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Buffett's Succession Plan Blows Up

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Warren Buffett delivered a bombshell yesterday, announcing the resignation of David Sokol, the chairman of Berkshire Hathaway's (NYSE: BRK-B  ) MidAmerican Energy unit. Sokol was widely considered to be the front-runner to become the CEO of Berkshire in the PB (post-Buffett) era. This is not good news for Berkshire shareholders and neither are some of the circumstances surrounding the departure.

In a memo-style press release from his own hand, Buffett explains that Sokol -- who had wanted to resign twice in the past -- is leaving to manage his personal wealth. Buffett also reveals that Sokol made a substantial purchase of Lubrizol (NYSE: LZ  ) shares in early January, just prior to suggesting to him that he consider the company as an acquisition target. Berkshire announced the $9.7 billion acquisition of Lubrizol on March 14.

This isn't the Berkshire way
The press release has a bit of Jedi-mind-trick quality to it ("This isn't the securities law infraction you're looking for. Move along."), with Buffett stating that he does not believe that the share purchases were illegal and that Sokol's decision to resign is unrelated to the share transaction. However, careful readers will note several clues to suggest this is not business as usual at Berkshire:

  1. Focusing solely on legality here is disingenuous. Buffett has always aspired to follow the letter and the spirit of the law.
  2. When Sokol tried to resign in the past, Buffett surely must have fought tooth and nail to retain him, as he wouldn't want to lose a manager of that caliber. However, this time, Buffett says he made no effort to persuade him to stay. I don't think this is an insignificant detail; rather, I think Buffett is signaling that he condemns Sokol's Lubrizol share purchase.

Why disclose the share purchases at all, if they tarnish Sokol's and Berkshire's images? First, Buffett likes to deal openly and fairly with his shareholders. Furthermore, it makes good sense to get out in front of a story like this if there is a risk that it will come out (and that risk is always there). Although this looks less serious than the case linking a Goldman Sachs (NYSE: GS  ) director to the alleged Rajaratnam insider trading ring, it's very odd that someone of David Sokol's stature would commit an error in judgment of this magnitude. In itself, that is probably enough for Buffett to have ruled him out for consideration as Berkshire's next CEO.

The bottom line for shareholders
Where does that leave Berkshire and its shareholders? It's certainly not good news, as Sokol was the most likely candidate for the top spot. In a filing in February, Berkshire said its board "has identified four current Berkshire subsidiary managers who are capable of being C.E.O.," so the company isn't without options. While the impact of Sokol's departure on Berkshire's long-term value need not be significant, it certainly increases the pressure on Buffett to share more information regarding the succession plan with his shareholders. For his biographer's opinion, click here.

To get our view on all the major developments affecting Berkshire shares, click here to add the stock to your watchlist. You'll get valuable updates as well as immediate access to a new special report, "Six Stocks to Watch from David and Tom Gardner." Click here to get started.

Fool contributor Alex Dumortier, CFA has no beneficial interest in any of the stocks mentioned in this article. You can follow him on Twitter. Berkshire Hathaway is a Motley Fool Inside Value recommendation. Berkshire Hathaway is a Motley Fool Stock Advisor selection. The Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (8) | Recommend This Article (17)

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  • Report this Comment On March 31, 2011, at 1:18 PM, TheDumbMoney wrote:

    You are 100% correct. The law has nothing to do it, Sokol committed a huge ethical breach even if he did not break the law, and he rendered himself unfit to lead. Moreover, I would say the earlier (I believe) public statement that the board stood behind Ajit Jain to take over, was a signal to Sokol that it was time for him to tender his resignation and move on. These were 100% not unconnected events.

  • Report this Comment On March 31, 2011, at 5:24 PM, ynotc wrote:

    Buffett's image is permanantly tarnished in my opinion. First he becomes a schill for tarp so that Goldman can get paid billions from AIG and now he is less than forthright about what amounts to criminal activity. He used to say things straight up even if it meant taking a short term hit.

  • Report this Comment On March 31, 2011, at 5:26 PM, knighttof3 wrote:

    X-posted from BRK board:

    In the Sokol fiasco, the thing that puzzled me the most was, why did he buy and then sell in a week 2300 shares? Seems like a pittance for him, and one would assume he is not a trader type.

    A cynic might believe that he bought and sold the shares prior to buying in bulk (96060 shares) to give himself plausible deniability. Maybe inside Berkshire, you have to disclose all stock purchases and sales to some internal auditor every quarter. On Dec 31 2010, the auditor would notice both by Mr Sokol. 2300 * 108 = $248.4K. I am guessing any buys/sells above $250K would trigger a more extensive audit or require the exact details of the transactions. Sokol avoided the trigger, then bought in Jan knowing if WEB asked him about LZ ownership, and then crosschecked with the auditor, WEB might presume Sokol had a few shares still left over. Sokol planned to be out before March 31 2011 anyway, because that would be the time for the next quarterly audit. The one thing he needed was to pursuade WEB to buy LZ. WEB, who when talking about Walter Schloss said "no power on Earth can convince him to buy a stock, not even me", did not follow his own precepts and bought LZ. Sokol got himself $3M. Maybe less than what he was hoping for - because maybe WEB can be pursuaded to buy but he canot be pursuaded to give away money by overpaying for a security. That, Mr Buffett will famously not do.

    It all adds up. Sokol got $3M for 3 months of dreaming and scheming and got out.

  • Report this Comment On March 31, 2011, at 6:30 PM, SolarisKing wrote:

    YES. Illegal.

    1, He received info that was not available to the public.

    2. He received it as a consequence of his job as an insider.

    3. Then he traded with an advantage.

    That is the exact definition of insider trading.

    In doing so he undoubtedly cost a smaller trader some money. Some chap who placed a market buy/sell, then went to his 9-5, then came home to find his strategy useless.

  • Report this Comment On March 31, 2011, at 7:08 PM, titus77 wrote:

    "In the Sokol fiasco, the thing that puzzled me the most was, why did he buy and then sell in a week 2300 shares? Seems like a pittance for him, and one would assume he is not a trader type."

    For what its worth, in the CNBC interview this morning, Sokol said that his initial purchase was so small because he put in a limit order and before it was fulfilled, the price increased beyond the limit. When the price didn't immediately go down at the end of the year he canceled the order and sold the shares since managing such a small amount wasn't worth the effort.

    When the price dipped, he put in another order which was mostly filled.

  • Report this Comment On March 31, 2011, at 8:45 PM, extremist wrote:

    At that level, there are only two types of operators: Ones whose skulduggery comes to light, as in this case, and ones who have yet to see their ill-gotten gains exposed.

  • Report this Comment On March 31, 2011, at 11:05 PM, hiopjpojopo wrote:
  • Report this Comment On April 01, 2011, at 6:42 AM, TMFAleph1 wrote:


    You wear your name well.

    Alex Dumortier

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