Berkshire Hathaway's Buffett Responds to Press Reports Over General Re and Other Probes
National News • March 30, 2005
Berkshire Hathaway Inc. Chief Executive Officer Warren Buffett has acknowledged that he will voluntarily speak with investigators next month while also moving to correct several press reports ...
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Subject: SIDE LETTERS AND TORT LIABILITY
Posted On: April 4, 2005, 6:09 pm CDT
Posted By: Bill Is Wondering
Comment:
General Re has been found to have done business more than once using so-called "side letters."
Side letters are inherently dishonest business behavior. They're intended to fool third parties not involved in the deal-particularly regulators, investors, and other customers and suppliers.
Discovering side letters is like discovering toxic waste at your manufacturing facility - a liability of dimensions not yet visible.
Also, the fact that a company offers side letters at all means explicitly that its management is of a character which is willing to cheat.
Many stockholders may think, "So what, as long as they get the job done and make money? This isn't the Girl Scouts."
The "so what" is that side letters create potential tort liability for both parties to the deal.
In Australia, a company called HIH collapsed financially after acquiring FAI Reinsurance, a company to which General Re gave a side letter. The deal with the side letter helped FAI to cook its books. As a result, HIH was misled; its stockholders were misled; they no doubt demand compensation; and they are probably are entitled to it.
A few, seemingly small-potatoes side letters can create a very large path of destruction.
For example, few remember what happened to McKesson Corp. when it bought HBOC in 1998-1999. That was the biggest scandal ever in the stock market until it was eclipsed by Enron, Global Crossing, MCI Worldcom, and Adelphia.
Side deals were at the center of that scandal.
McK's stock price collapsed from $95 the week before it acquired HBOC to $32 a few months later, when it restated HBOC's finances. In market cap, it fell from $27 billion down to $9 billion.
And the share price continued to drift down to $18 in the succeeding months as executives were indicted and the details of the dirty deals came out. Today, McK is still only at $37.
What caused that collapse? In the four years before selling itself to McKesson, HBOC faked its finances. Side letters with customers were among the key misbehaviors of HBOC. It used them to inflate revenues.
A difference between HBOC and General Re is that HBOC used side letters to cook its own finances, while General Re allowed others to use its side letters to cook theirs. But tort and criminal liability could make this difference irrelevant: see Arthur Andersen.
McKesson didn't do anything wrong-except insufficient due diligence in buying HBOC. In that sense, it was in the same position as Berkshire is with General Re.
General Re is now answering investigators' questions in Australia, Ireland, New York, and, I believe, Indiana.
So regardless of whether Warren Buffett was "involved," liability is liability.
However, this situation does raise a question in my mind about Mr. Buffett.
It has to do with due diligence when acquiring a company. Assuming that Berkshire's lawyers and accountants did their due diligence correctly when acquiring General Re, then Mr. Buffett did know, or should have known, that General Re had made side letters a business practice.
In fact, General Re has been found to have issued at least one side letter since being acquired by Berkshire -- that is, under Mr. Buffett's reign. I find it difficult to imagine that he did not know of the practice.
Subject: SIDE LETTERS AND TORT LIABILITY
Side letters are inherently dishonest business behavior. They're intended to fool third parties not involved in the deal-particularly regulators, investors, and other customers and suppliers.
Discovering side letters is like discovering toxic waste at your manufacturing facility - a liability of dimensions not yet visible.
Also, the fact that a company offers side letters at all means explicitly that its management is of a character which is willing to cheat.
Many stockholders may think, "So what, as long as they get the job done and make money? This isn't the Girl Scouts."
The "so what" is that side letters create potential tort liability for both parties to the deal.
In Australia, a company called HIH collapsed financially after acquiring FAI Reinsurance, a company to which General Re gave a side letter. The deal with the side letter helped FAI to cook its books. As a result, HIH was misled; its stockholders were misled; they no doubt demand compensation; and they are probably are entitled to it.
A few, seemingly small-potatoes side letters can create a very large path of destruction.
For example, few remember what happened to McKesson Corp. when it bought HBOC in 1998-1999. That was the biggest scandal ever in the stock market until it was eclipsed by Enron, Global Crossing, MCI Worldcom, and Adelphia.
Side deals were at the center of that scandal.
McK's stock price collapsed from $95 the week before it acquired HBOC to $32 a few months later, when it restated HBOC's finances. In market cap, it fell from $27 billion down to $9 billion.
And the share price continued to drift down to $18 in the succeeding months as executives were indicted and the details of the dirty deals came out. Today, McK is still only at $37.
What caused that collapse? In the four years before selling itself to McKesson, HBOC faked its finances. Side letters with customers were among the key misbehaviors of HBOC. It used them to inflate revenues.
A difference between HBOC and General Re is that HBOC used side letters to cook its own finances, while General Re allowed others to use its side letters to cook theirs. But tort and criminal liability could make this difference irrelevant: see Arthur Andersen.
McKesson didn't do anything wrong-except insufficient due diligence in buying HBOC. In that sense, it was in the same position as Berkshire is with General Re.
General Re is now answering investigators' questions in Australia, Ireland, New York, and, I believe, Indiana.
So regardless of whether Warren Buffett was "involved," liability is liability.
However, this situation does raise a question in my mind about Mr. Buffett.
It has to do with due diligence when acquiring a company. Assuming that Berkshire's lawyers and accountants did their due diligence correctly when acquiring General Re, then Mr. Buffett did know, or should have known, that General Re had made side letters a business practice.
In fact, General Re has been found to have issued at least one side letter since being acquired by Berkshire -- that is, under Mr. Buffett's reign. I find it difficult to imagine that he did not know of the practice.