I would like to start this with the public counterarguments from Sokol’s attorney:
I am profoundly disappointed that the Audit Committee of Berkshire Hathaway would authorize the issuance of its report to the public without the care and decency to ask even a single question of Mr. Sokol. Mr. Sokol had been associated with the Berkshire Hathaway companies for 11 years. During this time, his indefatigable efforts helped create enormous value for the Berkshire shareholders. He deserved better. While I take issue with much of the Committee’s report, I briefly make the following points. If the Audit Committee had asked, it would have learned that:
- Mr. Sokol had been studying Lubrizol for personal investment since the summer of 2010; such investments are specifically allowed by his employment agreement.
- Mr. Buffett was told twice, not once, about Mr. Sokol’s ownership of Lubrizol stock before Mr. Buffett engaged in any discussions with Lubrizol.
- Contrary to the Audit Committee’s statement, Mr. Sokol’s Lubrizol shares were not acquired pursuant to a “100,000 limit order.” Rather, they were purchased as a result of several limit orders, over a period of days, at specified prices, for the day only, in order to acquire the stock at low prices. At that time, Mr. Sokol had no reason to anticipate that Mr. Buffett would have any interest whatsoever in Lubrizol.
I have known Mr. Sokol and have represented his companies in business litigation since the mid 1980s. I know him to be a man of uncommon rectitude and probity. He would not, and did not, trade improperly, nor did he violate any fair reading of the Berkshire Hathaway policies.
Okay, let’s take the three points in order:
1) Yes, Sokol may have looked at Lubrizol (LZ) prior to December 2010, but he only chose to invest in Lubrizol in December 2010. Personal investments might be allowed by his employment agreement, but not those where Berkshire Hathaway (NYSE:BRK.A) might have an economic interest, at least not without full disclosure to the relevant powers inside BRK. Remember, though Buffett acts as a sort of King inside BRK, even he is subject to the corporation and the committees set up by the board.
2) And that is relevant to Sokol telling Buffett twice, something that was already known. Buffett is not the head of compliance. Sokol needed to give full disclosure to the CFO and the Audit Committee
As the audit committee wrote:
- “All actual and anticipated securities transactions of Berkshire and its subsidiaries that have not been publicly disclosed should be considered material.”
- “Other public companies to which this prohibition is applicable include those that may be involved in a significant transaction with Berkshire. . . .”
- “If a . . . Covered Employee is aware that Berkshire has taken or altered a position in a public company’s securities or that Berkshire is actively considering such action, trading in any securities of such public company ... [trading in the securities] is expressly prohibited prior to the public disclosure by Berkshire of its actions . . . (or until the [employee] becomes aware that Berkshire did not take and is no longer actively considering such action).”
and wrote again:
- “Covered Parties who have access to confidential information are not permitted to use or share that information for stock trading purposes or for any other purpose except the conduct of the Company’s business.”
- “Covered Parties are prohibited from taking for themselves opportunities that are discovered through the use of corporate property, information or position without the consent of the Board of Directors of the Company.”
And further wrote:
All of these internal policies are underscored by the law of Delaware, where Berkshire Hathaway is incorporated. Under Delaware law, corporate representatives owe their company a duty of loyalty. The duty of loyalty includes a duty of candor, which requires them to disclose to the corporation all material facts concerning corporate decisions, especially decisions from which they might derive a personal benefit. Mr. Sokol’s actions did not satisfy the duty of full disclosure inherent in the Berkshire Hathaway policies and mandated by state law. His remark to Mr. Buffett in January, revealing only that he owned some Lubrizol stock, did not tell Mr. Buffett what he needed to know. In the context of Mr. Buffett’s question how Mr. Sokol came to know Lubrizol, its effect was to mislead: it implied that Mr. Sokol owned the stock before he began considering Lubrizol as an acquisition candidate, when the truth was the reverse. A candid disclosure would have revealed the timing and size of the purchases, and the communications with Citi concerning obtaining a meeting to mutually explore interest in a potential acquisition that had preceded them. Knowledge of those facts would likely have prompted further questions by Mr. Buffett and could have allowed Berkshire Hathaway to evaluate measures that could have been taken to alleviate the problem before negotiations proceeded with Lubrizol.
Mr. Sokol’s answer to Berkshire Hathaway’s CFO, Mr. Hamburg, concerning the investment bankers similarly fell short of the degree of candor required of a corporate fiduciary, and suggests his answer to Mr. Buffett’s earlier inquiry noted above was intended to deceive.
The main idea here, as I have written about before, is that Sokol owed a duty to BRK as an employee. Could he buy stocks of companies, as specified by his employment agreement? Sure, but within limits which he violated. BRK deserved the initial benefits of his work, when the data was intended for BRK and not for Sokol.
3) That the orders were not 100,000 share limit orders is not relevant to the case at hand. Mr. Sokol, if your attorney is making such bogus arguments, either you have a really bad case, and should compromise, or you need a better attorney.
As I commented to the excellent Colin Barr, in his early piece on the topic:
I don’t think we need a new law here. If Buffett wants, he has grounds for a tort against Sokol on his misappropriation of data that rightfully belonged to BRK. I suspect Warren will just let it slip — Sokol did a lot of good for BRK, and Buffett has loyalty to managers generally. At least, that’s how it seems today. His ruthlessness for the reputation of BRK is subordinate it seems to his loyalty.
Which leaves any complaints that shareholders might have against BRK. Now, those complaints are not against Sokol, but against Buffett and his management team’s oversight of Sokol and his activities.
So, let’s be careful here. BRK is a conglomerate that owns insurers, and not an asset manager per se. The SEC and other regulators probably do not have something actionable here. But the two actions that I mentioned above could be taken in the civil courts, should Buffett or a group of shareholders decide to pursue those remedies.
Well, now we have a court case against BRK and the possibility of BRK proceeding against Sokol. Both of my tort remedies might happen.
But What About Buffett?
I think Warren Buffett can defuse most of his troubles through a heartfelt apology at his annual meeting. Something like, “Yes, I blundered. I should have asked Sokol for details, but I was rushed that day. I still firmly believe in the ethics that I have promulgated for BRK, but I slipped in not enforcing them as best I could. I gave him the benefit of the doubt, because he was so valuable to us, and I should not have done that.” And before that, go to those suing BRK and seek a resolution. Your reputation would prevail, Warren.
Look, I try to be an ethical guy, but I make mistakes also. The greater error as to deny guilt/fault when it is obvious to many. I have confessed fault freely during the times I have blown it, and have ended up stronger for it. Warren, the same would be true for you. People will forgive you if you accept your responsibility in the matter.
This is not the end of the Audit Committee’s work. Still under way are:
- Work with Company management and legal counsel to identify and implement lessons learned from these events, including possible enhancements to its procedures.
- Cooperation with any government investigations relating to this matter, and monitoring any developments that may emerge from them.
- Consideration by the Board, or the Audit Committee, or such other committee as the Board may think appropriate, of possible legal action against Mr. Sokol to recover any damage the Company has sustained, or his trading profits, or both, and of whether the Company is obligated to advance Mr. Sokol’s legal fees associated with proceedings in which he is named.
They may go after Sokol. The damages are far greater than the gain of $3 million on the takeover. As Buffett said, he cannot afford to lose any of his firm’s reputation. Now may Buffett heed his own advice.