In today’s Finshots, we tell you what an investigative journalism platform has revealed about the personal trades of one of the world’s greatest investors.
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If you manage or invest money for customers, there are 3 cardinal rules.
Rule #1: You don’t front-run orders. This means that if you know your company is buying a big chunk of stock in one of the funds that can potentially move the price, you don’t jump ahead in the queue and buy it in your personal account first. Or vice versa too. You don’t sell a stock before your fund sells.
Rule #2: You don’t do the exact opposite of what your fund’s doing. If your fund is buying Stock A, you don’t go and sell it in your account instead. It sends quite a conflicting message. Do you not believe in the stock your fund is buying?
Rule #3: You have skin in the game. Let’s say your fund likes the IT sector. Hypothetically. It wants to pick one stock and it has narrowed it down to Infosys and TCS. After much deliberation, the fund goes with Infosys. Ideally, if you want to bet on IT too, that’s the stock you will buy in your personal portfolio. You’ll buy the same stock. Albeit after the fund has completed its purchase. This way, there’s symmetry; you win if the fund pick is right. But if the fund makes a wrong decision and the customers or investors get hurt, you, the person in charge of the fund, share the downside too. Or if you’re a techie, you might relate to a concept called ‘dogfooding’ where a company’s employees use the same products as their users. If you’re selling it to someone, it better be good enough for you to use it.
Now here’s the thing. It appears that the legendary investor Warren Buffet might have bent or broken some of them. Or at least that’s what ProPublica claimed on Thursday.
Now you might be scratching your head wondering who’s ProPublica and if we can even rely on them. But let's suppose we give them the benefit of the doubt. This non-profit investigative journalism platform has done these sorts of deep dives into what they call “the abuse of power” before — such as exposing how the wealthiest Americans avoid income tax. And when they got access to tax records of wealthy Americans, they dug into Warren Buffet as well. Just to see what he was up to. And here’s what they found.
So let’s start with Rule#1.
Back in 2012, Buffett sold $35 million worth of shares in the pharma giant Johnson & Johnson. At the same time, his company Berkshire Hathaway was winding down its position in the company. And people got to know about Berkshire’s plans when they filed a report with the regulator. It’s not like they made a big press release out of it. So it took a bit of time to get to the public domain. But Berkshire wasn’t done. It took another 6 months to make its exit. It was slow and steady.
Now we’re not saying that Buffett indulged in front-running. But think about it for a minute. ProPublica points out something in Berkshire’s own ethics document which says:
…if an employee is “aware that Berkshire has taken or altered a position in a public company’s securities or that Berkshire is actively considering such action, trading in any securities of such public company” is “expressly prohibited prior to the public disclosure by Berkshire of its actions.”
Basically, assume you’re Buffett and you know that Berkshire is going to keep selling Johnson & Johnson. And you know how many months it’ll take to wind down your position. But the rest of the public doesn’t have access to this information. It’s information that’s private to you. So if you act on what you know, you’re trading on “inside information” and by placing your orders for your personal benefit, you’re kind of front-running the public too. Because when Berkshire sells, it could lead to other investors taking a cue and selling their shares. It could drive the price down. But you’ve managed to exit before the mayhem and protected yourself from the loss.
That doesn’t come across as ethically sound.
Then there’s Rule #2.
In 2009, it appears that Berkshire was doubling its stake in retail major Walmart. It had held the stock for over 3 years already and buying more was a major sign of confidence. But while that was happening, Buffett instead decided to sell $25 million worth of Walmart in his own portfolio. It was a conflicting trade.
Sure, without more information, you could argue that Buffett might’ve needed the cash for something. And when he looked at his portfolio, he felt that Walmart was the stock he wanted to sell. Also, ProPublica says that they can’t ascertain whether Berkshire bought first or Buffett sold first, so we can’t confidently say that he broke Rule #2. But this kind of trade does raise some red flags.
Imagine that Berkshire bought the stock first. The news would’ve become public. And other investors would’ve pushed to buy too. It could’ve pushed the price higher. So if Buffett knew that such a trade would take place, he could wait, and then sell stock once that scenario unfolded. He would’ve got more money in his account that way.
And finally, there’s Rule #3:
In 2009, Berkshire was one of the largest shareholders of Wells Fargo. Buffett praised the company publicly in all the interviews as well.
But behind the scenes, Warren Buffett was doing something else. He’d bought shares of a rival bank JPMorgan Chase instead.
But wait…he wasn’t keeping this information completely under wraps. He revealed his investment in JPMorgan in 2012. He said he had a rationale for this too. He said that since Berkshire was buying Wells Fargo, he couldn’t do that in his personal account. So he looked at what was the second choice in banking and picked that.
That’s a bit weird. And we can’t put this situation better than what Bloomberg’s Matt Levine:
“Warren Buffett, the legendary stock picker, picked two big banks that he liked; he bought one for himself and one for his shareholders. The one he bought for himself was, he said, his second choice, but it performed much better than the one that he bought for his shareholders. Is that not a conflict of interest? Would it not align interests a bit if Buffett bought the stocks for himself that he buys for his company?”
Yup, over the longer term, JPMorgan’s stock did better than Wells Fargo. Wells Fargo even ran into a massive scandal a few years ago — its staff opened customer accounts without permission, forged signature and identification numbers, and then some folks took it a step further and stole money from customer accounts too. The stock cratered and Berkshire was finally forced to sell.
So it does get one thinking, doesn’t it?
And the reason why all this is even more intriguing is that Buffett has been quite secretive about his own investments. For instance, one of the most famous books written about Buffett is by Alice Schroeder. It’s called The Snowball and Schroeder was hand-picked by Buffett to write about him. But apparently, even she says that while she was given access to just about everything in his life, he kept his personal investing record under lock and key.
Anyway Warren Buffett has been managing money for decades now. And you could say that he has a fairly unblemished record. Even the ProPublica information isn’t damning. It hasn’t said that Warren Buffett pocketed billions through his personal trades. Nor does it have exact information about the specific date when he decided to buy a stock. So it doesn’t seem like this will affect his reputation in any way.
But hey, we thought you should know about it. And if you have any thoughts on the ethics of a money manager investing their own money, tell us.
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