Berkshire Beyond Buffett(48)

Berkshire’s audit committee had lawyers from Munger, Tolles & Olson evaluate the case. On April 26, the committee concluded that Sokol’s purchase of Lubrizol stock violated Berkshire policies. These policies restrict managers from buying stock in companies Berkshire is considering acquiring and bar putting confidential corporate information to personal use. Above all, Sokol violated rule one of Buffett’s biannual letter to Berkshire CEOs mandating that they safeguard Berkshire’s reputation. The audit committee’s stinging rebuke overruled the slap on the wrist conveyed by Buffett’s March 30 press release.

With the rebuke coming on the heels of the press release, critics objected to the absence of an impartial investigation. The audit committee is an arm of the board, and the Lubrizol episode raised the question of board oversight. Moreover, the committee might have retained any number of firms to conduct a review, yet used Munger, Tolles & Olson, which has deep Berkshire ties.

Nevertheless, the audit committee’s repudiation of Buffett’s initial judgment caused Buffett to change his mind. On April 30, at Berkshire’s annual meeting, Buffett dedicated the opening segment to the topic. He showed a clip from his press interview at Salomon Brothers twenty years earlier in which he told employees to avoid behavior they would not wish reported on the front page of a newspaper. Then Buffett went on to denounce Sokol’s conduct as “inexcusable and inexplicable”—a phrase Buffett had also used when addressing the perpetrators of the Salomon scandal.39 Discussion turned to broader criticism then circulating about Berkshire’s culture of hands-off management.

Critics contended that the very fact that Sokol (or any executive) would violate company policy raised doubts about the effectiveness of a company’s internal control systems.40 Modern corporate control systems rely heavily on formal commands, consisting of mandatory procedures, reporting, approvals, and redundant oversight. Berkshire, in contrast, puts its trust in people rather than in processes.41 Critics suspected Berkshire’s culture of autonomy and trust was a culprit in the Sokol affair.42

It would be an overstatement to suggest that any given violation is an indictment of a corporation’s controls or culture. No system prevents all violations, not even the most effective command and control. Rather, the Sokol episode represented the kind of thing every company hopes that culture and controls will deter.43 The episode did expose limits of the autonomy-and-trust model.44

Munger expanded on this theme at Berkshire’s 2011 annual meeting on April 30:


The greatest institutions…select very trustworthy people, and they trust them a lot…There’s so much self-respect you get from [being] trusted and [being] worthy of the trust that [the] best compliance cultures are the ones which have this attitude of trust. [Some corporate cultures] with the biggest compliance departments, like Wall Street, have the most scandals. So it’s not so simple that you can make your behavior better automatically just by making the compliance department bigger. This general culture of trust is what works. Berkshire hasn’t had that many scandals of consequence, and I don’t think we’re going to get huge numbers either.45



In any corporate culture, it is important how officials respond to transgressions. In congressional testimony concerning the Salomon Brothers bond trading scandal, Buffett formalized his admonition to company personnel in words that reverberated through the arena of the 2011 Berkshire shareholders’ meeting: “Lose money for the firm, and I will be understanding; lose a shred of reputation for the firm, and I will be ruthless.”46

Amid the Sokol affair, other Berkshire subsidiaries found an opportunity to offer a lesson. Todd Raba, chief executive of Johns Manville, where Sokol had intervened as chairman, gave Buffett a copy of a note issued to his company’s employees the day the audit committee report was published. It said:


The audit committee clearly found that Mr. Sokol compromised the integrity-related values both Berkshire and JM have worked so hard to ingrain in the fabric of both companies. This should serve as a tragic lesson learned for every employee in JM. There are no gray areas when it comes to integrity.…47



In Sokol’s case, Berkshire turned over all information to the Securities and Exchange Commission. The SEC looked into the matter, but ultimately dropped the case in January 2013. The SEC did not offer any explanation, but a victory was uncertain. For one, Sokol had no authority over whether Berkshire would acquire Lubrizol. That meant the “information” he had when he bought Lubrizol stock was neither ripe nor reliable. So the SEC might have had difficulty proving the legal requirement of “materiality.” Plus, since Sokol was not a Lubrizol employee, he did not commit classic insider trading when buying its stock, so the SEC would need to show that he “misappropriated” Berkshire property, which was not obvious.48