Ethical Issues at Berkshire Hathaway: Controversy Following the Lubrizol Acquisition Deal

Abstract:

This case is about the controversy that engulfed Berkshire Hathaway in 2011 when one of its key executives resigned under the shadow of allegations that he had engaged in insider trading. Berkshire, headed by the legendary Warren Buffett (Buffett), was reputed for both the exemplary returns generated by it and for the ethical principles of operating businesses as espoused by Buffett. Shortly after the acquisition of The Lubrizol Corporation (Lubrizol) by Berkshire spearheaded by David Sokol (Sokol), Sokol resigned from his job. Sokol, in the course of negotiations with Lubrizol, had bought the latter’s shares amounting to US$10 million.

Following the acquisition, the value of Sokol's Lubrizol shares rose by US$3 million. Buffett, in announcing Sokol's resignation, claimed that the latter’s share purchases were not illegal. He came under fire as much for defending Sokol’s dealings as for his initial oversight after first coming to know from Sokol himself about the latter’s purchase of Lubrizol shares. According to critics, Buffett erred in not referring Sokol to Berkshire’s compliance department. This, they attributed, to Buffett's trust based management style and the lack of stringent internal controls at Berkshire. Roughly a month after the announcement of Sokol’s resignation, Berkshire’s Audit Committee blamed Sokol for violating the company’s insider-trading policies. The case raises the question of whether Buffett walked the talk when he defended Sokol’s dealings. The case also raises the question of whether a trust based management style can compensate for lack of stringent internal controls.

Issues:

» Understand various issues and challenges in individual and business ethics.
» Understand the circumstances under which purchase of shares based on confidential information could be categorized as insider trading.
» Appreciate the requirement for strict internal control and compliance mechanisms in any organization.
» Discuss and debate whether Sokol had engaged in insider trading when he bought Lubrizol shares.
» Discuss and debate whether Buffett actually committed a mistake when he did not initially query Sokol about his Lubrizol share purchases or whether he acted ethically by retaining faith in Sokol given the latter's contributions to Berkshire.
» Explore the internal controls and compliances that Berkshire could further put in place to prevent issues such as Sokol’s from cropping up in future.

Contents:

Keywords:

Ethics; Business Ethics; Corporate Governance; Compliance; Management Control Systems; Corporate opportunities; Insider trading; Conflict of interest; Materiality; Berkshire Hathaway; Warren Buffett; Lubrizol

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