Published on March 30, 2011

David L. Sokol

In a press release issued this afternoon, Berkshire Hathaway Chairman and CEO Warren Buffett announced the resignation of David Sokol.  Mr. Sokol served as Chairman of several Berkshire subsidiaries and many observers, including The Rational Walk, previously believed that he was the front runner to eventually assume the CEO position at Berkshire Hathaway.  Mr. Buffett indicated that Mr. Sokol resigned on Monday, March 28 by sending a letter delivered by an assistant.  Mr. Buffett did not ask for Mr. Sokol’s resignation and stated that he was surprised by the development although he noted that Mr. Sokol spoke to him about resigning on two prior occasions.

There will be ample time in the future to consider the implications of Mr. Sokol’s resignation on Berkshire Hathaway’s CEO succession process and we note that Berkshire should still have three candidates capable of taking the top job on an immediate basis if required.  In this article, we will instead focus on Mr. Sokol’s trading in Lubrizol stock during the time he was investigating potential investment candidates for Berkshire Hathaway.  Our effort is not designed to determine whether anything illegal took place but whether any potential ethical standards were violated that could have led Mr. Buffett to lose confidence in Mr. Sokol in recent weeks.

Timeline of Events

We have prepared the following timeline of events based on the information contained in Mr. Buffett’s press release along with Lubrizol’s latest proxy statement which was filed with the SEC on Friday, March 25.  In combination, these documents allow us to reconstruct the chain of events that took place with respect to Mr. Sokol’s involvement with the Lubrizol transaction.

Fall of 2010

Lubrizol’s proxy statement indicates that Mr. Sokol met “from time to time” with various investment banking firms to discuss capital-raising and transaction ideas.  During the Fall of 2010, Mr. Sokol requested that his contacts at Citigroup prepare additional information for his review concerning possible transactions in several industries including the chemicals industry.  Citi prepared a list of 18 companies for Mr. Sokol’s review.

December 13, 2010

The proxy statement states that Mr. Sokol met with Citi on December 13, 2010 to discuss the list of companies.  Mr. Sokol indicated that the only company of interest on the list was Lubrizol.  Mr. Sokol asked one of the Citi representatives to inform Lubrizol’s Chairman and CEO James Hambrick that he was interested in speaking with him to discuss Berkshire Hathaway and Lubrizol.  This seems to indicate that  Mr. Sokol’s interest in Lubrizol was related to a potential transaction with Berkshire rather than as a potential personal investment.

December 14, 2010

Mr. Buffett’s press release indicates that Mr. Sokol purchased 2,300 shares of Lubrizol on December 14.  Lubrizol traded in a range of $103.89 to $108.08 and December 14 and closed at $108.03 making this transaction worth between $239,000 and $248,500.

December 21, 2010

Mr. Buffett’s press release indicates that Mr. Sokol sold 2,300 shares of Lubrizol on December 21.  Lubrizol traded in a range of $108.83 to $110 on December 21 and closed at $109.28 making the transaction worth between $250,300 and $253,000.  This means that Mr. Sokol made a profit of between approximately $1,800 and $14,000 depending on the exact purchase and sale prices.  While a quick trade of this nature is odd, it is probably not particularly material to the situation.

January 5 – 7, 2011

According to Mr. Buffett’s press release, Mr. Sokol purchased 96,060 shares on January 5, 6, and 7 pursuant to a $104 per share limit price.  Lubrizol shares traded between $101.74 and $105.25 over the three day period.  If executed at the $104 limit, the transaction was worth nearly $10 million.

January 6 – 10, 2011

According to the Lubrizol proxy, Lubrizol’s Board met on January 6 to discuss news of Berkshire’s potential interest which was communicated via Citi on December 17.  Mr. Hambrick met with Lubrizol’s senior management on January 7 and the Board convened again on January 10 for a more thorough discussion of Berkshire’s potential interest.  The Board ultimately instructed Mr. Hambrick to arrange a meeting with Mr. Sokol.

January 14, 2011

The Lubrizol proxy indicates that Mr. Sokol and Mr. Hambrick had a telephone conference to discuss the corporate cultures of Berkshire Hathaway and Lubrizol and arranged to meet in person on January 25.

January 14 or 15, 2011

Mr. Buffett’s press release indicates that Mr. Sokol approached him on January 14 or 15 to discuss the potential Lubrizol transaction.  Mr. Buffett was “unimpressed” with the idea at the time. At this time, Mr. Sokol “mentioned that he owned stock in the company” in a “passing remark”.  Mr. Buffett did not ask Mr. Sokol about the date of his purchase or the extent of his holdings.  Although not stated, it seems safe to infer that Mr. Sokol did not volunteer such details at that time even though his purchases took place only days before.

January 24, 2011

Mr. Buffett sent Mr. Sokol a “short note indicating “my skepticism about making an offer for Lubrizol and my preference for another substantial acquisition for which MidAmerican had made a bid.”

January 25, 2011

Lubrizol’s proxy indicates that Mr. Sokol and Mr. Hambrick met in Cleveland, Ohio.  Although the account of the meeting indicates that much substance was discussed regarding Lubrizol’s business, the proxy makes it clear that price was not discussed and Mr. Sokol stressed that only Mr. Buffett was authorized to make a decision on proceeding with an offer and at what price.  Mr. Sokol must have been favorably impressed since Mr. Buffett indicates that Mr. Sokol’s account of the meeting made him “get interested in the acquisition of Lubrizol”. Presumably this discussion between Mr. Sokol and Mr. Buffett took place shortly after the dinner meeting on January 25.

January 27 to March 13, 2011

Lubrizol’s Board of Directors engages in various discussions and negotiations with Berkshire Hathaway regarding the terms of the acquisition.  While the details are of interest in terms of understanding Berkshire’s approach to acquisitions, they are not directly related to the question of Mr. Sokol’s transactions in Lubrizol stock.

March 13, 2011

Berkshire’s Board convened a special meeting and unanimously approved the transaction.  Berkshire Hathaway and Lubrizol executed and delivered the merger agreement.

March 14, 2011

Berkshire Hathaway and Lubrizol issue a joint press release announcing the transaction on Monday, March 14.  Lubrizol stock closes at $134.68 on March 14, up $29.24 from its close on Friday, March 11.  Assuming Mr. Sokol still held the shares of Lubrizol acquired on January 5, 6, and 7, the value of his holdings advanced by $2.8 million. 

March 19, 2011

Shortly before leaving for his trip to Asia on March 19, Mr. Buffett “learned that Dave first purchased 2,300 shares of Lubrizol on December 14, which he then sold on December 21. Subsequently, on January 5, 6 and 7, he bought 96,060 shares pursuant to a 100,000-share order he had placed with a $104 per share limit price.”  Note that Mr. Buffett does not say how he learned of the transaction so we do not know if Mr. Sokol provided this information or if Mr. Buffett learned about it from other sources.

March 25, 2011

Lubrizol’s proxy statement is released describing Mr. Sokol’s involvement in negotiating the transaction. However, there is no mention of Mr. Sokol’s personal ownership of Lubrizol stock in the proxy statement.

March 28, 2011

Mr. Buffett “received a letter of resignation from Dave, delivered by his assistant.”

March 30, 2011

Mr. Buffett announces Mr. Sokol’s resignation.

Regardless of Legal Status, Actions Reveal Poor Judgment

Mr. Buffett clearly states in the press release that neither he nor Mr. Sokol consider the transactions in question to be illegal and presumably Berkshire’s legal counsel has been involved in ascertaining the situation as well.  We will put forward no particular opinion regarding whether the transactions in question can be considered insider trading other than to note that the timeline of events reveal that Mr. Sokol made his purchases far before it became clear that Berkshire would be making an offer for Lubrizol.

However, regardless of the question of whether the transactions were legal, we believe that they displayed extremely poor judgment on Mr. Sokol’s part for several reasons:

First, Lubrizol’s proxy clearly indicates that Mr. Sokol was engaged with Citi to search for potential deals as a representative of Berkshire Hathaway rather than as a private investor.  Although it appears that Mr. Sokol has considerable personal assets to manage, he should not have combined his search for personal investments with securities that he thought could be potential acquisition candidates for Berkshire.  It is obvious that such transactions would appear to be questionable even if they are not illegal should Berkshire take an interest in the investment candidate and eventually initiate a transaction.  As Mr. Buffett has said on numerous occasions, it is best to stay far away from any “gray lines” when it comes to legal or ethical matters.

Second, although Mr. Sokol did tell Mr. Buffett about his ownership of Lubrizol shares when he initially approached Mr. Buffett with the idea on January 14 or 15, he did not volunteer information regarding either the size of his ownership or the date of his investment.  Although Mr. Buffett did not ask him for this information, Mr. Sokol should have disclosed the specifics given that he made the purchase only a few days earlier.  Such information is clearly material not only because of any legal or ethical issues should Berkshire make an acquisition but also because it could influence Mr. Sokol’s judgment when making recommendations to Mr. Buffett.

Third, it was inappropriate for Mr. Sokol to continue taking the lead on the transaction given the size of the stake and the recent date of his purchases.  For Mr. Sokol to continue discussions with Mr. Hambrick on January 25 and to then pitch the deal to Mr. Buffett again shortly thereafter involved a clear conflict of interest.  Although Mr. Sokol had no control or input regarding the price Berkshire would offer, he obviously knew that some type of control premium would be required and that any acceptable deal would occur at a price far above his recent cost basis in the shares.  There was a clear conflict of interest in continuing to be involved and to recommend the deal to Mr. Buffett.

Considerable Accomplishments Forever Tainted by Controversy

In Berkshire Hathaway’s 2010 annual report, Mr. Buffett included a letter he sent to all Berkshire managers which contained the following advice:

If you see anything whose propriety or legality causes you to hesitate, be sure to give me a call. However, it’s very likely that if a given course of action evokes such hesitation, it’s too close to the line and should be abandoned. There’s plenty of money to be made in the center of the court. If it’s questionable whether some action is close to the line, just assume it is outside and forget it.

We cannot help but feel profound disappointment regarding today’s announcement both in terms of Berkshire losing a very talented executive and the poor judgment displayed in the matter.  David Sokol has been controversial in the past, particularly related to the actions he took to restore NetJets to profitability.  However, Mr. Buffett has been steadfast in his praise for Mr. Sokol’s leadership and reiterated this praise in today’s news release.

Mr. Buffett writes that he did not personally ask Mr. Sokol to resign and that, when asked, Mr. Sokol stated that he did not submit his resignation due to the Lubrizol situation.  We have no reason to doubt Mr. Buffett’s honesty in making these statements, although we note that it is very possible that other Berkshire Directors acting of their own volition spoke to Mr. Sokol about the situation and may have reacted very negatively.  It  is obvious that everyone involved would have preferred Mr. Sokol’s departure from Berkshire to occur under more positive conditions.  As things stand, even if these transactions turn out to be perfectly legal, it is almost certain that Mr. Sokol’s considerable accomplishments at Berkshire will always be accompanied with a footnote regarding the controversy surrounding his departure.  This is an unfortunate outcome for a manager who has provided Berkshire with tremendous value over the years.

Disclosure:  Long Berkshire Hathaway.

Sokol’s Resignation Raises Questions Regarding Lubrizol Transaction

12 thoughts on “Sokol’s Resignation Raises Questions Regarding Lubrizol Transaction

  • March 30, 2011 at 9:49 pm
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    Ravi, you neglect to assign blame to Buffett as well, but instead you chose to throw only Sokol under the bus. I suspect you did so as you have a “Buffett Premium” business to sell or you are simply behaving like many other Buffett faithfuls who refuse to believe Buffett is anything less than God. Clearly Sokol is wrong. He made his first Lubrizol purchase on Dec 14, one day AFTER he discussed with Lubrizol about a potential transaction with Berkshire. This is akin to a M&A banker frontrunning a potential deal he is working on (whether the deal would transpire or not is irrelevant). When Sokol first told Buffett about his stock ownership, Buffett should have asked for detail. He didn’t and so he’s either sloppy or stupid. When Sokol disclosed the details after the deal was announced, Buffett should have FIRED Sokol on the spot. Remember what Buffett said to the Salomon employees during his Salomon days? “If you lose reputation for the firm I will be ruthless.” In the case of Sokol, Buffett was a coward and hypocrite. He probably didn’t want to lose Sokol so he decided to let the matter slide. I think there’s likely more the story. Maybe Buffett did fire Sokol. But in publicly claiming that Sokol left on his own and saying it had nothing to do with the personal stock transactions, Buffett would be lying and cover-up a scandal. Either way, doesn’t look good for you Buffett faithfuls.

    • March 30, 2011 at 9:54 pm
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      Berkshire Hathaway is run by Warren Buffett and Charlie Munger based on a “seamless web of deserved trust” and it is likely that the thought of David Sokol essentially front-running a potential Berkshire acquisition did not occur to Mr. Buffett at the time he was told of Mr. Sokol’s ownership.

      The fact that David Sokol didn’t say, “Hey, Warren, I feel so strongly about Lubrizol that I put $10 million into it just last week. I think it would be a great fit for Berkshire but I realize that I have a conflict and should recuse myself” probably was enough for Mr. Buffett to think it unnecessary to ask further questions. I can’t read minds, but if I had to bet, I would say that Mr. Buffett probably interpreted Mr. Sokol’s statement to mean that he was a longtime *owner* of Lubrizol, not someone who traded a few shares in December and days before put $10 million into it.

      I can think of no other explanation other than the “deserved trust” philosophy that can explain why that question was not asked. Sometimes the web of trust breaks down, as it did in this case. Better for Berkshire shareholders to have this occur today than to have this kind of behavior revealed in a future transaction 10 or 20 years from now.

  • March 30, 2011 at 10:16 pm
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    In M&A deals involving public companies, each party will get a list of people who made large or unusual trades in the target company stock before the transaction was announced. It is possible that Sokol’s name showed up on one of these lists and that is how he got exposed. Warren and Sokol may say and even believe that the trades were legal, but I would not be surprised at all if he is investigated and charged with illegal insider trading. The SEC loves high profile cases, and they are taking lots of heat for doing nothing about the sub-prime mortgage meltdown. Also one does not end a long term good working relationship with a sudden letter delivered by your assistant unless there is something bad going on.

  • March 30, 2011 at 10:19 pm
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    “Also one does not end a long term good working relationship with a sudden letter delivered by your assistant unless there is something bad going on.”

    Agreed, and I think there’s a reason the method of resignation was discussed in the press release even though how David Sokol resigned isn’t that material to the situation itself.

  • March 30, 2011 at 10:23 pm
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    Ravi,

    I agree with everything you’ve said about this subject so far, but I think commenter “Jim” has a point here. This *is* very similar to an M&A banker frontrunning a deal he’s working on. And Buffett was apparently ready to let this matter go – he explictly said the resignation surprised him and he didn’t ask for it.

    Sokol’s actions are inexplicable – I’m sure this really wasn’t whole lot of money to him. Why on earth would he have done this?

    Given how careful Buffett is with choosing his words, I think it’s interesting that he wrote there was nothing *illegal* about Sokol’s actions but didn’t defend him any further. I think the lack of a more strenuous defense says something. I also think it’s interesting that Buffett made a point of saying he didn’t try to talk Sokol out of resigning this time.

  • March 30, 2011 at 11:18 pm
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    So this was not a 100%-sure insider trade, but it was an insider trade nonetheless. Most insider trading is based on future events that are not ironclad certain anyway, and perhaps this one was a bit more on the uncertain side but I see no fundamental difference. I expect the SEC to go after Sokol, as it should.

    I would also not be surprised if Munger played a role in this by studying about the legal aspects and forcing Sokol to submit his resignation so that Buffet could honestly say that it was a surprise.

    • March 30, 2011 at 11:23 pm
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      “I would also not be surprised if Munger played a role in this”

      I’m sure Charlie Munger had influence in this and can guess what his reaction might have been when he heard about the trades. However, I take Buffett’s comments at face value regarding his surprise on the timing of the resignation.

  • March 31, 2011 at 8:41 am
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    If Buffett can be faulted, it’s because he trusted too much. He often talks about how hands-off he is with his managers and it appears to have come to bite him in the rear end. On the other hand, there is no reason for WB to assume or even suspect that Sokol would do something so stupid.

  • March 31, 2011 at 9:00 am
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    The January 14th/15th meeting showed bad judgment on both Sokol and Buffett. Sokol should have fully disclosed the details of his investmet transactions and Buffett should have either further questioned his ownership interest, or tell Sokol to run it by Munger Tolles (Berkshire’s law firm). It’s a shame that this incident of poor judgment tarnished n excellent mangement career at Berkshire.

  • March 31, 2011 at 10:57 am
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    Just read that Sokol said, had he known then what he knows now, he wouldn’t have told Buffett about Lubrizol – he would have just bought the stock for himself.

    Huh? Wasn’t his whole interaction with Citigroup, and communications with Lubrizol’s CEO, based on his role as a Berkshire executive? Wasn’t the list Citigroup compiled created for Berkshire? And once he decided to pitch the idea to Buffett, why not sell the shares just to be safe and not have any appearance of impropriety? I just don’t get it.

  • March 31, 2011 at 10:58 am
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    What he said was one of the most disturbing and disappointing things I’ve ever heard – as I describe more fully in a post just published.

  • March 31, 2011 at 5:11 pm
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    This makes things interesting. The presumed front runner is out. Buffett says Jain doesn’t want it and is more valuable where he is. It’s interesting that the job might end up going to someone that isn’t a long time member of the Berkshire family.

    Unsurprisingly, Buffett is being publicly supportive of Sokol. I would bet he’s feeling betrayed on some level at this point.

    Alice Schroeder’s comments were interesting. She’s just doing her job as a journalist, but I have to wonder how Buffett feels about her now that she’s made a career of being a Buffett expert.

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