A Key Takeaway From Buffett's Blunder

Even the smartest corporate leaders with the most sterling reputations can disappoint their shareholders on occasion. Headline news concerning a major blunder committed by none other than Warren Buffett gives investors many things to ponder. One key takeaway is how important strong corporate-governance policies are in giving shareholders some power over what goes on at their companies. 

Many investors view Berkshire Hathaway's (NYSE: BRK-B  ) Buffett as a corporate leader who can do no wrong. Some even see him as something akin to the marketplace's spiritual guide.

But this week's controversy surrounding trading behavior of former Berkshire heir apparent David Sokol shows that even Buffett can blunder, too -- and big time. If Buffett can make such a poor judgment in this situation, investors had better ponder the importance of checks and balances at all publicly traded companies.

Poor judgment in unexpected places
Buffett's in the spotlight following Sokol's resignation, which came with a side of extremely controversial news. Sokol bought stock in Lubrizol before encouraging Buffett to consider the lubricant manufacturer as a potential acquisition for Berkshire Hathaway.

Buffett and Sokol are both currently denying any shady or illegal behavior in this incident. Still, the situation looks sketchy, arrogant, and perhaps downright unethical -- if not illegal.

The New York Times has highlighted the takes from some corporate-governance experts: They're mystified that Buffett, of all people, would handle the situation in such a blundering manner.

Regardless of whether Sokol's actions were technically against the law, the experts wonder why Buffett didn't ask more questions when he learned that Sokol owned shares of the company being considered as an acquisition. The fact that Buffett knew this sheds even more mystery on what looks, at the very least, like a very poor judgment call.

This is, after all, Warren Buffett, a man who has so often strongly evangelized for strong ethics not only for his own company but also for the marketplace at large. He's known for his mega-smarts, so it's difficult to imagine he didn't quite catch how something like this might look to outsiders.

This is also the man who last summer cautioned Berkshire's managers: "We can afford to lose money -- even a lot of money. But we can't afford to lose reputation -- even a shred of reputation."

For a long time, Berkshire shareholders could have been forgiven for feeling safe to the point of complacency when it came to Buffett's stewardship. If you couldn't trust Buffett, whom could you trust? But now, it's arguable that stronger governance policies are in order, even at Berkshire Hathaway, a company many consider among the gold standard of U.S. companies because of Buffett's leadership.

Mark your calendar…
This time of year is the best time for considering strong corporate governance, so thanks to Buffett, we have one more reason to check the proxy statements that are showing up in our mailboxes and vote our opinions on these important issues.

Moxy Vote, an online vehicle for shareholder activism through proxy voting, tracks upcoming votes related to various causes at companies' annual meetings. Right now, the site has highlighted several corporate governance-related shareholder proposals that will be subject to voting in the next few weeks:

  • Paccar (Nasdaq: PCAR  ) : supermajority voting; director-vote thresholds.
  • C.R. Bard (NYSE: BCR  ) : annual election of directors.
  • Citigroup (NYSE: C  ) : ability to call special meetings; review and report on controls related to loans, foreclosures, and securitization.
  • Honeywell (NYSE: HON  ) : ability to call special meetings; shareholder action by written consent.
  • Hudson City Bancorp: Declassification of the board of directors.

One of the most accessible issues in corporate governance is CEO pay, and there's no shortage of attention in that regard this year, not to mention shareholder action. Shareholders have recently voted "no" on the compensation plans for major companies such as Hewlett-Packard (NYSE: HPQ  ) , Beazer Homes, and ShuffleMaster.

Democracies, not monarchies
There are good reasons shareholders need to have some methods of recourse and reaction these days, especially when boards of directors so frequently forget their place (and function), too.  

Corporate-governance policies such as a close tie between CEO pay and performance, majority voting, the power to call special meetings if necessary, board declassification, and the separation of CEO and chairman titles all give shareholders long-neglected sway in what goes on at their companies.

Corporate leaders aren't kings, not even Warren Buffett. Strong corporate-governance policies ensure some much-needed democratic spirit in a realm that has sorely needed it for quite a while.

Check back at Fool.com every Wednesday and Friday for Alyce Lomax's columns on corporate governance. And follow all the Fool's coverage of Berkshire Hathaway by adding it to My Watchlist.

Berkshire Hathaway is a Motley Fool Inside Value recommendation. Berkshire Hathaway and PACCAR are Motley Fool Stock Advisor choices. The Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days.

Alyce Lomax owns no shares of any of the companies mentioned; for more on this and other topics, check back at Fool.com, or follow her on Twitter: @AlyceLomax. We Fools don't 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 (13) | Recommend This Article (16)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 02, 2011, at 10:58 PM, buffalonate wrote:

    Sokol liked Lubrizol so he bought shares. He recommended that his boss by shares too. He also told said boss that he owned shares. He had no guarantee his boss would buy the company as his ideas had been shot down many times before. There is nothing illegal or unethical here. Move along people. This is a media creation nothing more.

  • Report this Comment On April 03, 2011, at 1:06 PM, mboisser wrote:

    Alyce gives me the feeling she would not be so vicious if women were involved. The comment by "buffalonate" covers this story with all the media attention it needs.

  • Report this Comment On April 03, 2011, at 1:50 PM, tshk1221 wrote:

    I agree with bufflonate. Media is the culprit. The primary point of concern will be, since the coincidental transaction made by David Sokol is not unethical and illegal and since David Sokol left BRK, to find the CEO candidates. A new stronger candidate will appear very soon who will eventually lead BRK into a whole new level.

  • Report this Comment On April 03, 2011, at 4:19 PM, TMFCop wrote:

    Or is it another case of Buffet saying one thing but doing another? Seems to me we're seeing a lot of that lately. He's called derivatives weapons of financial mass destruction, but uses them himself.

    He's also been opposed to using stock to make acquisitions, but at least part of the rationale behind splitting Berkshire's B shares was to make shares accessible to Burlington shareholders.

    While he was urging Americans to "Buy American," back when the financial crisis was full throated, he wasn't so much purchasing Goldman Sachs stock as lending to the company -- at fairly steep rates, too.

    Then when his shares of Kraft and US Bancorp dropped for extended periods of time, the SEC wanted to know why BRK hadn't written them down as other than temporary losses. Buffett's response was basically those rules are for everyone else, not me. We hold stocks for the long term and think we'll make our money back.

    He did that once before when he didn't want to have to notify the SEC when he made stock purchases because other investors would pile in and drive up the share price.

    Then he quickly moved into insuring municipal bonds when other insurers were in danger of going under only to give it up a year later. He's bet against the dollar, bought big into Chinese car maker BYD only to see the wheels come off, and bad-mouthed Kraft's management and sold down his stake over its purchase of Cadbury (so much for holding on for the long haul).

    No doubt Buffett is far better at corporate governance than just about anyone else, but he's not the saint he's often been made out to be. And the Cult of Warren has given him privilege and he's using it to serve his own ends, even if it means not playing by the same rules you or I are required to.

    Rich

  • Report this Comment On April 03, 2011, at 5:02 PM, tshk1221 wrote:

    Rich

    Of course, he is not the saint. He shouldn't be a saint. Actually, you have to view him as a wise, sometimes, shrewd money maker for the shareholders of BRK in this complex world of capitalism where one plus one can be three or four. When he said Buy American, did he mean that he must buy common stocks of Goldman? Goldman does not belong to the acceptable category of his common stock investment. So, he chose preferred instead and gave BRK shareholders an amazing yield of 15% a year.

    Derivatives? Whenever he sees money-making opportunities even though he superficially said they were weapons of financial destruction, he gets in to make money from them if those weapons are deemed to produce the money he needs to make for the shareholders of BRK.

    Accounting reporting issues with KFT and USB? Those accounting issues should be resolved first between SEC and the accounting board. The current mark-to-market has been always said to have a lot of issues.

    BYD? BYD does not belong to my chairman's acceptable category of common stock investment. It was an investment recommended by a Chinese hedge fund manager, Li Lu. If my chairman had invested for himself back then, he would have chosen other companies such as KO or WFC.

    If a management is making a costly acquisition with an estimated cap rate of less than 5%, I would definitely and openly criticize the management. I myself did not like KFT's acquisition of Cadbury.

    Buffet is a money maker from the opportunities that will compensate the risk he takes for the sake of shareholders of BRK. He does not exist for the sake of public by being a saint.

  • Report this Comment On April 04, 2011, at 3:39 PM, mtf00l wrote:

    I'm still waiting for my 15% on BRK-B. Not counting commission I'm still in the red over a year after initial purchase.

  • Report this Comment On April 04, 2011, at 3:41 PM, mtf00l wrote:

    I'll prognosticate further if any of us amassed the fortune Warren has we would feel entitled too!

  • Report this Comment On April 04, 2011, at 5:38 PM, jaketen2001 wrote:

    Aaaahhhhhhhhh,

    The Fool Bufferazzi crowd. Good to see all of you here, again, for the millionth time.

  • Report this Comment On April 04, 2011, at 11:21 PM, Zugersee wrote:

    I find Alyce's statement (below)

    "Buffett and Sokol are both currently denying any shady or illegal behavior in this incident. Still, the situation looks sketchy, arrogant, and perhaps downright unethical -- if not illegal."

    completely sensationalist - this should be based on fact and not on the authors opinion on what arrogance is.

    If I buy a stock, and tell my friend to buy some, and he does weeks later, is this still arrogant and unethical, or is the only reason you are whining so loud because the person who is buying the securities is Berkshire Hathaway.

    If for example he knew Berkshire was going to make the purchase, and front-ran the acquisition, then you may have a case - but that's not for us to decide, that's for the SEC and the courts, not for Alyce Lomax.

  • Report this Comment On April 04, 2011, at 11:53 PM, goalie37 wrote:

    While I respect the advocacy of share holder rights that Alyce has taken in many articles, my own position on the issue has been different. With thousands of publicly held corporations to choose from, why own one where I disagree with management. I dislike how JNJ's current leaders are running the company, therefore I refuse to own them until a change is made.

    My analogy is that I would rather get in a lifeboat than go steer the Titanic myself.

  • Report this Comment On April 05, 2011, at 9:25 AM, TMFCop wrote:

    Former hedge fund operator Michael Steinhardt had some pretty strong opinions about Buffett on CNBC today:

    "(H)e is the greatest PR person of recent times and he has managed to achieve a snow job that conned virtually everyone in the press to my knowledge. And it is remarkable that he continues to do it."

    At around the 7:55 mark in the video:

    http://video.cnbc.com/gallery/?video=3000014541

    He's got other choice critiques of Buffett too.

    Rich

  • Report this Comment On April 05, 2011, at 11:57 AM, TMFLomax wrote:

    Thanks for all the input, everybody. And TMFCop, thanks particularly for the very relevant reminders of times when Buffett hasn't quite lived up to the reputation he has in the marketplace (when I was reading The Snowball last year, it did occur to me that he's certainly not perfect, and a few of his mistakes seemed to be repeated several times over the long course of history). Thanks also for the link to the CNBC interview.

    goalie37, I like your analogy and I know we often agree on many issues. I don't think we shareholders should completely steer the boat, but that we should have some input and watch out for any signs the iceberg may be coming while the captain's distracted for whatever reason. ;)

    I also think that unmitigated hero worship of certain individuals is a huge mistake for investors (well of course, it's a huge mistake in other areas too, but here at the Fool we're concerned with investing). That was one of the main points of my article, as well as, well, Buffett/Berkshire shouldn't be perceived or assumed to be above or untouched by the same standards many of us would expect at many other companies. There's nothing wrong with some critical thinking about these issues and how they relate to corporate governance and share ownership in general.

    Thanks again for all the feedback. It's an interesting issue.

    Alyce

  • Report this Comment On April 05, 2011, at 3:32 PM, Clint35 wrote:

    I agree with TMFCop completely. Warren Buffet is a hypocrite. He's a great investor and seems to be a nice guy. But he's also a businessman. Lately rule #1 seems to be more important to him than anything else he might preach about publicly. Whether what he and Sokol did was Illegal might be debatable. But I think it was definitely unethical.

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