Corporate Governance Failure of Buffet

Is Warren Buffet throwing former Berkshire Hathaway executive David Sokol under the bus as a human sacrifice? Buffet has been criticized for failing to ask the right questions and act to block the company's acquisition of Lubrizol just weeks after Sokol bought 96,060 Lubrizol shares and told Buffett last January that the company could be a takeover candidate? The Berkshire Hathaway audit committee report absolves Buffet of any blame stating that he didn't realize until March 14, when the $9 billion deal was announced, that Citigroup had brought Lubrizol to Sokol's attention. In my view Buffet exercised poor business judgment and failed to exercise due care in his corporate governance role as CEO.

Here is an excerpt from the Berkshire Hathaway audit committee report that, not surprisingly, places the blame on Sokol:

"The Audit Committee has considered the conduct of David Sokol in connection with his trading in the shares of Lubrizol, and has determined that it violated those standards. In particular his purchases of Lubrizol shares while serving as a representative of Berkshire Hathaway in connection with a possible business combination with Lubrizol violated company policies, including Berkshire Hathaway’s Code of Business Conduct and Ethics and its Insider Trading Policies and Procedures.... His misleadingly incomplete disclosures to Berkshire Hathaway senior management concerning those purchases violated the duty of candor he owed the Company." The audit committee report can be found at: http://www.berkshirehathaway.com/dlsokol/DLSokolReport.pdf.

On April 19, shareholder Mason Kirby sued the company's board, Buffet, and Sokol over alleged unethical behavior in the holding company's $9.7 billion purchase of chemical company Lubrizol Corporation. The complaint claims that "Sokol knew that Buffet would closely consider and likely take his recommendation regarding an acquisition of Lubrizol," noting Sokol's widely reported position at the time as Buffett's most likely successor. After meeting with Sokol in late January, Buffett did in fact take his advice, acquiring Ohio-based Lubrizol for $135 per share in a $9.7 billion cash deal, Kirby alleges. Sokol made $13 million in profit when the value of Lubrizol shares jumped March 14, the day Berkshire pulled the trigger on the deal, the suit says. The suit also claims that Sokol owes shareholders damages and restitution for breaching his fiduciary duty.

Buffet's failure is one of leadership at a time when CEO's should be skeptical and err on the side of caution when a questionable recommendation by a top official might appear to a reasonable observer to be motivated by personal gain. Has he learned nothing from the financial meltdown of 2008? Buffet's own words reflect his failure to act with due diligence and care.  In the past he has been quoted as saying: "In the business world, the rear view mirror is always clearer than the windshield." His rear view mirror should have passed by the financial wreckage about three years ago. Was he asleep at the wheel? Is he not aware of the pursuit of self-interest behavior that has infected the corporate world? Another quote is that, "It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently." Someone with Buffet's experience and presumed sophistication as an investor should have taken his own statement to heart -- walk the talk and order an inquiry of Sokol's disclosure before the company had purchased Lubrizol.  He owed nothing less to the shareholders of Berkshire.

Buffet first defended Sokol's action on March 30 stating that, "neither Dave nor I feel his Lubrizol purchases were in any way unlawful," when he announced Sokol's departure. "He has told me that they were not a factor in his decision to resign." His naiveté is shocking. Buffet failed to inquire further about the timing and extent of Sokol's purchases — a failure constituting a violation of Berkshire corporate policy, according to the lawsuit. Berkshire's insider trading policy restricts trading not only to material nonpublic information relevant to its stock but also to information relevant to other publicly traded companies." The latter includes "securities of other public companies in which Berkshire has invested or may in the future invest," the complaint said, quoting the company's policy.

It's not very encouraging to find out that one of the most respected people in the investment world and spokesperson for ethical corporate governance admits to a mistake only after his actions are questioned in the press and prior to the shareholders meeting last Saturday. He seems to have dodged a bullet at the meeting based on his explanations to shareholders and because of his personal gravitas. However, his unwillingness to act after Sokol's disclosure reflects a troubling pattern that has been repeated by many top company (and government) officials over the years. While Buffet may not have violated any law and may be able to hide behind Sokol's lack of full disclosure, it doesn't lessen his ethical culpability.

 Blog by Steven Mintz, aka Ethics Sage, May 5, 2011