Thursday, March 31, 2011

Sokol's Great Lubrizol Misadventure

While there is much to say about Sokol's lapse of judgment (the kindest thing that can be said about his purchase of ~100k shares of Lubrizol and advancing the company forward as a potential investment prospect), I offer these four observations:

Observation 1: BH has a code of conduct of ethics that clearly outlines expectations of employees. You can read that code here.

Obervation 2: Sokol's activities appear to violate this code.  Specifically, the section on Corporate Opportunities, noted below (highlights are mine), seems to be at the forefront of his abrading against this code:

2.    Corporate Opportunities.

Covered Parties are prohibited from taking for themselves opportunities that are discovered through the use of corporate property, information or position without the consent of the Board of Directors of the Company.  No Covered Party may use corporate property, information or position for improper personal gain and no employee may compete with the Company directly or indirectly.  Covered Parties owe a duty to the Company to advance its legitimate interests whenever possible.

In his position, Sokol would have been invited into confidential discussions and provided confidential information that an ordinary investor would not be privvy to. His making a personal investment on information that he obtained while performing his duties appears to be a clear violation of the above policy (to my eye).  There is no defense to that code violation.

In the event that the clause above was too obscure, you would think that the following clause might give one engaged in such a transaction some pause:

Given the variety and complexity of ethical questions that may arise in the Company’s course of business, this Code of Business Conduct and Ethics serves only as a rough guide. Confronted with ethically ambiguous situations, the Covered Parties should remember the Company’s commitment to the highest ethical standards and seek advice from supervisors, managers or other appropriate personnel to ensure that all actions they take on behalf of the Company honor this commitment. When in doubt, remember Warren Buffett’s rule of thumb:

“…I want employees to ask themselves whether they are willing to have any contemplated act appear the next day on the front page of their local paper – to be read by their spouses, children and friends
– with the reporting done by an informed and critical reporter.”

And finally, under "Violations of Standards" we have this

2.    Accountability for Violations.

If the Company’s Audit Committee or its designee determines that this Code has been violated, either directly, by failure to report a violation, or by withholding information related to a violation, the offending Covered Party may be disciplined for non-compliance with penalties up to and including removal from office or dismissal. 

So egregious the transgression of this code, so indefensible his actions, there really was no choice but to resign for there would be no reasonable choice but to fire him.

Observation 3:  Perhaps the code should be a little more specific for those that are unable to comprehend their special access to information as an invitee for the purposes of BH making acquisition or the simplicity and power of  Buffet's rule of thumb and state: UNDER NO CIRCUMSTANCE IS A COVERED PARTY TO HAVE AN UNDISCLOSED FINANCIAL INTEREST IN A COMPANY THAT IS RECOMMENDED FOR CONSIDERATION FOR INVESTMENT/ACQUISITION. ALL SUCH FINANCIAL INTERESTS SHOULD BE DISCLOSED TO THE AUDIT COMMITTEE AND LEGAL COUNSEL AND THE COVERED PARTY WILL ACT IN ACCORD WITH RECOMMENDATIONS BY EITHER OF THOSE TWO BODIES. Or something like that...  At the very least, BH needs an internal control that BEFORE an investment is made, there is an internal conflict of interest check to ensure that such matters are discovered prior to their becoming issues and that executives with recommendation and/or approval responsibilities submits a periodic disclosure of his or her holdings.

 Observation 4:  You hear much about these so-called smart guys.  Well, you and I could easily read the Code of Conduct and know that buying Lubrizol on information obtained as an invitee for purposes of a transaction consideration and subsequently recommending Lubrizol without disclosing that one had a financial stake in the transaction, smells worse than three day old fish. Smart money has not looked too smart in the last decade, and not so smart in this new decade either.  Another good example for not selling yourself short!