Regarding David Sokol, Redux

I am republishing what I added to yesterday’s post, and adding onto it, because many readers would have missed it.

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In the cold light of morning, I have thought of one more issue? why is Buffett so loosey-goosey with things that ought to be mandatory disclosures for avoiding potential conflicts of interest?

Every firm I have worked for, and even now at the current small firm that I run, there were/are mandatory disclosure rules. My promise to clients is that I get the same results they do, win, lose or draw.

Regardless, it highlights a weakness in Buffett?s highly qualitative way of managing his company and managers. You not only have to avoid breaking the law; you have to avoid the appearance of breaking the law, or even the ?fairness code,? however defined. And, he has said as much to his managers in his biannual memo to them:

The priority is that all of us continue to zealously guard Berkshire?s reputation. We can?t be perfect but we can try to be. As I?ve said in these memos for more than 25 years: ?We can afford to lose money ? even a lot of money. But we can?t afford to lose reputation ? even a shred of reputation.? We must continue to measure every act against not only what is legal but also what we would be happy to have written about on the front page of a national newspaper in an article written by an unfriendly but intelligent reporter.

Sometimes your associates will say ?Everybody else is doing it.? This rationale is almost always a bad one if it is the main justification for a business action. It is totally unacceptable when evaluating a moral decision. Whenever somebody offers that phrase as a rationale, in effect they are saying that they can?t come up with a good reason. If anyone gives this explanation, tell them to try using it with a reporter or a judge and see how far it gets them.

If you see anything whose propriety or legality causes you to hesitate, be sure to give me a call. However, it?s very likely that if a given course of action evokes such hesitation, it?s too close to the line and should be abandoned. There?s plenty of money to be made in the center of the court. If it?s questionable whether some action is close to the line, just assume it is outside and forget it.

And Buffett implicitly confirms such a view by accepting Sokol?s resignation, with no hint that he tried to argue him out of it, as he did twice before. Implicitly, Sokol?s unethical behavior led to him leaving Berkshire Hathaway ? one can try to dress is up otherwise, but it fails the smell test.

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There are other issues in play here.

1) Sokol received a list of possible takeovers from Citi.? He was acting as an employee of BRK at the time.? As such, BRK should get the first benefit of his insight.? Yes, BRK is an industrial/financial conglomerate, and not a mutual fund.? But the first duty of an employee is to use data given to you for the benefit of the firm, and use it for the benefit of the firm.? Citi was not offering data to David Sokol as a retail client.

I faced similar situations at a fund that I worked for, where I did not make my case well enough for the portfolio manager.? After he did not want to buy my idea, I asked for the freedom to buy it myself.? It was not granted, and I did not buy it.

2) Sokol sent an assistant to hand Buffett the resignation letter; he did not want to face Buffett.? I suspect he knows that he disappointed Warren, and did not want to face him.

3) Buffett comes off high-handed in that he deems his initial letter to be all the data anyone will get on the matter.? I’m sorry, Warren, but the SEC may have a lot to say here — they don’t know that all of the relevant data has been disclosed.? Maybe you don’t either.? Sokol withheld material information from you; might he have withheld even more data from you?

4) Look, give Buffett some credit here — after so many years of doing business and trusting his managers, he has one blowup from a fellow who is temperamentally hotter than most of his managers.? This incident does not characterize Berky, but it does point out a weakness.? If I were talking to Warren, I would say this:

Look, Warren, you can centralize your company now, under your terms, while you are still alive and thinking clearly, or the company will do so after you die, and you will have no influence in the matter.? The failure with Sokol is basic, and you should have admitted fault in not asking him the size of his position, since you have been informal in requiring disclosure of investments from high-ranking employees.? Start analyzing Berkshire now, as an integrated company, and ask what you want centralized, and what you leave to the subsidiaries.

5) Sokol did not follow BRK’s ethics rules:

All directors and executive officers of the Company, and the chief executive officers and chief financial officers of Berkshire Hathaway?s subsidiaries, shall 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. No action may be taken with respect to such transaction or party unless and until such action has been approved by the Audit Committee.

and

Covered Parties are prohibited from taking for themselves opportunities that are discovered through the use of corporate property, information or position without the consent of the Board of Directors of the Company. No Covered Party may use corporate property, information or position for improper personal gain and no employee may compete with the Company directly or indirectly. Covered Parties owe a duty to the Company to advance its legitimate interests whenever possible.

Sokol had the idea of Lubrizol as a result of his position at BRK.? That data belonged to BRK, not Sokol, and he should not have used it for personal gain.

6) Is Buffett too trusting?? I would say no, but would add “Trust, but verify.”

7) As for Charlie buying shares of BYD, Charlie was not an employee of BRK, but a director, and as such, has a different standard of duty to BRK.? Sokol was an employee, and as such owed a duty to BRK to use data he received for the benefit of BRK first.

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I intend this as my last comment on Sokol, unless some amazing new data arrives.? Sokol and Buffett both blew it, but in different ways.? Sokol could have:

  • Left years ago.? Why wait to pursue a dream when you are already rich?
  • Told Buffett the full story voluntarily.? He had a lot of credibility inside Berky, so why not?
  • Donated all profits to charity.? (Weak, but mighta worked.)

Buffett could have:

  • Asked for the position size.
  • Asked him to sell as a condition of the merger.
  • Had better more regular disclosure of brokerage accounts from top employees.

What a mess.? Buffett should say more on this matter.? I believe he will be hurt if he says nothing more, without government coercion.

6 thoughts on “Regarding David Sokol, Redux

  1. It is hard to imagine the SEC doing anything about this, other than some silly posturing for the news cameras.

    As Merkel pointed out yesterday, it appears that Sokol committed an ethical lapse, but (as Buffett tried to weasel) Sokol probably did not break the law.

    Contrast that with two incidents (that we know of) from Goldman. Most firms would have faced ruinous litigation over something like the Abacus deal. The Facebook not-really but-mostly IPO was so bad even the general news papers knew it was a violation. The SEC does not enforce the law against its cronies

    Buffett is a crony, and still hasn’t come clean on what he knew about FNMA. He had a huge investment in FNMA and he claims he prefers to hold investments forever? Well, in under three years Buffett unwound his huge FNMA investment, a couple years before the disaster became apparent to the public. Buffett isn’t stupid, and others (like then Treasury Secretary John Snow) were pointing out at the time that FNMA had deep and serious problems.

    Of course, if Buffett had admitted what he knew at the time — it would not look good for Congressman Barney Frank who was running all over claiming FNMA was solvent and that taxpayers would never be on the hook even if FNMA had a problem…. DOH!!!

    Guess who co-authored financial reform recently? The same Barney Frank. The other author (Chris Dodd) was busy blocking for AIG and getting special loans from Countrywide.

    Not only are the foxes guarding the hen house, they run the security company and write the laws that govern the farm.

    Buffett is too smart not to realize all of this, plus his father was a Congressman. Buffett didn’t see the Sokol problem coming because he didn’t want to — and that is why he didn’t say more in his letter

  2. Alice Schroeder has a very good analysis of the whole mess:

    http://bloom.bg/egxaXG

    I’m quite sure that this is an example of hubris leading to a downfall. Sokol’s hubris combined with Buffett’s to create an atmosphere of moral blindness. As Richard Breeden said of Salomon brothers (before St. Warren and Berky rode in on the white horse): “It is not an adequate ethical standard to aspire to get through the day without being indicted.”

    For all the schadenfreude shown to an uber-rich manager who got caught with his hand in the cookie jar, this is bad for our industry. It reinforces the view that money managers are preening pigs. Trust is a delicate plant. It grows slowly and dies quickly. With apologies to Thomas Jefferson, I tremble for my industry when I reflect that God is just.

  3. David:

    Your comment–“Citi was not offering data to David Sokol as a retail client”–is telling. Sokol violated his duty of loyalty to his employer. It seems a violation of CFA Code standard VI.A., and may be a violation of IV.A. He’s not a member, but the Code is the standard for the industry. You and I are held to it. And the ten CFAs that share his last name will have to say “no relation” for the next year or so.

  4. I do not understand how the size of Sokol’s position has any relevance to how ethical or unethical the behavior was. Why would Buffett not advise Sokol to close his position before involvement by BRK? That seems like it would have been a better solution than what transpired.

  5. @Doug, I agree with your comments. However, the CFA comments aren’t very relevant since Berkshire is not an investment management organization. So the CFA Code is NOT standard for the financial/industrial conglomerate industry. That doesn’t make what Sokol or Buffett did any less unethical, but it violates common sense ethics as opposed to any code that is standard for Berkshire’s industry (as far as I’m aware). Although he did violate Berky’s own internal code, which is serious enough.

    Now, one of the questions for Buffett is whether he should manage his company and its ethics policies as though it were an SEC-registered investment management company. After all, Berky’s reputation in the general business world is not primarily based on the brilliant executives, like Sokol, that are running the businesses. It is based primarily on Buffett’s personal reputation as a mastermind money manager.

  6. @Dukana: The size *does* matter insofar as it is material. Example: I bought 200 shares of Ford in 1991. Through permutations and DRIPs, I now own ~200 shares of Citi. This has *no* influence on my investment activities, and I’ve never bothered disclosing them. Presumably, a $10mm position is material to Mr. Sokol.

    @ljoneil, I think the CFA Code *is* representative of the highest fiduciary standards. No, Mr. Sokol and Mr. Buffett are not CFAs nor are they members of the Institute. But they always hold themselves out as having *higher* standards than everyone else. That’s one of the things that is so annoying about Warren Buffett and why he gets lionized in the press–not just his money management skills. Look, people aren’t flocking to Steve Cohen for advice as to what to do with their lives, nor do they care what he thinks about Social Security. St. Warren is a different story. And this shreds some of his credibility.

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