Margin of Trust: The Berkshire Business Model

1. See Erik P. M. Vermeulen, “Corporate Governance in a Networked Age,” Wake Forest Law Review 50, no. 3 (2015): 711–42; Erik P. M. Vermeulen and Mark Fenwick, “The Future of Capitalism: ‘Un-Corporating’ Corporate Governance” (working paper, Lex Research Topics in Corporate Law & Economics, 2016); Mark Fenwick, Wulf A. Kaal, and Erik P. M. Vermeulen, “Regulation Tomorrow: What Happens When Technology Is Faster Than the Law?” https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2834531 (2017); Toshiyuki Kono, Mark Fenwick, and Erik P. M. Vermeulen, “Organizing-for-Innovation: New Perspectives on Corporate Governance” (2017).

2. See David F. Larcker and Brian Tayan, “Berkshire Hathaway: The Role of Trust in Governance” (Stanford Governance Research Program, May 28, 2010).

3. See Jay B. Barney and William S. Hesterly, Strategic Management and Competitive Advantage: Concepts and Cases, 6th ed. (New York: Pearson, 2018), 261–62.

4. See Subrata N. Chakravarty, “Three Little Words,” Forbes, April 6, 1998.

5. See Jerker Denrell, “Vicarious Learning, Undersampling of Failure, and the Myths of Management,” Organization Science 14, no. 3 (May–June 2003): 227–351.

6. See Aneil K. Mishra, “Organizational Responses to Crisis: The Centrality of Trust,” in Trust in Organizations: Frontiers of Theory and Research, ed. Roderick M. Kramer and Tom R. Tyler (Thousand Oaks, CA: Sage, 1996), 261, 282.

Recent discussions by both scholars and the business press suggest that trust is a central factor in organizational behavior and organizational survival for both public and private organization. Several scholars have recently proposed that trust is a central factor enhancing organizations’ long-term success and survival, especially because environments have become more uncertain and competitive.

See Jordan D. Lewis, Trusted Partners: How Companies Build Mutual Trust and Win Together (New York: Free Press, 1999); Christel Lane and Reinhard Bachmann, eds., Trust Within and Between Organizations (Oxford: Oxford University Press, 1998); and “Special Topic Forum on Trust in and Between Organizations,” Academy of Management Review 23, no. 3 (1998): 384–640.

7. See Dennis Reina and Michelle Reina, Trust and Betrayal in the Workplace: Building Effective Relationships in Your Organization (Oakland, CA: Berrett-Koehler, 2015); Ken Blanchard and Jesse Lyn Stoner, Full Steam Ahead: Unleash the Power of Vision in Your Work and Your Life (San Francisco, CA: Berrett-Koehler, 2011) (“People follow leaders by choice. Without trust, at best you get compliance.”); and Christel Lane, “Introduction: Theories and Issues in the Study of Trust,” in Trust Within and Between Organizations, 1 (“Trust is increasingly being viewed as a precondition for superior performance and competitive success in the new business environment.”); Sue Shellenbarger, “Workplace Upheavals Seem to Be Eroding Employees’ Trust,” Wall Street Journal, June 21, 2000.

8. Buffett is quoted as follows in a June 30, 1993, interview published in Outstanding Investor Digest:

What we refer to as a “moat” is what other people might call competitive advantage. It’s something that differentiates the company from its nearest competitors—either in service or low cost or taste or some other perceived virtue that the product possesses in the mind of the consumer versus the next best alternative. There are various kinds of moats. All economic moats are either widening or narrowing—even though you can’t see it.

See Michael E. Porter, Competitive Strategy: Techniques for Analyzing Industries and Competitors (New York: Free Press, 1980); Clayton Christensen, The Innovator’s Dilemma: When New Technologies Cause Great Companies to Fall (Boston: Harvard Business Review, 1997).

9. Mani, “Warren Buffett to Acquire Detlev Louis Motorradvertriebs In Europe Push,” Value Walk, February 20, 2015, https://www.valuewalk.com/2015/02/warren-buffett-detlev-louis/.

10. Beiten Burkhard, “Advises Ute Louis on the Sale of Detlev Louis Motorradvertriebs GmbH,” company statement, February 20, 2015.

11. “What Do You Get When You Cross Warren Buffett With a Motorcycle?” Motley Fool, February 21, 2015.

12. European Union, “Commission Clears Acquisition of Detlev Louis Motorradvertriebs by Berkshire Hathaway,” press release, April 27, 2015.

13. Alexander Möthe and Astrid Dörner, “Warren Buffet’s German To-Do-List,” Handelsblatt, February 25, 2015; see also Steve Jordon, “Warren Watch-Buffett’s ‘German Scout’ on the Hunt,” Omaha World-Herald, March 22, 2015.

14. This book adapts and significantly reworks material from more than twenty pieces written from 2013 to 2018 by Lawrence Cunningham and edited principally by Stephanie Cuba:

15. See Warren E. Buffett, “Before the Subcommittee on Telecommunications and Finance of the Energy and Commerce Committee of the U.S. House of Representatives” (1991), reprinted in Wall Street Journal, May 1, 2010.

1. See Deborah A. DeMott, “Agency Principles and Large Block Shareholders,” Cardozo Law Review 19, no. 2 (1997): 321–40.

2. See Lawrence E. Mitchell “The Human Corporation: Some Thoughts on Hume, Smith, and Buffett,” Cardozo Law Review 19, no. 2 (1997): 341.

3. Meinhard v. Salmon, 164 N.E. 545 (N.Y. 1928).

4. See Amy Deen Westbrook, “Warren Buffett’s Corporation: Reconnecting Owners and Managers,” Oklahoma City University Law Review 34, no. 3 (2009): 515–48.

5. See Michael Eisner and Aaron R. Cohen, Working Together: Why Great Partnerships Succeed (New York: Harper Collins, 2014).

6. See Melvin A. Eisenberg, “The Board of Directors and Internal Control,” Cardozo Law Review 19, no. 2 (1997): 237–64.

7. See Jill E. Fisch, “Taking Boards Seriously,” Cardozo Law Review 19, no. 2 (1997): 265–90.

8. Gary Strauss, “Directors See Pay Skyrocket,” USA Today, October 26, 2011. Among other lower-paying boards, consider Credit Acceptance Corporation and Constellation Software Inc. (on which author Lawrence Cunningham serves).

9. See Mark Calvey, “Berkshire Hathaway Director Susan Decker Offers Rare Peek Into Warren Buffett’s Boardroom,” San Francisco Business Times, December 9, 2014.

10. See James D. Cox and Harry L. Munsinger, “Bias in the Boardroom: Psychological Foundations and Legal Implications of Corporate Cohesion,” Law and Contemporary Problems 48, no. 3 (1985): 83–135.

11. See Charles McGrath, “80 Percent of Equity Market Cap Held by Institutions,” Pensions & Investments, April 25, 2017. Exact figures vary depending on timing, data, and definition of market scope. Similar figures emerge from examining Federal Reserve data from 1965 through 2015 as calculated by Gary Previts of Case Western Reserve University and on file with Lawrence Cunningham.

12. Lawrence Cunningham’s current research investigates the significance of such shareholder demographics across corporate America. It highlights what he calls quality shareholders, those who concentrate and hold long term, in contrast to indexers who do not concentrate and transients who do not hold long. They add substantial value to corporate affairs that such indexers and transients do not.

13. Warren E. Buffett and Lawrence A. Cunningham, The Essays of Warren Buffett: Lessons for Corporate America, 4th ed. (New York: The Cunningham Group; distributed by Carolina Academic Press, 2015), 101 (from the 1993 letter).

14. Buffett and Cunningham, The Essays of Warren Buffett, 27–28 (from the 1979 letter, later republished in An Owner’s Manual and ensuing annual reports from 1996).

15. See Richard Teitelbaum, “Berkshire Billionaire Found with More Shares Than Gates,” Bloomberg News, September 17, 2013.

16. Andrew Kilpatrick, Of Permanent Value: The Story of Warren Buffett (Birmingham, AL: AKPE, 2018).

17. Among the rare exceptions are the transfer of residual assets of Dexter Shoe into H. H. Brown Shoe after the former’s business deteriorated and the reassignment of Brad Kinstler from Cornhusker Casualty, to Fechheimer Brothers, to See’s Candies.

18. See Robert P. Miles, The Warren Buffett CEO: Secrets from the Berkshire Hathaway Managers (New York: Wiley, 2003), 357–58.

19. Just a year before Whitman passed, he gave Lawrence Cunningham the honor of writing the foreword to a family memoir Whitman had written, from which this is adapted.

20. Other examples include Jim Weber and Tom Manenti. Weber said he’s never been trusted so much in his career, which makes him feel even more accountable. Manenti said being so trusted by Buffett enabled him to trust his team members with enormous delegated responsibility.

1. Reluctantly, Berkshire terminated the program when social advocates opposed to some donor choices boycotted the products of a Berkshire subsidiary.

2. Today, Class A shares have one vote per share and an equivalent claim to the economic interest, such as dividends, whereas the Class B shares have 1/10,000 of that voting power and 1/1,500 of that economic interest.

3. William Zissner, On Writing Well (New York: Harper Collins 1990), 58.

1. Insolvency resulting from poor underwriting was nearly the fate of Berkshire’s GEICO subsidiary in the 1970s before Berkshire acquired it, and of Gen Re in the 2000s just after Berkshire acquired it.

2. These figures are inferential. Buffett’s 2010 letter to shareholders noted that Berkshire’s annual rent for headquarters was $270,212 and total investments in the facility amounted to $301,363. Warren E. Buffett and Lawrence A. Cunningham, The Essays of Warren Buffett: Lessons for Corporate America, 4th ed. (New York: The Cunningham Group; distributed by Carolina Academic Press, 2015), 80 (from the 2010 letter). Berkshire’s 2018 proxy statement, listing the highest-paid Berkshire employees, names the CFO with base salaries in 2015, 2016, and 2017 of, respectively, $1.35 million, $1.55 million, and $1.775 million.

3. Lawrence A. Cunningham, Berkshire Beyond Buffett (New York: Columbia University Press, 2014), 213.

4. Only one came from a broker Berkshire retained—an anomalous case in which Buffett asked a Berkshire unit CEO, David Sokol, to initiate the search. The epilogue elaborates.

1. John Mueller, Capitalism, Democracy and Ralph’s Pretty Good Grocery (Princeton, NJ: Princeton University Press, 1999), 96.

2. See Lawrence A. Cunningham, Berkshire Beyond Buffett: The Enduring Value of Values (New York: Columbia University Press, 2014), 11: “During the mid-1980s, Berkshire would divest a few other failing businesses the Buffett Partnership had initially acquired—such as the department store chains Diversified Retailing, Associated Retail Stores, and Hochshild Kohn—but thereafter forswore doing so.” It was then that Buffett discerned the economic value to sellers of Berkshire’s promise of permanence. It was not until 2019 that Berkshire divested another subsidiary, in this case Applied Underwriters, a small specialty insurer whose sale was reportedly triggered by Berkshire’s concurrent ownership of several rival companies operating in the same line. See Nicole Friedman, “Warren Buffett Is Doing Something Rare: Selling a Business,” Wall Street Journal, February 27, 2019.

3. Benjamin Moore; BNSF; Clayton Homes; CTB; Dairy Queen; Fruit of the Loom; Garan; Gen Re; Johns Manville; Justin; Lubrizol; MidAmerican Energy; Precision Castparts; Shaw Industries; and XTRA. It also joined in the acquisition of Heinz, followed by its merger with Kraft.

4. We confirmed our hunch about Munger’s drafting role by conferring with Robert Denham and Ronald Olson, two lawyers who were involved in the transaction and are still partners of the firm.

5. Such fiduciary “outs” did not become standard until shortly after this time. But even at this time, they were emerging with some frequency and taken seriously by courts, including in that year’s landmark case, Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985).

6. See Restatement (Second) of Contracts 193 (1981).

7. See Thomas Petzinger Jr., Oil & Honor: The Texaco-Pennzoil Wars (Washington, DC: Beard, 1987).

1. Lawrence A. Cunningham, “Conversations from the Warren Buffett Symposium” (transcript), Cardozo Law Review 19, no. 2 (1997): 719, 737; reprinted in Lawrence A. Cunningham, The Buffett Essays Symposium: A 20th Anniversary Annotated Transcript (Petersfield, UK: Harriman House, 2016), 13.

2. We owe this point to Ronald Olson, a Berkshire director and partner of Munger, Tolles & Olson.

3. Warren E. Buffett and Lawrence A. Cunningham, The Essays of Warren Buffett: Lessons for Corporate America, 4th ed. (New York: The Cunningham Group; distributed by Carolina Academic Press, 2015), 47 (from the 2002 letter).

1. See Stephen M. Bainbridge, “A Critique of the NYSE’s Director Independence Listing Standards,” Securities Regulation Law Journal 30, no. 4 (2002): 370, 381.

2. Compare Kelli A. Alces, “Beyond the Board of Directors,” Wake Forest Law Review 46 (2011): 783–836, with Stephen M. Bainbridge, “Director Primacy: The Means and Ends of Corporate Governance,” Northwestern University Law Review 97, no. 2 (2003): 547–607.

3. See Marcel Kahan and Edward Rock, “Embattled CEOs,” Texas Law Review 88, no. 987 (2010): 201–10.

4. See Tom C. W. Lin, “The Corporate Governance of Iconic Executives,” Notre Dame Law Review 87, no. 1 (2011): 351–82 (suggesting that iconic CEOs win too much organizational and legal deference, citing Steve Jobs; are prone to overconfidence, citing Buffett; and can even be licentious, citing Michael Eisner).

5. See Melvin A. Eisenberg, “The Board of Directors and Internal Control,” Cardozo Law Review 19, no. 2 (1997): 237–64.

6. See Michael Power, The Audit Society: Rituals of Verification (Oxford: Oxford University Press, 1997).

7. Warren E. Buffett and Lawrence A. Cunningham, The Essays of Warren Buffett: Lessons for Corporate America, 4th ed. (New York: The Cunningham Group; distributed by Carolina Academic Press, 2015), 298 (from the 2014 letter).

8. Gary S. Becker, “Crime and Punishment: An Economic Approach,” Journal of Political Economy 76, no. 2 (1968): 169–217.

9. David A. Skeel, Jr., “Shaming in Corporate Law,” University of Pennsylvania Law Review 149, no. 6 (2001): 1811–68; Margaret M. Blair and Lynn A. Stout, “Trust, Trustworthiness and the Behavioral Foundations of Corporate Law,” University of Pennsylvania Law Review 149, no. 6 (2001): 1735–810.

1. See Warren E. Buffett, Before the Subcommittee on Telecommunications and Finance of the Energy and Commerce Committee of the U.S. House of Representatives (1991), reprinted in Wall Street Journal, May 1, 2010. Buffett’s admonition began with the following:

The spirit about compliance is as important or more so than words about compliance. I want the right words and I want the full range of internal controls. But I also have asked every Salomon employee to be his or her own compliance officer. After they first obey all rules, 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, with the reporting done by an informed and critical reporter. If they follow this test, 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.

2. Eileen Appelbaum and Rosemary Batt, Private Equity at Work (New York: Russell Sage, 2014), 2.

3. Matthew D. Kain, Stephen B. McKeon, and Steven Davidoff Solomon, “Intermediation in Private Equity: The Role of Placement Agents,” July 14, 2017, https://ssrn.com/abstract=2586273.

4. Ryan Kantor and Ryan Sullivan, “A Lawyer’s Guide: Valuation Issues in Private Equity Funds,” December 6, 2012, https://ssrn.com/abstract=2408295.

5. Guy Fraser-Sampson, Private Equity as an Asset Class (Hoboken, NJ: Wiley, 2007) 9.

6. Appelbaum and Batt, Private Equity, 71–72.

7. Id. 68–71, 286–87.

9. See Victor Fleischer, “Two and Twenty: Taxing Partnership Profits in Private Equity Funds,” NYU Law Review 83, no. 1–59 (2008).

10. See Gretchen Morgenson, “Private Equity’s Free Pass,” New York Times, July 26, 2014; John C. Coffee Jr., “Political Economy of Dodd-Frank: Why Financial Reform Tends to be Frustrated and Systemic Risk Perpetuated,” Cornell Law Review 97, no. 5 (2012): 1019–82.

11. The Berkshire model is not exactly the stakeholder model, which may elevate other constituents above shareholders or make many or all of them pari passu.

12. George P. Baker and George David Smith, The New Financial Capitalists: Kohlberg Kravis Roberts and the Creation of Corporate Value (New York: Cambridge University Press, 1998).

13. Barker and Smith, The New Financial Capitalists, 100.

1. Kris Frieswick, ITW: Forging the Tools for Excellence (Bainbridge Island, WA: Fenwick, 2012), 67–70.

3. This discussion about Marmon is adapted from Lawrence A. Cunningham, Berkshire Beyond Buffett (New York: Columbia University Press, 2014) and is informed by both interviews and a 2015 book tour event Cunningham hosted with Marmon’s Frank Ptak at Northwestern University (Chicago, February 11, 2015).

4. See Tim Mullaney, “Opinion: The True Mastermind of Google’s Alphabet? Warren Buffett,” Marketwatch, August 17, 2015, https://www.marketwatch.com/story/the-true-mastermind-of-googles-alphabet-warren-buffett-2015-08-17 (extensively quoting Cunningham comparing aspects of the models).

1. See Peter Lattman, “A Record Buyout Turns Sour for Investors,” New York Times, February 28, 2012.

2. See Deena Shanker and Craig Giammona, “Kraft Heinz Slumps on SEC Subpoena, $15.4 Billion in Writedowns,” Crain’s Chicago Business, February 21, 2019.

3. See Revlon v. MacAndrews & Forbes, 506 A.2d 173 (Del. 1986).

4. See Paramount Communications, Inc. v. Time, Inc., 571 A.2d 1140 (Del. 1989).

5. See Denver Area Meat Cutters v. Clayton, 209 S.W.2d 584 (Tenn. Ct. App. 2006); Denver Area Meat Cutters v. Clayton, 120 S.W.3d 841 (Tenn. Ct. App. 2003).

1. Mark Greenblatt, “Berkshire Insurance Payments Criticized,” Scripps, October 6, 2013.

2. Berkshire Hathaway, News Release October 31, 2013.

3. Berkshire stressed that its payments in this business for claims and claims-expenses exceeded $2.4 billion annually and $20 billion cumulatively. It references honoring its multipronged duties to policyholders, insurers, and reinsurers for which it manages claims, regulators, and shareholders “who expect us to operate well above any minimum standards of practice for our business.” Berkshire also noted winning respect from all such constituencies, and awards from peers and industry trade groups. Acknowledging that the runoff and legacy areas involve complex contested claims, it said these cannot be reduced to sound bites, although the piece had tried to do just that. Berkshire stressed that it disfavors public comments on pending cases, but that it felt constrained to defend against a report that seemed calculated to influence those cases.

4. John Sylvester, “Policyholder Litigation Involving Claims Handling by Resolute Management Inc.” (presentation to the American Bar Foundation, January 2014).

5. For example, Dean Starkman, “AIG’s Other Reputation; Some Customers Say the Insurance Giant Is Too Reluctant to Pay Up,” Washington Post, August 21, 2005.

6. Daniel Wagner and Mike Baker, “Warren Buffett’s Mobile Home Empire Preys on the Poor,” April 3, 2015, http://www.publicintegrity.org/2015/04/03/17024/warren-buffetts-mobile-home-empire-preys-poor.

7. The piece called out its own key findings: using multiple corporate names to make buyers believe they are shopping around; lending at rates exceeding 15 percent and adding significant fees; customers complained of deception and predation via changes, pressure, and fees; and two former dealers said headquarters pressured them into channeling customers to borrow from Clayton despite these problems.

8. “Clayton Homes Statement on Mobile-Home Buyer Investigation,” Omaha World Herald, April 3, 2015.

9. Daniel Wagner and Mike Baker, “A Look at Berkshire Hathaway’s Response to ‘Mobile Home Trap’ Investigation,” April 6, 2015, http://www.publicintegrity.org/2015/04/06/17081/look-berkshire-hathawaysresponse-mobile-home-trap-investigation.

10. Mike Baker, “Buffett Sticks Up for Mobile-Home Business at Shareholder Meeting,” Seattle Times, May 2, 2015. All the claims contradict everything Clayton Homes stands for, as explained in both Berkshire Beyond Buffett, and in a New York Times column by Lawrence Cunningham several months before Baker’s May 2, 2015 piece. Clayton Homes cited Cunningham’s column in its response, which Wagner and Baker dismissed in rebuttal as written by “a longtime Buffett acolyte.”

11. Compare Clayton Homes, “Manufactured Home Living News,” press release, May 18, 2015, http://www.reuters.com/article/2015/05/18/idUSnGNX5smRmG+1c5+GNW20150518 (speaking of the importance of opposing regulation to facilitate access to manufactured housing) with Zach Carter, “House Republicans Hand Warren Buffett Big Win on Expensive Loans to the Poor,” Huffington Post, April 14, 2015, http://www.huffingtonpost.com/2015/04/14/manufactured-housing-republicans_n_7065810.html (as the title suggests, supporting regulation to protect the impecunious from high-cost loans).

12. Mike Baker, “Buffett’s Mobile Home Business Plan Has Most to Gain from Deregulation Plan,” Seattle Times, May 17, 2015, http://www.seattletimes.com/business/real-estate/buffetts-mobile-home-business-has-most-to-gain-from-deregulation-plan/; Baker, “Buffett Sticks Up for Mobile-Home Business.”

13. Ariz. Admin. Code, R14-2-1802 et seq; see ASU Energy Policy Innovation Council, Net Metering Rules Brief Sheet (Dec. 2013), https://energypolicy.asu.edu/wp-content/uploads/2014/01/Policies-to-Know-Arizona-Net-Metering-Rules-Brief-Sheet_Updated.pdf.

14. Reem Nasr, “Ground Zero in the Solar Wars: Nevada,” CNBC, May 26, 2015, https://www.cnbc.com/2015/05/26/ground-zero-in-the-solar-wars-nevada.html.

15. Mark Chediak, Noah Buhayar, and Margaret Newkirk, “Warren Buffett Is Sending Mixed Messages on Green Energy,” Bloomberg Business, May 18, 2015.

1. Robert Miles, The Warren Buffett CEO: Secrets from the Berkshire Hathaway Managers (New York: Wiley, 2003).

2. See Sanjai Bhagat, Andrei Shleifer, and Robert W. Vishny, “Hostile Takeovers in the 1980s: The Return to Corporate Specialization,” Brookings Papers on Economic Activity: Microeconomics, ed. M. N. Baily and C. Winston (Washington, DC: Brookings Institution, 1990), 1–84.

3. Robert Sobel, ITT: The Management of Opportunity (Washington, DC: Beard Books, 2000); George A. Roberts, with Robert J. McVicker, Distant Force: A Memoir of the Teledyne Corporation and the Man Who Created It (Thousand Oaks, CA: Teledyne Corporation, 2007); and Gerald F. Davis, Kristina Diekman, and Catherine H. Tinsley, “The Decline and Fall of the Conglomerate Firm in the 1980s: The Deinstitutionalization of an Organizational Form,” American Sociological Review 59, no. 4 (1994): 547–70.

4. George P. Baker and George David Smith, The New Financial Capitalists: Kohlberg Kravis Roberts and the Creation of Corporate Value (New York: Cambridge University Press, 1998), 168.

5. Davis et al., “The Decline and Fall of the Conglomerate Firm,” 554.

6. See Lawrence A. Cunningham, “Conversations from the Warren Buffett Symposium (Transcript),” Cardozo Law Review 19, no. 2 (1997), 719, 736–37, 813; reprinted in Lawrence A. Cunningham, The Buffett Essays Symposium: A 20th Anniversary Annotated Transcript (Petersfield, UK: Harriman House, 2016), 13, 73.

1. See “Berkshire Hathaway: Playing Out the Last Hand,” Economist, April 26, 2014; “Berkshire Hathaway: The Post-Buffett World,” Economist, January 10, 2015.

2. Steven Davidoff Salomon, “With His Magic Touch, Buffett May Be Irreplaceable for Berkshire,” New York Times, May 21, 2013.

3. See Gerald F. Davis, “The Twilight of the Berle and Means Corporation,” Seattle University Law Review 34 (2011): 1121–38; see also Jeffrey N. Gordon, “Corporations, Markets, and Courts,” Columbia Law Review 91, no. 8 (1991): 1931–88.

4. See Deborah A. DeMott, “Agency Principles and Large Block Shareholders,” Cardozo Law Review 19, no. 2 (1997): 321–40.

1. Berkshire Hathaway, Annual Report: Chairman’s Letter, 2009.

2. Warren Buffett, “Opening Comments” (Berkshire Hathaway Annual Meeting, Omaha, NE, April 30, 2011).

3. Buffett, “Opening Comments.”

4. Buffett, “Opening Comments” (responding to shareholder questions).

5. See Steve Schaefer, “Buffett Breaks Out Elephant Gun for $9B Lubrizol Buy,” Forbes, March 14, 2011; and Katya Wachtell, “Meet John Freund: Warren Buffett’s Broker of 30 Years and the Citi Banker Who Alerted Him to Sokol’s Deception,” Business Insider, May 2, 2011.

6. See also “David Sokol Defends His Controversial Lubrizol Stock Purchases” (transcript), CNBC, April 1, 2011, http://www.cnbc.com/id/42365586.

7. Ruling of the Court on Defendants’ Motion to Dismiss, In re Berkshire Hathaway Inc. Deriv. Litig., No. 6392-VCL, 2012 WL 978867 (Del. Ch. Mar. 19, 2012).

8. Buffett, “Opening Comments” (responding to shareholder questions); Charlie Munger (Berkshire Hathaway Annual Meeting, Omaha, NE, April 30, 2011) (responding to shareholder questions).

9. Ben Berkowitz, “Sokol Affair Tarnishes Buffett Style,” Globe & Mail, March 31, 2011, quoting Charles Elson of the University of Delaware: “the fact that this could happen does raise questions as to the effectiveness of the company’s controls to prevent something like this from happening”; Jenny Strasburg, “Buffett Is Seen as Too Trusting,” MarketWatch, March 31, 2011.

10. Berkowitz, “Sokol Affair,” quoting John Coffee of Columbia University: “It’s the kind of behaviour that, as a matter of corporate governance, sophisticated companies try to avoid.” There was little reason to believe that a more elaborate control system would have made Sokol act any differently. Suppose Berkshire had a large compliance department with detailed commands and controls, including a specific procedure for clearing personal investments through a compliance committee. If longstanding general policies Berkshire censured Sokol for violating did not dissuade Sokol’s trade, it is not obvious that an additional layer of bureaucracy would. To the contrary, it is possible that the command-and-control approach would displace the value of the autonomy-and-trust culture and stimulate more behavior that veered close to the edge.

11. Munger (responding to shareholder questions).

12. See Warren E. Buffett, “Before the Subcommittee on Telecommunications and Finance of the Energy and Commerce Committee of the U.S. House of Representatives” (1991), reprinted in Wall Street Journal, May 1, 2010. Buffett’s admonition began as follows:

13. The Sokol affair prompted some Berkshire shareholders to sue the board in Delaware, Berkshire’s state of incorporation. They argued that the board had failed to maintain an adequate system of internal control. The complaint echoed the public criticism of Berkshire’s trust-based culture and urged that the board had botched its oversight role by abjuring a command-and-control structure. The court dismissed the assertion as “profoundly weak.” Ruling of the Court on Defendants’ Motion to Dismiss, In re Berkshire Hathaway Inc. Deriv. Litig., No. 6392-VCL, 2012 WL 978867 (Del. Ch. Mar. 19, 2012).

These shareholders also tried to sue Sokol to recover $3 million in profits for Berkshire, which the board declined to do. Boards have the say over whether a corporation should sue someone unless shareholders can show that a board is unable to act impartially. The shareholders could not show that the Berkshire board’s independence was compromised concerning whether to sue Sokol. The Delaware court acknowledged that Buffett’s press release colored the matter, suggesting coziness between Sokol and Buffett that could have biased the board. But that was mere “smoke,” the court said, not enough to infect the board’s judgment. In re Berkshire Hathaway.

14. The Sokol affair also reflects Berkshire’s sensitivity to public perceptions, which undergirds Buffett’s admonition to test employee behavior according to how it would look if reported on the front page of a newspaper. Suppose Sokol, when he first called Buffett, had said, “Warren, I think Lubrizol is an attractive company—so attractive that I just bought $10 million for myself, and I think you ought to look at it for Berkshire.” That disclosure would have negated the story. Moreover, Sokol might have gone an extra step to eliminate any doubt about propriety, and said, “If Berkshire would like to buy my shares at cost, I’m happy to sell.” Buffett’s probable response would have been something like, “No, that’s fine. If we end up buying it, you’re entitled.”