B000U5KFIC EBOK (24 page)

Stamps were popular with housewives and with merchants, who
liked the increased sales and profits. One of the first trading stamp companies was S&H Green Stamps, but according to S&H's rules, only one
type of retailer-a single grocery store, gasoline station, or drugstore-in
each area could offer S&H stamps. A group of nine retailers, including
Chevron Oil, Thrifty Drugs, and important California grocery chains,
wanted the same competitive advantage, so they got together in 1956 and
created Blue Chip Stamp Company. The Company was controlled by the
nine retailers who organized it. Other store owners were allowed to offer
the stamps, but they had no say in how the business was run nor did they
share in the profits. Blue Chip became by far the largest trading stamp
company in California and was so successful that eventually it faced a law suit from the small retailers who thought they weren't getting a fair shake
from the founders. They claimed that the founding owners had violated
antitrust laws by not providing ownership rights to small merchants.

In December 1963, the Department of justice filed an antitrust action against Blue Chip Stamp and the nine founding shareholders. After
four years in court, a consent decree was entered in June 1967, calling for
a complete reorganization of the company so that the founders could no
longer exert complete control. Blue Chip Stamp Company then added an
"s" to its name and became Blue Chip Stamps.

Under the court's decree, Blue Chip was required to offer approximately 621,600 shares of its common stock to the smaller, retail users of
the stamps who previously were not shareholders. The shares were issued
on a pro rata basis determined by the quantity of stamps given out by
each of the nonstockholding retailers during a designated period. The offering consisted of three shares of common stock and a $100 debenture
for a cash payment of $101. Any of the 621,600 shares not purchased by
the nonstockholder users were to be sold on the open market. This new
stock part of the offering amounted to 55 percent of the common stock of
the company. To provide liquidity for old and new shareholders, the new
Blue Chip shares were traded over-the-counter.

"Thousands of little retailers ended up with Blue Chip stock," said
Buffett, and a market was born for the shares. "We saw this as a very
cheap stock and bought aggressively. Charlie, Rick, and I ended up controlling Blue Chip."

They acquired their shares separately. "I started with $80,000," said
Guerin, and built from there. Munger's investment matched Guerin's
fairly closely.

"At Blue Chip Stamps, we finally took over the company. It was a
friendly, gradual kind of takeover, but we took it over," said Munger.

By the early 1970s, Buffett's various entities had become Blue Chip's
largest stockholder, Munger was the second largest and Guerin was somewhere behind. The three had accumulated enough shares to warrant
positions on Blue Chip's board of directors.

"Blue Chip had an `old boys' board, some of whom resisted new guys,
especially these smart-alecky young guys," said Guerin. "Charlie went on
the board first, then convinced them they should accept me, and finally
Warren was accepted."

Soon, their shareholdings in Blue Chip became densely tangled. In
1971, Warren and Susan Buffett personally owned 13 percent; Berkshire
Hathaway Inc., of which the Buffetts were 36 percent owners, held 17
percent, and Diversified Retailing Co. Inc., of which the Buffetts owned 42 percent, held 16 percent. In addition, Diversified Retailing owned
shares in Berkshire, and Munger's partnership owned 10 percent of Diversified Retailing, plus 8 percent of Blue Chip. Guerin's partnership also
owned 5 percent of Blue Chip. Eventually, after more purchases of Blue
Chip stock, the liquidation of Wheeler, Munger, and the merger of Diversified Retailing into Berkshire, Berkshire's ownership reached 60 percent. Together Berkshire, Buffett, and Munger owned nearly 75 percent of
the outstanding shares of Blue Chip.

For some years, trading stamps continued to be Blue Chip's main
business. In 1970, Blue Chip sales peaked at more than $124 million, but
soon the popularity of trading stamps waned, and by 1982 sales plummeted down to $9 million. Sales amounted to only $200,000 a year by the
late 1990s when Blue Chip's trading stamps were primarily issued by a
few bowling alleys.

Buffett and Munger gained control of the investment committee once
they were board members, and so during the time that trading stamps
were slipping from favor, the investment committee was at work building
the value of Blue Chip's float.

Among the investments that Buffett and Munger acquired through
Blue Chip was the largest block of troubled Source Capital, a closed-end
investment company established in 1968 by the infamous "Go-Go" manager Fred Carr. Carr was a phenomenon for a while, but soon was discredited by the choppy stock market of the early 1970s. When Carr quit
Source Capital, the fund had $18 per share in asset value, but was trading
for $9. It was a situation much like that at the Fund of Letters, except
that after Carr left, portfolio managers at Source Capital had considerable
talent and a mind-set similar to that of Munger and Buffett. Blue Chip acquired 20 percent of the fund and Munger went on the board where he
got along well with the main portfolio managers. Source Capital remained
an independent company and is stilled listed on the New York Stock
Exchange. Munger and Buffett referred a lot of management clients to
Source Capital in subsequent years.

Most of Buffett's and Munger's acquisition attempts went smoothly,
but they did not get all the properties they sought to acquire. In 1971,
Blue Chip was outbid in an attempt to buy the Cincinnati Enquirer. The
Enquirer at the time had a daily circulation of 190,000 and a Sunday circulation of 300,000. E.W. Scripps Co. was being forced to sell the newspaper to settle a U.S. Justice Department case charging it with having an
illegal monopoly in the Cincinnati market. Blue Chip offered Scripps and
its affiliate, Scripps-Howard, $29.2 million for the newspaper but was
turned down. The Enquirer is now owned by the Gannett Company.

By 1980, Blue Chip had five areas of business: the remainder of its
trading stamp business, See's Candy Shops, Wesco Financial, the Buffalo
Evening News, and Precision Steel.

Along the way an uncomfortable incident involving Blue Chip's acquisition of Wesco Financial. The reaction of the Securities Exchange
Commission caused Buffett and Munger to re-evaluate the way they were
conducting their business.

The story began in the summer of 1972 when a broker offered Buffett
and Munger a block of Wesco Financial, the parent company of Pasadenabased Mutual Savings and Loan Association. Wesco's stock was trading in
the low teens, less than half its book value. Buffett and Munger agreed
that it was a bargain, and through Blue Chip, acquired 8 percent of
Wesco's shares. Even that early in its history, a $2 million stake was a
relatively minor investment for Blue Chip.

Then in January 1973, Wesco's management announced plans to
merge with another savings and loan, Financial Corp. of Santa Barbara.
Buffett and Munger felt that Wesco was selling itself at a fire sale price.
The deal called for Wesco shareholders to swap their undervalued shares
for those of overvalued Financial Corp. Munger and Buffett didn't think
the deal was a good one for shareholders on the Wesco side.

Said Buffett: "I read these terms, and I didn't believe them. And I told
Munger the terms and he couldn't believe it either. But it was there in
black and white on the Dow Jones tape."

Munger wanted to buy more Wesco stock to fight off the merger, but
Buffett did not. Charlie prevailed, and for six weeks, Blue Chip bought
every Wesco share it could find, accumulating about 17 percent of the
company. They couldn't buy more than 20 percent without regulatory
approval and that would take a long time to obtain.

Munger called on Louis R. Vincenti, Wesco's president, to inquire
about his reaction to the existence of a large unhappy shareholder.
Without being acrimonious, Vincenti said that Blue Chip was free to
vote against the merger if it wished and to solicit other shareholders to
do the same, but the outcome would be determined by shareholders,
not Vincenti. This was the kind of straight talk Munger liked. He
immediately developed an admiration for Vincenti, and Buffett soon did
the same.

For shareholders to vote the merger down, Munger and Buffett
would have to persuade Elizabeth Peters, a San Francisco heiress who
owned a Napa Valley vineyard, and her brothers, to go along with them.
Peters' father had founded the S&L and took it public in the 1950s and
the Peters still owned a large block of shares. Elizabeth Peters hoped
that the Financial Corp. merger would inflate Wesco's flagging share price. Donald Koeppel, Blue Chip's president, tried to persuade Betty
Peters to change her mind, and when he failed, Buffett gave it a try.

"I flew out and talked to her-out and back in one day-we talked in
the American Airlines lounge at the San Francisco airport," said Buffett.

Peters insisted that something had to be done to improve the S&L's
performance, and Buffett said he'd like to try it himself. She was impressed with his self-confidence, but asked a question that would be
posed again and again as Berkshire grew.

"Mr. Buffett, if I buy you, what happens if you get hit by a truck at
the intersection? Who would save Wesco then?" Buffett assured her that
Charlie Munger was waiting in the wings.'

Warren persuaded Peters to vote against the merger and to ride along
with her family's Wesco shares, remaining as a Wesco director on a board
that Munger would join. This turned out well for Peters, since Financial
Corp. went bust and Wesco prospered mightily with the help of Buffett
and Munger aboard.

After squelching the merger, Munger and Buffett could legally buy
only another 3 percent of Wesco's outstanding stock and they set out to
do so. They had been paying about $17 per share right up to the time the
merger was cancelled. They knew that Wesco stock was sure to decline in
the short term. Nonetheless, they offered $17 per share, thinking it only
fair since it was they who had interrupted the merger. "We decided in
some quixotic moment that it was the right way to behave," said Munger.'

After some period of time passed and the regulatory hurdles were
leaped, Blue Chip made several subsequent tender offers, and eventually
raised its Wesco stake to 24.9 percent. By mid-1974, Blue Chip owned the
majority of Wesco shares. Munger and Buffett would have acquired more
Wesco shares, but stopped at 80 percent at the request of Peters, who remains a large minority shareholder.3 Buffett lets Peters set Wesco's divided policy and she increases the payout slightly every year.

All through this, however, the SEC for some reason had been tracking
the activities of Buffett and Munger and had some questions about the
Wesco deal.

"I've always suspected that someone who wanted the Financial Corp.
merger to go through complained to the SEC," said Munger. And yet, he
admitted, the convoluted ownership at Blue Chip did appear suspicious.

"When the SEC started looking, there were all these criss-crossed
ownerships. That happened by accident. But it was complicated and because so many people create complications to hide fraud, the SEC delved
and delved and finally fixed its attention on something-how we got
Wesco. People assume if what you're doing is enormously complicated,
you're probably doing something wrong."

Indeed, Buffett, Munger, and to some extent Guerin, owned stakes in
an incredibly intertwined bundle of companies. The three men's investments had grown this way and that, taking whatever structure seemed
logical and fair at the time. The organization was a little too disorganized
for the tastes of the SEC. But there also was a legal question.

The SEC's concern was whether Blue Chip had unlawfully manipulated the stock of Wesco in some way. The SEC rightly concluded that
Munger and Buffett bought shares at an obviously higher-than-necessary
price, and suspected sonic sort of preemptive motive, rather than a
benevolent one. Buffett responded to the inquiries by shipping three cartons of documents, memos, stock transfer documents, and so on to Washington. Buffett reacted calmly: Munger, on the other hand, was impatient.

The SEC investigation became an impediment to Blue Chip's everyday business, and in the fall of 1974, Munger wrote to his attorney, Chuck
Rickershauser, "I hope the foregoing will satisfy everyone at the SEC and
that, if not, you can arrange that I receive the promptest possible response, preferably by direct telephone calls to me, so that we can clear up
any problems and get our merger consummated.""

Instead, the SEC opened a full-scale investigation of Buffett's investment practices: In the Matter of Blue Chip Stamps, Berkshire Hathaway
Inc., Warren Buffet [sic], HQ-784.

"Blue Chip, Berkshire, Buffet [sic], singly or in concert with others ... may have engaged in acts which may have directly or indirectly
operated as a device, scheme, or artifice to defraud; or included in an untrue state of material of fact or omitted .....

In the meantime, the Washington DC rumor mill churned with the
news that Munger's former law partner, Rod Hills, had been offered the
job of SEC chairman. Rickershauser, who also was acting as Buffett's
lawyer, called Hills and asked him to reject the job offer, claiming that if
he took the post, the SEC might feel compelled treat the Blue Chip case
more harshly just to make sure there was no suggestion of favoritism. According to some reports, Munger called Hills several times and berated
him for not standing by his friends, but Hills said that Munger never
called him about the matter. They never discussed it at the time or later.
At any rate, Hills dismissed Rickershauser's request as inappropriate and
accepted the job anyway.