1. Berkshire Hathaway chairman’s letter, 1988.
2. The tax code exemption applied to LIFO inventory liquidations. For tax purposes Rockwood used LIFO accounting, which let it calculate profits using the most recent cocoa-bean prices, which minimized taxes. Correspondingly, cocoa beans were carried in inventory at old prices. A large taxable profit would therefore occur if it sold the inventory.
3. Pritzker created a business conglomerate through his investing activities, but is best known as founder of the Hyatt hotel chain.
4. At the onset of the exchange period, Accra cocoa beans, which made up half of Rockwood’s 13-million-pound pile, were trading at $0.52 a pound. The price dropped to $0.44 per pound by the conclusion of the exchange period. The price of these beans had hit a high of $0.73 per pound in August 1954, causing candy companies to shrink the size of their 5¢ candy bars. George Auerbach, “Nickel Candy Bar Wins a Reprieve,” New York Times, March 26, 1955; “Commodity Cash Prices,” New York Times, October 4 and 20, 1954.
5. Letter to Stockholders of Rockwood & Co., September 28, 1954.
6. From the 1988 chairman’s letter in the Berkshire annual report to shareholders, which contains a brief description of the Rockwood transaction.
7. The speculator’s return on the contract also reflects his funding cost. For example, if the speculator broke even on a three-month contract—net of his fee—the contract would actually be unprofitable, considering the speculator’s funding cost.
8. In the futures market, the difference between a speculator and a hedger (or “insured”) is essentially whether an underlying position in the commodity exists to be hedged.
9. Interviews with Tom Knapp and Walter Schloss, as well as Buffett.
10. Warren Buffett letter to David Elliott, February 5, 1955.
11. Based on its profile in Moody’s Industrial Manual, Rockwood traded between $14.75 and $85 in 1954 and between $76 and $105 in 1955. Buffett held on to the shares through 1956. Profit on the trade is estimated. Rockwood traded above $80 a share during early 1956, based on the Graham-Newman annual report.
12. In the letter to David Elliott noted above (February 5, 1955), Buffett explains that Rockwood is his second-largest position (after Philadelphia & Reading, which he did not disclose) and writes that Pritzker “has operated quite fast in the past. He bought the Colson Corp. a couple years ago and after selling the bicycle division to Evans Products sold the balance to F. L. Jacobs. He bought Hiller & Hart about a year ago and immediately discontinued the pork-slaughtering business and changed it into a more or less real estate company.” Pritzker, he writes, “has about half the stock of Rockwood, which represents about $3 million in cocoa value. I am quite sure he is not happy about sitting with this kind of money in inventory of this type and will be looking for a merger of some sort promptly.” He had studied not just the numbers but Jay Pritzker.
13. Initially he had bought the stock from Graham-Newman when he was a stockbroker, after a minor mistake on an order from them caused them to DK (“don’t know,” or repudiate) the order. Warren kept the stock.
14. Before 2000, investors and analysts routinely sought and received nonpublic information that would be an advantage to them in trading stocks. This gradual flow of information, which benefited some investors at the expense of others, was considered part of the efficient workings of the capital markets and a reward for diligent research. Warren Buffett and his network of investor friends profited significantly from the old state of affairs. Ben Graham was questioned extensively about this practice before Congress in 1955. He commented that “a good deal of information from day to day and month to month naturally comes to the attention of directors and officers. It is not at all feasible to publish every day a report on the progress of the company … on the other hand, as a practical matter, there is no oath of secrecy imposed upon the officers or directors so that they cannot say anything about information that may come to their attention from week to week. The basic point involved is that where there is a matter of major importance it is generally felt that prompt disclosure should be made to all the stockholders so that nobody would get a substantial advantage in knowing that. But there are all degrees of importance, and it is very difficult to determine exactly what kind of information should or must be published and what kind should just go the usual grapevine route.” He added that all investors may not be aware of the grapevine, but, “I think that the average experienced person would assume that some people are bound to know more about the company [whose stock they are trading] than he would, and possibly trade on the additional knowledge.” Until 2000 that was, in effect, the state of the law.
While a full discussion of insider trading is beyond the scope of this book, the theory of insider trading was promulgated with SEC Rule 10b-5 in 1942, but “so firmly entrenched was the Wall Street tradition of taking advantage of the investing public,” as John Brooks puts it in The Go-Go Years, that the rule was not enforced until 1959, and it was not until the 1980s that anyone seriously questioned the duties of people other than insiders under insider-trading laws. Even then, the Supreme Court affirmed, in Dirks v. SEC, 463 U.S. 646 (1983), analysts could legitimately tell their clients this type of information, and the Supreme Court also noted in Chiarella v. United States, 445 U.S. 222 (1980), that “informational disparity is inevitable in the securities markets.” To some extent, there was understood to be some benefit to the market of a gradual leakage of inside information; in fact, how else was the information to get out? The practice of business public relations and conference calls had not developed.
In these 1980s cases, however, the Supreme Court defined a new “misappropriation” theory of insider trading, in which inside information that was misappropriated by a fiduciary could lead to liability if acted upon. Then, largely in response to the Bubble-era proliferation of “meeting and beating consensus” earnings and the “whisper numbers” that companies began to suggest to favored analysts that they were going to earn, in 2000, through Regulation FD (Fair Disclosure), the SEC broadened the misappropriation theory to include analysts who selectively receive and disseminate material nonpublic information from a company’s management. With the advent of Reg. FD, the “grapevine” largely ended, and a new era of carefully orchestrated disclosure practices began.
15. He registered the securities in his own name, rather than his brokers’, so the checks came straight to his home.
16. Interviews with George Gillespie, Elizabeth Trumble, who heard this story from Madeleine. Warren heard it for the first time at his fiftieth birthday party, from Gillespie. Apparently Susie had never mentioned it to him.
17. More than five decades later, Howie recalls this as his first memory. While that may seem improbable, in “Origins of Autobiographical Memory,” Harley and Reese (University of Chicago, Developmental Psychology, Vol. 35, No. 5, 1999) study theories of how childhood memories are recalled from the earliest months of life and conclude that this phenomenon does occur. One of the explanations is parents who repeat stories to their children. A gift from Ben Graham—probably significant to Warren—might plausibly be recalled by Howie from infancy because at least one parent helped him imprint it solidly in memory by discussing it so much.
18. Interview with Bernie and Rhoda Sarnat.
19. This story also is cited in Janet Lowe’s Benjamin Graham on Value Investing: Lessons from the Dean of Wall Street. Chicago: Dearborn Financial Publishing, 1994.
20. Interview with Walter Schloss.
21. Warren Buffett letter to the Hilton Head Group, February 3, 1976.
22. Schloss was starting the partnership with $5,000 of his own capital, a risky arrangement that left him nothing on which to live. Buffett got him help with housing from Dan Cowin. Ben Graham put in $10,000 and had some of his friends do so too; eight of Schloss’s friends put in $5,000 each. Schloss charged 25% of profits, “but that’s it. If the market went down, we would have to make up the loss until my partners were whole.”
23. Knapp was a security analyst at Van Cleef, Jordan & Wood, an investment adviser.
24. Interview with Tom Knapp.
25. Interview with Ed Anderson.
26. Ibid.
27. Graham was born May 9, 1894. He decided to shut down Graham-Newman when he was sixty-one, but the last Graham-Newman shareholder meeting was held on August 20, 1956.
28. Jason Zweig says in a July 2003 Money article, “Lessons from the Greatest Investor Ever,” that “From 1936 to 1956, at his Graham-Newman mutual fund, he produced an average annual gain of more than 14.7% vs. 12.2% for the overall market—one of the longest and widest margins of outperformance in Wall Street history.” This record does not reflect the impressive performance of GEICO, which was distributed to the shareholders in 1948.