Warren Buffett is sure to face tough questions about former Berkshire Hathaway executive David Sokol at this weekend's shareholders meeting. The company issued a report this week that said the former top executive violated the company's ethics policies.
Some shareholders say the incident _ stemming from Sokol's purchase of Lubrizol stock shortly before he recommended Berkshire buy the chemical company _ demonstrates a weakness of Berkshire's highly decentralized business model.
Berkshire's model relies on a strong culture of responsibility and trust with little oversight of its managers. Berkshire has just 21 employees at its Omaha headquarters to oversee about 260,000 worldwide, and Buffett tells shareholders that he and Vice Chairman Charlie Munger "delegate almost to the point of abdication."
By contrast, General Electric has about 500 executives at its Fairfield, Conn., headquarters to oversee 287,000 employees in its worldwide conglomerate, according to business information provider Hoover's.
Before Sokol's resignation, the shareholder questions at Saturday's meeting would have likely focused on what Berkshire plans to do with the $38 billion cash it held at the end of 2010. Other topics: buying Lubrizol, the success of last year's acquisition of the Burlington Northern Santa Fe railroad and Berkshire's investments in Goldman Sachs and General Electric. Investors are usually eager to hear Buffett's views on the economy and inflation, too.
Now the Sokol situation is likely to overshadow most other topics. That means discussion about the health of Berkshire's 80-odd subsidiaries or the merits of the $9 billion Lubrizol deal might be limited. One related topic that is still sure to come up: succession planning. Sokol was considered a top contender to succeed the 80-year-old Buffett as CEO.
Buffett hasn't directly addressed Sokol's actions since praising him in a news release announcing the executive's resignation last month, and he declined to comment for this story. But he told CNBC that he will welcome all questions about the Sokol situation at Saturday's meeting.
Sokol himself has denied any wrongdoing, and his lawyer disputed the report Berkshire released Wednesday concluding that Sokol had violated the company's insider trading and ethics policies with his Lubrizol trades and incomplete disclosures about them. Berkshire said the board may consider legal action against Sokol to recover his trading profits and any damage that Berkshire sustained.
Buffett will have the benefit of making his first comments about Sokol in front of a mostly friendly arena full of roughly 40,000 at Berkshire's annual meeting on Saturday. Buffett and Munger spend nearly six hours answering any and all questions at the meeting while munching treats produced by Berkshire's See's Candy and drinking soda made by Coca-Cola, which is one of Berkshire's bigger stock investments.
Jeff Matthews, a shareholder who wrote "Secrets in Plain Sight: Business & Investing Secrets of Warren Buffett," said the weaknesses exposed by the Sokol issue mean Buffett may have to change the way he runs Berkshire by expanding his headquarters and adding more oversight of the company's managers.
"He's basically violated every precept of proper business behavior that he has espoused over the last 40 years," Matthews said.
Buffett sends a letter to managers every two years that emphasizes the importance of protecting Berkshire's reputation as the company's most-important asset. Buffett promises to be ruthless if Berkshire's reputation is hurt but understanding if they lose money.
"He has not been ruthless. The letter he put out when he announced this was very oddly bland," Matthews said.
Buffett made a point in the statement he issued about Sokol's Lubrizol trades to say he didn't think Sokol's actions were illegal, and he praised Sokol's contributions to Berkshire as chairman of MidAmerican Energy and NetJets.
New information has emerged since Buffett's March 30 announcement, and the report Berkshire released this week was highly critical of Sokol. The report said Sokol violated company policies because he invested in nearly 100,000 Lubrizol shares while he was scouting acquisition candidates for Berkshire and he failed to be candid about the details when questioned by Buffett and other Berkshire executives.
Sokol's roughly $10 million Lubrizol investment became worth about $13 million after Berkshire announced its $135 per share offer for the company. The $9 billion deal also includes Berkshire assuming about $700 million in Lubrizol debt.
Morningstar analyst Greg Warren said the Sokol situation raises questions about the internal controls at Berkshire and has hurt the company's reputation. Berkshire appears to have strong policies, but he said the enforcement appears weak.
"Trust and integrity only get you so far. In this day and age, you have to have some controls in place," Warren said.
Andy Kilpatrick, the stockbroker-author of "Of Permanent Value, the Story of Warren Buffett," said he thinks Berkshire's board is willing to make changes to address this problem, if in the end its internal investigation shows they are warranted. Kilpatrick, who is also a Berkshire shareholder, said he is looking forward to hearing what Buffett has to say about Sokol's actions.
"This is his time to say whatever he wants to say publicly about this when everyone is listening," Kilpatrick said.
On Saturday morning, some shareholders will rush to 13 microphones set up around the Omaha arena as soon as the doors open at 7 a.m. to draw for a chance to ask a question. Throughout the day, questions alternate between the shareholder microphones and a panel of three journalists who collected questions from their readers and viewers via email beforehand. Buffett has said he hopes there will be enough time to get through about 30 questions each from the reporters and from shareholders.
As for the talk of succession, Sokol's departure will only add to shareholder speculation about who will eventually replace Buffett as chairman and CEO of Berkshire.
To replace Buffett, Berkshire plans to split his job into three parts _ chief executive officer, chairman and several investment managers. Buffett, however, has indicated that he has no plans to retire, and he says he loves his work and remains in good health. Buffett refuses to identify the candidates, but investors still speculate.
Besides Sokol, the other Berkshire managers who are believed to be possible chief executive successors are Ajit Jain, who runs Berkshire's reinsurance division; Greg Abel, president and CEO of MidAmerican; Tony Nicely, chief executive of Geico; and Burlington Northern Santa Fe CEO Matt Rose.
Berkshire owns clothing, furniture, railroad and jewelry firms, but its insurance and utility businesses typically account for more than half of the company's net income. It also has major investments in such companies as American Express, Washington Post Co. and Wells Fargo & Co.
Berkshire Hathaway Inc.: http://www.berkshirehathaway.com
Berkshire report on Sokol's actions: http://bit.ly/iOdpq5
Warren Buffett's initial statement on Sokol: http://bit.ly/h05Udr
History of Lubrizol deal: http://1.usa.gov/eUIPXD