The Other Side of the Trade
Reflections on trying to profit from the technical problems that caused Berkshire Hathaway and other stocks to temporarily crash on June 3, 2024.
Financial markets can do crazy things at any time.
I was not shocked to see Berkshire Hathaway’s Class A shares quoted at $185.10, down 99.97%, on Monday morning. I immediately assumed that this was a glitch caused by a software malfunction, and that assumption turned out to be correct. All trades of Berkshire’s stock that actually executed at ludicrously low prices were invalidated by the New York Stock Exchange.
I could not resist placing a limit order at $186 after seeing the glitch. Alas, my order was never filled, and even if it had been filled, the NYSE would have invalidated the trade. However, trades at temporarily insane prices are not always invalidated, as we saw during the 2010 flash crash, so I figured that entering a limit order was akin to a free lottery ticket. Crucially, this was a limit order, not a market order, so when trading resumed at normal prices, my order was not executed. Apparently, some traders ended up with executions at normal prices over $600,000 because they used market orders!
This event added excitement and humor to an otherwise mundane Monday morning, but it later occurred to me that my actions revealed a certain attitude toward the stock market that is at odds with what I believe common stock ownership really represents. When I placed my trade and hoped for an execution at a ridiculous price, I never even thought about the other side of the trade.
If ownership of common stocks represents a true ownership interest in a real company, and if other shareholders are truly your partners, would it be ethical to try to buy shares from your partners at a 99.97% discount due to some temporary trading glitch? The answer is obviously no if you regard the other side of the trade as a human being similar to yourself, but it is easy to rationalize this by viewing the other side of the trade as some faceless individual or, better yet, as some automated algorithm trading for a large financial institution.
One might point out that the only way a seller could have been hurt by Monday’s insanity is if he or she placed a market order to sell rather than a limit order, and doing so would be their own fault. This is true, to a point, but individual investors make this mistake frequently. Would I feel good if my trade had been filled and the other side of the trade was an individual investor who had owned their shares for years or even decades? When a name and face is associated with the trade, the ethical assessment naturally changes.
What if the other side actually was a financial institution, not an individual shareholder? Would the ethics change? Large institutional investors are supposed to be fiduciaries. They are not the ultimate owners of a security. They own securities on behalf of others. Is the individual investor in a fund who indirectly owns shares of a stock any less of a “partner” in the business than someone who owns shares directly? In theory, that individual is still a partner, albeit indirectly and probably in a small way. However, the ethical implications seem identical to me.
The implications of this sort of ethical rumination go beyond the question of capitalizing on a trading glitch like we witnessed on Monday morning. To what extent is it justified to purchase stock that is trading normally but you believe to be undervalued when the other side of the trade is an individual who either directly or indirectly owns the shares? In normal markets, nearly everyone would say that it is perfectly fair to “take advantage” of the seller in this situation and I would agree. If I did not agree, how could I make any active purchase of a security? Was it wrong for me to purchase shares of Berkshire Hathaway in February and March 2000 when I thought it to be undervalued because the individual on the other side was selling too cheaply? I would argue that this was ethical.
For many years, Warren Buffett was very reluctant to repurchase shares of Berkshire Hathaway. When Berkshire traded only slightly above book value during the summer of 2011, Mr. Buffett finally decided to put in place a formal repurchase program, but he handcuffed himself by imposing a price-to-book limit of 110%, which was raised to 120% the following year. Very few shares were repurchased.
Based on studying Mr. Buffett’s comments and writings over many years, I am convinced that he views Berkshire Hathaway shareholders as partners, particularly those who own the stock directly and have held for decades. However, I am sure that he also feels a fiduciary duty to indirect shareholders who own Berkshire through funds managed by financial institutions. I suspect that at least part of his reluctance to repurchase shares was due to not wanting to benefit from selling shareholders who would be parting with their shares too cheaply.
In 2018, Berkshire amended its share repurchase policy to make it far easier to buy back large amounts of stock. Berkshire has used $77.6 billion to retire 208,226 Class A equivalents since 2018 reducing the share count by 12.6%. Mr. Buffett is restricted to making repurchases only when he considers the shares to be trading below a conservative estimate of intrinsic value. Berkshire’s repurchases have represented a transfer of wealth from willing sellers operating in a fair market. Selling shareholders knew that Berkshire was repurchasing shares and elected to sell anyway. Berkshire’s presence in the market likely resulted in sellers receiving a slightly higher price than they would have otherwise received.
The lesson seems clear. Trading with willing buyers and sellers in a fair and free market poses no ethical dilemma, even when transacting with people who are rightfully regarded as business partners. However, taking advantage of severe glitches, such as what happened on Monday morning, does not represent ethical behavior even if the seller made an error by placing a market order rather than a limit order.
If my trade had filled and the NYSE had not invalidated all such trades, I would have no doubt felt temporary euphoria followed by quite a bit of guilt and regret. This might seem like virtue signaling, but I think it is how I would have actually felt given adequate time to reflect on what actually took place.
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