Berkshire Hathaway Inc. former manager David Sokol exercised poor judgment yet may not have broken insider-trading laws by buying stock in a company he later proposed as a takeover target to Chairman Warren Buffett, legal experts said.
Sokol, 54, bought 96,060 shares of Lubrizol Corp. in early January before recommending that Omaha, Nebraska-based Berkshire Hathaway acquire the company, Buffett said in a March 30 statement announcing Sokol’s resignation. Sokol had dinner on Jan. 25 with Lubrizol Chief Executive Officer James Hambrick, sparking Buffett’s interest in the deal, according to the statement.
Sokol bought the shares before discussing Lubrizol with Buffett and had “no voice in Berkshire’s decision once he suggested the idea,” said Buffett, 80. Berkshire announced March 14 that it was acquiring Lubrizol, an engine lubricant-maker, for $9 billion. Sokol may have made a profit of about $3 million, according to Buffett’s disclosure and data compiled by Bloomberg.
“I don’t think this is insider trading,” said John Coffee, a Columbia University law professor. “This is misconduct because he knowingly placed himself in a conflict-of-interest position. Once he made a multimillion-dollar investment in Lubrizol, he could no longer serve as an objective agent for Berkshire Hathaway because his own interests were that Berkshire Hathaway make an acquisition.”
The U.S. Securities and Exchange Commission is probing whether Sokol bought Lubrizol shares on inside information, said a person with knowledge of the matter who declined to be identified because the investigation is secret. The SEC is seeking records from Sokol’s brokerage and examining trading data from the Financial Industry Regulatory Authority, the person said.
In his statement, Buffett said that “neither Dave nor I feel his Lubrizol purchases were in any way unlawful.” Sokol, who was considered a possible successor to Buffett, didn’t believe he “did anything wrong,” he said yesterday in a CNBC interview.
“I can understand the appearance issue and that’s why we made it public in the press release,” Sokol said. “The reality is that I have no control over a deal ever happening.”
Sokol said that the 96,060 Lubrizol shares he bought on Jan. 5, 6 and 7 ranged in price from $102 to $104 each, meaning he paid at least $9.8 million.
His stake as reported by Buffett would have been worth about $9.92 million on Jan. 7, based on the closing price on the New York Stock Exchange. The shares have risen about 30 percent to $133.96 since Buffett’s deal was announced, boosting the stake, if Sokol still owns it, to $12.9 million.
Sokol had instructed Citigroup Inc. on Dec. 13 to arrange a meeting with Lubrizol CEO James Hambrick, according to an SEC filing last week. The two men spoke on the telephone on Jan. 14 and met on Jan. 25.
Sokol first told Buffett on either Jan. 14 or 15 about the idea of Berkshire Hathaway’s buying Wickliffe, Ohio-based Lubrizol, leaving his boss “unimpressed,” according to Buffett’s statement. After Buffett learned of Sokol’s CEO dinner meeting, he “quickly warmed to the idea” of the acquisition.
Insider trading typically involves someone buying or selling stock after receiving material, non-public information from someone with a duty to keep it confidential.
“On the surface, it would be hard to say that he illegally traded on inside information,” said Paul Atkins, a former SEC commissioner who is now a financial services consultant. “The question is: to whom did he have a duty of confidentiality, and did he violate that duty?”
Robert Heim, a former assistant regional director of the SEC’s New York office, said another issue is whether Sokol had material, non-public information.
“What’s been disclosed to date is that it was non-public,” Heim said. “The question is whether the merger process was far enough along to deem it material.”
“I don’t think he violated any securities laws, specifically insider trading,” said Peter Henning, a law professor at Wayne State University. “I don’t think that this type of information rose to the level of materiality that the SEC would need to bring a case. The SEC likes cleaner cases in which the information is more obviously material. It helps them to establish fraud if there is some kind of hiding of his trading, and he does not appear to have done that.”
Heim said Sokol “certainly exercised poor judgment by purchasing a stock that he later brought to the attention of Warren Buffett as a possible acquisition candidate. An executive like Mr. Sokol is not permitted to use information that he gained during the course of his employment for personal financial gain.”
“The open question is whether Berkshire Hathaway’s internal controls were strong enough,” Heim said.
The Code of Business Conduct and Ethics on Berkshire Hathaway’s website urges employees to remember Buffett’s “rule of thumb.” They must “ask themselves whether they are willing to have any contemplated act appear the next day on the front page of their local paper -- to be read by their spouses, children and friends -- with the reporting done by an informed and critical reporter.”
Employees with access to confidential information can’t use or share it “for any other purpose except the conduct of the company’s business,” according to the code.
Sokol told CNBC that Berkshire Hathaway had a list of stocks that employees were banned from trading in, and Lubrizol wasn’t on that list.
Attorney Philip Korologos of Boies Schiller & Flexner LLP said: “People are going to focus on whether he exercised good judgment given the role he played in recommending companies for Berkshire Hathaway to invest in. Given the focus, I would bet he wishes now that he had done it differently.”
Sokol was chairman of Berkshire’s MidAmerican Energy Holdings and its Johns Manville roofing unit. He was also CEO of NetJets Inc., Berkshire’s luxury-flight unit.
Sokol’s compensation from MidAmerican totaled $59.5 million in the last five years, according to the unit’s SEC filings.
Sokol joined Berkshire in 2000 when he sold MidAmerican, which he led as CEO, to Buffett for about $9 billion. Under Berkshire, Sokol retained a minority equity stake in MidAmerican and expanded the unit by buying a natural gas pipeline and power producers in California and the U.K.
Sokol relinquished the CEO job in 2008 and broadened his duties at Berkshire by scouting deals, including an investment in China’s BYD Co. and a rescue for Constellation Energy Group Inc.
“He was the heir apparent,” said David Kass, a professor at the University of Maryland’s Robert H. Smith School of Business. “The exercise of his recommending Lubrizol to Warren Buffett was like a CEO in training.”
Berkshire said in February that it had four candidates to succeed Buffett as CEO, without publicly identifying them. Investors including Buffett biographer Andrew Kilpatrick had said Sokol was the most likely successor.
Buffett said in the statement that he hadn’t asked for Sokol’s resignation and that it came as a surprise. Twice before in past years, Sokol had considered resigning and been persuaded to stay, Buffett said. Berkshire is “far more valuable today” because of Sokol’s service, Buffett said. Sokol said he will devote his career to investing his family’s resources and may start an enterprise, according to Buffett’s statement.