With Sokol Under the Bus, Is Buffett Home Free?

NEW YORK (TheStreet) -- Berkshire Hathaway has thrown David Sokol under the bus, but will that be enough to clear the road for the teflon CEO Warren Buffett?

Berkshire Hathaway tried to pre-empt the firestorm that Buffett is sure to face at this weekend's Berkshire annual meeting by releasing the results of a Berkshire board audit committee review that slams former Berkshire senior officer Sokol.

The audit committee report states that trades Sokol made in shares of Lubrizol weren't just a violation of Berkshire Hathaway policy and fiduciary duty, but part of a nefarious plot to fool the most revered investor of all time and his famed investment company.

The Berkshire Hathaway board described Sokol's intentions to deceive Buffett specifically about the trades, and said Sokol made misleading disclosures to Berkshire.

As the Berkshire Hathaway annual meeting approaches, Berkshire shareholders -- and the media -- have been pressing Buffett to offer some kind of statement going beyond what was said in the original Sokol press release. That release included the Buffett "line in the sand" that he would have nothing more to say on the Sokol matter in public and would simply refer all questions back to the press release.

Making the results of the Berkshire Hathaway board review of Sokol's trades public is one step to put out the fire, but the flip-flop in Buffett and Berkshire's statements about Sokol have changed so dramatically over the course of one month that many questions remain. Berkshire Hathaway also said on Wednesday that any and all questions related to Sokol that are asked at the annual meeting this weekend will be posted on the company's Web site.

Speaking to Fox News on Thursday night, Buffett said that he expects the Sokol questions to dominate the annual meeting and that shareholders should ask any and all questions, and if his lawyers try to wrestle him to the ground, he will keep on talking. It's been mud wrestling so far between Berkshire's board and Sokol's lawyer, and Buffett, in the least, has lots of explaining to do. The clean-as-a-whistle CEO who says he hates to get into altercations might yet get a little dirty, but will it be dirt on his honest Abe face or more of the fresh Berkshire mud pies being slinged at Sokol?

"How does Buffett fill the gap? It just seems weird and sort of amateurish. Don't you think there has to be more to the story for Buffett to go the way he did on March 30 and now enter a mud-slinging match? We're going to be in daily after-market entertainment mode with who's got the next press release, Sokol's lawyer or Berkshire," said Paul Howard, founder of Solstice Investment Research, and also a Bekshire Hathaway shareholder [Howard used to cover Berkshire Hathaway for Janney Montgomery].

"The fact that they are going to open it up to questions shocked me, but maybe they just want to get it all out in the open and put the issue to bed," Howard said.

Of course, how Buffett answers any questions about Sokol at the annual meeting is more important than whether his answers are posted online. Buffett may be famous as a "straight shooter," but that image is at odds, at least sometimes, with a historical record that shows a Buffett not inclined to point the finger at companies or individuals.

That's not the case with the second Sokol statement. "Buffett didn't pick on Moody's," Morningstar analyst Greggory Warren said [in fact, Buffett had to be brought by federal subpoena to testify before the Financial Crisis Inquiry Commission]. Though the analyst added that this time things were different: "Buffett has said in the past of problems at companies in which he has invested that he is just a 'passive' investor. Sokol is not a passive subordinate and the Lubrizol deal was not a passive deal.

Analysts noted that with one Berkshire Hathaway shareholder lawsuit already filed related to Sokol's trades, Buffett may be limited in what he can say, or at least in what he will say. Furthermore, with the audit committee releasing a full accounting of the Berkshire Hathaway view, Buffett can refer to the report without having to offer anything new and without having to personally criticize Sokol, or offer any comment on mistakes made by himself and Berkshire Hathaway.

Buffett's longtime law firm Munger, Tolles & Olson [Berkshire vice chairman is Charlie Munger ]helped prepare the audit committee report on Sokol, and Buffett longtime lawyer Ron Olson is on the Berkshire board. Given that Berkshire has been sued by a shareholder over the damage from Sokol's trades, though, is the situation any different than BP pointing the oil spill finger at Transocean, and Transocean pointing it back at BP? Arguably the situation is closer to the federal government saying both BP and Transocean are to blame. Even though Buffett can't be held responsible for Sokol's insider trading, questions about Berkshire's fiduciary duties and lack of best practices remain.

Directors and officers (D&O) liability attorney Kevin LaCroix writes on his D&O blog that, in fact, the Berkshire board was more or less compelled by shareholder lawsuit to prove it's on the ball. "Among other things that the Audit Committee's report does is that it makes it difficult for the plaintiff in the recently filed derivative action relating to these matters to be able to contend that a demand to the Berkshire board to take up this claim would have been futile...(Among other reasons the plaintiff cited in support of his demand futilty allegation is that the company lacks "traditional corporate infrastructure.")

"I don't expect direct answers or answers that might create more problems when it comes to lawsuits, but at the same time, Buffett has to admit mistakes were made. It really depends on how open he is willing to be about the whole thing and admitting that mistakes were made might do it," said the Morningstar analyst.

The Berkshire Hathaway statement on Wednesday had far more to say about the mistakes made by Sokol than any problems with the internal controls at Berkshire Hathaway. That issue has also been on the minds of analysts who cover the company. After the company's stock slid when the Sokol drama unfolded, reputational stain morphed, with minor financial damage to Berkshire Hathaway [Berkshire shares have partially rebounded from the Sokol-triggered decline, which saw shares dip from above $85, and recently hit as low as $79.83. Berkshire B shares were trading at $83 on Thursday.]

"Buffett has said he spent so much time talking to the media because he was concerned about his legacy and that's fair, but media impressions matter to him in a way they don't to others, and whether it's fair or not, these questions need to be asked," said Meyer Shields, analyst at Stifel.

Berkshire's board did indicate that it will "work with company management and legal counsel to identity and implement lessons learned from these events, including possible enhancements to its procedures."
In the press release and report issued by Berkshire Hathaway's board on Wednesday, the audit committee of the board says that the shift in Berkshire's position toward Sokol came because Buffett and the company did not have the full story in March.

Yet questions have been asked about why Berkshire Hathaway did not have the internal controls in place to monitor this situation before it spiraled out of control. Does not having the full story mean that Berkshire Hathaway is free of any responsibility for lax oversight? The statement in this week's press release was that the board will look into the issue of Berkshire's potential lapses. When will that report be made available to the public?

On Sokol's resignation, the specific statements in the two Sokol releases are confusing.

In the first release, Buffett says that he did not ask for Sokol's resignation and was surprised to receive the resignation letter. The original letter said that Sokol had tried to resign twice previously, and both times Buffett had convinced him to stay, and Buffett said in the letter that Berkshire Hathaway and its shareholders were much better off as a result. The update from the Berkshire audit committee says that Sokol asked Buffett to delete one line in the original release, which would have implied he was resigning due to fear of what the Lubrizol trade investigation would do to his chances at the Berkshire CEO job.

Morningstar's Warren said of the original Sokol resignation release, "Buffett said he accepted Sokol's resignation and it was more like he was glad to see Sokol's back side, as opposed to chastising him. That was classic Warren Buffett stuff."

The biggest change of all, though, was the level of conviction Buffett expressed in the first Sokol release about his view of the matter being firm and unlikely to change. Buffett's statement in the original Sokol press release was that he would have nothing more to say on the matter and would simply refer people to the press release. In the original release, Berkshire offers what seems to be a history of trades and what it considered at the time a complete accounting of events.

It's fair for Berkshire to say it has learned more since its original findings, but in most cases where a corporation is reviewing potential violations of securities law, a company would put the allegations under review without admitting or denying any wrongdoing, and await results of a full investigation. Buffett went much further in support of the claim that nothing illegal occurred one month ago. Buffett had the confidence to say then that he did not think Sokol did anything wrong. Buffett didn't say, "as events evolve Berkshire Hathaway may release additional information." He was categorical in saying it would be the final word. End of story.

Since the media frenzy has only increased leading up to the annual meeting, why shouldn't a Berkshire shareholder come to the conclusion that this latest press release was issued simply because the issue didn't go away on its own in time to make it a non-issue in the media and around the annual meeting? An indictment from Berkshire's audit board of Sokol may not be enough for everyone to feel that Buffett has offered a concession personally.

In the end, there is really only one question for Buffett that won't go away: Will he accept that Berkshire made any mistake other than falling prey to Sokol's misleading disclosures and Sokol's intent to deceive, and especially given the strong support he voiced for Sokol in the original release?

Paul Howard, the current Berkshire shareholder and founder of insurance research shop Solstice Investment Research, told TheStreet on the road and on his way to the Berkshire annual meeting, "Lots of people come to the annual meeting to feel good, and that might sound strange, but people want to go because they want to feel good about America and business and owning a stock and making money.

Howard continued, "The expectation is, 'Hey, Warren, make me feel good.' I still think that's part of the reason so many people go today. Let me hear a good story from a good speaker on why the country is great and there is hope, and about the economic benefits of owning shares. This is an interesting soap opera on the side, posing lots of questions and there aren't lots of answers right now, but I'd still rather learn more about what Buffett's doing with the business and what the insurance market look likes."

If only it were that simple.

Greggory Warren, the Morningstar analyst who has been skeptical of the original Sokol release from Berkshire Hathaway all along, said of the annual meeting, "Two things are occurring. The economy remains unsettled and lots of Berkshire shareholders were disappointed last year when Warren wouldn't lambaste Wall Street. They are still dissatisfied this year, and concerned that Buffett was glossing over what to most of us is a failing of one of his key subordinates, enriching himself to the detriment of shareholders."

Berkshire Hathaway and Buffett took care of the "glossing over" of Sokol's trades on Wednesday.

However, the Berkshire Hathaway annual meeting tone hasn't surely taken a turn to the positive. "I don't see a rah-rah event this year, and it was a bit less of a love fest last year. It's been nothing but negative news throughout the month, and the shareholder base has changed," Morningstar's Warren said, referring to the fact that many more institutional shareholders, activists among them, invested in Berkshire Hathaway after its S&P 500 inclusion.

There may be one question to be posed to Buffett this weekend even more important for Berkshire shareholders, if esoteric in nature. Buffett has said the company can't afford to lose any of its reputation, reputation being more important than money.

For Berkshire shareholders, then, the question running beneath all of the continuing frustration over the Sokol situation may be this: Even with all of the contributions made by Sokol to Berkshire Hathaway over the years, does the fact that Berkshire's risk/reward formula factors in reputation above all other variables imply that Berkshire Hathaway shareholders would be better off if David Sokol had never been an employee of the company?