Sokol, Buffett, and the SEC
NBC is running an online poll about the behavior of David Sokol, an executive of a Berkshire Hathaway subsidiary who invested about $10 million in Lubrizol, a company that Berkshire then bought at his suggestion, leaving him with a profit of about $3 million. Nine percent of respondents say what he did was illegal, 32% say it was unethical, and 33% say it was both illegal and unethical. Only 25% say it is "no big deal."
Mr. Sokol himself said on CNBC this morning that while he doesn't think he did anything illegal, unethical, or inappropriate, if he had it to do over again he wouldn't have mentioned the company to Mr. Buffett. Regular readers of this site know I'm a frequent critic of Berkshire CEO Warren Buffett, but in this case, on the basis of the information that's out there so far, I think he and Mr. Sokol are getting a bit of a raw deal in the press coverage.
The Wall Street Journal prints an analysis by a retired lawyer claiming that the case has "the primary elements of a violation of the insider trading rule" and asserting, "The SEC is likely to investigate as will, I expect, the U.S. Attorney's Office to determine if any potential crime has been committed."
The New York Times has an analysis asserting that Mr. Sokol "at a minimum, did a dumb thing...in today's climate any hint of insider trading just doesn't look good."
But Mr. Sokol isn't the head of mergers and acquisitions for Berkshire Hathaway. He runs NetJets, a utility company, and a roofing materials company that are owned by Berkshire Hathaway. Who was hurt by his action? Shareholders in Lubrizol? Their share prices went up. Shareholders in Berkshire? One could argue that they are hurt because they are overpaying for Lubrizol in a deal motivated by personal gain for Mr. Sokol rather than the interest of Berkshire shareholders, and that they are paying more for Lubrizol shares than Mr. Sokol paid when he bought them for himself. But it wasn't Mr. Sokol's decision that Berkshire would buy Lubrizol — it was the decision of Mr. Buffett and the Berkshire board, which Mr. Sokol is not on. And at least according to Mr. Buffett's account, he knew Mr. Sokol was a Lubrizol shareholder, because Mr. Sokol told him that.
The best case is probably that the Lubrizol shareholders who sold to Mr. Sokol were hurt, because they sold without access to material, nonpublic information that Mr. Sokol had, which is that the company could soon be presented to Warren Buffett as a Berkshire acquisition opportunity. That asymmetry of information is something that the government tries to prevent. On the other hand, just about any publicly traded company, and lots of privately held companies, are potential Berkshire acquisition opportunities. You don't need to be an insider to realize that. And the value in Lubrizol that Mr. Sokol saw may have related to just its inherent strength as a business or as a bargain stock rather than as a potential Berkshire acquisition. Those are things that the selling Lubrizol shareholders had the same opportunity to see that Mr. Sokol did.
So suppose that when Mr. Sokol bought Lubrizol shares, he just thought it was a good investment for himself on its own, and that he wasn't even thinking about the potential that it would be acquired by Berkshire. That's probably what he meant when he said that in retrospect he would have just held onto it and not mentioned it to Mr. Buffett. Suppose he had kept quiet about it, and the stock then went up 100% over the course of a year. By not mentioning it to Mr. Buffett, Mr. Sokol would have denied Berkshire shareholders the chance to participate in those gains.
Every big company with lots of subsidiaries has executives with their own diverse set of investments. If the company wants to impose conditions on those investments, it can, so long as the executives agree to accept them. Mr. Buffett could have told Mr. Sokol when he hired him that Mr. Buffett had to approve any personal investments that Mr. Sokol made other than in Berkshire Hathway stock, or that Mr. Buffett wanted the first look at any investment ideas that Mr. Sokol came up with. But there's no indication that there was any such deal in place.
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