Economic analysis

Berkshire comes clean on Sokolgate

But will Buffett say sorry?

Warren Buffett got a lot of things seriously wrong about the David Sokol-insider trading affair, starting with this: When Buffett announced the resignation of Sokol, one of his top-lieutenants, amid questionable stock trades, he declared it would be his last comments on the matter. Turns out, not so much.

Berkshire Hathaway’s Audit Committee authorized Buffett to release an in-depth report today which states in no uncertain terms that Sokol breached the company’s insider trading policies. (See our original story, Say It Ain’t So, Warren, for background.)

From the report:

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, includingBerkshire Hathaway’s Code of Business Conduct and Ethics and its Insider Trading Policies and Procedures. … By engaging in such questionable conduct, Mr. Sokol threatened Berkshire Hathaway’s reputation–or would have done so had he remained with the Company.

Given the huge uproar over Sokol’s actions, this report is an important first step to repairing the damage to Berkshire’s cherished reputation. The question is, will it be enough? The release comes just three days before Berkshire’s annual general meeting in Omaha, Nebraska, and a lot will depend on how Buffett handles the matter there. The key being whether he apologizes. While it was Sokol who placed the trades and kept information from his boss, Buffett trusted him and did not probe deeper into the matter. And as chairman and CEO of Berkshire Hathaway, Buffett is ultimately responsible for any actions by his employees that damage the company’s reputation. Buffett has a long history of saying sorry, but this could be the most important apology of his career.

Anyway, on to the report. There’s a lot that’s fascinating in the plainly-worded disclosure:

-Berkshire is contemplating legal action against Sokol “to recover any damage the Company has sustained, or his trading profits, or both.” The company says will also cooperate with any government investigation into the matter, though it doesn’t come out and say that there is an investigation.

-Last October investment bankers at Citi brought a list of 18 chemical companies to Sokol as possible takeover targets. It was Sokol who narrowed the list down to one name, Lubrizol. That was two months before Sokol made his first purchase of Lubrizol shares.

-On March 14, after Berkshire announced the takeover of Lubrizol, a banker from Citi congratulated Buffett on the deal and took credit for bringing it to Berkshire’s attention. Until then Buffett had just assumed that Sokol had owned his shares in the company for some time and thought it was a great company Berkshire could buy. Suddenly, on the day of the big announcement, Buffett gets sideswiped by the revelation the deal had been cooked up by investment bankers. One can only imagine what was going throug his head at that point.

-The statement Buffett issued at the end of March announcing Sokol’s resignation was absent a passage Sokol had objected to, but which makes it clear Buffett knew Sokol’s actions stunk to high heaven.

Mr. Buffett deleted from the release the one passage Mr. Sokol said was inaccurate: a passage 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. 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 all but calls Sokol a liar. It notes that Sokol “left unchanged” key points in the draft version of Buffett’s statement about his resignation that were untrue. The final version of the statement said Sokol “did not know what Lubrizol’s reaction would be” when in fact he knew full well the company was keen to be acquired by Berkshire.

-The report is also notable for what it doesn’t discuss. After Sokol resigned, he appeared on CNBC. In the interview he said he’d done nothing wrong, and that Charlie Munger, Buffett’s investing partner, had owned shares in Chinese electric car company BYD before Berkshire acquired it at Munger’s suggestion. The Audit committee doesn’t go into this trade at all. Having said that, the circumstance are much different. Munger had owned his shares for a couple of years, fully disclosed his shareholdings to Buffett and was in no way involved in the deal to buy BYD.

BTW, for what it’s worth, I see the latest episode of Warren Buffett’s Secret Millionaire’s Club, an Internet cartoon that aims to teach kids about business and investing, is all about the importance of keeping a good reputation. It’s oh-so-appropriately titled “Cancel My Reputation.”