The SEC Thought Charlie Munger Was Hiding A Hedge Fund In Some Newspapers

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Here's a neat little story from Bloomberg: Charlie Munger, Warren Buffett's long-time right-hand man at Berkshire Hathaway, moonlights as the chairman of the board of a wee newspaper company called Daily Journal. Daily Journal owns a collection of newspapers so dull that they "specializ[e] in public notice advertising," particularly notices of foreclosure sales. It also owns $128 million in marketable securities, virtually all of it ($121mm) in common stocks. This is noteworthy because, one, Charlie Munger is the one picking the stocks, and two, Daily Journal's total book assets are only $173.8mm, its book equity is $106mm, and its market cap is around $190mm. For every dollar you invest in Daily Journal, you're getting around 33 cents of foreclosure notices and 67 cents of Charlie Munger's stock-picking. Charlie Munger's stock-picking: pretty good, as it happens, and in any case a commodity that some people desire.1

Which led to an amusing exchange with the SEC where:

  • the SEC asked Daily Journal, "hey wait are you just a front for a Charlie Munger stock-pickery?," and
  • Daily Journal replied (1) no but (2) the Charlie Munger stock-pickery worked out pretty well for us, huh?

The reason for the question is that you can't just go around having a public company whose business is investing in stocks picked by Charlie Munger, or anyone else of course. To be a public company whose business is stock-picking, you need to be a mutual fund, which entails various registrations, restrictions on investments and leverage, disclosure requirements, etc.2 Or of course you could be a hedge fund, which avoids many of those requirements, but at the cost of (1) limiting your fund-raising to accredited investors, which is somewhat liquidity-reducing, and (2) normally, abiding by the custom that hedge fund capital is not locked up permanently the way public equities tend to be.

Being a mostly-unregulated hedge fund wrapped in a public company with the ability to raise permanent capital from retail investors is an attractive enough proposition that lots of people want to do it. There is, for instance, the insurance racket, which is more or less Buffett & Munger's own approach with Berkshire Hathaway. This subjects you to insurance regulation, which imposes its own burdens, though if your insurer is a reinsurer incorporated in Bermuda those burdens do not appear to be unduly taxing. Thus lots of hedge funds have reinsurers that are not all that gung-ho about actually writing reinsurance, more or less for permanent-capital purposes, plus some tax evasion.

Also another way to run a lightly regulated hedge fund with permanent capital from the public markets is to be an investment bank but that is a somewhat don't-try-this-at-home strategy these days.3

But newspapers are sort of a new one! Obviously lots of real companies invest their spare cash in securities, and some of them - Apple comes to mind - do so quite actively and in size. But the law is roughly that if you're "primarily engaged ... in a business or businesses other than that of investing, reinvesting, owning, holding, or trading in securities" you don't have to register as a mutual fund. Eyebrows start being raised when investment securities exceed 40% of your assets.

Daily Journal is well over that threshold,4 but their letter to the SEC explains why they are nonetheless not a mutual fund, and the SEC seems to agree. Like: Daily Journal "presents itself to the public" as a newspaper company, not a front for Charlie Munger's investment prowess. Like: "None of the company’s officers or employees spend any time selecting or managing the Company’s investments in marketable securities," because Charlie does it all himself.5 Like: Daily Journal gets most of its income from newspapering, not investing, though this is to some extent a trick of accounting.6

Now the best evidence that Charlie Munger is not running a secret hedge fund inside of a tiny newspaper company in order to skirt SEC rules is that he's Charlie Munger. If he wanted to start a hedge fund he could just sit in an Omaha diner drinking Cherry Coke for an hour and billions of dollars in long-term locked-up institutional money would find its way into his pockets. People are pretty into the Buffett effect, even by proxy. He just happens to be on the board of this newspaper company, and the least he can do for them is make them some money on stocks, and it's hard to criticize him just because he made them a lot more money on stocks than they made on newspapering. Better than losing them money on stocks, surely.

Still I wonder if the precedent might be useful to anyone else. The future seems to involve a lot of retailization of alternative asset managers, with for instance broad hedge fund advertising, the rise of BDCs, this Blackstone mutual-fund-of-hedge-funds, etc. Those efforts get a lot of attention, some of it fairly skeptical, because when the likes of Goldman and Blackstone sell unorthodox products to retail investors the press tends to assume that those investors are getting fleeced. On the other hand, if you did your unregulated investing of retail money through a newspaper, who could find fault with that?

Daily Journal letter to SEC [EDGAR]
Daily Journal Tells SEC Munger Knows Best Buying Stocks [Bloomberg]

1.Bloomberg:

Daily Journal’s stock bets have soared in recent years and accounted for about 70 percent of the publisher’s $173.8 million of assets at the end of June. Much of that gain can probably be traced to bets on Wells Fargo & Co. (WFC), according to investors who attended the publisher’s annual meetings. The largest U.S. home lender has climbed more than five-fold since its 2009 low and is the top holding at Buffett’s Berkshire Hathaway Inc.

2.For instance you gotta say what you invest in. Here's Daily Journal's description:

During the first quarter of fiscal 2012, the Company bought shares of common stock of a Fortune 200 company, and during the third quarter of fiscal 2012, it bought additional shares of common stock of one of the foreign manufacturing companies in which it had previously invested. There have been no additional purchases in fiscal 2013. The investments in marketable securities, which cost approximately $49,694,000 and had a market value of about $128,421,000 at June 30, 2013, generated approximately $1,832,000 in dividends and interest income, which lowers the effective income tax rate because of the dividends received deduction. As of June 30, 2013, there were unrealized pretax gains of $78,727,000 as compared to $52,464,000 at September 30, 2012. Most of the unrealized gains were in the common stocks.

A mutual fund couldn't just go around saying "we got a lotta stock in a Fortune 200 company. We won't tell you which one. We'll give you 200 guesses."

3.I meeeeeeeeean. You know what this footnote says. Volcker etc. Anyway it's a less compelling strategy than it used to be.

4.So's Apple btw.

5.Ehh, him and another director and major stockholder, J.P. Guerin.

6.In 2012, for instance, Daily Journal had about $8.7mm in income from newspapering, about $2mm in income from its investments, and about $2.9mm in other-than-temporary impairment losses on its investments. So more than 100% of its net income was from newspapering. But! It also had $15.1mm - twice its GAAP net income - in unrealized appreciation in those investments, which go to comprehensive income but not to net income. Daily Journal thinks that the right test is realized income only:

It is worth noting that all of the unrealized appreciation in the Company’s marketable securities is considered “comprehensive income”, but that is not included in calculating net earnings or in earnings per share. The accountants’ use of the word “income” is a bit misleading because the unrealized appreciation does not actually represent income until it is realized and net of taxes. It would not be appropriate to consider “comprehensive income” when applying the ... “present income” test because “comprehensive income” reflects nothing more than changes in the market value of the Company’s marketable securities over time and is not present income of the Company.

I guess I buy that? In any case, if it is a hedge fund, it's not a particularly churny one. Oh also by the way this is a fascinating story about why it's doing so well in the newspaper business, from the same letter to the SEC:

That the Company even had excess cash to invest is due primarily to the confluence of a unique aspect of its publishing business and the country’s largest financial crisis in more than 70 years. The Company’s newspapers are “adjudicated”, which means they are eligible to publish legal notices, including notices of residential foreclosure sales that are required by California and Arizona law to be published by the foreclosure trustee in an adjudicated newspaper. The Company aggressively competes for the opportunity to publish trustee foreclosure notices, and there were lots and lots of them to be published in California and Arizona beginning in 2006.

So, while the “Great Recession” ironically benefitted Daily Journal, the Board knew that it needed to plan for the Company’s post-recession operations.

So it gave the money to Charlie Munger etc. etc. That's pretty ghoulish though.

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