Buffett admits error, says Sokol events inexcusable

By Ben Berkowitz

OMAHA, Nebraska (Reuters) – Warren Buffett said he was wrong not to press David Sokol about purchases of Lubrizol Corp stock while his former top lieutenant was pitching the chemicals company as a possible takeover target for Berkshire Hathaway Inc.

It was the kind of answer investors had clamored to hear from Buffett at this year’s Berkshire annual meeting, ordinarily a lovefest for tens of thousands of shareholders, and over which the Sokol episode had cast a cloud.

Buffett said Sokol had violated Berkshire insider trading rules, and other rules he orders managers to follow, by failing to disclose his January purchase of Lubrizol shares, less than four weeks after starting talks with Citigroup Inc bankers about the company.

Sokol, who chaired Berkshire’s MidAmerican Energy unit, ran its NetJets plane leasing unit, and was a top Buffett deal maker, was considered a leading contender to succeed 80-year-old Buffett as Berkshire’s chief executive.

But he resigned last month when his Lubrizol stake was revealed. Sokol got a $3 million profit on that stake when Berkshire agreed to buy Lubrizol for about $9 billion.

The U.S. Securities and Exchange Commission is probing Sokol, a person familiar with the matter has said, and the controversy has called Buffett’s management style into question.

“I obviously made a big mistake by not saying, ‘Well when did you buy it?'” Buffett said on Saturday, as he and Vice Chairman Charlie Munger fielded shareholder questions for five hours from the stage of the Qwest Center in Omaha, Nebraska.

Calling the Sokol situation “inexplicable and inexcusable.” Buffett used the same language he had used 20 years ago to describe the failure by management at Salomon Brothers Inc, which he chaired, to tell regulators of wrongdoing tied to a Treasury bidding scandal.

“Lose money for the firm, and I will be understanding,” Buffett told Congress at the time. “Lose a shred of reputation for the firm, and I will be ruthless.” As in past years, a video of this testimony was played on Saturday as part of the annual shareholder movie. It drew scattered applause.

STRAIGHT ARROW

Berkshire is expected to split the CEO and chief investment officer roles after Buffett leaves. Buffett hired hedge fund manager Todd Combs as a potential successor for the latter.

Prior to Sokol’s departure, Berkshire had said it had four potential internal successors to become chief executive.

Among the possible candidates are insurance executive Ajit Jain, Burlington Northern Santa Fe railroad chief Matthew Rose, Geico auto insurance chief Tony Nicely, MidAmerican Energy chief Greg Abel and reinsurer General Re chief Tad Montross.

“Certainly the candidate that I think is the leading candidate now, I would lay a lot of money on the fact that he is as straight as an arrow,” Buffett said.

He later effusively praised Jain, saying, “I can’t think of any decision Ajit Jain has ever made that I could make better.” The comments drew loud applause from an audience that perhaps surmised Buffett might be offering a tip about his successor.

That might have been Sokol, but in a scathing April 26 report a committee on Berkshire’s board found that he had deliberately misled Buffett about his Lubrizol investments, and that his “misleadingly incomplete disclosures” violated his duty to be candid.

“I think that for reasons that are laid out in the audit committee report, I don’t think there’s any question about the inexcusable part,” Buffett said.

Buffett said he did not understand Sokol’s actions, and added, “We hope to get some value out of this experience.”

Munger attributed Sokol’s behavior to “hubris.”

Barry Levine, a partner at Dickstein Shapiro LLP representing Sokol, faulted Buffett’s comments, and said his client at all times had honored his fiduciary duties to Berkshire.

“David Sokol is deeply saddened that Mr. Buffett, whom he considered a friend and mentor, would disparage him as he has done today,” Levine said in an e-mailed statement. “It is alarming that Mr. Buffett would be advised to so completely flip-flop and resort to transparent scapegoatism.”

After discussing Sokol, Buffett focused on topics such as deal making, one of his most important responsibilities and a reason shareholders focus so intently on who will succeed him.

Buffett said he remained on the prowl for acquisitions, and said Berkshire was looking at two similar in size to Lubrizol. “They’re worth doing, but we can’t do a really big elephant now, and we won’t stretch,” he said.

The meeting drew close to 40,000 shareholders and others for a weekend Buffett calls “Woodstock for Capitalists.”

“From an investor’s point of view, I think it’s background noise,” mutual fund manager Mario Gabelli told Reuters Insider about the Sokol matter.

EARTHQUAKES RATTLE PROFIT

Buffett revealed that losses from earthquakes in Japan and New Zealand and other catastrophes had driven Berkshire’s first-quarter profit down about 58 percent.

Preliminary results indicate that net earnings fell to $1.51 billion from $3.63 billion a year ago.

Operating earnings fell 28 percent to $1.59 billion from $2.22 billion, with improvement in “pretty much all” of Berkshire’s roughly 80 other businesses, other than those linked to residential housing, Buffett said.

Losses totaled $1.07 billion from the Japan earthquake and $412 million from the New Zealand earthquake. Buffett said Berkshire would in 2011 likely post its first full-year loss in insurance underwriting in nine years.

The company relies on insurance businesses as a low-cost funding source for investments because it receives premiums well before it pays out money to cover insurance losses. Such losses can effectively raise funding costs.

Buffett rejected calls by some investors for Berkshire to pay a dividend, saying it was better to invest Berkshire’s cash hoard, which totaled $38.23 billion at year end.

“I predict the day that Berkshire declares a dividend, the stock will go down and it should go down,” Buffett said.

Jeff Matthews, investment manager and author of “Pilgrimage to Warren Buffett’s Omaha,” called the comments surprising for their candor. “I don’t think he ever said it quite that plainly before.”

Buffett also fielded questions about the economy. While remaining upbeat about U.S. prospects, he warned Congress that it would be that body’s “most asinine act” not to raise the $14.3 trillion U.S. debt limit before it expires in mid-May.