Warren Buffett's cultivated image takes a beating

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.

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 announcing Sokol’s resignation.

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 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. “I don’t think I did anything inappropriate,” Sokol told CNBC. “I bought stock in a company that I thought was a good company.”

The departure of Sokol also calls into question the future of the company’s management team, shuffling the cast of Berkshire executives who could succeed Buffett as chief. Although Berkshire has built up a fairly deep bench in recent years, Sokol was seen as the frontrunner. Jay Gelb, an analyst with Barclays Capital, called Sokol’s resignation an “unfavorable development” for the company’s stock, which was down more than 2 per cent on Thursday. “Buffett may be the only one who can manage the company with as much success as in the past,” Gelb said in a report.

Some rising stars at Berkshire might also hesitate to assume the burden of filling Buffett’s shoes. Other protégées, analysts say, might be lured away by bigger paydays at hedge funds and the like.

Of course, Berkshire pays well, too. Sokol earned roughly $24 million as chairman of MidAmerican Energy, a Berkshire subsidiary. 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 a February regulatory filing, Berkshire said its board had identified four current Berkshire subsidiary managers who were capable of being chief executive. With Sokol’s departure, it is now down to three. Buffett wants to split his role into a few positions: a chief executive spot and two or more top managers who will run Berkshire’s $158 billion investment portfolio. The leading candidate for one of the investment jobs is the company’s current chief investment officer, Todd Combs, a former hedge fund manager.
As for the chief executive spot, the new favorite is Ajit Jain, who runs Berkshire’s reinsurance operations. Jain joined Berkshire in the 1980s, after stints at IBM and McKinsey & Company. Buffett has been quick on past occasions to heap praise on Jain.
Also in the mix are Tad Montross of General Re, Matthew Rose at Burlington Northern Santa Fe, Tony Nicely of Geico and Greg Abel, chief executive of MidAmerican. The managers are hardly under the thumb of Buffett, who keeps in touch with his deputies but is famous for writing them a letter every two years.

“At Berkshire, managers can focus on running their businesses; they are not subjected to meetings at headquarters nor financing worries nor Wall Street harassment,” Buffett has said. The managers can “call me when they wish.”

That hands-off approach, however, may face pressure to change in the wake of Sokol’s resignation. Sokol, before mentioning a potential bid for Lubrizol to Buffett, had bought 2,300 shares of the company, which he then sold a week later. Sokol accumulated another 96,060 Lubrizol shares, then worth nearly $10 million, on Jan 5, 6 and 7. When Sokol brought the idea to takeover Lubrizol to Buffett on or around Jan. 14, he mentioned his stake in the company. But it was not until an unspecified day in mid-March, shortly after the deal was announced on March 14, that Buffett learned the extent of Sokol’s investment in Lubrizol.

The news came not from Sokol, but Marc Hamburg, senior vice president and chief financial officer at Berkshire. Some corporate governance experts said Buffett should have pushed for more details.

‘You would expect the people at Berkshire to discuss this explicitly,” said David F Larcker, an accounting professor and director of the Corporate Governance Research Program at Stanford’s graduate business school. Still, he added that Berkshire should not abandon its “culture of trust” in favor of “endless rules.” “When you’re doing a lot of transactions, every once in a while something is going to be unusual.”