The Snowball

by Alice Schroeder

  The supervoting provisions of the A shares meant that the resolution could never pass, but Buffett cared deeply what his shareholders thought of him and the company. The question was mooted when, by the end of 2007, for reasons that he said were unrelated to the Darfur question, Buffett sold the PetroChina investment. It had cost Berkshire just under $500 million; the company netted a profit of $3.5 billion. Energy prices continued to soar afterward, and he was accused of selling too soon. Meanwhile, the shareholder meetings remained a model of decorum; more protestors had begun to arrive at the microphone, where they were greeted respectfully. Then the festival went on.

  Berkshire had bought a number of other new businesses. The most significant included Iscar, a highly automated Israeli maker of metal cutting tools, in 2006, Berkshire’s first acquisition of a non-U.S. company. For Fruit of the Loom, he bought Russell Athletics. He took control of Equitas, assuming the old claims of Lloyd’s of London in exchange for $7 billion worth of insurance float. Berkshire also bought electronics distributor TTI. In 2007, Buffett invested in the stock of BNSF (Burlington Northern Santa Fe) railroad, setting off a minor frenzy for railroad stocks. One investment that Buffett did not make was in the Wall Street Journal. He had never owned stock in his favorite newspaper by 2007 when press lord Rupert Murdoch offered to buy it. Some Journal editors and staffers hoped that Buffett would save the paper in the cause of quality journalism. But he would not pay a premium price for a rich man’s trophy, even to become the savior of quality journalism. Long ago, in the days of the Washington Monthly, the unsentimental side of Buffett had divorced his fondness for journalism from his wallet. Nothing had changed that.

  In 2008, candymaker Mars, Inc. announced that it was buying Wm. Wrigley Jr. Company for $23 billion. Buffett had agreed, through Berkshire, to lend $6.5 billion as part of the deal, in an arrangement facilitated by Byron Trott, his investment banker at Goldman Sachs. Trott had been responsible for several of Berkshire’s acquisitions. He understood how Buffett thought, and Buffett said that he had Berkshire’s interests at heart. “I’ve been conducting a seventy-year taste test,” Buffett said about Wrigley’s. The Wrigley deal harkened back to the old days when he had refused to sell a single stick of gum to Virginia Macoubrie.

  Buffett’s first thought after agreeing to make the loan—of course—had been to call Kelly Muchemore Broz and ask her to set aside a little space at the Berkshire meeting, in case Mars and Wrigley wanted to sell some products to his shareholders. The shareholder meeting turned into a mini-festival of candy and chewing gum. Attendance set a new record; 31,000 people came.

  Also in 2008, Berkshire had acquired Marmon, a small industrial conglomerate that made electrical components, railroad tank cars and containers, truck flatbeds, industrial equipment and materials, and the like, with revenues of $7 billion. The seller was the Pritzker family, which had decided to break up its conglomerate to settle family squabbling that had broken out after the death of Buffett’s old coattailing hero Jay Pritzker in 1999.

  Buffett had seen many examples of family squabbles among the rich when the patriarch died; he was comfortable that his own arrangements would prevent that. Little squabbling was going on within the Buffett family in the wake of Susie’s will and the gift to the Gates Foundation. Howie and Susie Jr. were doing what they loved: farming and giving money away. Peter was in discussions with Robert Redford to bring Spirit: The Seventh Fire to Redford’s Sundance resort as an annual summer event. He was also in talks with sponsors in Germany and in China about overseas tours of the show, and was about to release his latest CD, Imaginary Kingdom.

  The one exception to the harmony was Buffett’s adopted granddaughter Nicole Buffett. In 2006 Nicole had participated in Jamie Johnson and Nick Kurzon’s documentary The One Percent, a story about the children of the rich. In the documentary, Nicole unwisely positioned herself as a spokesman for the unspoiled Buffett way of life. The documentary, which appeared shortly before Buffett’s donation to the Gates Foundation, resulted in follow-up appearances on CNN, National Public Radio, and an invitation to appear on an Oprah episode about social class in America. Buffett’s reaction was harsh; he had sent word to Nicole that he didn’t consider her his granddaughter, and if asked, would say so. Nicole told Oprah, “It’s a weird thing to be working for a very wealthy family considering I do come from one of the wealthiest families in America.” She said she was “at peace with” not having inherited wealth—apparently a reference to the small amounts that Susie had left her grandchildren—but added, “I do feel that it would be nice to be involved with creating things for others with that money and to be involved in it. I feel completely excluded from it.” The “poor little me” aspect of her interview was her second mistake.

  Afterward, she sent Buffett a letter asking why he had disavowed her. In August 2006, he wrote back3 offering her good wishes, told her that she had reason to be proud of her accomplishments, and gave her some worthwhile advice. Positioning herself with people as a member of the Buffett family was a mistake, he wrote. “If you do so, it will become your primary identity with them. People will react to you based on that ‘fact’ rather than to who you are or what you have accomplished.” He also wrote, “I have not legally or emotionally adopted you as a grandchild, nor have the rest of my family adopted you as a niece or cousin…. It is simply a fact that just as [your mother] is in no respect my daughter-in-law, her children are not my grandchildren.”

  Despite the controlled tone of the letter, Nicole had wounded him in his most tender spot—his identity and that of his family. Otherwise, he might have thought twice about sending the letter, which backfired badly on him. Nicole may have been wrong, but she seemed sincere. Instead of reining her in, the rejection letter set her off on another round of interviews that made Buffett look like Ebenezer Scrooge; one result was a Page Six story in the New York Post (“Buffett to Kin: You’re Fired!”)4 portraying him as taking vengeance on her for participating in the documentary. To the man who had worked so hard for a lifetime never to alienate anyone, it was a painful irony—but perhaps the story would have a happier ending someday. Buffett had been able to make up with Mrs. B; he could make up with anybody who wanted to make up with him, given enough time.

  By 2008, Coca-Cola’s stock was up forty-five percent from its low, to $58. Profits had risen steadily under CEO Neville Isdell. He had settled the Department of Justice investigation and closed a $200 million discrimination lawsuit over racial bias. Buffett left the board in February 2006. His last Coca-Cola shareholder meeting had been another carnival of activists, but nobody had to be wrestled to the floor, and the tension was set to a lower thermostat. In 2007, Isdell had announced that he was retiring. The new CEO, Muhtar Kent, was responsible for the company’s successful push into non-cola drinks, where Coca-Cola had been lagging and was strategically off course.

  “I always used to tell Gates that a ham sandwich could run Coca-Cola. And it was a damn good thing, too, because we had a period there a couple of years ago where, if it hadn’t been that great of a business, it might not have survived.”

  General Re, Berkshire’s other problem-child investment, had benefited from favorable insurance markets after September 11. It reported the most profitable results in its history in 2007, with $2.2 billion of pretax operating earnings.5 By then Gen Re had earned back the losses and restored its balance sheet to a better condition than when Buffett bought it. From $14 billion of float at the end of 1998, a decade later General Re had $23 billion of float and $12.5 billion of capital. It was operating with nearly one-third fewer employees and the company had been transformed.6 Since 2001, General Re had produced a 13.4 percent annualized return on capital; a number that would be higher, CEO Joe Brandon noted in a letter to Buffett, were it not for “a number of infamous legacy issues.”7 These included $2.3 billion of losses related to insurance and reinsurance sold in prior years, and $412 million of charges for the run-off of Gen Re Securities, the company’s derivatives uni
t. Nevertheless, General Re had escaped the fate of Salomon and overcome the stigma of its Scarlet Letter. Buffett was finally able to praise it and its senior managers in some depth in his 2007 shareholder letter, saying “the luster of the company has been restored” by “doing first-class business in a first-class way.”8

  One large and lingering trace of General Re’s former problems remained. Its last act of ignominy before the change of management in 2001 had been to create a Salomon-type scandal of its own in which it broke Buffett’s rule of not “losing reputation for the firm.” This was the event that would, as it unfolded, adjust Buffett’s perception to the new legal enforcement environment, in which showing extreme contrition and cooperation produced no advantage in how a company was treated by prosecutors. Extreme contrition and cooperation were now the expected minimum standard—in part because of Salomon. Anything short of that—for a company to defend itself or its employees, for example—could be considered grounds for indictment.

  General Re had become entangled in legal and regulatory problems when New York Attorney General Eliot Spitzer started investigating the insurance industry over “finite” reinsurance in 2004. “Finite” reinsurance has been defined in many ways, but, put simply, it is a type of reinsurance used by the client mainly for financial or accounting reasons—either to bolster its capital or to improve the amount or timing of its earnings. While usually legal and sometimes legitimate, finite reinsurance had been subject to such widespread abuse that accounting rulemakers have spent decades trying to rein it in.

  Before working on Wall Street, I was one of those trying to rein it in, as a project manager at the Financial Accounting Standards Board, the primary accounting rulemaker. I helped to draft rules that specify how to account for finite reinsurance. After leaving the FASB, I became a financial analyst. While working at PaineWebber, I covered the stock of General Re at the time it was acquired by Berkshire Hathaway. I first met Warren in connection with the acquisition, and subsequently began to cover Berkshire. Warren had not previously spoken with Wall Street analysts, but he made an exception for me. He told the New York Times that he liked the way I thought and wrote.

  In 2003, after I started working on this book, both General Re and Ajit Jain’s Berkshire Re were condemned in a special investigation for selling finite reinsurance that allegedly contributed to the collapse of an Australian insurer, HIH.9 Two years later, General Re was accused of fraud by insurance regulators and policyholders in connection with the failure of a Virginia medical malpractice insurer, the Reciprocal of America. While the Department of Justice investigated the allegations extensively, no charges were brought against Gen Re or any of its employees.10 That same year, Eliot Spitzer’s investigation of the insurance industry prompted an investigation by Berkshire’s law firm, Munger, Tolles & Olson, which discovered that six employees, including General Re’s former CEO, Ron Ferguson, and its former chief financial officer, Elizabeth Monrad, had allegedly conspired with a customer, AIG, to aid and abet an accounting fraud. The alleged fraud was executed through a reinsurance transaction designed to deceive investors and Wall Street analysts (including me) by transferring $500 million in reserves to AIG to window-dress AIG’s balance sheet. In June 2005, two of the alleged conspirators, Richard Napier and John Houldsworth, plea-bargained and testified for the prosecution, while five others—four senior managers from Gen Re and one from AIG—were indicted on conspiracy and fraud charges.

  The trial, conducted in federal court in Hartford, Connecticut, in January and February 2008, was noteworthy for the prosecution’s use of taped telephone conversations in which several of the defendants had repeatedly discussed the transaction in colorful terms. The defendants invoked the “Buffett defense,” saying that Buffett had approved the outlines of the structured transaction and was involved in setting the fee. Buffett was not charged with any wrongdoing, and prosecutors said he was not involved. General Re’s CEO Joseph Brandon, who was listed among various unindicted co-conspirators in the case, was repeatedly cited by the defendants’ lawyers as having knowledge of the deal. He had cooperated with federal prosecutors without asking for immunity. General Re chief operating officer Tad Montross was also named by the defendants as having knowledge of the transaction. Neither he nor Buffett, however, was listed among the unindicted co-conspirators. None of the three men testified in the case.

  I was subpoenaed by the prosecution as both a fact witness and expert and testified that I would “almost certainly” have not upgraded AIG to a “strong buy” in early 2000 had I known the company’s true financial position. Under cross-examination I testified about my acquaintance with all of the defendants. I know some of them better than others, but have always had high regard for all of them. I also testified about my relationship with Warren, that I was writing this book, and that Joe Brandon has been a close friend since 1992. I wasn’t asked about Tad, but I’m also acquainted with him.

  In February 2008, all five defendants were convicted on all counts in the indictment. They face sentencing as this book goes to print; the potential sentences range up to life imprisonment, although the odds seem to be that the terms will be much lower than that. The convicted defendants have said that they will appeal.

  Currently I am also under subpoena from former AIG CEO Hank Greenberg in a related case brought against him by the New York Attorney General’s office. At this writing, Berkshire Hathaway has settled with neither the SEC nor the Department of Justice. In April 2008, General Re’s CEO Joe Brandon resigned to help facilitate a settlement between the company and government authorities.

  Accordingly, I cannot comment further on the case at this time. Warren Buffett’s personality, however, is laid out in this book; readers should be able to form their own opinion about whether he would participate in or condone the aiding and abetting of a fraud committed by a customer of Berkshire Hathaway.

  Finally, New York Governor Eliot Spitzer, who launched the investigation, resigned only a month after the defendants in the AIG trial were convicted, following revelations that he patronized the prostitutes of an escort service called the Emperor’s Club.

  Notes

  Chapter 1

  1. This quote, or its variation, “Behind every great fortune there is a great crime,” is cited endlessly without a specific source: for example, in Mario Puzo’s The Godfather and in commentary on The Sopranos and on the Internet bubble. This pithier version condenses what Honoré de Balzac actually wrote in Father Goriot: “The secret of a great success for which you are at a loss to account is a crime that has never been found out, because it was properly executed.”

  Chapter 2

  1. Herbert Allen made an exception for Ken Auletta, the first and only time a writer was allowed to attend and write about Sun Valley. “What I Did at Summer Camp” appeared in the New Yorker, July 26, 1999.

  2. Interview with Don Keough. Other guests commented on Buffett’s role at Sun Valley as well.

  3. Except Donald Trump, of course.

  4. Dyan Machan, “Herbert Allen and His Merry Dealsters,” Forbes, July 1, 1996.

  5. Elephant herds are matriarchal, and the females eject the males from the herd as soon as they are old enough to become dominant and aggressive. Then the solitary males approach herds of females, trying to mate. However, this isn’t exactly the way human elephant-bumping works.

  6. Allen & Co. does not release the numbers, but the conference was said to cost around $10 million, more than $36,000 per invited family. Whether $5 or $15 million, that pays for a lot of fly-fishing and golf over the course of a long weekend. Much of the money pays for the conference’s exhaustive security and logistics.

  7. Buffett likes to tell a joke about having worked his way up to this exalted state: starting from a trailer, then the lodge, then a lesser condo, and so forth.

  8. Herbert Allen’s son Herbert Jr. is usually referred to as “Herb.” However, Buffett refers to Herbert Sr. as “Herb” as a mark of their friendship, as do a few o
ther people.

  9. This portrait of Sun Valley and the impact of the dotcom billionaires is drawn from interviews with a number of people, including investment managers with no ax to grind. Most asked not to be named.

  10. Allen & Co. and author estimate. This is the total assets under management of money managers who attend the conference, added to the personal fortunes of the guests. It represents their total economic power, not their consumption of wealth. By comparison, the capitalized value of the U.S. stock market at the time was about ten trillion dollars.

  11. $340,000 per car in Alaska, Delaware, Hawaii, Montana, New Hampshire, both Dakotas, Vermont, Wyoming, and throw in Washington, D.C., to boot (since the District of Columbia is not a state).

  12. Interview with Herbert Allen.

  13. Buffett had spoken twice before at the Allen conference, in 1992 and 1995.

  14. Buffett and Munger preached plenty to their shareholders at Berkshire Hathaway annual meetings, but this preaching to the choir doesn’t count.

  15. Al Pagel, “Coca-Cola Turns to the Midlands for Leadership,” Omaha World-Herald, March 14,1982.

  16. Buffett’s remarks have been condensed for readability and length.

  17. PowerPoint is the Microsoft program most often used to make the slide presentations so ubiquitous in corporate America.

  18. Interview with Bill Gates.

  19. Corporate profits at the time were more than 6% of GDP, compared to a long-term average of 4.88%. They have since risen to over 9%, far above historic standards.