Warren Buffett holds a very special place in the investing world. People all over the world flock to his shareholder meetings in Omaha and anyone who’s serious about making money in the markets carefully reads through his annual letters to shareholders, sifting through them for insights.
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Warren Buffett is often held up as a man of immense character and a genius investor but did you know that between 1974 and 1976 Buffett was investigated by the SEC for manipulating the price of a penny stock called Wesco? It’s true. He sort of admits what he did was wrong and paid a hefty fine of $115,000.
The Oracle of Omaha is a true pioneer of investment philosophy and is known for his folksy wisdom about life and business. He’s said things like: “Never underestimate the man who overestimates himself”, or “Price is what you pay. Value is what you get”.
Buffett is also legendarily frugal, living a lifestyle that hasn’t changed much from the time before his many, many billions. Even though the man is the third-richest man in the world and worth about $73 billion, he still lives in the same house he bought in 1958, a house he bought for $31,500 (or $260k in 2015 dollars).
So What Happened in 1974?
More than 40 years ago, Warren Buffett assisted in the takeover of Wesco Financial, a savings-and-loan company based in Pasadena, California. In 1972 he and his partner Charlie Munger began acquiring shares in Wesco via Blue Chip Stamps.
Wesco Financial went public in the 1950s, but by the 1970s it was having a tough time of it. Buffett had been following the company for a while and by 1972 Wesco’s share price was only about half of its book value. Book value is the value of a business as calculated from its “books” or financial statements. Very generally, a company’s book value is the difference between its total assets (property owned, anything that generates cash) and total liabilities (debts or obligations).
At the time, Wesco’s plan was to merge with another company and the heads of Berkshire were aware that Wesco was offering itself at a deep discount. Blue Chip Stamps was a trading stamps company and fully owned by Buffett’s Berkshire Hathaway. Using this company as a middleman, Buffett vacuumed up 8% of the stock for about $2 million. Soon they would up their investment to 20% in order to influence the directors of Wesco against the merger.
It didn’t work.
Enter Betty Peters, the only member of the founding family of Wesco that was interested in Buffett’s view on the deal. She met with the Oracle and was swayed. Peters was able to move the other family members of the board and the merger was called off.
This sent Wesco stock into the ground, crashing to $11 from over $18. At the same time Blue Chip was still increasing its stake in Wesco, the share rising to 25%. The shares kept falling and Berkshire, through Blue Chip, kept raising its stake until 1974 when it became a majority shareholder in the company.
That’s when the SEC came calling.
The SEC, or Securities and Exchange Commission, was poking around the events that transpired over the past two years. They concluded that Buffett and Munger had deliberately broken up the Wesco merger by offering a higher price for the stock than the stock merited and then using the opportunities once the stock crashed to buy up the rest.
They were operating on the assumption that Buffett and Blue Chip had planned to take over Wesco from the very beginning, and now Buffett was in a fight to save his reputation.
The situation was complicated by the fact that Buffett had actually paid above market price once the shares had collapsed. That didn’t look good. Their reasoning: they felt slightly indebted to the management at Wesco, as they had been counselling a breakup of the merger. As Buffett said in 1975 when asked why they had over-paid, “…the general business reputation of Blue Chip would not have been as good. I think someone might have been sore about…[it’s] important how Wesco management feels about us.” Charlie Munger admitted that the details of the deal did not look good but echoed Buffett’s thoughts, remarking, “We wanted to look fair to Lou Vincenti and Betty Peters”.
The SEC lawyers seemed to sense the good character of Buffett but could not ignore the sequence of events and the subsequent entanglement. Neither could Munger and Buffett and in fact, after a while of maintaining his view of the events, Buffett confronted the prosecutor: “If you look at it your way, you’re right, there is a technical violation. If you look at it our way, there isn’t. But we weren’t out to do anything wrong. Now how do we solve it?”
Wesco Stock & Warren Buffett’s Fate
But it didn’t matter – a case had been opened. Now the SEC either had to prosecute or settle, and so the SEC offered a settlement deal. In a settlement the offending party pays a penalty without having to officially admit guilt.
And so the SEC slapped Blue Chip on the wrist, and levied a fine of $115,000 without naming any individuals in the case. They formally charged Blue Chip of manipulating the stock price of Wesco, which Blue Chip neither agreed nor denied. At the time Blue Chip owned 80% of Wesco and would later merge with Berkshire Hathaway in 1983.
The publicity regarding the investigation had been trivial and quickly faded out of memory. So much so that today when you read this, it may well be the first time you’ve ever heard of Buffett being in trouble with the law.
It didn’t hurt him too much.