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.