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Berkshire Hathaway Annual Meeting
April 30, 2011

(Notes taken by ProfessorsDavid Kassand Susan White, Department of Finance, Robert H. Smith School of Business,
University of Maryland)

A one hour humorous film was shown in which there were a series of commercials for Berkshire products and numerous comedy routines. The highlights of the movie included an animated segment about Moody’s ruthless “MBA” trading machines that were planning to destroy the world. But Arnold Schwarzenegger suits up as “The Governator” (having stepped down as governor of California) and saves the world. There was also an appearance of Warren Buffett and Charlie Munger with the cast of “The Office”.

Warren Buffett (age 80) and Charlie Munger (age 87) then walk on stage and sit down. Buffett says “I can see and Charlie can hear, that’s why we work together”.

The format for asking questions was the same as that followed at the last two annual meetings. Half of the questions were selected by three business journalists: Andrew Ross Sorkin (The New York Times), Becky Quick (CNBC), and Carol Loomis (Fortune). Shareholders had e-mailed over 2,000 questions to the journalists, who then selected 27 questions relating to Berkshire and its operations. The journalists, who were seated on stage, alternated with shareholders in the audience in the asking of the questions.

Approximately 36,000 – 40,000 shareholders were in attendance, similar to last year’s turnout. (This is compared to previous records of 35,000 in 2009, 31,000 in 2008, 27,000 in 2007, and 24,000 in 2006.)

Buffett initially commented on first quarter earnings and related slides were projected on the screen. All of the businesses with the exception of those related to residential construction are getting better. Buffett believes that Berkshire Hathaway represents a cross section of the U.S. economy and includes a fair amount of international business as well. In the first quarter, Berkshire experienced the second worst quarter in the insurance industry in terms of catastrophes around the world. Usually the third quarter is the worst due to hurricanes in the U.S., with 50% occurring in September. In the first quarter there were some major catastrophes in Asia (Japan). These hit the reinsurance business very hard – probably about $50 billion for the industry. Based on Berkshire’s market share, the company expects to participate in about 3 – 5% of those losses. For the past 8 years the insurance business has been profitable, but that is unlikely in 2011 since the remainder of the year is unlikely to be hurricane-free. Buffett expects insurance underwriting to breakeven over time. If it does, Berkshire gets free use of the float.

Investment income was down and will go down because of the called (or soon to be called) preferred shares from General Electric, Goldman Sachs, and Swiss Re. They are losing at least three very high yield investments that cannot be replaced. Berkshire had full ownership of BNSF for a full year in the first quarter of this year. The entire railroad industry will have a good year. Their competitive advantage will grow as fuel prices increase.

Overall the business did well except for insurance. The three major catastrophes (Australian floods, New Zealand and Japan earthquakes) cost them an estimated $1.673 billion pretax. Nobody knows what the ultimate insured losses will be from the Japan earthquake. About 40% of the loss from Japan comes from a 5 year contract with Swiss Re. Swiss Re has told Berkshire that it will not be renewing the contract. Buffett joked that he wishes they had told him that three months earlier. As a result of tornadoes, 25,000 car owners will file auto claims. There has been an extraordinary tornado season this year, but those losses do not hit the reinsurance business much. The New Zealand earthquake has caused $12 billion in damage.There has been good growth in Geico policies and the company has been gaining market share. Buffett said there is $1 billion in Geico goodwill on the books which he estimates is worth $14 billion.

Buffett said investors should ignore gains or losses in Berkshire Hathaway - this is a lot of accounting. He said, suppose we own a security for quite a while and will sell it for 80% of its value. We’re supposed to mark it down and go through the P&L account. We owned Wells Fargo, with some bought at higher prices that we’re required to mark down. We also had gains on some of the purchases, but we couldn’t hold the gains against the losses. The method we use requires greater markdowns, but saves money when we sell investments.

With respect to Dave Sokol, his behavior was inexplicable and inexcusable. (Source: BRK website) “You know, I will never understand exactly why some of the events that transpired did transpire. And to some extent, in looking at what happened a few months ago with Dave Sokol’s failure to notify me at all that he’d had any kind of contact with Citigroup, in fact, he directed my attention to the fact that they represented Lubrizol and never said a word about any contact with them, and then the purchase of stock immediately prior to recommending Lubrizol (LZ) to Berkshire (BRK) , I think I – for reasons that are laid out in the audit committee report, which I urge you to read and which is on our website, I don’t think there’s any question about the inexcusable part that Dave violated our insider trading rules, and he violated the principles I laid out – I lay out every two years in a direct personal letter to all of our managers and which I’ve been doing for a long time. ..

The inexplicable part is somewhat – well it’s inexplicable..Dave to my knowledge made no attempt to disguise the fact that he was buying the stock, for example, by using a neighbor or cousin to buy instead. Dave left a total record of the purchase.

The second fact, which is puzzling, … but Dave has a net worth in very high numbers. He made I think close to $24 million. He earned it from BRK last year… But I will give you one instance that does make it puzzling.. Based on a five-year compounded gain in earnings, and we were starting from a high base, and we set a figure that no other utility company in the U.S. was going to come close to. But if that figure were achieved, we were going to give $50 million to Dave and $25 million to Greg Abel. And I had Dave come to the office … move forward at 16% compounded per year, here’s the payout. ..But he said there is just one change I would make… You should split it equally between me and Greg. It should be $37 and a half apiece… So we saw Dave transfer over 12 and a half million dollars to his junior partner. … and what really makes it extraordinary is that $3 million ten or so years later would have led to the kind of troubles that it’s led to…I had eight university groups, 160 students in on that Friday … and I spent most of the day with them. And the 10K and the 10Q that got printed out on Saturday have that date on them, the 15th, when I looked at LZ for the first time. He said, take a look at it, it might fit BRK. I said how come? He said I’ve owned it and it’s a good company. It’s a BRK type company. And you know I obviously made a big mistake by not saying, Well when did you buy it, but I think if somebody says I’ve owned the stock, you know it sounds like they didn’t buy it the previous week…

Munger: It’s a mistake to assume rationality will be perfect, even in good people.

Buffett: (to Munger): Do you have any explanation for the irrational?

Munger: Yeah. I think hubris contributes to it.” (Source: BRK website.)

Loomis: We’re each getting questions via email in the multi-hundreds, maybe thousands.

Buffett and Munger: We don’t know the questions.

Munger: We don’t know the answers either.

Questions were asked in the following order:

(1)Loomis: Question from a long time shareholder - Why wasn’t Buffett ruthless (Salomon Brothers quote) and fire Sokol on the spot when he learned of the details? Why was the press release so indirect? Why didn’t he express more anger? Why did he handle the matter so inadequately?
Buffett: In between January 14 and March 14, Sokol gave no indication that he had had any contact with Citi of any kind. Apparently, Citi had met with him in October and talked about potential BRK takeover candidates. He said Evercore and Citi represented LZ. When the deal was announced, Buffett got a call from John Freund who works for Citi in Chicago and has handled a lot of BRK’s equity business for decades. Buffett has a direct line with Freund, who called to congratulate Buffett on the LZ deal. He then mentioned that Citi’s team had worked with Sokol on the purchase and said they were proud to be part of it. The fact that Citi had been involved was news to Buffett and what Freund said immediately set off some yellow lights. Buffett then had BRK’s CFO, Mark Hamburg, call Sokol, who readily gave him the information on when he had bought the stock and how much he owned. Then he was asked about Citi’s participation. At that point, Sokol said that he called Citi just to get a phone number, which turned out to be somewhat of an understatement.

As a result of the deal, LZ had to issue a proxy statement. BRK was not issuing shares, so no proxy was necessary. Law firm Jones, Day worked with LZ on the proxy. Given what Freund had said, Buffett eagerly awaited to see the first draft. Buffett was leaving for Asia and wanted to see what LZ had to say about the Citi matter. Ultimately, the LZ proxy had a lot of information on Sokol’s involvement with Citi. At that point BRK’s law firm Munger, Tolles got involved and discussed with the LZ lawyers the discrepancy between what Sokol said and what the proxy stated.

Ron Olson (of Munger, Tolles, and Olson) was on the trip to Asia with Buffett. All he and Buffett knew at that point was that partners at Munger,Tolles were interviewing Sokol and others. They talked to Sokol at least three times about stock purchases and the relationship with Citi. Buffett decided that when they got back they would need to have a BRK board meeting on this matter. Specifically, Buffett wanted to know what the lawyers had found out in their interviews. Soon after, a letter was delivered by Sokol’s assistant (that was unexpected) in which Sokol said he was retiring at a high point. Buffett doesn’t know if the questioning had affected his attitude or this decision. Buffett immediately realized that the resignation could save BRK some money. If they had fired him, there could have been an argument regarding whether he was fired with or without cause. Given that he retired, there was likely to be no litigation and no severance costs.

Buffett thought it was proper to inform shareholders of Sokol’s resignation and he drafted a press release that laid out the good things Sokol had done. He also laid out some actions that he thought were not illegal (based on what he knew then). He then talked to Charlie and Ron Olson about the press release and they had no problems with it. Next he ran it by Sokol to make sure the facts were accurate. But Sokol objected to the idea that one reason he retired was that he had had his hopes of succeeding Buffett dashed. Accordingly, Buffett was willing to take that part out after Sokol affirmed all the other facts. Finally, even after a second viewing, Sokol said it was OK.

But, as Buffett would later find out from the LZ proxy, Sokol had known that LZ had an interest in being acquired even though the press release said the opposite. Sokol made no attempts to correct the facts on CNBC when he was interviewed. In the meantime, BRK delivered (through its law firm) some information to the head of the enforcement division of the SEC that detailed the facts regarding the stock purchases. In that case, BRK acted very promptly to make sure that the SEC was well versed in what had taken place up to that point. From his standpoint, Buffett thought Dave was gone and that there was little chance of future litigation. He also knew that he had presented some very damaging information to the SEC. But people are upset about the lack of outrage and Warren pleads guilty on that. His defense is that Sokol had contributed so much to BRK that he decided to focus on the positives instead. He believes Sokol’s actions were not the result of dashed hopes of being Buffett’s successor. Sokol didn’t expect to succeed Buffett. Buffett said he acted promptly when he knew the information. He called the head of SEC enforcement as soon as he knew and turned over damning evidence to the SEC and the public. He said he was guilty of not showing outrage.

Munger: That press release was not the cleverest press release in the history of the world. The facts were complicated and they did not foresee the reaction from the public and from shareholders. However, you do not want to make decisions in anger. Tom Murphy always told the people at Cap Cities that “you can always tell someone to go to hell tomorrow if that is such a good idea”. In this case, it was important to remember a man’s virtues and faults.

Buffett: We should not be surprised that Charlie approved the press release. Warren and Charlie have never had an argument even though they have worked together for 50 years.

(2)(Audience): What do you think will be the effect POMO (Permanent Open Market Operations) of the Federal Reserve ending its QE2 (Quantitative Easing) program at the end of June on the economy and stock market?

Buffett: With POMO, you’re one acronym ahead of me. QE2 is the most advertised open market purchase in history, in terms of timing and the amount purchased. Therefore, he does not think that something that well known (ending of QE2) can have any effect because the information has already been discounted by the markets at this point in time. Therefore, he sees no significant impact on the stock or bond markets.

(3)Quick: You have an emphasis on hiring and retaining managers who are talented. How do you know there are there no more “Sokols” among Berkshire’s managers?

Buffett:The potential for there to be more Sokols is a reason why Howard Buffett will be the Chairman when Warren Buffett dies. You can always make a mistake in choosing a CEO. In this case it is very unlikely but it is not impossible. The leading candidate now is straight as an arrow. Removing CEO’s has become less tough over time, especially when moral or ethical issues are involved. But, it is still difficult. An independent chairman who owns a lot of stock represents a safety measure to protect against a wrong decision. The directors will be thinking about the quality of the person as a human being as much as thinking about managerial skills. The directors are likely to find someone who cares more about BRK that he does about himself and they have multiple candidates who fulfill that. It’s easier to change a bad CEO but harder to replace a mediocre one.

(4)(Audience): If you were going to live another 50 years, what sector or asset class would you add to your circle of competence and why?

Buffett: He would pick a sector that is large enough so it would make a difference in BRK’s large portfolio. It would have to be in the technology field. Technology is going to be a huge field with huge winners but a lot of losers. Picking winners is going to be tough.

Munger: It would either be technology or energy. But we are the wrong people to develop that expertise. If it was going to happen, it would have happened. They want to identify someone else who has the abilities they lack.

(5)Sorkin: In the original press release regarding the Sokol matter, you said you were initially unenthused about making a deal to acquire LZ. But, in a short period, you warmed to the idea. How did that happen? What changed? Did Sokol convince you?

Buffett: Buffett didn’t know anything about the business and the chemistry of additives. All he cares about are the competitive dynamics including moats and durable competitive advantages. Buffett asked Sokol to discuss the company with Munger. But Sokol never called Munger, who didn’t know anything about the company either. Eventually Sokol passed along information to Buffett after having dinner with LZ CEO James Hambrick. As a result of that information, Buffett felt that he got an understanding of industry dynamics and how the oil industry is related to the additives business. Buffett realized that LZ had a durable competitive advantage. It had the number one market share in this business, a $10 billion market, and the position was sustainable; it had lots of patents and worked with customers on new engines. Lubricants help engines run longer and will alwaysbe around. The LZ management see BRK as an ideal home.