Buffett's handling of deputy baffles experts

Analysts say Buffett should have pushed David Sokol to disclose the extent of his stake in Lubrizol Corporation

Warren E Buffett is an old-school capitalist with a rock star’s aura, a global celebrity who is revered like a small-town hero.

Yet that carefully cultivated image — the envy of nearly every top executive — risks being tarnished by a disclosure that he knew one of his right-hand executives had bought shares in a company before Buffett’s company announced a deal for it.

Buffett is certainly not the typical chief executive, and the questions surrounding him concern an apparent failure to act that had corporate governance experts and analysts scratching their heads on Thursday. The scrutiny stems from a meeting in January, when the deputy, David L Sokol, approached Buffett about possibly buying a lubricant manufacturer. During the discussion, Sokol, once seen as a potential successor to Buffett, made a brief admission to his boss: he owned stock in the takeover target.

At that point, most corporate chieftains would have asked questions, directed the executive to seek legal advice or even put the idea of a deal on ice, experts said. But Buffett did none of those things — even though his company, Berkshire Hathaway, like most large companies, has policies that restrict employees from using or sharing confidential information for “stock trading purposes.”

“It just seems odd to me that it didn’t throw up some red flags,” said Greggory Warren, a senior stock analyst at Morningstar. “As much as they don’t like to have their hands in what managers are doing, there are occasions like this where they have to.” Buffett assumed that Sokol had held the stock for years, not days, which would make the timing of the deal less suspicious. “It was a passing remark and I did not ask him about the date of his purchase or the extent of his holdings,” Buffett said in a statement on Wednesday announcing Sokol’s resignation. Buffett did not respond to requests for comment on Thursday.

In the wake of the disclosure, Berkshire Hathaway shareholders, analysts and corporate governance experts called for tighter controls at Berkshire. They questioned Buffett’s trusting manner, saying he should have pushed Sokol to disclose the extent of his stake in Lubrizol, the lubricant maker. Morningstar analysts said in a report on Thursday that Sokol’s Lubrizol trades “tarnish Berkshire’s reputation.”

Sokol acquired a roughly $10 million personal stake in Lubrizol in January, just days before he pitched a takeover of the company to Buffett. Berkshire agreed in March to buy Lubrizol for $9 billion, earning Sokol an estimated $3 million profit.

Thomas Russo, a partner at investment firm Gardner Russo & Gardner, which owns Berkshire shares valued at some $300 million, said the episode would probably prove to be a wake-up call for the Omaha-based company.

“They will likely have to introduce slightly more controls to eliminate the headline risk we have seen,” he said. “That is a good thing, especially as the operations of Berkshire fall into more hands.”

But Berkshire has made no indication that it plans to overhaul its conflict of interest policy or tweak its internal controls. Even so, the questions about Sokol’s stock ownership already has the company on the defensive.

“Neither Dave nor I feel his Lubrizol purchases were in any way unlawful,” Buffett said in the statement.

Charles T Munger, Berkshire’s vice chairman and Buffett’s longtime business partner, also expressed support for Sokol.

“Few people understand how good he is, how really good he is,” Munger said in an interview. “He’s like a guy on a baseball team that could play six of the nine positions.”

Still, in a company with a culture that has long emphasized ethics, the news about Sokol’s trades may cause waves within Berkshire. In a July 2010 letter, Buffett instructed his managers to “zealously guard Berkshire’s reputation.”

“We can afford to lose money — even a lot of money,” Buffett said. “But we can’t afford to lose reputation — even a shred of reputation.”

Berkshire’s conflict of interest policy requires all directors, chief executives and chief financial officers to “disclose any material transaction or relationship that reasonably could be expected to give rise to such a conflict to the chairman of the company’s audit committee.”

The company also circulates a list of stocks that executives are not allowed to buy.

Buffett, 80, has said he has no immediate plans to retire. Yet the contest to replace him has been among the most watched succession races in corporate history.

In associates with Evelyn M Rusli & Susanne Craig

©2011 The New York Times News Service