no commentthe question that was actually asked was not about Buffetts lack of outrage in the press release. It was about Buffetts lack of ruthlessnessan adjective lifted straight from his Salomon Brothers Congressional testimony that is played for shareholders before the start of every annual meeting: Lose money for the firm and I will be understanding/Lose one shred of reputation and I will be ruthless. Letting Sokol resign from Berkshirea money-saving move, to hear Buffetts subsequent rationalization at the annual meetingand repeating, in the press release, Sokols assertion that the Lubrizol stock purchases were not a factor in his decision to resign, is hardly ruthless. But what really stunned longtime Berkshire investors from that press releaseand were not talking about the masses who jumped on the Berkshire bandwagon as Buffetts celebrity profile rose in recent years and were more inclined to wonder what all the fuss was about with Sokols stock purchases and Buffetts handling of the affair: were talking decades-long investors whose names a reader would recognizewas the single sentence in which Buffett excused the entire episode with the kind of defense youd expect to hear from a Wall Street fat cat, not from The Oracle of Omaha: Neither Dave nor I feel his Lubrizol purchases were in any way unlawful. (As one Berkshire regular said, Dennis Kozlowski didnt feel he did anything wrong either. Who cares what the guy feels, and since when did Berkshire Hathaway start doing business based on that standard anyway?)

No, Berkshire shareholders were not looking for some big sense of outrage, as Buffett put it; they were looking for a straightforward acknowledgement that what happened didnt pass Buffetts simple smell test for operating a business: If its questionable whether some action is close to the line, just assume it is outside and forget it. Theres plenty of money to be made in the center of the court. And they would have expected a more ruthless exit strategy for an individual Buffett clearly believed violated Berkshires principles than the mere acceptance of that individual's resignation. But theres a second issue raised by the Sokol Affair, and one that has not been addressed by either Buffett or Munger to this day: how do they and the rest of the Berkshire board of directors know that nothing like the Lubrizol purchases ever happened before at Berkshire Hathaway? All weve been told is that Berkshires own law firm, Munger, Tolles & Olson, worked with the Lubrizol counsel in pulling together what Warren described as Lubrizols proxy and that was according to Ron Olson, a partner at Munger, Tolles & Olson and a member of Berkshires board of directors. Leaving aside the obvious questionwhy a law firm founded by Charlie Munger and which today has a partner who also serves on Berkshires board of directors, was in charge of examining the Sokol Affair for the Berkshire board, rather than an outside firm without the obvious and multiple conflicts of interestDavid Sokol was involved in plenty of Berkshire deals in the past. He vetted the BYD investment for Buffett; he came up with the enormously profitable Constellation Energy investment during the financial crisis, and he presumably was involved in the PacifiCorp, Northern Natural Gas and Kern River Transmission acquisitions for MidAmerican. So how does Berkshires board of directors know that nothing like this occurred previously? Were not suggesting anything did occur: but, as a Berkshire shareholder, it seems like a logical question to ask, and if we were on the board, its a question to which wed want the answer. And theres a third issue raised by all this: how close did Berkshire come to naming David Sokol as the eventual replacement for Warren Buffett, and what does it portend for Berkshire shareholders when Buffett is no longer alive? One shareholder almost got the answer when he asked, How can you ensure that there are no more Sokols in the lineup of successional managers that you have? But Buffett dismissed the notion that Sokol was indeed the successor-in-waiting, without disclosing what name actually appears in the envelope Buffett keeps in his desk for the day the unthinkable occurs: Yeah, he made an assumption there about Sokol being the next in line, which Im not sure was warranted. Buffett then added, That is one of the reasons that I think its a good idea if my son, Howard Buffettbe the chairman after Im not around because you can make a mistake in selecting a CEO. How Howard Buffett will handle that kind of mistake compared to how his father handled David Sokol is not clear. What is clear is that, given the high profile David Sokol carried at Berkshire Hathaway, Warren Buffetts life work may have come uncomfortable close to being run by a guy who saw (and still sees) nothing close to the lineabout doing something (trading stock while sniffing around potential acquisitions in what the investment bankers surely presumed was his role as a

representative of Berkshire Hathaway) that his boss (Warren Buffett) would never, ever, have dreamed a CEO of his would be doing. And maybe thats why attendance at this years meeting was downfor the first time in Berkshire historyand why Charlie Munger was unusually talkative at the meeting. The fallout from the David Sokol affair may not be over. To be continued Wednesday, July 20, 2011 Mungers Revenge, Concluded: The Tiger Woods Syndrome, and What Made Berkshire Hathaway as We Know It Well, Tiger Woods Syndrome is breaking out all over, even in Omaha, Nebraska. By Tiger Woods Syndrome we refer to what happens when the Mainstream Media has been sitting on a story it has long known of but couldnt go with because the subject was too powerful: when the story suddenly, irrevocably blows wide open (like, oh, the guys wife tries to bash his head in with a golf club), well, suddenly everyone has a story to tell, and the press is happy to tell it. And while the David Sokol Affair didnt involve sex or golf, it did involve enough bad judgment to blow the cover off the notion that Warren Buffetts perceived successor had everything a Berkshire shareholder could ask for, which is precisely when the knives came out here in Omaha at the Berkshire Hathaway shareholder meeting. Friends and financial reporters whod been told things over the years would say quietly to us, Dont quote me, but and then tell a Sokol story (more about judgment and personality than about anything you could put down as being wrong) that had either been dismissed as just sour grapes from a Sokol competitor or had been suppressed for the same reason nobody in the Mainstream Media ever bothered to investigate Tiger Woods extracurricular activities: the guy was too rich and too powerful. And, hey, David Sokol had Warren Buffetts blessing. But with Sokol gone, so is the glowand a lot of shareholders would like to know exactly how close did Berkshire Hathaway come to putting Warren Buffetts lifes work in the hands of a guy willing to pick off a few points in a stock ahead of his employers acquisition of that company? Unfortunately, the real answer to that questionprobably a lot closer than Warren Buffett would like to admitwas never actually addressed at the Berkshire meeting, either by Buffett or Charlie Munger. Indeed, because of the Sokol Affair, Buffett seemed on his guard and more defensive than usual. In contrast to last years defense of Berkshires relationship with Goldman Sachs, when Buffett came out swinging, this year he was more reflective and less direct in getting to the heart of the Sokol-related questions. He seemed still stunned at the whole turn of events. Charlie Munger, by contrast, was sharp, hard-nosed and positively voluble throughout. Munger also got the funniest line of the day in the video within the movie that kicked things off.

(The videothe best in yearswas a laugh-out-loud takeoff on the TV show The Office, called Michaels Replacement, in which Buffett and Munger take over at Dunder Mifflin from the clueless Michael Scott and his conspiratorial number two, Dwight Schrute. When a jealous Dwight sizes up Munger, his replacement as Number Two, sneering, You dont look so tough, Munger adjusts Dwights tie, leans in and says menacingly, There are eighteen ways I could kill you.) But it was in the six-hour Q&A following the movie that Munger demonstrated what has made him so valuable to Warren Buffett and to Berkshire Hathaway all these years, participating in an unprecedented number of questions, and with more substance and fewer jokes than usual. In fact, at one point Munger abruptly took over one of the Sokol questions from Buffett, saying sharply, Ill handle this, when a shareholder suggested Lubrizols board of directors had violated its fiduciary duty by negotiating only with Berkshire Hathaway, and not auctioning the company. And whereas Buffett mainly played defense, with long-winded explanations of Sokol-related issues, Munger played offense, summing up matters crisply and, as usual, with no holds barred. Sisters Under the Skin For example, after Buffett explains in long and meandering detail how he came to believe Lubrizol belonged in the Berkshire family, despite its tainted upbringing, Munger simply says, You know ISCAR and Lubrizol are to some extent sisters under the skin...very small markets...fanaticism in service. If you have any more like that, give Warren a call. We Own So Many Wonderful Businesses When Buffett wrestles with an explanation for the current valuation of Berkshires stock ($125,000 a share at the time of the meeting) compared to one observers estimated intrinsic value of $185,000 (based on the faulty premise that Berkshires $95,000 per share worth of investments are somehow unrelated to the insurance businesses and therefore a cash-equivalent that should be added to $90,000 per share for the businesses themselves) Munger dismisses the premise that Berkshires share price is tied to any break-up calculation, and instead focuses the crowd on the long-term value of Berkshire: Its terrible trouble you people have...we own so many wonderful businesses we hate to part with them. Europe Survived the Black Death As usual, while Buffett takes the bright side of most issues in keeping with his inherent optimism in the future, Munger offers a dour, cynical view based on his broad knowledge of history and human behaviorbut usually arrives in the same spot. Asked How can a lousy long-term U.S. economy make you happy? Buffett gives a long, enthusiastic, cheerleaders answer, winding up with, All I can tell you is...the power of capitalism is incredible. Munger, on the other hand, dryly notes: Europe survived the Black Death when a third of the people died, but were gonna move on. Still, Buffett is crisper and forceful when it comes to his comfort zone: Berkshire and its

legacy. He minces no words when asked about whether, and when, Berkshire will pay a dividend. There will come a time, and who knows how soon because the numbers are getting big...when a dollar only buying 90c of value...but I predict the day Berkshire declares a dividend the stock will go down because that will mean it is no longer a compounding machine... It Had Its Head Up Its--And Munger does hold back at least once in the six hours of Q&A, when they are asked about Berkshires position in Wells Fargo, one of the banking giants whose inherent profitability has been impaired by the Dodd-Frank legislation and the housing implosion. Buffett defends the investment without much input from Munger: US banking profitability will be considerably less than early part of this century; one reason is the leverage will be reduced... If you keep out of trouble on the asset side, it's a good business because credit is very cheap. I like our positions there. Yet, months later, speaking to investors in Los Angeles, Munger will say that what he admired about Wells Fargo is its management didnt hesitate to admit it had its head up its ass when it came to mortgage lending. But Munger bit his tongue here in Omaha. Not a Terribly Rational Thing Still, when he does speak here, it is just as straightforward as that observation in defense of Wells Fargo management. When asked about gold as an investment, for example, Buffett launches into almost a professorial discussion of investing. There are three categories of investment, Buffett begins, describing currency, which depends on the behavior of monetary authorities to maintain its value; gold and other commodities that dont produce anything and you hope somebody will pay you more for later one, and then assets that make things, like a business, a farmwhich is the category Buffett and Munger have generally stuck to, with a few bets on currencies and commodities along the way. Munger simply says: Buying something that only goes up if the world goes to hell is not a terribly rational thing. This Attitude of Trust When Buffett is prodded by a shareholder about Berkshire's lack of formal compliance procedures like most firms, he gets defensive, first saying I don't think most companies have them (which is absolutely not true when it comes to financial giants like Berkshire), then dismisses the idea altogether: But we could have all the records in the world...they could be trading in their cousin's name. Munger, on the other hand, defends Berkshires culture entirely: If you look at the greatest institutions in the world, they trust their people...its so liberating...I think your best compliance cultures are the ones that have this attitude of trust.

Glitches That attitude of trust may be Mungers Achilles heel when it comes to BYD, the Chinese car company of which Munger was a shareholder and fan for their efforts in battery technology well before Berkshire invested in the company. BYDs initials stand for Build Your Dreams, but the company has been accused of copying other carmakers designs in diplomatic cables uncovered by WikiLeaks, one of which read: BYD seeks to Build Your Dreamsbased on Someone Elses Designs. Asked by a shareholder about the company, whose earnings and share price have been under pressure, Buffett demurs, saying, Charlies the BYD expert. Munger begins his answer with the worst line of defense, BYDs stock price, and then dismisses any issues with bland assurances as uncharacteristic as they are unenlightening: Of course the price is still way higher than the price BRK paid Any company that tries to move as fast...is going to have its glitches...I'm quite encouraged... Glitches is the same term Munger employed to describe the Sokol stock trading affair in the immediate aftermath of that black eye, and it may be as understated an adjective when applied to BYD as it was to Sokols $10 million investment in Lubrizol in the weeks preceding Berkshires bid for the company. BYD thus far has failed to produce anything like its past promises, as contained in this 2009 Reuters article: BYD says that its new E6 electric car due out before the end of the year will do 250 miles (400km) on a single charge. This is a very big number. The Tesla electric sports car does almost as much, but has little room for anything else in the car but the battery. The E6 is roomy with space for five passengers and a good-sized boot. The battery tucks under the back seat. Roger Harrabin, Reuters The E6 was not out before the end of the year 2009, nor was it out before the end of the year 2010. And when the Wall Street Journal inquired about the delay late last year, BYD gave the paper a howler of an excuse: Stella Li, BYD's senior vice president and head of its U.S. operations, said the holdup was caused by BYD's efforts to make the car roomier, especially its rear-seat area that was cramped thanks to a beefy battery pack that needs to be stored under the seat. Ms. Li told the Journal the E6 would be ready for sale in 2012. (We here at NotMakingThisUp would call that bluff.) A Star Rises in the East But, BYD aside, Munger has few blind spots, and enough blunt assessments about the ways of the world to keep Berkshire shareholders happy On why Berkshire does not trade commodities like oil: Oil trading worked best of all for the people who bribed Nigeria. On what caused the financial collapse: My answer is that past panics and depressions tended to involve great waves of speculation.... I think you can confidently expect a new mess before your career is over... Part of this mess is due

to our academic institutions... Finance really attracts people who should be in snake charming. On the political environment in Washington: I remember an era when we had a bipartisan foreign policy, the Marshall plan. Now it seems we have two parties competing to be more stupid. On CEO compensation: I think somebody has to be an exemplar for not grabbing all you can... On which asset class he would add to his circle of competence if he were going to live another 50 years: It would either be tech or energy. But the best line of the dayone not picked up on by everyone in the arena, so fast and subtle it wascame towards the end, on a question asked by a very sincere investor. If you were to have a baby in the next 5 years, the shareholder begins, drawing titters from the crowd, how would you incentivize them to compete against hungrier kids from other parts of the world... Munger, whose age (six years older than Buffett and now approaching 90) has always been the subject of jokes between the two men, sits up in his chair and a huge smile crosses his face at the idea of becoming a father as an octogenarian: A star rises in the east, he says in an awe-struck voice, drawing broad laughter as Buffett begins his answer. A Fortune Fairly Won and Wisely Used Still, it is not wisecracking that makes Charlie Munger so important to Berkshire Hathaway. It is the genius of his recognitionforged as an attorney working with struggling companies in Los Angeles before hooking up with his fellow Omaha native in the 1960sthat buying good businesses at reasonable prices was better in the long run than buying bad businesses however cheap they appeared to be, which was how Warren Buffett came to take control of Berkshire Hathaway before Munger came along. It was Mungers crucial notion about the long-term value of good businesses versus bad business (Bad businesses throw tough decision after tough decision at you; good businesses throw cash, was how he once put it) that led the two men to make their first acquisition together in 1972Sees Candies, for $25 million. And See's was a very good business. For one thing, it almost immediately began generating excess cash (well over a billion dollars so far) for Buffett to reinvest elsewhere. For another, it created the template by which Berkshire would amass a collection of good companies, bought at reasonable prices, that today employee over a quarter-million people and churn out a billion dollars a month in cash. Asked about their legacies at the Berkshire meeting, Buffett initially wisecracks that he would like it to be Old age, then says hed like to be known as a teacher. Munger, who has always seemed more well-rounded, if less wealthy, than his partner, sums up his answer as succinctly, and appropriately, as youd expect: I have an uncle with a saying: A fortune fairly won and wisely used. Indeed. The End.