Berkshire Hathaway Chairman Warren Buffett was not exaggerating when he stated at the opening of the company’s March 30, 2011 press release (here) that the release “will be unusual.” Not only did Buffett disclose the resignation of David Sokol as Chairman and CEO of several subsidiaries, but the release also revealed that Sokol had acquired shares of Lubrizol before bringing the idea to Buffett that Berkshire should acquire Lubrizol. (Berkshire had announced its intention to acquire Lubrizol just days earlier.)
As odd and inexplicable as were the events described in the March 30 Berkshire press release, the story became even odder and more inexplicable as information came out that Sokol acquired Lubrizol shares after specifically discussing -- apparently as a representative for Berkshire -- with investment bankers that possibility that Lubrizol might be an appropriate acquisition target for Berkshire. Sokol also apparently acted as a representative for Berkshire in connection with negotiations with Lubrizol about a possible Berkshire acquisition.
Given the high-profile and sensational nature of these allegations, it was perhaps inevitable that litigation would follow. Indeed, a lawsuit was duly filed in Delaware Chancery Court on April 18, 2011. The complaint, which can be found here, presents a shareholders’ derivative claim against Berkshire, as nominal defendant, as well as against Sokol and against the twelve individual members of Berkshire’s board – including not only Buffett, but his chum Charlie Munger and his fellow billionaire Bill Gates. The complaint asserts two substantive claims, one against all of the individual defendants for breach of fiduciary duty and one against Sokol for disgorgement.
As a Berkshire shareholder myself as well as a long time Buffett devotee, I have to admit I winced – hard—when reading the March 30 press release. Just the same, the lawsuit makes me uneasy too. Perhaps my long devotion to Buffett biases my view. I confess that I have been unable to bring myself to write about the lawsuit until now because of my conflicted feelings. I do have to admit that the complaint does make for some interesting reading. The time line of events portrayed in the complaint does not reflect well on Sokol, to say the least.
The Complaint is less compelling when it tries to detail the specific harms these events have caused the Company. Among other things, the Complaint cites credit analysts to the effect that these events “could result in a negative credit rating for Berkshire” and that have “flagged concerns over the Company’s lack of traditional corporate infrastructure.” The Complaint also cites the decline in Berkshire’s share price that following the March 30 disclosure.
One threshold problem the claimant will face is showing that the requisite demand on Berkshire’s board would have been futile. In order to try to establish demand futility, the complaint alleges that the board could not be relied upon to “take proper action on behalf of the Company” due to their “inter-related business, professional and personal relationships” as well as “debilitating conflicts of interest” arising from “prejudicial entanglements and transactions which compromise their independence.” (Francine McKenna’s blog post about the demand futility issue on her Accounting Watchdog blog at Forbes.com can be found here. )
But assuming for the sake of argument that the plaintiff can overcome the demand futility hurdles there is the question of whether or not the plaintiff can hope to prevail on the merits.
Over at the Delaware Corporate and Commercial Litigation Blog (here), esteemed fellow blogger Francis Pileggi has assembled a host of helpful links and commentaries about the lawsuit. (I would be remiss if I did not also mention here my thanks to Francis for his blog’s provision of a link to the Complaint, as well.) Among the more interesting sources he cites is UCLA Law Professor Stephen Bainbridge’s thorough analysis of the possible merits of the claim, which can be found here and here.
Among other things, in the second of his two posts, Professor Bainbridge expressly raises the problems that the plaintiff will have meeting the demand futility test. More interestingly, in both posts, Bainbridge elaborates on the view that the disgorgement claim against Sokol seems to be supported under existing Delaware case law.
Professor Bainbridge’s analysis is interesting and persuasive. But it doesn’t answer what is for me the even more interesting question this lawsuit presents, which relates to the breach of fiduciary duty claim alleged against the Berkshire directors. Can the directors – or any one of them (say, for example, Buffett) -- possibly be held liable for failing to take actions that allegedly could have prevented supposed harm to the company?
UPDATE:In a subsequent post (here), Professor Baibridge has answered my question about the possibility that the Berkshire board could be liable for failing to supervise Sokol's trades. In Bainbridge's view, the answer to the question is "no," for reasons he explains in his post.
I guess I have too much of a practical habit of mind. Or perhaps it is just because I am a Berkshire shareholder. But I do have to wonder what this lawsuit ultimately is going to produce, other than the generation of massive amounts of legal fees (as if that were something that would be in any company’s interest). Sure, sure, if Professor Bainbridge is right, the disgorgement claim against Sokol might be meritorious, in which case Sokol would have to disgorge h is trading profits to Berkshire. Even so, the most that would garner for the company is about $3 million or so, as I understand it, at the cost of God know how much in legal fees (plus of course the payment of plaintiff’s attorneys fees -- or at least so the plaintiff’s attorneys’ hope).
If all this case is about is the disgorgement claim, this sure seems like an enormous waste of everybody’s time. (Indeed, Sokol could save himself and everyone else a whole lot of aggravation if her were to just take out his checkbook and write Berkshire a check for his trading profits.)
Of course, there is always at least the theoretical possibility of damages for the breach of fiduciary duty claim against the other directors. It is only really conceivable to even think about this possibility by overlooking the highly speculative nature of the alleged harms the company sustained and the evanescence of the share price decline. And even then -- perhaps others can form a picture of say, Buffett, paying money to Berkshire, but it would take a lot more to persuade me that that could happen here and if it could that it would remotely make sense.
One other possibility that does come to mind is that, if the case gets that far, perhaps the resolution of this case, like the resolution of many shareholder derivative lawsuits, will include the company’s agreement to adopt certain corporate governance reforms. There would be something highly ironic about Berkshire, of all companies, taking on, say, board oversight obligations. However, the original source of the irony is in the events that led to all of this, which is that, at least as the plaintiff would have you believe, Buffett failed to follow the company’s own existing internal guidelines on these types of matters.
There would be something ironic indeed if Berkshire were to have to implement more “traditional governance infrastructure.” I appreciate irony as much as anybody. But as a shareholder I do wonder whether that would actually be good for the company.
One final thought. To paraphrase a recent post on the Deal Journal blog (here) -- You don’t suppose there might be a question or two about all of this at next week’s meeting of Berkshire’s shareholder, do you?
Where are Today’s Tsunami Stones?: The April 21, 2011 New York Times has a fascinating article entitled “Tsunami Warning for the Ages, Carved in Stone” (here). The article is about the small village of Aneyoshi, Japan, where an aging stone marker set into the hills warns “Do not build your homes below this point!” Village residents say this warning kept their homes safely out of reach of the deadly tsunami last month.
There apparently are hundreds of these stones scattered throughout Japan. Sadly, in modern times, residents came to put more faith in advanced technology and higher sea walls, and many of the warning were ignored.
The stones were meant to communicate a critically important message. But their very existence suggests something deeper. The people who put those stones up were capable of thinking very concretely about future generations. They were able to envision the people 80 or 100 years in the future who might need to know what they knew. The erection of the tsunami stones was an act of incredible foresight and incredible generosity.
Toward its end the article quotes a Japanese scientist as saying “We need a modern version of the tsunami stones.” The scientist was thinking specifically about potential harm from future tsunamis. But I think the need for warnings to future generations is not limited just to Japan and not just to tsunamis. There are so many things that future generations will need to know. I wonder whether we are able to look forward as those who built the original tsunami stones did. What are we willing to do to protect those unborn people who need to know what we have seen? I sometimes worry that we are incapable of thinking about the needs of those who will be living their lives 80 or 100 years from now.
And then finally, there is the lesson of the tsunami stones that were disregarded. As long as people insist on building in flood planes, for example, there will be people who suffer because they choose to disregard the evidence. And as someone who works in the insurance industry, I know all too well how significant economic activity can be carried out in complete obliviousness to the stark warnings of the past. . The landscape of the insurance industry is littered with its own version of tsunami stones yet the warnings of the past are so often disregarded.