The Snowball

by Alice Schroeder

  The man who had always been on the receiving end was now learning to give. Rather than being taken care of by his wife, he was taking care of her. Buffett, of course, had not become some other person. But by acting out his values—loyalty, stewardship—he seemed, in his own way, to have incorporated some of the lessons of Susie’s life into his own.

  60

  Frozen Coke

  Omaha and Wilmington, Delaware • Spring 2004

  Toward the end of her radiation, Susie’s mouth was so burned and dry that some days she could not eat or drink. The doctors put her back on the feeding tube because her throat was choked with a thick, dry mucus. She spent most of the time sleeping. But every day, she and her daughter or Kathleen walked a few blocks on Sacramento Street. As spring stole over San Francisco, Susie stayed bundled in a coat, gloves, scarf, and earmuffs to stay warm.

  She hated to be alone. “Can’t you just sit on the couch and look at magazines while I’m awake?” she asked Susie Jr. Then she scribbled, “WHT,” her father’s initials, on a piece of paper, a wry reference to the family trait of becoming anxious when alone.

  She was cared for by her nurses, Kathleen, her daughter, and John McCabe, her former tennis coach, who after many years of looking after her once they had both moved to San Francisco, was well-schooled in acting in a one-hundred-percent supportive role. Anyone else, however, was likely to trigger her “giving” impulses and to drain her of energy.1 On the weekends, when Warren came, he sat with Susie in the TV room watching old episodes of Frasier, or simply hung around in his bathrobe, reading the paper. Susie was comfortable with him there; he made her feel secure—but decades of her “giving” and his receiving didn’t disappear overnight. Sometimes Susie was so sick from the radiation that even Warren had to leave. But he was doing his best to immerse himself in the day-to-day needs of his family in a way that he had never done before. To give his daughter a break from endless days in Susie’s apartment, Warren would take her to Johnny Rockets for a burger. The rest of the time he spent with Sharon.

  He had even gotten involved in the minutiae of Susie’s radiation treatment, however. “Her taste buds aren’t gone yet. I talked to the radiation oncologist, and it’s conceivable that some of the tongue won’t get hit by what they’re doing, which could presumably mean a fair number of taste buds would stick around.”

  Warren Buffett—the man who ducked the subject of a common cold and used terms like “not feeling up to par” as euphemisms for illness; the man who changed the subject uneasily whenever anyone spoke of physical complaints and who professed ignorance of the most basic points of anatomy—was using terms like “radiation oncologist” and doing medical homework for his wife.

  But as he grew more optimistic about Susie’s recovery, he started to become more irritable and needy. The business events of the year 2004 began to consume him, in between the trips he made back and forth to San Francisco every weekend. Unlike the ascending journey to glory of 2003, this would be a very different kind of year. Moreover, early in 2004 he was deprived of his regular source of support. Sharon Osberg had gone on a lengthy trip to Antarctica with his sister Bertie. On a ship cutting through the ice, she was reachable only by occasional e-mails. He filled the hours by scribbling away at his letter to shareholders, e-mailing it back and forth to Carol Loomis, and by serving as teacher and unpaid father confessor to corporate America. He had become the elder statesman of the business world. Buffett always said, Be long-term greedy, not short-term greedy. People turned to him because they trusted his direct way of getting to the heart of things and his sense of right and wrong. Although rich beyond even his own wildest dreams, he had passed up a lot of opportunities to make more money or to make it faster. This had brought him power and respect of a different sort. He was not feared like so many businessmen. He was admired.

  Prominent people made the pilgrimage to Omaha or sought him out at events to ask for his influence and help. Sports figures like Michael Jordan, LeBron James, Cal Ripken Jr., and Alex Rodriguez came for advice. Bill Clinton stopped by for lunch to get advice on fund-raising for his new charity. Buffett was also pals with Mike Bloomberg, got along with John McCain, and maintained a good relationship with the senior Bushes and other Republicans like Chris Shays. He endorsed Senator John Kerry for president, but Kerry was not The Candidate, and unlike the entertaining triumph of the Schwarzenegger campaign for governor of California—Schwarzenegger most definitely was The Candidate—Buffett found himself associated with a respected senator who had no charisma.

  The less-than-electrifying Kerry campaign meant that Buffett focused far more on his business relationships during 2004. CEOs like Jeffrey Immelt of General Electric, Anne Mulcahy of Xerox, and Jamie Dimon of JP Morgan showed up in Omaha to pick his brain.2 The Internet-search firm Google was going public that summer, and its cofounders, Sergey Brin and Larry Page, were stopping in to see him because they admired his shareholder letters. The previous fall, after her indictment for lying to the government in connection with allegations of insider trading—for which she was never charged—Martha Stewart and her CEO Sharon Patrick had come out to Omaha to visit him. Buffett bought Stewart and Patrick a steak dinner, but couldn’t solve Stewart’s legal problems.

  The environment for prosecution of white-collar fraud was changing rapidly, partly because there was just so much white-collar fraud to prosecute these days. New York Attorney General Eliot Spitzer, who had launched a merciless attack on corruption in business and on Wall Street, now led the SEC and the Department of Justice in a three-legged race to see which agency could prosecute most zealously. The others hopped along desperately trying to keep up with Spitzer’s pace; all their charges got bundled into one trial or settlement in the end. Spitzer was diabolically inventive at using the new electronic tools of the Internet—especially e-mail—as evidence, at harnessing an accommodating press as a weapon, and at wielding an arcane New York statute, the Martin Act, that gave him virtually unlimited powers, checked only by his personal—and virtually nonexistent—sense of prosecutorial discretion.

  With these tools, he had forced two prominent CEOs to resign—Buffett’s business colleague Hank Greenberg, who was now the former CEO of AIG, and his son, Jeffrey Greenberg, the former CEO of insurance broker Marsh & McLennan. A pall of fear hung over corporate America; Spitzer was so successful at execution-by-media that the bitter joke had become that he was saving the government the cost of indictment and trial. Juries that formerly treated white-collar malefactors with deference were now routinely sending them to prison like any other criminal; under new mandatory sentencing guidelines, judges were imposing harsh sentences on them. Some of this mayhem was well-deserved. Greed, hubris, and lack of enforcement had given many people in business the impression that the rules did not apply to them. Just as stock options and the Internet bubble had engorged the senior echelons of business’s wallets at an exponential speed, so had the backlash arrived in gargantuan proportions. Buffett—like most of corporate America—had not fully adjusted to this new environment; his view of proportion was shaped by the earlier era: defined by the careful prosecutorial calibrations of former SEC Enforcement Chief Stanley Sporkin and U.S. Attorney Otto Obermaier; by the travails of Salomon, when even Paul Mozer, who nearly brought down the whole financial system after Gutfreund failed to report his crime, had only served four months in prison. His viewpoint would eventually be revised, however, by the outcome of events that had occurred at Berkshire Hathaway itself.

  Buffett usually arrived at the airport to pick up his guests personally. He took them on a nerve-racking ride to the office (if, that is, they were not too dazzled by him to notice), spent a couple of hours listening to their issues and throwing out ideas, then usually escorted them to Gorat’s and treated them to a T-bone and hash-brown meal. He told them to be plainspoken with shareholders in annual reports, to pay employees in alignment with shareholders, not to run their business according to the whims of Wall Street analysts, to deal
with problems forthrightly, not to engage in accounting shenanigans, and to choose good pension-plan advisers. Sometimes people asked how to manage their own money, but while he gave them some basic ideas, he didn’t hand out stock tips.

  To all those who felt the life of a CEO under scrutiny was not what it used to be, Buffett talked about “the ninety-eighth floor” in terms a CEO could understand. People who were looking down from the top at everybody else had to keep things in perspective. So what if they got knocked down a few pegs or lost some of their money? Those who still had their family, their health, and a chance to do something useful for the world should try to count their blessings, not their curses.

  “If you go from the first floor to the hundredth floor of a building and then go back to the ninety-eighth, you’ll feel worse than if you’ve just gone from the first to the second, you know. But you’ve got to fight that feeling, because you’re still on the ninety-eighth floor.”

  He considered himself on the hundredth floor most of the time. However, during the spring, 2004 was definitely shaping up to be a ninety-eighth-floor kind of year. He waited with impatience as Susie suffered through her radiation until the moment later in the spring when her doctors would perform an MRI to determine whether the treatment had knocked out the cancer cells. Business was also problematic on various fronts: Buffett felt that he had “struck out” when it came to bringing home the gingersnaps: new acquisitions and new stocks to buy. Berkshire had around $40 billion in cash or the equivalent, which was “not a happy position.”3

  Most of the companies within Berkshire Hathaway were doing well—even the beleaguered General Re had finally but truly reversed course and posted an underwriting profit in 2003. But GEICO had just emerged from a bitter price war and was locked in a battle for customers with its archrival, Progressive. GEICO had run a commercial in 1999 featuring a popular new character, the GEICO gecko. But GEICO’s Internet presence was lagging behind Progressive’s Web page, which let customers comparison-shop. Buffett had been thinking about the Internet and auto insurance for a decade now; he went to meetings at the company’s headquarters near Washington and repeated one statement over and over: “He who wins the Internet, wins the war.” He waited impatiently for the Internet business to reach its potential. Berkshire had appointed a new board member, Charlotte Guyman, a former Microsoft executive. The board now had its first woman, who also lowered the average age. Buffett said, however, that he did not seek board members for their demographics. He wanted “owner-oriented, business-savvy, interested, and truly independent” board members.4 Now Buffett sent Sharon Osberg and Guyman to Washington to help GEICO speed up its Web site improvement. “I have total confidence in GEICO,” he said, all the while invoking his new Internet mantra, He who wins the Internet, wins the war.

  Buffett paid more attention to GEICO than almost any other business he owned, simply because he loved it. He was also a great fan of both Tony Nicely and his co-CEO Lou Simpson, whose investing track record he now trumpeted to shareholders in his annual newsletter for the first time. For the past twenty-five years, Simpson had averaged 20.3 percent, beating the market by an average of 6.8 percent a year. The stocks he bought were different from Buffett’s, but the method was the same, and his record was almost as good as Buffett’s own. Now it was obvious why Buffett granted him so much autonomy and paid him so well. Simpson qualified as another of the Superinvestors of Graham-and-Doddsville. Admittedly, however, as competition increased, the Superinvestors’ job was getting harder all the time.

  Still, the challenge of finding new investments wasn’t nearly as severe as bird-dogging the ones that Berkshire already had. Coca-Cola was again evolving into a nightmarish preoccupation. Since the death of Goizueta, quarter by quarter, month by month, its business had grown steadily worse. New evidence of accounting manipulation appeared like barnacles on Coca-Cola’s earnings; the stock had sunk below $50, from a high in the $80s. In percentage terms it was hovering somewhere around the sixtieth floor.

  Doug Daft had earned a reputation for volatile moods and byzantine politicking; a number of senior members of management had departed during his tenure.5 His subtle tweaking of the four main Coke brands had produced unspectacular results, along with column after column of copy meowing at inept ads.6 Pepsi had pulled off a huge success with Gatorade after Coca-Cola failed to make that deal with Quaker Oats back in 2000. Then, a whistle-blower declared that Coca-Cola rigged a marketing test for a fountain product called Frozen Coke to impress a longtime customer, Burger King. The whistle-blower had also accused Coke of accounting fraud, and the SEC, the FBI, and the U.S. Attorney’s office started investigating. The company’s stock price shrank to $43. Buffett had had enough of the “managed earnings” that underlay these problems, in which the Wall Street analysts’ predictions of what a company would earn enticed managers to dig behind the sofa cushions in order to “make the numbers,” thereby meeting or beating “consensus” expectations to please investors. Because the vast majority of companies had tried to set, then surpass Wall Street’s expectations instead of simply reporting what they earned—making the practice uniform—even a penny-per-share shortfall made them look as though they were having problems and often led to precipitous declines in stock prices. Thus, companies claimed they “must” manage earnings, in a vicious, self-fulfilling game. But “earnings management” was a sort of Ponzi-ing. If carried on long enough, a petty form of cheating snowballed into larceny.

  “I can’t tell you how much I hate managed earnings in terms of what they do to people. The nature of managed earnings is that you start out small. It’s like stealing five bucks from the cash register and promising yourself you’ll pay it back. You never do. You end up the next time stealing ten bucks. Once you start that kind of game, it draws everybody in. The organization picks up on it, people get cute and clever, and it snowballs. I gave these speeches after we discovered it. I told them, ‘Now the monkey’s off our back. We don’t have to predict anything to the analysts. Let’s just give the damn handout showing the results every year, and whatever we earn, we earn.’”7

  Buffett wanted out of the game. If asked off the record what his worst business mistake was, he no longer listed “sins of omission” instead, he said, “Serving on boards.” He was weary most of all of the way it tied his hands. Coca-Cola had changed its policy of requiring directors to retire at age seventy-four to one that merely required directors at that age to submit a letter of resignation for the board to consider. Leaving the Coke board would have let him tap-dance off into the sunset. But for the savior of Salomon to snub a company in trouble would be like sticking a dagger in the stock. “I wouldn’t stay on the board, except I don’t feel like leaving the other guys” to deal with the mess at Coca-Cola, Buffett said. His pro forma letter was, of course, rejected. This was seen externally as a power play to maintain the coziness of a board of cronies. Buffett had no idea what a plateful of misery he had just ordered.

  As soon as the proxy statement was filed with Buffett’s name listed for election as a director, Institutional Shareholder Services, a powerful organization that consulted on shareholder voting and voted proxies on behalf of institutional investors, told its clients to withhold their votes for him. ISS said that Buffett’s independence as a member of the audit committee could be affected by the fact that Berkshire Hathaway companies like Dairy Queen and McLane bought $102 million of Coca-Cola products. At a time when scandals involving conflicts of interest had shaken confidence in institutions ranging from the church to the military, the government, and business and nonprofit organizations, accusations of conflicts of interest and questions of governance were taken with a new seriousness. The cronyism of Coca-Cola’s board could have been attacked on other grounds, but ISS lacked any sense of proportion in applying its principles regarding conflict of interest. Its lack of proportion was in keeping with the lack of proportion shown by most who were attacking business at the time (which, to be fair, some in the business wor
ld had more than earned)—but nonetheless, disproportionate it was. Since Berkshire’s purchases of Coke for its businesses were trivial when compared to Berkshire’s ownership stake in Coke, which was huge, how could Buffett’s behavior as a member of the audit committee or the board of Coca-Cola be said to be compromised?8

  The rules of ISS, however, were based on a checklist, with no leeway whatsoever for common sense. CalPERS, the powerful California Public Employees’ Retirement System, also decided to withhold support for half of Coke’s directors, among them Buffett, in his case because the audit committee on which he sat had approved the auditors to do nonaudit work.9 While CalPERS was taking a principled stance on auditors, this recommendation was sort of like putting out the candles on a birthday cake with a fire extinguisher.

  Buffett made a quasi-joke of it in public, saying that he was paying CalPERS and ISS to rally votes against him as an excuse to get off the board. But in fact he was mad, especially at ISS. It seemed obvious to him that the billions of dollars’ worth of Coca-Cola stock that Berkshire owned grossly outweighed the Coke products that Berkshire Hathaway bought.

  “If I were a wino off the street, those amounts they’re talking about might be significant. But I own eight percent of Coca-Cola. We’ve got so many more dollars in Coke than anything else. How would I possibly favor Dairy Queen’s interests over Coke’s when I own so much more of Coke’s stock?”

  Herbert Allen sent an emotional letter to the Wall Street Journal, citing the Salem witch trials, when “reasonably stupid people accused reasonably smart and gifted people of being witches and casting spells. Then they burned them…. Up until the geniuses at ISS said it, nobody knew that Warren was really a witch.”10