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Sokol's Stock Purchases Prior to Berkshire's Acquisition Shows Potential Gaps in Disclosure Laws

Source: WSJ - Leslie Scism, Jean Eaglesham, Erik Holm

Posted on 07 Apr 2011

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The disclosure that David Sokol, former top lieutenant of Berkshire, purchased shares of chemical maker Lubrizol a week before he suggested that Berkshire and Warren Buffet purchase the company sheds light on what some say could be a gap in securities disclosure: There is no rule requiring that executives' holdings in an acquisition target be revealed.

It's the public company's decision generally whether executives' holdings of public securities rise to the level of "material" information that should be disclosed. The test, lawyers say, is whether a reasonable investor would consider the information important in making a decision to buy, sell or hold the shares. In a deal situation, conflicts of interest rules can come into play but won't necessarily result in a disclosure decision, they say.

Berkshire Chairman and Chief Executive Warren Buffett last week disclosed that top lieutenant Sokol bought shares of a chemicals maker about a week before suggesting that Berkshire buy the company, which it later agreed to do. In the statement, in which Mr. Sokol's resignation was announced, Mr. Buffett said he believed the stock purchases weren't unlawful. Mr. Sokol has said he believes he did nothing wrong and the trades weren't a factor in his decision to resign.

The developments have prompted discussion among lawyers and investors about whether the purchases, had they not been revealed in the Berkshire news release, would ever have come to light. A spokesman for the Securities and Exchange Commission, which is investigating the matter, declined to comment on the disclosure issue. Neither Mr. Sokol nor Mr. Buffett responded to requests for comment.

In an interview with CNBC last week, Mr. Sokol said he expected his ownership in the company, Lubrizol Corp., eventually would become known.

Discussing Berkshire's news release of his resignation, he said: The "purpose there was those shares, my ownership there, would come out 30 or 60 days from now when the voting takes place, etc., on that transaction. And we did not want people to look back and say, 'Why didn't they tell us that?' So it's out there."

However, it isn't clear how he thought the Lubrizol share ownership would have come to light.

Securities laws generally require that a company being acquired must disclose its managers' potential conflicts of interest before shareholders vote on a proposed deal.

Lawyers say that because Mr. Sokol doesn't work for Lubrizol, and because it is a cash deal in which the Lubrizol shareholders get bought out and won't have a stake in Berkshire, the chemicals maker wouldn't necessarily be required to disclose anything about Mr. Sokol's holdings in its deal filings.

"You care about whether the people making the recommendations to shareholders are biased," says Ronald L. Rubin, a securities lawyer in New York.

"The potential motives of an executive at Berkshire are not terribly relevant to Lubrizol shareholders. What matters to them is the price."

A Lubrizol representative said the company became aware of Mr. Sokol's resignation and his purchases of Lubrizol stock when Berkshire put out its news release last week. She declined to comment further.

Because Berkshire has offered to pay cash for Lubrizol and isn't required to put the matter to a shareholder vote, it doesn't have to issue a proxy filing to shareholders about the deal, lawyers say.

And Mr. Sokol's position in the company, at about $10 million, wasn't large enough to warrant the public disclosure required by someone who owns 5% or more of a public company.

It is possible that Mr. Sokol in the CNBC interview was referring to his holdings coming to the attention of Lubrizol staffers when that company prepares a shareholder mailing list for a vote on the deal. However, lawyers say, such lists generally don't become public.

Several securities lawyers and academics said the Berkshire situation is unusual in that an executive had recently bought shares in a target company on his own. Other companies' executives often invest in blind trusts or mutual funds and thus don't know if they stand to gain financially from a specific transaction. Or compliance controls concerning stock ownership avoid potential conflicts.

David L. Yermack, a professor at New York University's Leonard N. Stern School of Business, says he has spent decades studying regulatory disclosures and doesn't recall a single instance of a senior executive at an acquiring company holding shares of an acquirer and disclosing it in a filing.

"This is just an odd set of facts," Prof. Yermack says.

In the CNBC interview, Mr. Sokol he had "made all kinds of suggestions" on potential deals over the years, "many of which we ultimately did." He said he had no say in Berkshire's decision to buy Lubrizol after recommending the company to Mr. Buffett.

Asked if there were other Berkshire transactions where executives pitching the deal stood to gain personally, he responded: "If there's any, any inappropriate behavior, I mean, it certainly should be looked at. I don't, I know of none and I certainly don't believe I've done any." He said "obviously" he "could never have any involvement" with transactions done by a Berkshire subsidiary that he ran.