Tuesday, May 17, 2011

A Chink in His Armor

A couple of weeks ago, Berkshire Hathaway's audit committee issued an 18-page report about David Sokol's stock trades in Lubrizol Corporation. What stood out was how vigorously the report defended Warren Buffett, how strongly it blamed David Sokol, and how much it differed from Warren Buffett's own news release dated just one month earlier.

The audit committee concluded that Sokol had violated company policies and that he made misleading and incomplete disclosures about his stock trades. All that might be true, yet Buffett's earlier release defended Sokol and his stock trades. Buffett wrote, "Neither Dave nor I feel his Lubrizol trades were in any way unlawful." That statement might also be true. So far, at least, Sokol has not been charged with a crime. However, since the SEC is still investigating, the matter isn't closed. In any case, it certainly does appear that Sokol violated his fiduciary responsibility to Berkshire Hathaway. It seems that Lubrizol's CEO and the Citigroup bankers who brought Lubrizol to Sokol's attention were under the impression that Sokol was representing Berkshire Hathaway. Sokol should not have been using that information to execute trades in his own account.

The mere fact that Sokol resigned suggests there is probably more to this story. Most likely, Sokol would not have resigned unless he was asked to resign or unless he thought he had done something wrong. Buffett wrote that Sokol's resignation "came as a surprise to me." That's a bit hard to believe, especially since Buffett also says that Sokol tried to resign twice before. Furthermore, the report issued by the audit committee states that Buffett asked Berkshire's CFO Marc Hamburg to look into Sokol's trades as early as March 15, two weeks before Sokol resigned.

Furthermore, if the company's board of directors is genuinely convinced that Sokol violated company policy by trading in Lubrizol stock, it seems they would have an obligation to all their shareholders to try and recoup Sokol's profits from those trades. Initiating legal action, however, could require that both Sokol and Buffett testify under oath; something the board might prefer to avoid.

Unfortunately, the entire matter has given Buffett's stellar reputation a bit of a blow. At worst, it appears that Buffett tacitly approved Sokol's inappropriate trades, or at least chose to ignore the matter. At best, it appears that Buffett was completely duped by one of his most trusted lieutenants. Either way, this incident has put a chink in Buffett's shining armor.