Warren Buffett Owes Shareholders a Discussion About the Sokol Issue

Apr.15.11 | About: Berkshire Hathaway (BRK.A)

I’m sure by now you are very familiar with - and tired of the hearing about - the David Sokol/Lubrizol (LZ)/Berkshire Hathaway (NYSE:BRK.A) issue. The timing is probably one of the worst aspects of it for Mr. Buffett, since this little scandal still has some heat to it and we are only a couple of weeks out from the Berkshire annual meeting. Buffett has long made clear that the annual meeting is his single favorite day of the year.

I’m a huge Buffett fan and I really hate it when the talking heads on television rush out to criticize him whenever there is a bit of controversy surrounding Berkshire. I think if you have followed Buffett at all you know where he stands and if everyone in the business world followed his example we would be much better off.

But while I am a big Buffett admirer I do find his silence on some pretty material issues interesting. After all Warren considers his shareholders his partners, and as partners full disclosure would be expected. And I expect that what we are going to get on the Sokol issue at the annual meeting is a lot more silence. Sokol’s Lubrizol transactions represent by my count the third somewhat uncomfortable issue for Buffett involving very senior managers at Berkshire in the past few years. I'm referring to the departures of:

David Sokol – MidAmerican Energy Subsidiary (resignation amid stock purchase controversy)

Richard Santulli – NetJets Subsidiary (resigned in what seems a less than happy split)

Ronald Ferguson – General Re (departed amid fraud charges on a reinsurance deal)

Buffett has long heaped praise on the managers who run his subsidiary companies. The Berkshire business model is to keep day to day responsibility far away from Buffett and leave the managers to generate cash flow that Buffett can use to grow his giant collection of companies and securities.

An example of Buffett’s “catch more bees with honey” approach to managing comes from the 2000 letter to shareholders:

“Our managers are a very special breed. At most large companies, the truly talented divisional managers seldom have the job they really want. Instead they yearn to become CEOs, either at their present employer or elsewhere. Indeed, if they stay put, they and their colleagues are likely to feel they have failed.

At Berkshire, our all-stars have exactly the jobs they want, ones that they hope and expect to keep throughout their business lifetimes. They therefore concentrate solely on maximizing the long-term value of the businesses that they "own" and love. If the businesses succeed, they have succeeded. And they stick with us: In our last 36 years, Berkshire has never had a manager of a significant subsidiary voluntarily leave to join another business.”

And I’m sure these managers do great jobs. After all most of them started from scratch and made themselves extraordinarily wealthy before Buffett found them. But the uncomfortable fact is that at Berkshire’s two largest (pre-Burlington) subsidiaries, MidAmerican and General Re, there are instances of manager behavior that is less than stellar.

We now have in the last decade allegations that one manager, Sokol, engaged in questionable stock dealings in and around a Berkshire Hathaway transaction. This is a guy Buffett trusted with billions and billions of dollars at MidAmerican. And the other manager, Ron Ferguson (and three others) at General Re convicted for helping AIG pretty up its financial statements using a reinsurance transaction. When you consider that General Re is a huge reinsurance player and creates billions of dollars of risk for Berkshire, the quality of management is essential.

That appears to be two pretty big black markets for Berkshire at two very big parts of its business. I don’t recall Warren saying anything about the Ferguson situation at any point and when you consider that it involved illegal activity, you have to think he should discuss it with his shareholders/partners. And when you see two instances of questionable conduct at such high levels it does make you wonder if there is not enough oversight from Berkshire headquarters.

I hope Warren talks about the Sokol issue at the AGM this time as I think it does merit further explanation.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.