Berkshire Hathaway’s Audit Committee has determined that David Sokol’s trades in Lubrizol shares prior to Berkshire’s announced acquisition of the company “violated company policies.” It also determined that his “misleadingly incomplete disclosures” to Berkshire management “violated the duty of candor he owed the Company.” The Audit Committee reported these findings in an April 26 report to the Berkshire board, which released on its website on April 27, 2011. The report and accompanying press release can be found here. (Full disclosure: I own BRK shares.)
The report is the product of three Audit Committee meetings on April 6, 21 and 16, as well as a meeting of the full board in late March, and communications between the audit committee chair and company management and company counsel. In other words, while the rabble rousers outside the company were raising a ruckus about Sokol’s trades, the Audit Committee was conducting its own investigation. And it is pretty clear that as a result of this investigation, the Audit Committee is, in the words of UCLA Law Professor Stephen Bainbridge, “throwing Sokol to the wolves.”
The report specifically concludes that Sokol’s trading activity and his statements to Berkshire management about his trading violated the company’s Code of Business Conduct and Ethics and its Insider Trading Policies and Procedures. It also found that his conduct violated the company’s standards as articulated by its Chairman, Warren Buffett, to “zealously guard Berkshire’s reputation.” It also concluded that Sokol violated his duty of full disclosure to the Company.
The report specifically concludes that by trading in the Lubrizol shares, Sokol had misappropriated an opportunity that was Berkshire’s and that Sokol was only able to exploit by virtue of his position acting as Berkshire’s representative in connection with the negotiations and the transaction.
The report points out that Sokol’s voluntary resignation “had the effect of preventing him from receiving any severance-related benefit substantially different from those to which he would have been entitled if he were terminated for cause on the same effective date. He has thus suffered a sever consequence from his violations of Company policy.”
Nevertheless, the report concludes, the board is considering “possible legal action against Mr. Sokol to recover any damage the Company has sustained, or his trading profits, or both, and … whether the Company is obligated to advance Mr. Sokol’s legal fees associated with proceedings in which he is named.”
Finally, the company’s press release notes that it will post on its website a “complete transcript” of any questions or answers related to David Sokol at the upcoming April 30 meeting of Berkshire’s shareholders. (There might be a question or two on the topic…)
Among other things that the Audit Committee’s report does is that it makes it difficult for the plaintiff in the recently filed derivative action relating to these matters to be able to contend that a demand to the Berkshire board to take up this claim would have been futile. The board and its Audit Committee are quite capable of taking up these questions, thank you very much. (Among other reasons the plaintiff cited in support of his demand futilty allegatoin is that the company lacks "traditional corporate infrastructure" -- that contention look particularly wrongfooted in light of the Audit Committe's report).
The report’s final note about the board’s consideration of whether or not the company must advance Sokol’s legal fees is an interesting one to me. Buffett has been very public about the fact that Berkshire does not buy D&O insurance. In his most recent letter to shareholders, Buffett said, by way of explanation of why the company does not buy D&O insurance, “If they mess up with your money, they will lose their money as well.”
So if the company withholds defense expense advancement from Sokol, his choices are to defend himself out of his own pocket or to try to sue the company to enforce its advancement obligations. Neither is a particularly attractive choice for Sokol, as it will either cost him a fortune or put him in the very unattractive position of suing his former company.
I know the audit committee’s report does not include Sokol’s side of the story. (The report does not state specifically whether or not the audit committee interviewed Sokol in connection with its investigation and report). He likely has a different perspective on these events. But it seems to me that Sokol could go along way toward rehabilitating himself and his public reputation by offering to pay Berkshire trading profits he made for the Lubrizol trades and by offering to reimburse the company for its legal expenses in investigating the trades. Any other path means more expense for the company and for Sokol and merely increases the amount that Sokol might have to pay to extricate himself from this situation later on. It just seems to me that this situation is unlikely to get better for Sokol, it will only get worse, and it won’t help Berkshire either.
Lost among all this hoopla is that the Lubrizol transaction still has not closed and indeed the Lubrizol shareholders have not yet had their vote -- the Lubrizol shareholder vote is set for June 9, 2011. Lubrizol is located outside Cleveland, and I can tell you that here in Cleveland , no one is talking about Sokol’s trades. Rather, they are talking about the $97 million that Lubrizol CEO James Hambrick stands to reap if the deal goes through. Indeed, the lead article on the front page of the April 26, 2011 Cleveland Plain Dealer was captioned “Lubrizol CEO Poised to Soar on Fabulous Golden Parachute.” (Fulll disclosure: I have met Hambrick socially here in Cleveland.)
I guess a lot of questions are being asked about who will be making how much as a result of this transaction. Somewhere amidst all these issues is the larger question of whether or not the transaction itself is in the interests of the shareholders of both companies. Of course, shareholders might feel more comfortable about their interests if individuals involved in the transaction were not profiting individually from the deal.
Speakers' Corner: On May 11, 2011, I will be moderting a session in Menlo Park, California entitled "Dodd-Frank and the Rise of Shareholder Empowerment." The session is sponsored by the Orrick law firm, The Directors Network and Deloitte, and will take at place at the Orrick law firm's Menlo Park offices. The program, which is free and which will run from 8:45 am to 11:45 am, will provide insights and practical advice regarding fundamental changes in the corporate governance environment and the emerging role of shareholders in the U.S. corporation.
The session includes an all-star cast of panelists, including Roel Campos, who served as an SEC Commissioner from 2002-2007; Consuelo Hitchcock, Principal, Regulatory and Public Policy at Deloitte; Marc Gross, of the Pomerantz, Haudek, Grossman & Gross law firm; Anne Sheehan, Director of Corporate Governance at CalSTRS; Marc Schneider, Associate General Counsel at SEIU; George Paulin, the President of George Cook & Co.; and Jonathan Ocker and Bob Varian of the Orrick law firm.
Furher information about the program, including regiistration information, can be found here.