Berkshire report raps Sokol deal

• Online extra: Read the Berkshire Hathaway audit committee's full report

* * * * * * *

David Sokol misled senior Berkshire Hathaway Inc. executives, including Chairman and CEO Warren Buffett, in the process of netting a $3 million profit in a stock trade, the company said Wednesday.

Sokol's violations of company policies could be punishable by firing, but his voluntary resignation already prevents him from receiving severance benefits. “He has thus suffered a severe consequence from his violations of company policy,” an audit committee of three company directors said.

The committee, however, noted that Berkshire still could sue Sokol to recover damages, his trading profits or both. The committee also said it would cooperate with any government investigations. Federal securities officials reportedly are looking into the matter.

Messages left for Sokol were not returned, but his attorney told Reuters that Sokol “would not, and did not, trade improperly, nor did he violate any fair reading of the Berkshire Hathaway policies.”

“I have known Mr. Sokol and have represented his companies in business litigation since the mid-1980s,” said Barry Levine, who has done work for Sokol's former company MidAmerican Energy and shares leadership of the white collar criminal defense practice of the Dickstein Shapiro law firm.

In two interviews immediately after his resignation, Sokol defended his stock trades in the chemical company Lubrizol, saying that they were a good investment for his family, that his research was from public information and that, at the time, he had no idea Buffett would make an offer to purchase Lubrizol.

The release of the audit committee's report just three days before Berkshire's annual meeting in Omaha answers the question of whether Buffett will address the matter. The committee said a transcript of the Sokol-related questions that Buffett receives and the answers he gives Saturday will be posted on Berkshire's website.

Buffett has not commented publicly since March 30, when he announced Sokol's surprise resignation. But it was Buffett who put the committee's scathing report online and issued a press release containing its full text.

Over the past month Buffett has been criticized for his handling of the Sokol matter, including complaints that Berkshire apparently didn't have adequate controls governing conduct by its executives.

The report says that Berkshire's board began talking about Sokol on March 30 and that the committee met three times this month, as recently as Tuesday.

The report also mentions Sokol's position as a possible successor to Buffett as CEO of Berkshire, although it quotes him as saying he never wanted the job.

In a resignation letter to Buffett, Sokol said he resigned to form his own investment company, and he told Buffett that the Lubrizol matter was not a factor.

But the audit committee report makes it clear that Sokol was questioned closely about his conduct by Berkshire Treasurer Marc Hamburg, at Buffett's request, just before the resignation.

And Wednesday's report indicates that the committee learned more about what Sokol said and what he did than Buffett knew at the time of the resignation.

The Berkshire directors on the committee are Charlotte Guyman, a retired Microsoft Corp. executive; Donald R. Keough, chairman of the Allen & Co. investment firm and retired Coca-Cola executive; and Thomas S. Murphy, retired chairman and CEO of Capital Cities/ABC.

Among their findings:

» Sokol violated the company's ethics standards by purchasing the stock while serving as a representative of Berkshire and discussing a possible purchase of Lubrizol.

» Sokol's “misleadingly incomplete disclosures” to Buffett and Hamburg “violated the duty of candor he owed the company,” a requirement that also is spelled out by the laws of Delaware, where Berkshire is incorporated.

» Sokol violated Berkshire's insider trading policy, which he had signed in May 2010, which forbids trading securities in a company while having “material nonpublic information.”

» The Sokol matter “should serve as an opportunity to reinforce to all officers, directors and employees of Berkshire Hathaway and its subsidiaries the importance of adhering to those policies and avoiding conduct that comes close to, or strays over, the line of propriety.”

Sokol was chairman of Berkshire's MidAmerican Energy Holdings, NetJets and Johns Manville subsidiaries and was considered one of four possible successors to Buffett as CEO of Berkshire.
In December, Sokol had talked to Citi­Bank investment bankers about Lubrizol as a Berkshire acquisition target. The bankers relayed the information to Lubrizol CEO Jim Hambrick who, in turn, told his company's directors.

Sokol bought $10 million worth of Lubrizol stock in mid-January, just days before he proposed the purchase to Buffett.

The audit committee report said Buffett asked Sokol how he knew about Lu­brizol, and Sokol said he owned some stock, not mentioning his discussion with the investment bankers or a meeting he was arranging with Lubrizol's CEO.

Buffett did not know about the Sokol-Lubrizol discussions, the report said, adding:

“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.”

It wasn't until March 14, the day Buffett announced the purchase of Lubrizol for $9 billion, that Buffett learned that Citi­Bank had a role in the Lubrizol purchase, which “did not square with Mr. Sokol's remark in January that he had come to know Lubrizol by owning the stock,” the report said.

The next day Buffett had Hamburg phone Sokol and get details about his Lubrizol stock holdings and CitiBank's role in the purchase.

“Mr. Sokol answered that he thought he had called a banker he knew at Citi to get Mr. Hambrick's phone number,” the report said.

But over the next week it became clear that Sokol had done more with Citi­Bank than ask for a phone number.

The report said that Buffett gave Sokol a draft of the resignation announcement and that Buffett deleted, because Sokol said it was inaccurate, “a passage that implied that Mr. Sokol had resigned because he must have known that the Lubrizol trades would likely hurt his chances of being Mr. Buffett's successor.”

“Mr. Sokol told Mr. Buffett that he had not hoped to be Mr. Buffett's successor, and was resigning for reasons unrelated to those trades.”

The audit committee said Sokol should have considered Lubrizol's stock off-limits because of Berkshire's insider trading policies starting in December, when he first selected it from a list of 18 chemical companies provided by Citi­Bank and asked for a meeting with Lubrizol's CEO, “and even more so” as the discussions went on.

“Mr. Sokol's trades violated that prohibition,” the report said.

Sokol's actions may not violate federal insider trading law, but Berkshire's policy “requires a higher standard of conduct than what is required to avoid being charged with a federal securities violation,” the report said.

Sokol should have not interpreted the company policy “narrowly” to mean only companies that Buffett was actively considering, the committee said.

Berkshire's code of ethics also prohibits trading on “confidential information,” and Sokol's knowledge of his own actions “prohibited him from trading on it,” the report said. Buying the Lubrizol stock violated the ethics code.

“If its representatives were to trade ahead of potential mergers in which they represented Berkshire Hathaway, they could undermine the trust that Berkshire Hathaway strives to earn from its potential merger partners,” the committee said.

Even if Sokol's trading had stayed within the “precise language” of the trading policy and ethics code, “it could not be reconciled with the obligation to stay well within the lines. By engaging in such questionable conduct, the report says, Mr. Sokol threatened Berkshire Hathaway's reputation — or would have done so had he remained with the company.”

Sokol also failed an obligation to fully inform the company of an “ethically ambiguous situation” and seek advice from supervisors, the committee said.

Sokol's comments to Buffett “did not tell Mr. Buffett what he needed to know” and were misleading, the report said. Knowing more of the facts would have prompted more questions by Buffett and “could have allowed Berkshire Hathaway to evaluate measures that could have been taken to alleviate the problem before negotiations proceeded with Lubrizol.”

His later answers to Hamburg “fell short of the degree of candor required” and suggest that “his answer to Mr. Buffett's earlier inquiry noted above was intended to deceive,” the report said.

Sokol should have told the Berkshire audit committee about the stock purchases and the potential conflict of interest, the committee said.

The committee said it thought Sokol was sincere in saying it was in Berkshire's interest to consider acquiring Lubrizol, but it was up to the board's audit committee — not Sokol — to decide whether his stock purchases were proper.

“By not disclosing in advance his intention to trade, Mr. Sokol took that decision away from the audit committee,” the report said.

Paul Lountzis, a Berkshire shareholder who heads an investment company in Wyomissing, Pa., said Wednesday's report shows that Berkshire has effective governance policies in place and handled the matter appropriately through its board of directors.

“It shows that the board sticks up for what is right,” Lountzis said.

Buffett might have headed off the “hurricane” of criticism by announcing initially that Berkshire was investigating the matter further, he said.

But the thoroughness of Wednesday's report and its clear condemnation of Sokol's actions goes a long way toward restoring any loss of reputation that Buffett or Berkshire may have suffered over the past four weeks, Lountzis said.

Other observers continued to criticize Buffett.

Ronald Barusch, a Wall Street Journal commentator, wrote, “Buffett may have been misled in the beginning, but that does not absolve his later conduct,” such as acting as a “lone wolf” on acquisitions that should be up to the board of directors and not reporting Sokol to the board's audit committee soon enough.

Barusch said the matter “proves a serious lapse in corporate governance.”

Supratim Adhikari of Business Spectator, an Australian website, wrote, “There were many who believed that Buffet was putting his reputation on the line by going soft on Sokol, and Berkshire's audit committee evidently agrees.”

The committee said that making its report public “will demonstrate to all who work for Berkshire Hathaway, as well as the other constituencies Berkshire Hathaway serves, that the company takes its policies very seriously and that its instructions to all its representatives to play in the middle of the court is company policy, not public relations.”

“We expect this report to send a loud message that those policies are designed to be read broadly and to deter anyone who may be contemplating a violation of the spirit or letter of those policies in the future.”

The committee also said there may be changes to company procedures to “implement lessons learned.”

« News

Share