1997: How do all-stock mergers work?

AUDIENCE MEMBER: My name is Ted Vokali (PH) from Corpus Christi, Texas. And I would like to ask a question to you.

Companies are purchased from time to time, and the purchasing company will give shares instead of cash, and their shareholder will receive new shares.

Can an individual investor transfer non-Berkshire to Berkshire with or without going through a broker? And if not, how does Berkshire do this with another company? And if possible, I would like to also receive a copy of the annual report.

WARREN BUFFETT: OK, we’ll get you a copy of the annual report.

The only way I know of — and maybe Charlie knows some other way — the only way you can switch your shares in one company for — into shares of another company is to have a tax-free merger. And the Internal Revenue Code has specifications about that.

You can have a transaction, as we had with FlightSafety where a portion is — of the shareholders — can take cash, and a portion can take stock, and it’s still tax-free for the people who elect stock.

You can’t have too many people take cash and have that happen. There are a lot of technical rules about what’s tax-free.

But there’s no way that you can own General Motors and transfer it into General Electric stock without a tax and a broker. Well, you don’t have to have a broker. If your neighbor happens to own it you could make a deal privately. But the easiest way usually is through a broker.

But there’s no way you can do it without tax, unless General Motors and General Electric decide to merge at some point.

So the opportunities to switch from one security to another without tax are really limited to merger.

And in terms of brokerage costs, it just happens to be that it’s — that the most economical way of finding the person in the world that wants to both buy the stock you want to sell and sell you the stock you want to buy is through an intermediary — a broker. And the costs of that actually can be relatively low.

Charlie?

CHARLIE MUNGER: Well, I think there’s one way still permitted by the tax laws. You can still form a partnership. If you own General Electric and I own General Motors and we each feel too concentrated, well, you could form a partnership and each put in your stock. And in essence you would each thereafter be invested half and half with some diversification. I will predict that Wall Street will eventually get around to promoting such partnerships.

WARREN BUFFETT: Yeah, well, they did through swap funds, you know, since 25 years ago. And then — that was where you put in your highly — your stock that had an enormous amount of unrealized appreciation in it, and a whole bunch of other people did, and then you owned a fund which itself had a lot of unrealized appreciation in it. And you had —

CHARLIE MUNGER: Plus a new layer of costs.

WARREN BUFFETT: Yeah, plus a new layer of costs, always.

And you owned a piece of this larger fund, and you owned a piece of everything else — everything that the other people wanted to get rid of, and they owned a piece of what you wanted to get rid of, and superimposed with some costs.

But that vehicle was sort of stopped in its tracks, I think, in the mid-’70s by an amendment to the Internal Revenue Code.

But as Charlie said, you could replicate the effect of a swap fund by doing it with a partnership. It’d be kind of awkward, but it can be done.