David Sokol of Berkshire Hathaway fame – A Business Ethics disaster! What motivated his behavior?

Warren Buffett’s Berkshire Hathaway has a reputation for being squeaky clean – a model ethical company.  At least that is the general perception from those on the outside who look in.  But this week – the unexpected resignation of David Sokol – Buffett’s heir apparent seems to show that all is not as it seems.

Picture from Midamerican.com

Telling CNBC, “I don’t believe I did anything wrong,” Sokol denied any wrongdoing with his personal investment actions while an insider at Berkshire.  According to a CNN report,

Buffett’s press release about the resignation came Wednesday in the form of an unusually candid letter in which he said Sokol’s resignation was “a total surprise.”

Buffett revealed that Sokol pushed him in January to buy chemical company Lubrizol. Though Buffett said he was “skeptical” at first, Berkshire purchased Lubrizol (LZ, Fortune 500) earlier this month for $9.7 billion — one of the largest acquisitions in the company’s history.

After Berkshire announced plans on March 14 to buy Lubrizol, Buffett said he found out that Sokol had bought 2,300 shares of Lubrizol on Dec. 14 — which he then sold on Dec. 21.

Then, on Jan. 5, 6 and 7, Sokol bought 96,060 Lubrizol shares pursuant to a 100,000-share order he had placed, with a $104 per share limit price.

“Dave’s purchases were made before he had discussed Lubrizol with me and with no knowledge of how I might react to his idea. In addition, of course, he did not know what Lubrizol’s reaction would be if I developed an interest,” Buffett wrote in the release.

WARREN BUFFETT WAS KIND…

While I have no inside knowledge, I suspect that Warren Buffett was kind with his public comments.  I can only imagine that he might have been furious to find that his trusted lieutenant was buying stock in advance of his recommendation to Buffett.  Interesting that Buffett said (seemingly protecting himself and Sokol) that “Dave’s purchases were made before he had discussed Lubrizol with me and with no knowledge of how I might react to his idea. In addition, of course, he did not know what Lubrizol’s reaction would be if I developed an interest.”

So here’s the question.  One – if Buffett felt that Sokol was his right hand man and heir apparent, then wouldn’t it stand to reason that Sokol would have expected Buffett to accept his recommendation?

Though Buffett said he was “skeptical” at first, Berkshire purchased Lubrizol (LZ, Fortune 500) earlier this month for $9.7 billion — one of the largest acquisitions in the company’s history.

Skeptical  –  but Buffett or rather Berkshire bought…so further evidence of the influence that Sokol had with Buffett.  So…Sokol buys the stock in advance of his recommendation feeling that there was a high probability that Buffett would bite.  Ethical or Unethical?

Buffett says that “he did not know what Lubrizol’s reaction would be if I developed an interest.”  Now…again I ask, how many companies would turn down an offer by Berkshire if the price were right.  One would naturally assume that this purchase…”one of the largest acquisitions in the company’s history,” made some folks at Lubrizol quite wealthy.  Oh…and had the potential to add to the personal coffers of Mr. Sokol.  Do you really think that Sokol expected that the shareholders of Lubrizol would turn this down.  My guess is that it was a deal done before the recommendation…otherwise he would not have recommended it.

INSIDER TRADING QUESTION:

I’m not an attorney, but how can this not be insider trading?  According again to a CNN report,

He also said that he did not have any control over Berkshire’s decisions to merge with other companies and he did not consider his investments to be insider trading.

He (Sokol) buys stock in advance.  He makes a recommendation to Buffett to buy the company.  Buffett follows the advice without knowing that Sokol had taken a position in the stock.  How can that not be insider trading?

LEGAL?  ETHICAL?

Assuming for a moment that Sokol’s actions are legal (which I hope there is some clarification on)…are they ETHICAL?  If ethics is doing the right thing so that there will be no practical question of propriety, then Sokol fails in my opinion…

WHAT’S YOUR OPINION?  YOUR COMMENTS ARE WELCOME!

HERE’S THE NEWS RELEASE

OMAHA, NE—This press release will be unusual. First, I will write it almost as if it were a letter. Second, it will contain two sets of facts, both about Dave Sokol, Chairman of several Berkshire subsidiaries.

Late in the day on March 28, I received a letter of resignation from Dave, delivered by his assistant. His reasons were as follows:

“As I have mentioned to you in the past, it is my goal to utilize the time remaining in my career to invest my family’s resources in such a way as to create enduring equity value and hopefully an enterprise which will provide opportunity for my descendents and funding for my philanthropic interests. I have no more detailed plan than this because my obligations from Berkshire Hathaway have been my first and only business priority.”

I had not asked for his resignation, and it came as a surprise to me. Twice before, most recently two or so years ago, Dave had talked to me of resigning. In each case he had given me the same reasons that he laid out in his Monday letter. Both times, I and other Board members persuaded him to stay. Berkshire is far more valuable today because we were successful in those efforts.

Dave’s contributions have been extraordinary. At MidAmerican, he and Greg Abel have delivered the best performance of any managers in the public utility field. At NetJets, Dave resurrected an operation that was destined for bankruptcy, absent Berkshire’s deep pockets. He has been of enormous help in the operation of Johns Manville, where he installed new management some years ago and oversaw major change.

Finally, Dave brought the idea for purchasing Lubrizol to me on either January 14 or 15. Initially, I was unimpressed, but after his report of a January 25 talk with its CEO, James Hambrick, I quickly warmed to the idea. Though the offer to purchase was entirely my decision, supported by Berkshire’s Board on March 13, it would not have occurred without Dave’s early efforts.

That brings us to our second set of facts. In our first talk about Lubrizol, Dave mentioned that he owned stock in the company. It was a passing remark and I did not ask him about the date of his purchase or the extent of his holdings.

Shortly before I left for Asia on March 19, I learned that Dave first purchased 2,300 shares of Lubrizol on December 14, which he then sold on December 21. Subsequently, on January 5, 6 and 7, he bought 96,060 shares pursuant to a 100,000-share order he had placed with a $104 per share limit price.

Dave’s purchases were made before he had discussed Lubrizol with me and with no knowledge of how I might react to his idea. In addition, of course, he did not know what Lubrizol’s reaction would be if I developed an interest.

Furthermore, he knew he would have no voice in Berkshire’s decision once he suggested the idea; it would be up to me and Charlie Munger, subject to ratification by the Berkshire Board of which Dave is not a member.

As late as January 24, I sent Dave a short note indicating my skepticism about making an offer for Lubrizol and my preference for another substantial acquisition for which MidAmerican had made a bid. Only after Dave reported on the January 25 dinner conversation with James Hambrick did I get interested in the acquisition of Lubrizol.

Neither Dave nor I feel his Lubrizol purchases were in any way unlawful. He has told me that they were not a factor in his decision to resign. Dave’s letter was a total surprise to me, despite the two earlier resignation talks. I had spoken with him the previous day about various operating matters and received no hint of his intention to resign. This time, however, I did not attempt to talk him out of his decision and accepted his resignation.

* * *

Effective with Dave’s resignation, Greg Abel, presently President and CEO of MidAmerican Holding Company, will become its Chairman Todd Raba, President and CEO of Johns Manville, will become its Chairman; and Jordan Hansell, President of NetJets, will become its Chairman and CEO.

I have held back nothing in this statement. Therefore, if questioned about this matter in the future, I will simply refer the questioner back to this release.

Berkshire Hathaway and its subsidiaries engage in diverse business activities including property and casualty insurance and reinsurance, utilities and energy, finance, manufacturing, retailing and services. Common stock of the company is listed on the New York Stock Exchange, trading symbols BRK.A and BRK.B.

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One Response to David Sokol of Berkshire Hathaway fame – A Business Ethics disaster! What motivated his behavior?

  1. southwerk says:

    I had heard about Buffet and the crisis on the web briefly. This analysis really helps give me a feel for the issues. Thanks!
    James Pilant

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