Reflection on the Sokol Affair

This blog assumes some familiarity with the Dave Sokol affair and Berkshire Hathaway.  Hearing Sokol on CNBC, it was unclear to me whether Sokol had acted wrongly given Lubrizol not being on Berkshire's restricted list, Sokol having no control over Berkshire's investments, and Sokol engendering nonpublic information in the form of a potential transaction only after his decision to invest in Lubrizol. 

The potentially damning event from a legal perspective: "on December 17, 2010, Citi informed Mr. Sokol that Mr. Hambrick [Lubrizol CEO] had indicated that he would discuss Berkshire Hathaway's possible interest with the board."[1]  Is that material nonpublic information in itself?  If it is, then, and contrary to other commentaries, Sokol's Lubrizol buys thereafter might be considered illegal.

Berkshire's "'Insider' Trading Policies and Procedures" may be further basis of discontent with the affair: "The trading of securities of Berkshire or any other public company while the trader is in possession of material nonpublic information is prohibited…. Other public companies to which this prohibition is applicable include those that may be involved in a significant transaction with Berkshire…."[2]

In other words, Berkshire prohibited covered employees trading securities of a company with knowledge that it may be a Berkshire acquisition, and considered that knowledge material nonpublic information.  Sokol's trading may appear both contra Berkshire's internal policies and illegal from this standpoint.

Others expressed severe disappointment with Sokol in early April, when I found potentially no fault with the affair.  I want to consider why.  I think it's due to three reasons.

First, my unshared reaction in early April was before Lubrizol's April 11th filing.  Its March 25, 2011 filing made no mention of Sokol receiving feedback from Lubrizol in December: "On December 17, 2010, Citi called Mr. Hambrick and relayed the substance of the conversation between Citi and Mr. Sokol on December 13, 2010. Mr. Hambrick indicated that he would inform the [Lubrizol] Board of Berkshire Hathaway’s possible interest."[3]  That was the end of the December story.

Contrast that with Lubrizol's statement filed April 11, 2011: "On December 17, 2010, Citi called Mr. Hambrick and relayed the substance of the conversation between Citi and Mr. Sokol on December 13, 2010. Mr. Hambrick indicated that he would inform the Board of Berkshire Hathaway’s possible interest and discussed that Citi would so inform Mr. Sokol. Later on December 17, 2010, Citi informed Mr. Sokol that Mr. Hambrick had indicated that he would discuss Berkshire Hathaway’s possible interest with the Board."[1]

Sokol only instigated a potential discussion in the March 25th version.  He knew a material nonpublic discussion was underway in the April 11th version.  Sokol's trading may be contra Berkshire's policies in either case but also externally illegal in the latter case.

I wonder whether Messrs. Buffett and Munger had a similar reaction to the revised disclosure.

Second, the roughly $3 million Sokol profited on his Lubrizol shares struck me as immaterial relative to a typical investment banking fee for facilitating a $9 billion acquisition.  Viewing it simply, I thought Sokol must either have acted as an investment banker for Berkshire or not.  If he was, he should have received a transaction fee or compensation for acting in that capacity and it would have been obviously inappropriate to trade in a potential target, both because it would be frontrunning and because it would affect his duty of impartial analysis in the capacity.  If he wasn't, and had no control of acquisitions, why should he be restricted from investing in an unrestricted security before suggesting an idea to the acquisition department?

That thinking was before I saw the full reported back and forth with Citi, which indicated that Sokol had not just potentially instigated but entered into an investment banking role regardless of his compensation terms, and was privy to consideration of a transaction.  That rendered his subsequent trading inexplicable.  I haven't seen this distinction between the March 25th and April 11th filings elsewhere highlighted.

Third, as Michael Douglas' character Gordon Gekko says near the end of "Wall Street: Money Never Sleeps": "People are a mixed bag."  I've lost almost all of my heroes over the years as they've disappointed me in some way.  It's no fun to lose heroes.  I've tried to embrace that Gekko sentiment as a means of admiring in-many-ways admirable executives.  Sokol's actions disappoint me less than certain other actions that have yet to be widely criticized or rectified.

I suppose the first two reasons were fair reactions to the facts presented in March.  The third reason bothers me a bit.  I want heroes.

Notes and Disclosure

[1] Lubrizol Corp PRER14A filed with the SEC April 11, 2011, accessed via 10kwizard.com.

[2] Berkshire Hathaway Inc. memorandum from Warren E. Buffett "Re: 'Insider' Trading Policies and Procedures" accessed via Berkshire's website.

[3] Lubrizol Corp PREM14A filed with the SEC March 25, 2011, accessed via 10kwizard.com.

Disclosure: The author makes no commitment, and disclaims any duty, to update this disclosure.  The author does not intend to update this disclosure.  The author manages a limited partnership and separate accounts (collectively, "accounts").  None of the accounts owns any security of Berkshire Hathaway Inc. at this time.  The author may buy or sell any position at any time.  The author may change positions in light of emergent facts or considerations, including new price-to-value estimates of the author's current and prospective investments.