Berkshare Hathway Case Study

8/3/2019 Berkshare Hathway Case Study

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CASESTUDY

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BERKSHIRE HATHAWAY

Berkshire Hathaway traces its roots to a textile manufacturing company established by OliverChace in 1839 as the Valley Falls Company in Valley Falls, Rhode Island. Chace had previouslyworked for Samuel Slater, the founder of the first successful textile mill in America. Chace

founded his first textile mill in 1806. In 1929 the Valley Falls Company merged with theBerkshire Cotton Manufacturing Company established in 1889, in Adams, Massachusetts. Thecombined company was known as Berkshire Fine Spinning Associates.In 1955 Berkshire Fine Spinning Associates merged with the Hathaway ManufacturingCompany which was founded in 1888 in New Bedford, Massachusetts by Horatio Hathaway.Hathaway was successful in its first decades, but it suffered during a general decline in the textileindustry after World War I. At this time, Hathaway was run by Seabury Stanton, whoseinvestment efforts were rewarded with renewed profitability after the Depression. After themerger Berkshire Hathaway had 15 plants employing over 12,000 workers with over $120million in revenue and was headquartered in New Bedford, Massachusetts. However, seven ofthose locations were closed by the end of the decade, accompanied by large layoffs.

In 1962, Warren Buffett began buying stock in Berkshire Hathaway after noticing a pattern in theprice direction of its stock whenever the company closed a mill. Eventually, Buffettacknowledged that the textile business was waning and the company's financial situation was notgoing to improve. In 1964, Stanton made a verbal tender offer of $1112 per share for thecompany to buy back Buffett's shares. Buffett agreed to the deal. A few weeks later, WarrenBuffett received the tender offer in writing, but the tender offer was for only $1138. Buffett lateradmitted that this lower, undercutting offer made him angry. Instead of selling at the slightlylower price, Buffett decided to buy more of the stock to take control of the company and fireStanton (which he did). However, this put Buffett in a situation where he was now majorityowner of a textile business that was failing.In 2010, Buffett claimed that purchasing Berkshire Hathaway was the biggest investmentmistake he had ever made, and claimed that it had denied him compounded investment returns ofabout $200 billion over the previous 45 years. Buffett claimed that had he invested that moneydirectly in insurance businesses instead of buying out Berkshire Hathaway (due to what heperceived as a slight by an individual), those investments would have paid off severalhundredfold.Buffett initially maintained Berkshire's core business of textiles, but by 1967, he was expandinginto the insurance industry and other investments. Berkshire first ventured into the insurancebusiness with the purchase of National Indemnity Company. In the late 1970s, Berkshireacquired an equity stake in the Government Employees Insurance Company (GEICO), whichforms the core of its insurance operations today (and is a major source of capital for BerkshireHathaway's other investments). In 1985, the last textile operations (Hathaway's historic core)were shut down.


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Corporate affairsKiewit Tower, the location of Berkshire's corporate officesBerkshire's class A shares sold for $108,020.00 as of September 28, 2011, making them thehighest-priced shares on the New York Stock Exchange, in part because they have never had astock split and never paid a dividend, retaining corporate earnings on its balance sheet in a

manner that is impermissible for private investors and mutual funds. Shares closed over$100,000 for the first time on October 23, 2006 and closed at an all-time high of $150,000 onDecember 13, 2007. Despite its size, Berkshire has not been included in broad stock marketindices such as the S&P 500 due to the lack of liquidity in its shares; however, following a 50-to-1 split of Berkshire's class B shares in January 2010, Burlington Northern was replaced byBerkshire in the S&P 500 on February 16, 2010.Berkshire's CEO is Warren Buffett. His annual chairman's letters are widely read and quoted.Barron's Magazine named Berkshire the most respected company in the world in 2007 based ona survey of American money managers.In 2008, Berkshire invested in preferred shares of Goldman Sachs as part of a recapitalization ofthe investment bank. Buffett defended Goldman CEO Lloyd Blankfein's $13.2 million pay

package when the company had taken and not yet paid back $10 billion in Troubled Asset ReliefProgram (TARP) money from the United States Department of Treasury.As of July 1, 2010, Buffett owned 32.4% aggregate voting power of Berkshire's sharesoutstanding and 23.3% of the economic value of those shares. Berkshire's vice-chairman, CharlieMunger, also holds a stake big enough to make him a billionaire, and early investments inBerkshire by David Gottesman and Franklin Otis Booth resulted in their becoming billionaires aswell. Bill Gates' Cascade Investments LLC is the second largest shareholder of Berkshire andowns more than 5% of class B shares.Berkshire Hathaway is notable in that it has never split its shares, which not only contributed totheir high per-share price but also significantly reduced the liquidity of the stock. This refusal tosplit the stock reflects the management's desire to attract long-term investors as opposed to short-term speculators. However, Berkshire Hathaway has created a Class B stock, with a per-sharevalue originally kept (by specific management rules) close to 130 of that of the original shares(now Class A) and 1200 of the per-share voting rights, and after the January 2010 split, at11,500 the price and 110,000 the voting rights of the Class-A shares. Holders of class A stockare allowed to convert their stock to Class B, though not vice versa. Buffett was reluctant tocreate the class B shares, but did so to thwart the creation of unit trusts that would have marketedthemselves as Berkshire look-alikes. As Buffett said in his 1995 shareholder letter: "The unittrusts that have recently surfaced fly in the face of these goals. They would be sold by brokersworking for big commissions, would impose other burdensome costs on their shareholders, andwould be marketed en masse to unsophisticated buyers, apt to be seduced by our past record andbeguiled by the publicity Berkshire and I have received in recent years. The sure outcome: amultitude of investors destined to be disappointed."Berkshire's annual shareholders' meetings, taking place in the Qwest Center in Omaha, Nebraska,are routinely visited by 20,000 people. The 2007 meeting had an attendance of approximately27,000. The meetings, nicknamed "Woodstock for Capitalists", are considered Omaha's largestannual event along with the baseball College World Series. Known for their humor and light-heartedness, the meetings typically start with a movie made for Berkshire shareholders. The2004 movie featured Arnold Schwarzenegger in the role of "The Warrenator" who travelsthrough time to stop Buffett and Munger's attempt to save the world from a "mega" corporation


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formed by Microsoft-Starbucks-Wal-Mart. Schwarzenegger is later shown arguing in a gym withBuffett regarding Proposition 13. The 2006 movie depicted actresses Jamie Lee Curtis andNicollette Sheridan lusting after Munger. The meeting, scheduled to last six hours, is anopportunity for investors to ask Buffett questions.The salary for the CEO is US$100,000 per year with no stock options, which is among the

lowest salaries for CEOs of large companies in the United States.GovernanceThe current members of the board of directors of Berkshire Hathaway are Warren Buffett,Charlie Munger, Walter Scott, Jr., Thomas S. Murphy, Howard Graham Buffett, Ronald Olson,Donald Keough, Charlotte Guyman, David Gottesman, Bill Gates, Stephen Burke and SusanDecker.

Succession plansIn May 2010, Buffett, months away from his 80th birthday, said he would be succeeded atBerkshire Hathaway by a team consisting of a CEO and three or four investment managers; eachof the latter would be responsible for a "significant portion of Berkshire's investment

portfolio."Five months later, Berkshire announced that Todd Combs, manager of the hedge fundCastle Point Capital, would join them as an investment manager.On September 12, 2011, Berkshire Hathaway announced that 50-year-old Ted Weschler, founderof Peninsula Capital Advisors, will join Berkshire in early 2012 as a second investment manager.Businesses

Insurance groupInsurance and reinsurance business activities are conducted through approximately 70 domesticand foreign-based insurance companies. Berkshires insurance businesses provide insurance andreinsurance of property and casualty risks primarily in the United States. In addition, as a resultof the General Re acquisition in December 1998, Berkshires insurance businesses also includedlife, accident and health reinsurers, as well as internationally based property and casualtyreinsurers. Berkshires insurance companies maintain capital strength at exceptionally highlevels. This strength differentiates Berkshires insurance companies from their competitors.Collectively, the aggregate statutory surplus of Berkshires U.S. based insurers wasapproximately $48 billion as of December 31, 2004. All of Berkshires major insurancesubsidiaries are rated AAA by Standard & Poors Corporation, the highest Financial StrengthRating assigned by Standard & Poors, and are rated A++ (superior) by A. M. Best with respectto their financial condition and operating performance.GEICO Berkshire acquired GEICO in January 1996. GEICO is headquartered in Chevy Chase,Maryland, and its principal insurance subsidiaries include: Government Employees InsuranceCompany, GEICO General Insurance Company, GEICO Indemnity Company, and GEICOCasualty Company. Over the past five years, these companies have offered primarily privatepassenger automobile insurance to individuals in all 50 states and the District of Columbia. Thesubsidiaries market their policies primarily through direct response methods, in whichapplications for insurance are submitted directly to the companies by telephone, through themail, or via the Internet.General Re Berkshire acquired General Re in December 1998. General Re held a 91%ownership interest in Cologne Re as of December 31, 2004. General Re subsidiaries currentlyconduct global reinsurance business in approximately 72 cities and provide reinsurance coverage


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worldwide. General Re operates the following reinsurance businesses: North Americanproperty/casualty, international property/casualty, which principally consists of Cologne Re andthe Faraday operations, and life/health reinsurance. General Res reinsurance operations areprimarily based in Stamford, Connecticut and Cologne, Germany. General Re is one of thelargest reinsurers in the world based on net premiums written and capital.

NRG (Nederlandse Reassurantie Groep) Berkshire acquired NRG, a Dutch life reinsurancecompany, from ING Group in December 2007.Berkshire Hathaway Assurance Berkshire created a government bond insurance company toinsure municipal and state bonds. These type bonds are issued by local governments to financepublic works projects such as schools, hospitals, roads, and sewer systems. Few companies arecapable of competing in this area.

Utilities and energy groupBerkshire currently holds 83.7% (80.5% on a fully diluted basis) of the MidAmerican EnergyHoldings Company. At the time of purchase, Berkshire's voting interest was limited to 10% ofthe company's shares, but this restriction ended when the Public Utility Holding Company Act of

1935 was repealed in 2005. A major subsidiary of MidAmerican is CE Electric UK.

Manufacturing, service, and retailingApparelBerkshires apparel businesses include manufacturers and distributors of a variety of clothingand footwear. Businesses engaged in the manufacture and distribution of clothing include UnionUnderwear Corp. Fruit of the Loom, Garan, Fechheimer Brothers and Russell Corporation.Berkshires footwear businesses include H.H. Brown Shoe Group, Acme Boots and JustinBrands. Berkshire acquired Fruit of the Loom on April 29, 2002 for $835 million in cash. Fruitof the Loom, headquartered in Bowling Green, Kentucky, is a vertically integrated manufacturerof basic apparel. Berkshire acquired Russell Corporation on August 2, 2006 for $600 million or$18.00 per share.

Building productsIn August 2000, Berkshire entered the building products business with the acquisition of AcmeBuilding Brands. Acme, headquartered in Fort Worth, Texas, manufactures and distributes claybricks (Acme Brick), concrete block (Featherlite) and cut limestone (Texas Quarries). Itexpanded its building products business in December 2000, when it acquired Benjamin Moore &Co. of Montvale, New Jersey. Moore formulates, manufactures and sells primarily architecturalcoatings that are available principally in the United States and Canada.In 2001, Berkshire acquired three additional building products companies. In February, itpurchased Johns Manville which was established in 1885 and manufactures fiber glass woolinsulation products for homes and commercial buildings, as well as pipe, duct and equipmentinsulation products. In July, Berkshire acquired a 90% equity interest in MiTek Inc., whichmakes engineered connector products, engineering software and services, and manufacturingmachinery for the truss fabrication segment of the building components industry and isheadquartered in Chesterfield, Missouri. Finally in 2001, Berkshire acquired 87 percent ofDalton, Georgia-based Shaw Industries, Inc. Shaw is the worlds largest carpet manufacturerbased on both revenue and volume of production and designs and manufactures over 3,000 stylesof tufted and woven carpet and laminate flooring for residential and commercial use under


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approximately 30 brand and trade names and under certain private labels. In 2002, BerkshireAcquired the remaining 12.7 percent of Shaw.On August 7, 2003, Berkshire acquired Clayton Homes, Inc. Clayton, headquartered nearKnoxville, Tennessee, is a vertically integrated manufactured housing company. At year-end2004, Clayton operated 32 manufacturing plants in 12 states. Claytons homes are marketed in

48 states through a network of 1,540 retailers, 391 of which are company-owned sales centers.On May 1, 2008, Mitek acquired Hohmann & Barnard a fabricator of anchors and reinforcementsystems for masonry and on October 3 of that year, Mitek acquired Blok-Lok, Ltd. of Toronto,Canada. On April 23, 2010, Mitek acquired the assets of Dur-O-Wal from Dayton Superior

Corporation.Flight servicesIn 1996, Berkshire acquired FlightSafety International Inc. FSIs corporate headquarters islocated at LaGuardia Airport in Flushing, New York. FSI engages primarily in the business ofproviding high technology training to operators of aircraft and ships. FlightSafety is the world'sleading provider of professional aviation training services. Berkshire acquired NetJets Inc. in

1998. NetJets is the worlds leading provider of fractional ownership programs for generalaviation aircraft. In 1986, NetJets created the fractional ownership of aircraft concept andintroduced its NetJets program in the United States with one aircraft type. In 2004, the NetJetsprogram operated 15 aircraft types.

RetailThe home furnishings businesses are the Nebraska Furniture Mart, R.C. Willey HomeFurnishings, Star Furniture Company, and Jordans Furniture, Inc. CORT Business ServicesCorporation was acquired in 2000 by an 80.1% owned subsidiary of Berkshire and is the leadingnational provider of rental furniture, accessories and related services in the rent-to-rentsegment of the furniture rental industry.In May 2000, Berkshire purchase Ben Bridge Jewelers. A chain of jewellery stores established in1912 with locations primarily in the western United States.[28] This joined Berkshire's otherjeweler acquisition, Helzberg Diamonds. Helzberg is a chain of jewellery stores based in KansasCity that began in 1915 and became part of Berkshire in 1995.In 2002, Berkshire acquired The Pampered Chef, Ltd., the largest direct seller of kitchen tools inthe United States. Products are researched, designed and tested by The Pampered Chef, andmanufactured by third party suppliers. From its Addison, Illinois headquarters, The PamperedChef utilizes a network of more than 65,000 independent sales representatives to sell its productsthrough home-based party demonstrations, principally in the United States.See's Candies produces boxed chocolates and other confectionery products in two large kitchensin California. Sees revenues are highly seasonal with approximately 50% of total annualrevenues being earned in the months of November and December. Dairy Queen services asystem of approximately 6,000 stores operating under the names Dairy Queen, Orange Julius andKarmelkorn that offer various dairy desserts, beverages, prepared foods, blended fruit drinks,popcorn and other snack foods.Other non-insuranceIn 1977, Berkshire Hathaway purchased the Buffalo News and resumed publication of a Sundayedition of the paper that ceased in 1914. After the morning newspaper Buffalo Courier-Express


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ceased operation in 1982, the paper began to print morning and evening editions.[30] It remainsBerkshire's only newspaper holding.On December 25, 2007, Berkshire Hathaway acquired Marmon Holdings Inc. Previously it was aprivately held conglomerate owned by the Pritzker family for over fifty years, which owned andoperated an assortment of manufacturing companies that produce railroad tank cars, shopping

carts, plumbing pipes, metal fasteners, wiring and water treatment products used in residentialconstruction.Andin International (designer and manufacturer of fine jewelry), founded by the Buddhistteacher Geshe Michael Roach, is a division of The Richline Group, Inc., a wholly ownedsubsidiary of Berkshire Hathaway formed in 2007.Berkshire acquired McLane Company, Inc. in May 2003 from Wal-Mart Stores, Inc., whichbrought on other subsidiaries such as Professional Datasolutions, Inc. and Salado Sales, amongothers. McLane provides wholesale distribution and logistics services in all 50 states andinternationally in Brazil to customers that include discount retailers, convenience stores, quickservice restaurants, drug stores and movie theatre complexes. Scott Fetzer Companies TheScott Fetzer Companies are a diversified group of 21 businesses that manufacture and distribute

a wide variety of products for residential, industrial and institutional use. The three mostsignificant of these businesses are Kirby home cleaning systems, Wayne Water Systems andCampbell Hausfeld products. Scott Fetzer also manufactures Ginsu Knives.In 2002, Berkshire acquired Albecca Inc. Albecca is headquartered in Norcross, Georgia, andprimarily does business under the Larson-Juhl name. Albecca designs, manufactures anddistributes custom framing products, including wood and metal molding, matboard, foamboard,glass, equipment and other framing supplies. Berkshire acquired CTB International Corp. in2002. CTB, headquartered in Milford, Indiana, is a designer, manufacturer and marketer ofsystems used in the grain industry and in the production of poultry, hogs, and eggs. Products areproduced in the United States and Europe and are sold primarily through a global network ofindependent dealers and distributors, with peak sales occurring in the second and third quarters.Finance and financial productsBerkshire acquired XTRA Lease in September 2001. XTRA, headquartered in St. Louis,Missouri, is a leading transportation equipment lessor. XTRA manages a diverse fleet ofapproximately 105,000 units, constituting a net investment of approximately $1 billion as ofDecember 31, 2004. The fleet includes over-the-road and storage trailers, chassis, intermodalpiggyback trailers and domestic containers.Clayton's finance business, (loans to manufactured home owners), earned $206 million downfrom $526 million in 2007. Loan losses remain 3.6% up from 2.9%.

First, the company operates under a highly decentralized business model. Executives who runthe companys subsidiarieswhich include a diverse mix of insurance, railroads, utilities,wholesalers, retailers, and suppliersare afforded considerable autonomy to make short- andlong-term business decisions largely without the approval of headquarters. Second, thecompany operates with low levels of internal controls. Managers are given general instructionsto grow their businesses with a focus on improving competitive position, but they are notrequired to submit strategic plans or operating budgets that project how they will achieve results.Finally, all capital allocation decisions at the parent levelthose involving the acquisition of

new businesses or the purchase of publicly traded securitiesare made exclusively by Chairmanand CEO Warren Buffett, in consultation with Vice Chairman Charlie Munger.


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The company does not employ analytical staff nor does an investment committee review orapprove investmentdecisions.

The success of this system is predicated on the expectation that Berkshire Hathaway managers

operate with high levels of integrity. In evaluating management, Buffett has said that he looksfor integrity, intelligence, and energy, with an emphasis on the former.

In making decisions, he asks managers to consider what he calls the newspaper test: How wouldthey feel about any

DAVID SOKOL AND LUBRIZOLDavid Sokol came to Berkshire Hathaway through the companys acquisition of MidAmericanEnergy in 1999, where he served as CEO.

Over the years, Sokol distinguished himself through his managerial performance and, in theprocess, earned considerable praise from Buffett. For example, in 2008, Buffett wrote in theannual letter to shareholders that Sokols results were unmatched elsewhere in the utilityindustry. In 2009, he described Sokol as an enormously talented builder and operator.

Sokol also distinguished himself for his contributions to Berkshire beyond his role atMidAmerican. In 2008, he flew to China to facilitate a $230 million investment in Chineseautomobile and battery manufacturer BYD. That same year, he negotiated a $4.7 billioninvestment in Constellation Energy.

Buffett also expanded Sokols operatingresponsibilities by naming him CEO of JohnsManville (2007) and CEO of NetJets (2009).These were unusual moves in that Berkshire managers rarely assumed responsibility for morethan one business unit. Because of his high profile within the company, many observersspeculated that Sokol was the front-runner on a short list of potential successors to one dayreplace Warren Buffett as CEO.

For these reasons, it came as a shock to many when Buffett announced the sudden resignation ofSokol in a March 2011 press release. Buffett explained that the decision was made for personalreasons and unrelated to Sokols performance at Berkshire. He noted that I had not asked forhis resignation, and it came as a surprise to me. He also noted that Sokol had discussedstepping down from his roles at Berkshire twice before in prior years and both times, I and otherboard members persuaded him to stay.More bizarre were the circumstances surrounding the announcement. Just two weeks beforeSokols resignation, Berkshire had agreed to acquire specialty chemical company Lubrizol in adeal valued at $9.7 billion. Sokol had been instrumental in arranging the discussion between

A Conversation with Warren Buffett, The Charlie Rose Show, Jul. 10, 2006.


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Warren Buffett, Chairman of Salomon, Testifies Before House Subcommittee, PR Newswire,Sep. 4, 1991.

Wesco Financial, 2007 Annual Meeting, cited in: Outstanding Investor Digest, Vol. XXI, No.1&2, Feb. 29, 2008.

MidAmerican owns utilities, natural gas pipelines, and other energy assets in the United Statesand United Kingdom. David Sokol (chairman and CEO), Greg Abel (president), and WalterScott (director) have continued to hold a minority ownership position in MidAmerican since theacquisition. Scott, who recommended the deal to Buffett, has been a director of BerkshireHathaway since 1988 and was on the board at the time of the purchase.

Although the deal was terminated when Berkshire was outbid by the French utility EDF,Berkshire earned a $1.2billion profit from interest, common stock conversion, and termination fees for its commitment.

Andrew Bary, Sokol More Likely to Succeed Buffett, Barrons, Aug. 10, 2009.The Buffett andLubrizol CEO James Hambrick that lead to the deal. What was bizarre was that inthe same press release that Buffett announced Sokols resignation, he also disclosed that,unbeknownst to him at the time, Sokol had purchased $10 million in Lubrizol stock just daysbefore proposing the acquisition to Buffett.Buffett did not condemn Sokol for his actions. Instead, he simply stated that Sokolspurchaseswere made before he had discussed Lubrizol with me and with no knowledge of how I mightreact to his idea. Furthermore, he knew he would have no voice in Berkshires decision oncehe suggested the idea. For these reasons, neither Dave nor I feel his Lubrizol purchases werein any way unlawful. He has told me that they were not a factor in his decision to resign.Buffett concluded the press release by returning to the topic of Sokols resignation:Daves letter was a total surprise to me, despite the two earlier resignation talks. Ihad spoken with him the previous day about various operating matters andreceived no hint of his intention to resign. This time, however, I did not attempt totalk him out of his decision and accepted his resignation.He ended by stating, I have held back nothing in this statement. Therefore, if questioned aboutthis matter in the future, I will simply refer the questioner back to this release.

True to his word, Buffett did not make public comment on the matter in the weeks thatfollowed.

If he believed that Sokols actions were wrong, he expressed that sentiment more bywhat he did not write in the press release than what he did (see Exhibit 1).Sokol, however, was vocal in defending his actions. In a lengthy interview on CNBC, he said, Idont believe I did anything wrong. He explained that he never had any authority atBerkshireto invest a dollar in stocks. He also said that he didnt think there was even a five percentchance that Buffett would agree to the deal. He concluded, I guess, knowing today what Iknow, what I would do differently is I just would never have mentioned it to Warren, and just


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made my own investment and left it alone. When asked about the implication of his resignationon Berkshire Hathaways succession plan, he stated, Its just not a job I would aspire to,because nobody is going to do it as well as Warren does. And theres going to be a lot ofchangethat comes with that. But the reality is Warrens not going anywhere. I admire enormously

what hes done. But whoever replaces Warren will not get to do it the way he does it.

REACTION AND IMPLICATIONSThere was considerable public reaction to the news. Although legal experts expected an SECinvestigation, there was some doubt whether Sokols actions constituted insider tradingbecause

Berkshire Hathaway, Warren E. Buffett, CEO of Berkshire Hathaway, Announces theResignation of David L.Sokol,.

However, he was expected to face shareholder questions at the companys annual meeting onemonth later.

he did not have access to material nonpublic information at the time of his purchases.

It was also unclear that Sokol breached a fiduciary duty to Berkshire, given that he was notinvolved in the decision to acquire Lubrizol or the negotiation of purchase price.

While some speculated that Sokol might have violated Berkshires insider trading policy,which prohibits trading in securities that Berkshire is actively considering taking a publicposition in, subsequent reports revealed that Lubrizol was not on the list of restricted securitiesthat Buffett circulated among management .

The criticism of Warren Buffett, however, tended to be stronger than the criticism of Sokol.Experts contended that he should have asked for more details about Sokols holdings inLubrizolwhen Sokol first brought up the matter. Others criticized Buffett for not taking a harder lineagainst Sokols actions. According to one commentator:Even if the SEC concludes that Sokol did nothing illegal, the known facts suggestthat what Sokol did was wrong.... Instead of condemning Sokol, Buffett gave hima pat on the back on the way out the door. Buffett missed an opportunity toshow moral courage, stand up for principle, reinforce to his employees what heexpects from them, and, not least of all, to live up to his own public reputation.

Another commentator was more blunt: Mr. Buffett whitewashed Mr. Sokols blazinglyobviousethical lapse.

A third asked, Why hasnt Mr. Buffett been ruthless?


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Some blamed the corporate governance system of Berkshire Hathaway for having lax internalcontrols. According to one journalist, the unfolding events are raising questions about controlsand governance at the highest levels of his business.

Another questioned whether, Berkshireneeds more compliance programs and people to manage them.

A third contended thatBerkshire Hathaways board was in part to blame: The Berkshire Hathaway board is full ofindependence issues. Its just that no one seems to care. She accused the audit committee ofbeing passive with regard to Buffett and not proactively probing management, internalauditors and external auditors to gain insight and to make oversight decisions that will hold up, ifnecessary, in court.

According to some, his actions appeared closer to front running than insider trading. Frontrunning occurs when a stock broker purchases (or sells) public securities in advance of acustomer order to purchase (or sell) those same securities. Front running is illegal in a brokeragesetting because it reduces the profitability of the trade for the client and constitutes self-dealingby the broker. It is not clear how front running applies in a private setting.Finally, Sokols resignation highlighted the succession challenges at Berkshire. While Buffetthad assured investors in the past that the directors and I have thought through the successionquestion carefully and that we are well prepared, Sokols sudden resignation and in particularthe comments he made regarding the challenges of succeeding Buffett were troubling.

WHY THIS MATTERS1. Given its size, Berkshire Hathaway has had a relatively clean record on governance-relatedmatters. This track record speaks to the quality of corporate governance and the ability of itstrust-based model to work. Still, the Sokol matter raises significant issues for the board:a. How much has the reputation of the firm suffered from Sokols actions? Is this a flashin the pan, or will there be long-term ramifications?b. Did Sokol violate the companys insider trading policy?c. Did Sokols actions reveal shortcomings in the companys governance system thatneed to be addressed? Or were they instead an isolated incident?d. Should the company add additional controls to prevent similar events from recurring?If so, what would be the cost of these controls in terms of decision making,performance, and culture?e. Do potential successors need to be held to a higher standard of conduct so that theiractions do not negatively impact the reputation of the firm?2. The Sokol matter also raises questions that are general to all organizations. What events mustoccur before a company decides that changes to the overall governance system are required?

David Sokol: Interview on CNBC Squawk Box (Excerpted Comments)


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BECKY: I guess the question that some people have asked is, why create your own mini-Berkshire when you couldbe running the actual Berkshire?SOKOL: Well, there are two reasons really. One isto be honestWarrens not goinganywhere. And by the way,

its just not a job I would aspire to, because nobody is going to do it as well as Warren does.And theres going to be a lot of change that comes with that. But the reality is Warrens notgoing anywhere. Hes in great shape. Hes every bit as sharp today as he was when I first methim eleven or twelve years ago. I actually think in some ways hes gotten better because heseems to have an even broader perspective than he did before. Hes incredibly intelligent andinsightful. And frankly, Berkshire is very fortunate to have him. But Id like to do kind of likewhat he did in 1965, which is invest my own money, control a significant piece of it and controlmy own schedule. I admire enormously what hes done. But whoever replaces Warren will notget to do it the way he does it. He owns 34 percent of the company. And again, none of that is acriticism. I actuallyif I could be a thousandth as successful as he is when I am done and whenIm 75 or 80, Ill be real pleased.\

BECKY: You know, the questions come out of this though, revolving your ownership inLubrizol shares, and the timing on that as you were bringing this deal to Berkshire as a potentialacquisition.SOKOL: Let me hit two things there. One is, first of all, it was in the press release in an effort tobe a hundred percent transparent. The goal, which is a little interesting given some of thecomments Ive read and that I thought full disclosure was a good thing. And the purposethere was those shares, my ownership there, would come out 30 or 60 days from now when thevoting takes place [by Lubrizol shareholder], etc., on that transaction. And we did not wantpeople to look back and say, Why didnt they tell us that? So its out there. The thingpeople need to understand is, I have never had any authority at Berkshire to invest a dollar instocks. Ihave a lot of authority within MidAmerican, Johns Manville, NetJets. But Ive always beenlooking for transactions,both to invest in personally, and then if I thought a company was something that Warren mighthave an interest in, I would forward it to him. Lubrizol is exactly that. I got interested in Lubrizol frankly I cant tell you where I first heard the name sometime last fall. I pulled their 10-K. Found what theyve been doing the past couple of years interesting. I made a decision to buysome shares. When I mentioned to Warren that I thought there was an opportunity, perhaps, forBerkshire, I told him that I owned some shares. And frankly, I didnt think he had anyinterest. Most of the ideas that Ive forwarded to Warren over the years just were not companiesthat he had an interest in.

BECKY: December 14th is when you bought the first shares of the company. 2,300 shares?SOKOL: I put an offer in, actually, to buy 50,000 shares with a limit price JOE: But were under the impression that on the 13th you told Citigroup to set up a meetingwith Lubrizols board, that Berkshire might be interested in SOKOL: No, no.JOE: Thats not true? Its not that Berkshire might be interested in acquiring Lubrizol?David Sokol: Interview on CNBC Squawk Box (Excerpted Comments, continued)


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SOKOL: We had a broad conversation where one of the bankers who was in the meeting said heknew 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.JOE: But not about Berkshire buying Lubrizol at that point?SOKOL: Well, we didnt even I mean, he would have certainly have inferred since I worked

for Berkshire, you know, that Berkshire would have an interest.JOE: Although you didnt, you said already, you didnt usually decide what Berkshire wasgoing to buy?SOKOL: I cant decide. I have no but I work for Berkshire so Im just saying that itcertainly would, I think he would have assumed my interest was in some way for Berkshire.BECKY: Why did you sell that stake seven days later?SOKOL: Well, I put a bid, or an offer in for 50,000 shares at, I believe it was at $104 dollarslimit. And they only got 2,300, if I remember the number right. And then the stock had gone upfrom there. About a week later I was doing some tax planning and I had some short-term lossesand some short-term gains. It looked like thats all the shares I was going to get, and you know,its not worth my time to try to manage 2,300 shares in our portfolio. And so I figured Id take

the gain and put it against the losses.BECKY: So why did you buy back in, I guess, on January 5th, 6th, and 7th, was when you werebuying in. That was about 96,000 shares?SOKOL: Right. First of all, I liked Lubrizol. I thought it was a good company, a company Idbe happy to be invested in long-term. The stock came back down. Actually, dont hold me tothese numbers exactly, but Id put in an offer in to buy a 100,000 shares if I remember right, tomy broker. And he got a certain amount of them at just under $104 and then the stock actuallycame down some more. Bought the remainder at $102, thereabouts, and then the stock went upand we werent able to get any more. Thats how I tend to buy stocks, is determine what Ithink is a price that I want to buy a certain block. I dont have time to trade or do any of thosekinds of things. If I can get it great, if I cant And so anyways, 96,000 shares. The next thingthat 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 to, want to get together fordinner.JOE: Had you spoken to Buffett yet and said that this is a company we, that Berkshire shouldlook at? When was the very first time you said that?SOKOL: I believe the first time was either, either just before Mr. Hambrick called me or justafter. I dont recall.BECKY: Would that be before or after you bought the second tranche of shares?SOKOL: Oh, it was after.BECKY: After.SOKOL: After. That would have been the 14th because Mr. Hambrick called me on the 14th, so I either called Warren just before that call or just after it. And we had a pleasantconversation. Mr. Hambrick told me about a health issue he had recently had and talked aboutmy son, who has a similar health issue historically. And then I called Warren and said, Youknow, theres an opportunity here either for you or I to have dinner with James.

David Sokol: Interview on CNBC Squawk Box (Excerpted Comments, continued)told Warren I purchased shares in the company. And frankly, at that time Warren was pretty coolto the idea. He says, Yeah, I know the company. Its interesting, but Im not sure it


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economically makes sense. But hadnt looked at it for awhile. But, you know what, whydont you do ahead and have a meeting and see if theres anything there.And subsequently had dinner with James up in Cleveland. I believe it was the 25th.

BECKY: OK. And then after that dinner, when you talked to Buffett again and explained what

had happened at that dinner, he was more interested based on those conversations?SOKOL: Well, just before that dinner he had sent me an email, actually with, I think it was aStandard & Poors tear sheet, circling their margins saying, The real question is, you know,can they sustain this margin growth, you know, that theyve had the last couple of years. Andthat is the, frankly, that is the element of, I think, Lubrizol that you have to get comfortable with,that they do have the ability to sustain their margins. That was the primary conversation then thatI had with James. And James offered that if Warren had an interest in continuing thediscussion, hed love to come and meet Warren. And so, talked to Warren the next day andfrom that point on I had no more conversations with JOE: You knew at that point you had almost a hundred-thousand shares and the wheels werestarting 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

SOKOL: Not at all. Actually, I think it would have been wrong for me to do anything. Once Imentioned 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. I would certainly help them, ifWarren wanted me to, as he has in other transactions, but its 100 percent his decision. I madethe decision to buy the shares because I thought it was a good investment for my,my family, and I would do it again tomorrow.JOE: But it had already entered your mind that maybe it would be good for Berkshire to acquireit, might be an attractive SOKOL: Sure. Yeah. But thats up to Berkshire. Thats why when I mentioned to Warren thatI had either talked to, or was talking to James on the phone, that I owned shares. You know,Warren certainly needed, deserved to know that. Berkshire should know that. But I, I also knewthat the decision going forward would be theirs and they should know any conflicts I have.BECKY: But some people have raised the question on timing around that. If it was a stake thatyou had held for, lets say, six months, a year, two years, weve had other people who havebeen on who have said that wouldnt concern them at all. The idea that this came in such closeconnection with the idea being brought to Berkshire, to Warrens attention, thats where theyhave a conflict. Do you understand that that could give the appearance of impropriety?SOKOL: I, I can understand the appearance issue, and thats why we made it public in the pressrelease, is that we want people to know there is nothing there. The reality is, I have no controlover a deal ever happening. And so to I mean, the alternative would be for me to only investmy family assets and if I think theres a good deal for Berkshire, not give it to them. I mean,that, to me, makes no sense. Its ultimately their decision.

David Sokol: Interview on CNBC Squawk Box (Excerpted Comments, continued)SOKOL: I disclosed to Warren that I owned the shares. The reason he learned of it at that timewas Marc Hamburg, the CFO, had called me and said, Hey, Warren had told me you ownedsome shares of Lubrizol. Well need to disclose those ultimately. Can you give me thedetails? And I


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BECKY: So he knew you had a stake but he didnt know, necessarily, how much you owned orwhen you bought it?SOKOL: Thats right. He didnt ask, and but ultimately, obviously, when Marc called andsaid, Hey, I just need the details of that, he got them.

JOE: You know, David, Warren is, and Berkshire, has such a squeaky clean reputation and Iknow theres a lot that goes into your decision to resign. But you can see that someone mightsay that Warren accepted your resignation this time because of what happened and the way that itmight look or the way that it might smell to people? As much as he protects his reputation andBerkshires, you dont think theres anything to that?SOKOL: Well, I think, you know, I, you have to ask Warren why he ultimately accepted it.BECKY: If you had to do it over, seeing the hoopla thats broken out, if you had to do it over,would you change your mind on it?SOKOL: Ah, you know, I guess, knowing today what I know, what I would do differently is Ijust would never have mentioned it to Warren, and just made my own investment and left italone. I think thats a disservice to Berkshire, but if thats what people want in the future,

thats fine. You cant, or at least I dont think you can, ask executives to not invest their ownfamilys capital in a company that Berkshire had no interest, or even knowledge of, andsomehow police that. The only thing you can do is just say if you invest your own money, dontevermention it to anybody at Berkshire. That doesnt make sense to me either, but, but thatscertainly what it sounds like.

STEPS TAKEN BY WARREN BUFFETT

Warren Buffett in his plain and simple way dived straight to the topic that everyone wantedquestion him on, the recent controversy regarding David Sokol. Buffett stated that Sokol's action

were "inexplicable and inexcusable", just as the scandal that damaged the reputation of Saloman

Brothers. He further added that this incident will not have a lasting effect on his reputation.

Buffett reportedly said in a press conference, "I don't think it will change a record of 80 years."

Though, Buffett seemed unwilling or unable to talk in detail on his own failings in the failure of

oversight, when addressing Berkshire shareholders. He pleaded guilty to not express any outrage.

"I obviously made a big mistake not saying, 'Well, when did you buy it?'" Mr. Buffett said. Laterhe joked that Charlie Munger, his longtime investing partner would be taking care of future news

releases.

Some experts have rather asked, did Buffett learn from Salamon incident? Their point is that the

crude trading had exposed poor controls of the management.


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There are Treasury trading rules, and Violation of these by Paul W. Mozer was only a major

symptom of a bigger internal ailment. Even senior management including John H. Gutfreund,

who was the chairman and chief executive officer of Salomon Brothers, had neglected to inform

the board of the company and also the regulators about the full extent of the trading misdeeds.

Sokol"s actions at Berkshire may not be comparable to that of Mozer at Salmon but it does show

a lack of oversight. The company was admired by many investors around the world for strong

focus on ethics. This blind spot came in picture after the audit committee report. Nonetheless, it

shows a lack of appropriate governance and control.

Sokol, who has resigned from Berkshire, said his decision to leave the company was unrelated tohis purchase of the shares and that he believes he did nothing wrong. After the shareholders

meeting, Sokol through his lawyer accused of making him a scapegoat.

In a statement on March 30, Mr. Buffett had said he and Mr. Sokol didn't regard the Lubrizol

trades as being unlawful.

OUR VIEW POINT

The company should reinforce their policies and code of ethics.

Senior management should be more accountable and they should know every transaction carried

by the top managements. And financial accounting of top management and financial audits

should be done frequently.

We would have charged Mr. sokol with insider trading.

Full disclosure of Mr. sokol should have been taken as mandated by satae law, in Delaware

where Berkshire have been incorporated.

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