Why This Suit Against Berkshire Hathaway & Sokol Does Not Matter (BRK-A, BRK-B, LZ, GS)

Multiple reports are out that Berkshire Hathaway Inc. (NYSE: BRK-A)(NYSE: BRK-B) has been sued by a shareholder who is seeking disgorgement of David Sokol’s profits from Lubrizol Corporation (NYSE: LZ) and for the company to restore its reputation. Today’s news of a lawsuit seems to be more noise than news.  In fact, there are many reasons why the suit might not even matter.  We have to throw out the caveat up front that anything is possible, but as far as a legal issue with real world damages this whole incident is likely to end up solely as a David Sokol issue rather than a Warren Buffett issue.  Now that some of the emotional dust has settled, we have a brief survey for our readers at the very end as well.

First and foremost, David Sokol is the real issue here.  Warren Buffett obviously doesn’t seem to police such matters, and chances are that this hands-off monitoring will not be true ahead.  The odds are likely slim to none that Buffett said “David, go ahead and load up on this ‘as a great investment for your family’ and I will acquire the company so you can have a great pay-day.”

What Sokol did is still not currently close to being a proven case of insider trading. Is there a real lapse of judgment AND an awful policy for controls & procedures in place?  You bet, and on both!  Our take is that Buffett is going to have an internal change over all procedures over who can buy what in securities and what disclosures have to be made. Still, whether this violates the true litmus test for insider trading depends upon whom you ask.  That means that the case is no slam dunk.

Sokol was probably going have to disgorge this money, case or no case, if Buffett requested it.  It seems very likely that Buffett told Sokol, “You go try to sell that story of yours to the public through CNBC and other media outlets.”  This was likely a strategy to get any heat off of the company, and probably the right strategy.

Sokol’s resignation was probably very far from a real resignation.  We read the same letter you did with the same explanation that Buffett gave, so we have only an industry insight here being used for what seems obvious.  You can believe old Warren if you want to about this being the third time Sokol tried to leave.  Either way, that is a ‘behind closed doors’ matter that the public will probably never get to learn about.

Sokol was always considered a possible CEO replacement for Buffett by the media or by the public, but that did not really seem to be the case.  Ajit Jain has seemed to be the favorite if you trace sentiment internally.  Buffett was quoted in a fairly recent annual letter: “If Charlie (Munger), I and Ajit are ever in a sinking boat – and you can only save one of us – swim to Ajit.”

Sokol might have had an influence and it might not have been a true Chinese Wall, but Sokol likely was telling the truth about not knowing if Buffett would jump on it.  Buffett had already blown out many positions without question over a prior manager’s portfolio exit.  The company easily fits within the Berkshire Hathaway portfolio.

This doesn’t seem to be the first time that Sokol bought shares and told Warren about the companies.  Sokol hinted in his CNBC day-after interview that he had personally bought shares in other companies in the past ahead of turning in “look at buying lists” but this was obviously the biggest infraction.

Buffett has not exactly been equally yoked with his shareholders of late, particularly since he tried defending Lloyd Blankfein saying he wished he could find a twin brother to hire.  Berkshire Hathaway shareholders may not mind making money off of Goldman Sachs Group Inc. (NYSE: GS), but they might not want to be forced to like Goldman Sachs.  Buffett also keeps using historic success and analogies of how America’s greatest days are ahead of it despite that this view is not really as widespread as it used to be.

Unless it surfaces that the next closest thing to front-running has been standard and encouraged procedure at Berkshire Hathaway, Buffett and Berkshire both have a history here that will be protected.  Buffett is probably going to stay a bit out of the media for a while until this blows over, but again this is on Sokol and Buffett can claim he did not know.

The timing was awful.  Buffett had been out in Asia for a week right before this.  He also sat on the news of the Sokol resignation and trading incident in Lubrizol.  The timing of the even actually works more to Buffett’s and Berkshire’s favor if you think about it.

The public will likely never know what happened in the end.  Berkshire Hathaway seems to have a policy of being about as available with clear data as a fortune-teller.  Call in for the spokesperson or better yet call in for CFO Marc Hamburg and see if you get anything more than his voicemail.  Berkshire Hathaway is not very open and transparent, it only communicates what it wants to communicate, it has special filing privileges from the SEC for holdings, and the company won’t even tell you ahead of time what day most filings are going to hit the tape.  Why does that help in this particular case?  Simple, it means that the real answer will also be what the company wants it to be.

Using psychology on Buffett may be easier than elsewhere other than predicting what company he will land on next.  Buffett generally will take the high ground.  Making an extra buck is not his game because he’d rather have a reputation.  Buffett will ultimately say that he is changing the policies as far as we can tell.

Lubrizol is not trading down at all.  At $134.45, it is effectively at its highs.  If there was real trouble, you would see it in the Lubrizol shares and you would see Lubrizol’s CEO out throwing Sokol in front of the bus.  Buffett got a cheap company here and its multiples are such that Buffett would have bought it even if Sokol was an insider there.

It is always interesting to see when shareholders sue companies.  Getting the best of Warren Buffett in court is not going to be an easy task.  Berkshire’s shares have continued to slide, but this slide has not exactly been enough that would signal the end of the world as far as Buffett nor his long-term holders are concerned.

Disgorgement is a fairly accurate term for the Sokol funds.  Chances are that he’ll either donate those proceeds to Warren’s charities or that he’ll give back a portion of those profits to Berkshire Hathaway.  Take our survey below:

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JON C. OGG