Why Berkshire Has a Breach

Includes: BRK.A, BRK.B
by: SoundView Technology Group

First of all, I’d cast no stones in the general direction of either Warren Buffett or Charlie Munger. However, Mr. Sokol had clearly stepped over a line of ethics, if not of legality. If you’ve missed the story in the news media, it’s best to read the release straight from the Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B)website.

What’s the big deal? The key factor that condemns Mr. Sokol, in my view at least, is the fact that he is paid by Berkshire Hathaway and the shareholders to do his job first and foremost for them as an investment management company. Once you’ve taken on such a role, your own investments and your "personal account" should either be eliminated or suspended, or allowed only to transact with supervisions and restrictions.

The WSJ claims that Mr. Sokol made $3m on his Lubrizol stock when Berkshire subsequently bought the company. I think they must be mistaken. That would imply that Mr. Sokol actually held on to the 96,060 shares he bought in early January. The purchase of the stock so close to an internal discussion and evaluation of a company for potential acquisition is already over the line. As the SEC might say, the expectation that BRK was going to actively evaluate a potential acquisition is substantive enough even if the outcome was unknown.

To go a step further and suggest that the transaction was approved and acted upon, while Mr. Sokol was not forced to liquidate his holdings before the purchase, implies a level of impropriety that would tarnish the reputation of Berkshire as a company and would suggest that Mr. Sokol should hire an attorney.

The "normal" resolution to a situation like this would be for a compliance officer and/or general counsel to instruct Mr. Sokol to sell all his shares and refrain from any further transactions. He might also pay a small fine or receive a warning that goes into his file. Finally, they often add a bit of advice, which is to spend a few thousand dollars on hiring your own securities lawyer and just review the situation and the laws that pertain to it, so you are better informed the next time.

It was probably easier just to "let Mr. Sokol go" and hope that the situation wouldn’t snowball into anything more annoying. Many have raised the succession issue at BRK again, and now can add some compliance and business practice concerns. Warren Buffett and Charlie Munger have done a superb job, and have taught the entire investing world a great deal.

This is certainly not their best moment. Although Mr. Buffett makes it clear that the matter is closed, and that he has "held nothing back," the situation is not tenable if we don’t know whether Mr. Sokol sold his shares before the acquisition or not. The letter is silent on that matter.