Jeff Matthews - Secrets in Plain Sight: Business & Investing Secrets of Warren Buffett, 2011 Edition (eBooks on Investing Series)

At the Berkshire Hathaway 2011 Annual Meeting. Its only 9 a.m. on a quiet Saturday morning, but the Qwest Center in Omaha, Nebraska, is full, almost to the rafters, and the most widely attended financial gathering in the world is already under way.

Some 36,000 Berkshire Hathaway shareholders, company managers, Wall Street analysts and reporters are here, half here in the main arena and the rest watching along on jumbo screens in other parts of the complex.

What were all watching is the hour-long movie that traditionally kicks off the proceedings before the start of the real purpose of our gatheringsix hours of questions and answers with Berkshires chairman, Warren Buffett, and his longtime business partner and Berkshire vice chairman, Charlie Munger.

As usual, this years movie has a rousing mix of fast-paced TV commercials touting Berkshire companies such as Dairy Queen and Geico, clips from previous Berkshire gatherings, as well as slick new bits, including a preview of Too Big to Fail, a new HBO movie about the 2008 financial crisis in which Warren Buffett plays a behind-the-scenes role.

But for now, all eyes are focused on what comes next: grainy, 20 year-old footage of a man giving testimony before a congressional committee. That man is Warren Buffett.

I Will Be Ruthless

Mr. Chairman, I thank you for the opportunity to appear before this subcommittee. I would like to start by apologizing for the acts that have brought us here.

So begins the centerpiece of the Berkshire movie: a brief, riveting video clip of Warren Buffett testifying in the midst of a financial scandal in 1991, when bond traders at Salomon Brothers were caught trying to corner the U.S. Treasury market.

The nation has a right to expect its rules and laws to be obeyed, Buffett said in his familiar, gruff voice (his hair blacker but his eyebrows just as bushy as now). And at Salomon, certain of these were broken. Almost all of Salomons 8,000 employees regret this as deeply as I do. And I apologize on their behalf as well as mine.

Though now a mere footnote in the history of twentieth-century finance, the Salomon Brothers scandal was a whopper in its day, and only the great exertions of Warren Buffett and Charlie Munger saved the company from prosecution and ruinand protected Berkshires investment in the firm.

Buffetts solemn, straightforward testimony is shown to the Berkshire shareholders and managers here at the meeting every year, in order to reinforce the message that, above all things, Buffett wants to protect Berkshires reputation, even at the expense of profits:

After they first obey all rules, Buffett told Congress, describing his new mandate for Salomons people, I then want employees to ask themselves whether they are willing to have any contemplated act appear the next day on the front page of their local paper, to be read by their spouses, children, and friends.

If they follow this test, he continued solemnly, they need not fear my other message to them: Lose money for the firm, and I will be understanding; lose a shred of reputation for the firm, and I will be ruthless.

Those words, spoken 20 years ago, carry a special meaning at this meeting, thanks to a press release that stunned Wall Street and many of the people in this arena.

The Press Release that Stunned Wall Street

The press release that stopped Wall Street in its tracks and left investors around the world in a state of disbelief and wonder went out on March 30, 2011, one month before the Berkshire meeting.

This press release will be unusual, it began. First, I will write it as if it were a letter. Second, it will contain two sets of facts, both about Dave Sokol, Chairman of several Berkshire subsidiaries.

The author was Berkshire Hathaway Chairman and CEO Warren Buffett, investment legend and Oracle of Omaha.

And what followed, in 14 short paragraphs of Buffetts characteristically clear, straightforward style, was the announcement of the abrupt and unexpected resignation of David Sokolthe longtime chairman of Berkshires hugely profitable MidAmerican Energy utility and the widely perceived successor to Warren Buffett himself at the helm of Berkshire Hathawayfor what seemed, to most professionals reading the news, to be shockingly inappropriate behavior.

Sokol, Buffett disclosed, had traded in shares of Lubrizol for himself while lobbying Buffett to buy the chemical company for Berkshire, without fully disclosing his trades until after the $10 billion deal was announced. Not only did he make a personal profit of some $3 million based on the figures in Buffetts letter, but he made Warren Buffett look foolish.

Now, some Buffett followers dismissed Sokols actions: Not a big deal, they said. But they were wrong. Trading for your own account while working on behalf of another company, whether for a profit of three dollars or $3 million, is called front-running on Wall Street, and it is one of the first things even a summer intern learns nevereverto do.

Sokol, of course, was no summer intern. He was a veteran, not merely of boardrooms but also of the ways of Wall Street. MidAmerican Energy was one of the largest Berkshire businesses, and Sokol was quite well paid for running itclose to $90 million in cash compensation plus an additional $145 million in stock-related proceeds over the course of his decade-long career with Berkshire.

Why would Sokol risk that position, not to mention the prestige of being considered a potential successor to Warren Buffett as CEO of the greatest financial success story of our times, by doing something so tawdry?

Buffett offered no answers in his March 30 press release, but neither did he display any of the ruthlessness he had promised Congress 20 years ago. In fact, he appeared to dismiss what Sokol did, as others had, writing:

Neither Dave nor I feel his Lubrizol purchases were in any way unlawful.

For all the good Warren Buffett has done for his shareholders over the yearsand growing Berkshires stock price from $18 a share to over $100,000 a share is only part of what has drawn 36,000 shareholders to Omaha this weekendit is that press release that is on everyones mind here this morning.

In fact, the first question of this meeting will be a stinging rebuke to Warren Buffett from a Berkshire shareholder: Why did you handle this matter so inadequately?

To find out why Warren Buffetts reaction to the Sokol Affair seemed so out of character to his shareholders and to learn how Buffett was able to handle himself in front of 36,000 people, read on!

Jeff Matthews

June 2011