Berkshire Audit Panel Alleges Sokol Misled Buffett on Lubrizol, Violated Trading Rules

Thursday, 28 Apr 2011 07:08 AM

 

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David Sokol violated Berkshire Hathaway Inc.’s insider-trading rules and misled the company about his personal stake in Lubrizol Corp., which he recommended as a takeover target to Chairman Warren Buffett, the firm said.

An 18-page report released yesterday by Berkshire’s audit committee portrayed Buffett as a victim of deception and said the company should weigh suing Sokol, 54, to recover his trading profits. The U.S. Securities and Exchange Commission is probing whether Sokol bought Lubrizol shares on inside information that Buffett was considering a buyout, according to a person who declined to be identified because the investigation is secret.

“They’re throwing Sokol under the bus,” said Stephen Bainbridge, a professor at the UCLA School of Law who has written and taught about corporate governance. Sokol was previously considered a candidate to replace Buffett as Berkshire’s chief executive officer.

Buffett, 80, is facing questions about his oversight of managers and criticism for not condemning the stock trading that preceded Sokol’s resignation from Omaha, Nebraska-based Berkshire. Buffett had said March 30 in announcing Sokol’s departure that he didn’t believe the trades were unlawful.

Sokol “would not, and did not, trade improperly, nor did he violate any fair reading of the Berkshire Hathaway policies,” according to a statement from William Levine, a lawyer for Sokol at Dickstein Shapiro LLP in Washington.

The report, released three days before Berkshire’s annual meeting, is “something of a reprimand” to Buffett for not fully vetting Sokol’s trades and statements, Meyer Shields, an analyst with Stifel Nicolaus & Co. said in a report.

Buffett’s Duty

Buffett “had a duty to assemble the kind of facts and opinions that the audit committee did,” said Janet Tavakoli, president of Tavakoli Structured Finance Inc. “But Buffett didn’t do that.” Buffett didn’t immediately return a message left with an assistant for comment.

Sokol’s purchase of about $10 million in Lubrizol stock while representing Berkshire in a deal to buy the lubricant maker violated company policies on insider trading, and he failed to meet his disclosure obligations under state law in Delaware, where Berkshire is incorporated, the committee found.

The report “increases the prospect that he breached a fiduciary duty to Berkshire, which is what the SEC would need to prove to bring a case against him,” said John Coffee, securities law professor at Columbia University. “This is a significant shift in tone by Berkshire, probably because they’re embarrassed by having been slow to recognize the problem.”

Questions, Answers

Buffett said March 30 that he’d held back nothing from his comments that day and would refer future inquiries to his written statement. Yesterday, Berkshire said the company would post a transcript “as soon as possible” after Buffett’s April 30 meeting of questions and answers about Sokol and Lubrizol.

Buffett will face about five hours of questions from shareholders and journalists at the meeting, which draws tens of thousands of people to Omaha each year and gives the billionaire a forum to discuss his company, corporate governance and the economy. The report was a “pre-emptive action” ahead of the meeting, said Michael Yoshikami, chief investment strategist at Berkshire shareholder YCMNet Advisors.

Sokol had been studying Lubrizol for personal investment since the summer of 2010, his purchases were “specifically allowed by his employment agreement” and he twice told Buffett about his stake, according to his lawyer’s statement. When Sokol acquired the shares, he had “no reason to anticipate that Mr. Buffett would have any interest whatsoever in Lubrizol.”

Interest in Lubrizol

Uncertainty about whether Lubrizol and Buffett would be interested in a deal at the time of Sokol’s trading may mean he didn’t violate laws on insider trading, the committee said. Berkshire’s policy demands “a higher standard of conduct than what is required to avoid being charged with a federal securities violation,” the panel found.

The Berkshire audit committee’s chairman is director Thomas Murphy, 85, and the panel includes board members Charlotte Guyman, a former general manager of Microsoft Corp., and Donald Keough, the ex-president of Coca-Cola Co., according to a filing last month. Last year, Murphy was asked in a Bloomberg Television interview about candidates to succeed Buffett, and called Sokol a “first-class guy.”

Sokol met with Citigroup Inc. representatives on Dec. 13 and asked that they approach Lubrizol about a possible deal, according to the report. The bank told Sokol later that month that Lubrizol’s CEO had told the board of the Wickliffe, Ohio- based firm about Berkshire’s possible interest.

Sokol’s Purchase

Sokol bought 96,060 Lubrizol shares the first week of January and told Buffett later that month that the company could be a takeover candidate. Sokol told Buffett he held a Lubrizol stake, which the billionaire took to mean that Sokol had been following the company as a shareholder and deemed it a buyout target, the audit committee found. Buffett didn’t realize until March 14, when the $9 billion deal was announced, that Citigroup had brought Lubrizol to Sokol’s attention, the panel found.

Sokol’s “misleadingly incomplete disclosures to Berkshire Hathaway senior management concerning those purchases violated the duty of candor he owed the company,” the committee said.

Buffett learned of Citigroup’s role only when a representative from the bank called to congratulate him on the deal, according to the report.

Buffett said March 14 he would pay $135 a share for Lubrizol, compared with the closing price of $105.44 on the New York Stock Exchange in the last trading day before the announcement. Sokol’s investment may have given him a profit of about $3 million, according to Buffett’s disclosure and data compiled by Bloomberg.

‘Gloves Are Off’

“The gloves are off,” said Yoshikami. Buffett’s “response was benevolent, and now the audit committee is coming back and saying, ‘You might be benevolent but, as a protector of the values of the firm, we don’t think benevolence is appropriate.’”

Sokol joined Berkshire in 2000 when he sold MidAmerican Energy Holdings Co., which he led, to the company. Buffett had sent Sokol to China to scout an investment in carmaker BYD Co. and tasked the executive with the turnaround of NetJets Inc., Berkshire’s luxury-flight unit. Buffett biographer Andrew Kilpatrick had said Sokol was the most likely candidate to replace the billionaire as CEO.

Sokol told Buffett before the March 30 statement that he hadn’t hoped to become CEO, according to the report. Sokol made the statement when given an opportunity to review a draft of Buffett’s comments for accuracy.

The draft had a passage, which Buffett later excluded, “that implied that Mr. Sokol had resigned because he must have known the Lubrizol trades would likely hurt his chances of being Mr. Buffett’s successor,” according to the report.

© Copyright 2014 Bloomberg News. All rights reserved.

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