David Sokol, the former head of Berkshire Hathaway (BRK.A) units MidAmerican Energy Holdings and NetJets, abruptly exited Warren Buffett's empire on Wednesday. Although the SEC claims not to be investigating the reasons, Sokol's actions regarding a recent $9.7 billion Berkshire acquisition raise important questions. Sokol's departure was head-spinningly fast, and it highlights how afraid Buffett is of anything that might damage the smooth PR sheen he has spread over himself.
Despite pulling in $59.5 million in the last five years from MidAmerican alone, Sokol might have felt wasn't getting paid enough. So he hatched a little plan: He would recommend to Buffett that Berkshire use its cash hoard to buy lubricant maker Lubrizol, then lubricate his pocket with tens of thousands of its shares. The "good" news for Sokol is that two months later, Berkshire announced it would spend $9.7 billion to acquire Lubrizol, according to Dealbook.
While that deal immediately boosted the value of Sokol's Lubrizol holdings by 27%, Buffett feared that news of Sokol's windfall would become a public embarrassment, and tossed him out of Berkshire.
Sokol as Costanza: "Was That Wrong?"
In this, Sokol reminds me of Seinfeld character, George Costanza, whose boss at Pendant Publishing, Mr. Lippman, learned that Costanza had used his office desk to engage in "relations" with Pendant's cleaning lady. When Lippman confronted him about it, Costanza exclaimed, "Was that wrong? Should I not have done that? I tell you, I gotta plead ignorance on this thing, because if anyone had said anything to me at all when I first started here that that sort of thing is frowned upon... you know, cause I've worked in a lot of offices, and I tell you, people do that all the time."
According to The Wall Street Journal, Sokol's initial interest in Lubrizol was piqued during a Dec. 13 meeting with Citigroup (C) bankers to discuss a list of "possible transactions." According to Dealbook, Sokol bought 2,300 shares of Lubrizol on Dec. 14, which he then sold on Dec. 21.
Then, I imagine, he got his nerve back and bought a fresh batch of 96,060 additional shares on Jan. 5, 6 and 7. The next week, Sokol pitched Buffett on the idea of purchasing Lubrizol. Buffett got Berkshire's board to approve the deal on March 13, and announced it March 14.
Sokol's brazen behavior looks like insider trading, but would it pass the legal test? According to a lawyer Dealbook quoted anonymously, insider trading requires the perpetrator to possess "material nonpublic information at the time he bought or sold the stock and to have breached a duty [of trust] to his employer, Berkshire Hathaway."
This lawyer suggested that Sokol would be off the hook because he didn't know Berkshire was going to buy Lubrizol in January -- when he mentioned his Lubrizol stake to Buffett in January as "a passing remark." This last bit is crucial because it suggests that Buffett knew Sokol owned shares in Lubrizol two months before Berkshire acquired it.
So what key facts spurred this parting of ways? Maybe Buffett knew that it wouldn't look good in the press when the report about Sokol's Lubrizol shares was filed with the SEC. Buffett has long admonished his people not to do anything that would make them uncomfortable with their families and friends were it to appear in the local newspaper, but his failure to realize in January that Sokol's Lubrizol holdings would be a problem suggests a gap between his talk and his walk.
Buffett as Spin Master
Buffett is well known for his investment skills, but as I wrote on DailyFinance in May 2010, his public relations skills are also formidable. Decades ago, he hired a Fortune reporter, Carol Loomis, to write his annual reports, and he is popular with business journalists for giving detailed background briefings to selected reporters. These moves and others seem to have won him the embrace of the media. How else to explain how Buffett always comes out smelling like a rose, despite the many contradictions between his words and and his actions, among them:
- Deriding "casino markets" while buying the ultimate Wall Street casino, Salomon Brothers, in the early 1990s;
- Attacking derivatives as "financial weapons of mass" destruction while losing $1.7 billion on them in 2008;
- Buying a big chunk of Moody's (MCO), whose AAA-ratings on dodgy mortgage-backed securities helped cause the 2008 financial crisis; and
- Investing $5 billion in Goldman Sachs (GS), one of the bigger traders in those mortgage-backed securities, whose former director, Raj Gupta, faces an administrative action from the SEC for tipping off hedge fund owner, Raj Rajaratnam, to Buffett's Goldman deal minutes after the board meeting ended.
Heirs to the Berkshire Throne
But investors likely care more about who will succeed Buffett than about his ability to spin the media. With Sokol out, four possible successors remain for his CEO job (he plans to have a different person take his investment management role). According to Dealbook, they are:
- Ajit Jain, the head of Berkshire's reinsurance operations;
- Tad Montross of General Re,
- Matt Rose of Burlington Northern Santa Fe; and
- Tony Nicely of Geico.
For Berkshire, the biggest mistake investors could make is to assume that everything will stay the same after that genius leaves the stage. Yet the departure of former top successor candidate Sokol under a cloud raises the question: Was Buffett aware of Sokol's apparent ethical blind spot before he came on board in 2000, or did he just discover it this month?
If Buffett has known about this for a long time -- and Dealbook suggests he knew Sokol owned Lubrizol shares two months before the deal -- it suggests one of two things. Either Buffett has his own ethical blind spots, or he isn't supervising his people well enough.
When it comes to insider trading, perhaps George Costanza was right: People do do that all the time.