Last month, the news broke that David Sokol, who was Warren Buffett’s presumed heir apparent at Berkshire Hathaway Inc. (BRK/A), made $3 million from Lubrizol Corp. (LZ) stock purchases while he was pushing Buffett to buy the company.
In the statement announcing Sokol’s resignation, Buffett downplayed the importance of front-running Lubrizol stock, excusing Sokol on the grounds that he did nothing “unlawful.” That, wrote Buffett, was all he planned to say on the subject -- until yesterday.
That’s when Berkshire issued an audit-committee report condemning Sokol for having misled Buffett and the company. It also said Berkshire might sue Sokol. The report responds to weeks of criticism about Berkshire’s seeming indifference to ethical standards, and comes just before some 40,000 people descend on Omaha, Nebraska, for the annual shareholder meeting.
For Buffett, sometimes dubbed the Oracle for his investing acumen, the meeting is a double-edged sword. The event at which he and his vice chairman, Charles T. Munger, spend almost six hours answering questions puts considerable pressure on him to be more forthcoming. On the other hand, Buffett will be speaking with a home-field advantage to a receptive audience that wants to think well of him.
He will need their good will. The audit-committee report answers some questions about what happened with Sokol, but not the most important ones: Why did Berkshire fail to condemn his behavior initially, and instead praised his “extraordinary” contributions to Berkshire? And what will Berkshire do to improve its corporate governance?
The company lays out a story in which Sokol misled Buffett and Berkshire’s chief financial officer, Marc Hamburg. These revelations are damning, and the audit committee has concluded in harsh terms that Sokol violated Berkshire’s code of conduct, its insider-trading policy and failed his duties as a manager. But according to the report, the essential elements were known by the Berkshire board before March 30. This is when Buffett praised Sokol in a press statement and declared Sokol’s actions kosher because they were “not unlawful.”
According to a statement by Sokol’s attorney, Barry Levine, Buffett “was told twice, not once,” about Sokol’s ownership of Lubrizol shares before Buffett began takeover talks with the company.
It’s understandable that a continuing investigation might justify taking a harsher view of the facts, but Berkshire’s opinion hasn’t just evolved. It has taken a 180-degree turn. Behavior that was explained away just a month ago is now being condemned. Obviously, Buffett did need to change his mind and be clear about the reasons.
The problem isn’t the about-face. It is the missing explanation for why Berkshire went so easy on Sokol in the first place. Whatever the detailed reasons, ultimately it boils down to Berkshire’s reliance on Buffett’s personal judgment about his managers and his ability to delegate to them to the point of abdication. When this one-man infrastructure makes a mistake, it’s hard to admit that Buffett is at fault. Changes in the way the company is managed are personal, not corporate. Under the circumstances, the temptation is high to blame everything on a single rogue employee. That doesn’t excuse Sokol’s behavior, but the failure of oversight needs to be acknowledged and corrected.
Instead, Berkshire is struggling with how to handle this situation. For years, Buffett’s quirky management style was hailed as a strength, and he escaped this kind of scrutiny. His former Teflon status is making the backlash all the harder.
Buffett has plenty of enemies, though they have stayed underground until recently. They include fat cats who don’t want to pay the higher taxes Buffett advocates, chief executive officers weary of being called greedy parasites by one of the world’s richest men, and Wall Streeters of all stripes who think Buffett’s hellfire-and-damnation tirades about their business are hypocritical.
Now, caught in the painful fall stage of the great American narrative known as rise, fall and redemption, it’s hard to see how Buffett can change the narrative’s overall course through public relations. But he can avoid making it worse for himself by taking responsibility.
The more explicitly Buffett shoulders some of the blame for having waffled on ethics, the more future redemption points he will get. If he dumps on Sokol while trying to avoid all entanglement in the situation, or reaches for credit for having turned tough, it won’t be convincing. Based on the audit- committee report, it looks as though this is where things are headed, but it’s not too late for Buffett to change direction.
Governance, rightfully, will be high on the audience’s mind during the meeting, because Sokol is only a symptom of an underlying cause. The world acknowledges that a $200 billion company that employs about 260,000 people can’t be run by a single man. Buffett should step up on these issues now, before a public outcry puts him in conflict with his own board.
The No. 1 thing everyone wants to know is who would run Berkshire if Buffett vanished today. Why not just tell them? If it is Ajit Jain, who runs Berkshire’s reinsurance operation, Buffett should say so. He can always hedge and say his choice doesn’t bind the board and later events might change things.
The Sokol incident has boomeranged to become a referendum on Buffett’s judgment of people and management style, Berkshire’s corporate governance, institutional infrastructure, risk-management and internal controls, and the succession process for a new CEO. It has also raised questions about the board’s committee structure, compensation and responsibilities.
These issues weren’t addressed in the audit-committee report, and it is a tall order to do so. All this is probably too much to expect from Buffett in a single weekend. But the more straightforward Buffett is at this meeting, the better off Berkshire’s shareholders will be -- and so will he.
(Alice Schroeder, author of “The Snowball: Warren Buffett and the Business of Life” and a former managing director at Morgan Stanley, is a Bloomberg News columnist. The opinions expressed are her own.)
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