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Warren Buffett Faces Insider Trading: a Case Study by Christian Koch, University of South Florida

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Warren Buffett Faces Insider Trading: a Case Study by Christian Koch, University of South Florida Volume 4, Number 1 Example Case Study 8 SEPTEMBER 2020 Warren Buffett Faces Insider Trading: A Case Study By Christian Koch, University of South Florida illionaire Warren Buffett has amassed a tially committed insider trading. Sokol resigns large following among those in the invest- from his position unexpectedly. In rank, Sokol Bment world and the numerous sharehold- is behind Charlie Munger, Buffett’s long-time ers of Berkshire Hathaway. Headquartered in business partner. Sokol is Chairman of sever- Omaha, Nebraska, Berkshire Hathaway oper- al Berkshire subsidiaries and has had a long, ates as a conglomerate that owns and operates successful relationship working with Buffett. businesses with famil- In fact, Sokol is consid- iar brand names like ered Buffett’s protégé Fruit of the Loom, GE- and the lead candidate ICO, Dairy Queen and In March 2011, Warren Buffett to replace Buffett upon Duracell. It also oper- stepped into chaos. The Chairman retirement. ates a large marketable of one of Berkshire Hathaway sub- In a March 30, 2011 securities portfolio run sidiaries, David Sokol, had resigned press release, Buffett by Buffett. Some top his position, but there was more to states, “in our first talk equity holdings are Co- the story. about Lubrizol, Dave ca-Cola, Bank of Amer- Sokol mentioned that ica, American Express, he owned stock in the Wells Fargo and Kraft company. It was a pass- Heinz. ing remark and I did not ask him about the date Buffett learns days after the public announce- of his purchase or the extent of his holdings” ment of the all-cash deal to acquire Lubrizol, (Busines Wire, March 30, 2011). that his top executive, David Sokol, has poten- How does Buffett respond? Keywords: Berkshire Hathaway, Warren Buffett, David Sokol, Insider Trading, Ethics, Stockdale Par- adox, Leadership, Case Study Copyright © 2020, Christian Koch. This article is published under a Creative Commons BY-NC license. Permission is granted to copy and distribute this article for non-commercial purposes, in both printed and electronic formats Buffett Faces Insider Trading In the words of Warren Buffett: shire, “Dave’s contributions have been extraor- To my knowledge, Dave Sokol did not dis- dinary. At MidAmerican, he and Greg Able have guise the trading. That’s somewhat inexplica- delivered the best performance of any mangers ble if he really felt he was engaging in insider in the public utility field” (Business Wire). trading and knew the penalties that could be Sokol was the Chairman of MidAmerican ener- attached to it, that he essentially did it right gy and several other subsidiaries for Berkshire out in the open. The second fact, which is less Hathaway. Part of Sokol’s job was to look for puzzling, but Dave obviously has a net worth companies that would be attractive acquisitions in very high numbers. He made, I think, close for Berkshire and to report his findings to Buf- to $24 million. He earned it from Berkshire fett. In the first quarter of 2011, Sokol had iden- last year, and we got our money’s worth, but tified a target:Lubrizol , which was a company he did get $24 million. (Busines Wire, March known for its large industrial lubricants busi- 30, 2011). ness. In addition, Lubrizol was a brand name As soon as Buffett is informed of the insid- that would fit well under the Berkshire tent of er trading claim, the situation turns into a operating companies. The size of the acquisition decision-making problem with four core ele- of Lubrizol was valued at $9.7 billion making it ments: 1) Managerially difficult; 2) Emotionally one of the largest acquisitions in Berkshire Ha- charged; 3) Intense media coverage; 4) Ethical thaway history. and moral paradox. This case study explores the issues and Buffett’s response to the insider trad- Company Background and Sokol ing example. Stock Purchases David Sokol was a well-known business execu- In 2010, Lubrizol had $5.4 billion in revenue tive. He had developed a reputation as a highly and was a global manufacturing operator with skilled professional operating manger. Berkshire facilities in 17 countries. The company was well Hathaway purchased MidAmerican at the end of known for new technology and producing spe- 1999 and Dave was one of the senior operating cialty chemicals, specifically lubricant additives people. By background and temperament, Sokol for engine oils. These additives were widely used was a good fit at Berkshire and Buffett trusted for engine oils and as industrial lubricants. The him. In a press release dated March 30, 2011, company’s global headquarters is located in Buffet explains Sokol’s contribution to Berk- Wickliffe, Ohio. Figure 1. Sokol’s stock purchases 144 Volume 4, Number 16 Koch In December 2010, Sokol purchased 2,300 March 14, 2011 press release, Buffett states, “our shares of Lubrizol, as shown in Figure 1. He pur- only instruction to James-Just keep doing for chased shares in Lubrizol because he thought us what you have done so successfully for your the underlying economics of the business were shareholders” (Business Wire). attractive. He subsequently purchased 96,060 In a March 30, 2011, press release, Buffett stat- shares on January 5, 6, and 7, 2011. Sokol’s un- ed, “In our first talk about Lubrizol, David men- derlying motive was to buy a position to see how tioned that he owned stock in the company. the company trades in the market. To see how It was a passing remark and I did not ask him easy or difficult it was to obtain the stock and about the data of his purchase or the extent of to develop the interest to study the company his holdings” (Business Wire). Buffett further further. Often that process is only done once an explained, “I learned that David first purchased analyst is a shareholder. There is a much greater 2,300 shares of Lubrizol on December 14, 2010 feeling of commitment and thus ownership to which he then sold on December 21, 2010. Sub- examine something you own than just another sequently, on January 5, 6, and 7, 2011 he bought paper investment. 96,060 shares pursuant to a 100,000-share order he had placed with a $104 per share limit price” Buffett and Insider Trading (Business Wire, March 30, 2011). Warren Buffett is the Chairman of Berkshire Hathaway, a large conglomerate of different A Brief History of Events businesses. Berkshire has several private oper- Buffett’s troubles began shortly after the an- ating businesses, including See’s Candy, NetJets, nouncement of the Lubrizol purchase. Much of Clayton Homes, GEICO and Benjamin Moore, the turmoil centered on disclosure, and conflicts to name a few. These large businesses are run of interest between Buffett, Berkshire and Sokol. from a decentralized management structure. Buffett (2011) states, “As late as January 24, 2011, Buffett takes a long-term approach to finding I sent Dave a short note indicating my skepti- new operating companies, highly emphasize cism about making an offer for Lubrizol and my acquisitions that are a cultural fit for Berkshire preference for another substantial acquisition Hathaway. After completing an acquisition, for which MidAmerica had made a bid. Only Buffett’s goal is to keep the present management after Dave reported on the January 2011 dinner team in place to run the business as if it were still conversation with James Hambrick, CEO of Lu- independent. This approach is different from brizol, did I get interested in the acquisition.” the typical strategy of firing top management See Figure 2 for an abbreviated visual timeline and focusing on cost savings and economic syn- of the insider trading scandal involving the Lu- ergies to drive short-term earnings growth. In a brizol purchase. Figure 2. Abbreviated Timeline of Lubrizol insider trading scandal Muma Business Review 145 Buffett Faces Insider Trading Below is a detailed description of events involv- report of a January 25, 2011 talk with its CEO, ing the Lubrizol acquisition. James Hambrick, I quickly warmed to the idea. On March 14, 2011, Berkshire Hathaway issued Though the offer to purchase was entirely my a Press Release (Exhibit 1) announcing the pur- decision, supported by Berkshire’s Board on chase and definitive agreement for Berkshire March 13, 2011, it would not have occurred Hathaway to acquire 100% of Lubrizol in an all- without Dave’s early efforts” (Business Wire, cash transaction. March 30, 2011). On April 27, 2011, Berkshire Hathaway issued a Buffett (Business Wire) explained, “Late in the Press Release (Exhibit 2) regarding the trading day on March 28, 2011, I received a letter of in Lubrizol Corporation shares by David Sokol. resignation for Dave, delivered by his assistant” Mr. Sokol was accused of insider trading. (March 30, 2011). He further commented, “I had not asked for his resignation, and it came On April 30, 2011, during the Berkshire Hatha- as a surprise to me. Twice before, most recently way annual shareholder meeting, Buffett (2011) two or so years ago, Dave talked to me of resign- classified Sokol’s actions as inexplicable“ and ing. In each case he had given me the same rea- inexcusable.” sons that he laid out in his Monday letter. Both On January 3, 2013, a Reuters’ article titled SEC times, I and other Board members persuaded drops case against ex-Berkshire exec Sokol him to stay. Berkshire is far more valuable to- stated, “The U.S. securities regulator has decid- day because we were successful in those efforts” ed not to take action against David Sokol, once (Business Wire, March 30, 2011). considered a possible candidate for the top job A few days later, Berkshire held its annual share- at Warren Buffett’s Berkshire Hathaway Inc, holder meeting where Buffett was given the Sokol’s lawyer told Reuters” (Prasad, 2013).
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