Insider Trading

 UPDATED I have just finished reading 2 weeks' worth of articles and blog posts about the Sokol Debacle. While (virtually) everyone agrees that he behaved unethically, it's striking how quickly most writers dismiss the possibility that Sokol could be found guilty of insider trading.  Insider trading is hard to prove, but until more facts are known, it seems a bit early to jump to conclusions about whether Sokol will be charged with or be found to have committed insider trading. Only a few facts are publicly known, and it appears that even Buffett/Berkshire may have had incomplete information when they declared that Sokol did nothing "unlawful." At this point, I'm agnostic on the insider trading question until more facts are known. Some speculations about related issues:

>  I suspect Sokol's story will continue to crumble and more evidence will emerge that suggests he was in possession of what some would consider material nonpublic information when he bought the stock in Lubrizol (whether or not he is charged with anything). There were gaps and holes in the story given out in Sokol's ill-conceived CNBC interview, including a vagueness about how the idea of Lubrizol first came to his attention. Chances are that more details will be forthcoming and they will not be flattering to Sokol because whatever is flattering has already come out in his own version of the story.

> IThe old truism that the cover-up is worse than the crime may come into play. (p.s. I use the term "crime" partly as a metaphor because most insider trading cases are civil, not criminal.) Statements made in Sokol's CNBC interview have been contradicted by Lubrizol's amended preliminary proxy statement. Although a cash deal, Berkshire's acquisition of Lubrizol must be approved by Lubrizol's shareholders, and therefore public communications before the vote presumably are subject to scrutiny for how they might affect the transaction's consummation or its price. From a statement in a March 24, 2011 Department of Justice press release by William J. Maddalena, Acting Special Agent in Charge of the FBI's Miami Office, about an (unrelated) criminal case: "When false statements are disseminated to deceive the investing public, whether they're designed to prop up a company or tear it down, the FBI will dedicate all available resources to bring disseminators of such falsehoods to justice." Even if Sokol's intended purpose was not primarily to protect and enable the acquisition, he was clearly a beneficiary by $3 million if it was consummated.

> I think it's very likely that Buffett will distance himself from Sokol at at the shareholder meeting, without necessarily doing a 180 degree turn and saying he was mistaken in the original press release.

> CHANGE IN POINT OF VIEW. ORIGINALLY I didn't think Buffett was going to entertain questions on this subject at the meeting. I think he'll talk about it for maybe five or ten minutes in a statement at the beginning of the meeting, much of which time will be a recap of what happened. He could then cite litigation as a reason for why he can't have an open-ended discussion and take questions. However, my current thought is that it doesn't really matter whether he formally takes questions or just makes a statement. Whatever he decides to say in advance, he can put out in any format he wants, including answering some questions that don't contain any information beyond what he's willing or able to share. The derivative litigation is almost certain to constrain what is said, whether that is specifically identified or not. Either way, I'm pretty sure Buffett will open with a statement about Lubrizol because nobody will be able to pay attention to the rest of what he says until he puts this to rest. 

> Whatever he says, listen carefully to the nuances. I know that many of you are preparing to interpret these statements, and also are drafting questions for the meeting that touch on important topics other than the question of insider trading. Let me remind you once again that everything Buffett says is extremely precise and literal. The implications of his statements will be bounded by the exact words employed, no more and no less. Make your interpretations and draft your questions accordingly.




Mind the Gap

The strangest thing about the whole Sokol affair is the gap between when he sold the initial shares back and the decision to purchase ten million dollars worth. What happened in that gap of time? One must wonder if he initially sold the first Lubrizol shares back to avoid a conflict of interest but in the time between was told he would definitely not be WB's replacement and decided to purchase the LZ stock as a offensive measure, to do as much damage to BRK as possible out of spite.

Those who have looked directly into Sokol's eyes know what he is capable of and he is certainly able to execute corporate terrorism on this level, a fiscal suicide bomb aimed directly at Buffet and Munger. Why go on CNBC the very next day if not to ensure that his shrapnel hit the vital organs of those who wronged him?

From a reader -- LZ Valuation

"The press reports that the Lubrizol acquisition will be made at a very favorable PE ratio of 13. However, this calculation is based on Lubrizol’s 2010 earnings, which were far and away higher than any other year in Lubrizol’s history. If you look at the PE ratio of the purchase price based on 2009 earnings or 2006 or 2005 earnings, the PE ratio is 19 to 48.

Why would Lubrizol’s performance in 2010 be more indicative of its future performance than its performance during 2005-2009?"

REPLY: Anyone who follows chemicals, please chime in. And does this explain Buffett's questions about whether LZ could maintain its margins?

Cover Up

The fact that Sokol never made any serious effort to cover up his LZ share purchases makes this a highly unusual in the annals of insider trading. Everyone -- including Bud Fox in Wall Street -- attempts to put some distance between the source of information and the trades. This is unusually strong circumstantial evidence regarding Sokol's state of mind at the time regarding the legality of his actions.

"Too Soon/More Facts"

Dates, conversations, times, trades including the type (limit orders) and exact number of timing of each purchase have been released.

Sokol, LZ in their filings, and Buffett are all in basic agreement regarding these facts -- they are essentially uncontested. Sokol went on television and repeated them.

The idea that more is needed to make the case is an indication that a case for insider trading is weak. It's really a legal issue now -- do the facts as known and agreed upon constitute insider trading?

"Sokol Story Crumbles?"

Did Citi essentially cold call Sokol or did BRK engage Citi for a fee or WTF was their relationship in December. I doubt if Sokol could spend $10 of BRK's money engaging an investment bank without Buffett's approval. I also doubt if he could or would sign anything before the meetings.

What did their initial 'letter' say, to whom was it addressed, etc. Was it quasi personal, "Dear David -- lets talk"? This sort of detail is about as likely to support Sokol as hurt him.

Sokol said he wanted to talk to Hambrick. Instead of setting up an informal lunch or phone call, Citi did everything possible to put the company into play. Of course, that's what investment bankers do.

In my opinion, EVERYONE looks bad in this situation.

"Buffett will distance himself "

Since Sokol quit, Sokol has distanced himself from Buffett. So, of course.

The hapless Gen Re management was kept on the payroll and in their positions and explicitly ORDERED to cooperate fully with any and all investigations.

It's possible that Buffett took the same tack with Sokol. Who then saw himself as roadkill if he stayed. I have no idea. But I wouldn't be surprised if Buffett was actually surprised by Sokol's resignation for reasons similar to this.

"PR nightmare"

Buffett has always made distinctions between good and bad big businessmen. No one cares or is buying that Goldman was several notches above Lehman and the bottom fishers of the financial world.

Billionaire populist isn't getting any traction. Nuance makes no difference -- people are angry at the rich.

Buffett has considerable influence in shaping the context for discussion of Sokol -- Round 2. I hope he will realize and adapt to the new reality of increasing class animosity.

REPLY: I must respectfully disagree on parts of what you said. Other than the dates and amounts of trades, I believe that major parts of Sokol's story that he (personally) got interested in Lubrizol (remember, he can't recall how he first heard about it), then (personally) got a 10-k and studied the company, then went off to Citi to talk about chemical companies, without indicating that Berkshire was a buyer (something the bankers have already contradicted), and then invested (for his family) are unlikely to hold up. Lubrizol has already contradicted a major element of his story in its revised proxy.

I agree that everybody looks bad, and your suspicions about Sokol's motivations post-blowup are very likely correct -- he is anticipating the "distancing" I spoke of. I called it "distancing" instead of "throwing under the bus" because it's not clear to me yet how far it will go. However, as you point out, the real question is whether Sokol will resist being the sole fall guy and will try to take Buffett down with him to lessen the heat from himself. I think his personality leans in that direction. He already tried to drag Charlie Munger into the mess by bringing up BYD. The Gen Re folks, as you also point out, resisted pressure to testify against Buffett, to their own detriment. Unlike the Gen Re executives, Sokol is a junkyard dog. He also made it clear on CNBC that he looks after his own interests before Berkshire's.

All of this is going to create more shocks for shareholders. I know that people who are loyal to Buffett do not want to believe this thing is real, or that Buffett could have been duped, or that his interests and Sokol's conflict so strongly. This already been the biggest public relations headache Buffett has ever faced.

My guess -- right now, Berkshire is running the well-honed "MTO Playbook" which consists of -- isolate the accused, villainize the accused, sterilize Buffett by disassociating him from the disaster.

I suppose I am a Buffett

I suppose I am a Buffett loyalist. And I appreciate your patience, since you must tire of being in the middle between fans and enemies.

Your point is well taken regarding Sokol's potential ruthlessness. I don't doubt that Sokol would do it, but it is still hard for me to imagine how his story would improve if he dragged Buffett into it. I suppose I am also assuming that Sokol is rational.

I thought the Gen Re fiasco was potentially much more difficult, since there were multiple investigations by NYAG, DOJ, with Australia still smarting over HIH and potentially the UK regulators jumping on.

I thought BRK was in a position where they couldn't settle any of the pieces without hurting their position with the others.

REPLY: Thanks for your comments. Yes there are a lot of nuances. I feel it's best never to assume people behave rationally in stress-filled situations :-) on the D&O the only thing I know for sure is that there are corporate indemnities but they are limited by law. And regarding your first point, yes, being in the middle between fans and enemies has its disadvantages because you get brickbats from both sides, but I care a lot more about being on the right side of history than what people think of me in the short term.


hi, its hard to believe buffett got or took legal advice before he put out that press release. Would this fit buffett's MO, to issue that release without having a securities lawyer sign off on it ?

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