Does Buffett Have a Corporate Governance Problem?

Does Buffett Have a Corporate Governance Problem?

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In Warren Buffett’s annual letter to Berkshire Hathaway shareholders, in addition to discussing the company’s business operations, he typically singles out individuals he believes have done an extraordinary job.  David Sokol’s name has come up on several occasions.  Buffett’s praise for Sokol has been so effusive that many observers were convinced that Sokol, CEO of two Berkshire subsidiaries, was the odds on favorite to one day  succeed Buffett as CEO of the whole company. 

Not anymore.  On Monday, David Sokol resigned.  Although he denied it, it certainly appears that his resignation was the result of stock trades he made in Lubrizol that on the surface look improper.  While it remains to be determined if Sokol did anything illegal, his trading activities fail to pass the smell test.  Here’s a chronology of what happened:

December 13, 2010 – Citigroup bankers provide Sokol with a list of companies they believe would make for interesting acquisitions.  Sokol expresses interest in Lubrizol and requests a meeting with James Hambrick, the company’s CEO.

December 14, 2010 – Sokol places a limit order to buy 50,000 shares of Lubrizol common stock .  Although the price isn’t disclosed, only 2,300 shares are purchased. 

December 21, 2010 – Sokol sells the 2,300 shares of Lubrizol for a profit.  He claims the sale was made for tax-planning purposes.

January 5-7, 2011 – Sokol places a limit order to buy 100,000 shares of Lurbrizol at $104 per share;  96,060 shares are purchased. 

January 14 or 15, 2011 – Sokol brings Lubrizol to Buffett’s attention.  Buffett says he is not impressed by the company.

January 24, 2011 – Buffett sends Sokol a note expressing his skepticism about acquiring Lubrizol.

January 25, 2011 – Sokol dines with Lubrizol CEO James Hambrick.  Sometime later he reports to Buffett about this meeting.  This time Buffett changes his mind and becomes interested in acquiring Lubrizol.

March 13, 2011 – Berkshire’s board supports Buffett’s decision to acquire Lubrizol.

March 19, 2011 – Buffett learns about Sokol’s stock trades.

March 28, 2011 – Sokol tenders his resignation.

March 30, 2011 – Late in the day, Berkshire Hathaway posts a news release announcing Sokol’s resignation.  Sokol’s paper profit stands at almost $3 million.

Sokol claims he was not responsible for making investment decisions at Berkshire and that he never had the authority to do so.  Why did he request to meet with James Hambrick?  Did he really think that Hambrick wouldn’t assume Sokol was representing Berkshire Hathaway?  Clearly, the purpose of that meeting was to determine if Lubrizol was open to being acquired by Berkshire. 

These events bring into question the effectiveness of Berkshire Hathaway’s corporate governance policies.  They also remind us of an incident a few years ago involving Joe Brandon, former CEO of General Reinsurance, one of Berkshire Hathaway’s largest subsidiaries.  Brandon suddenly resigned just a few weeks before the 2008 Berkshire Hathaway shareholders’ meeting. He was named as an unindicted coconspirator in a fraud case involving General Reinsurance and AIG, but wasn’t charged with any wrongdoing. It is widely believed that federal prosecutors pressured Buffett to get rid of Brandon.  Although Buffett had often praised Brandon in his letters to shareholders, including one just before Brandon’s resignation, he made no comment about the resignation at the meeting. More surprising, not one shareholder lucky enough to get to a microphone asked about it.  Even the media ignored the entire event.   

This time around hard questions are being asked.  CNBC managed to snare an in-studio interview with Sokol, which no doubt will give his lawyers heartburn.  And Buffett’s press release is a welcome change from his silence in the Brandon case.  The good news for shareholders is that these events aren’t likely to have a negative impact on the stock price long term; it was down 2.2 percent Thursday.  Nonetheless, Berkshire’s board better look into the matter and make sure something like this doesn’t happen again.