By now, everyone and his brother has had an opinion on
the l'affaire Sokol. I've poked around a little and given it some
thought. I think there are two issues. First is the corporate
opportunity issue. I think that's pretty clear. The second, and
more ambiguous issue, is the potential insider trading liability. I have
thoughts on that one, but I'm clearly still in the elevator stage of my
I found it amusing that in his CNBC "defense"
of his trading, Sokol took away from his experience the conclusion that in the
future it would be better for managers not to share opportunities with their
employers. Uh... no. That's not the right answer. The
Lubrizol deal presents a pretty straightforward example of a corporate opportunity.
Here's the clearest statement of the doctrine from Broz v Cellular Info. Systems:
The corporate opportunity doctrine, as
delineated by [Guth v Loft] and its progeny, holds that
a corporate officer or director may not take a
business opportunity for his own if: (1) the corporation is
financially able to exploit the opportunity; (2) the opportunity is
within the corporation's line of business; (3) the corporation has an interest
or expectancy in the opportunity; and (4) by taking
the opportunity for his own, the corporate fiduciary will
thereby be placed in a position inimicable to his duties to the corporation.
The Court in Guth also derived a corollary which states that a
director or officer may take
a corporate opportunity if: (1) the opportunity is
presented to the director or officer in his individual and not
his corporate capacity; (2) the opportunity is not
essential to the corporation; (3) the corporation holds no interest or
expectancy in the opportunity; and (4) the director or officer has not
wrongfully employed the resources of the corporation in pursuing or exploiting
Now, this doctrine is not a 'check-the-box' approach to
corporate opportunities. Rather, directors must consider all of elements
as a whole. In any event, Sokol apparently first learns about the
Lubrizol in his corporate capacity at a meeting with Citigroup bankers
who are pitching potential acquisition targets for Berkshire Hathaway.
The bankers say they are "shocked" that Sokol bought
shares after their meeting with them. It's hard to imagine too many
things that will shock a group of bankers pitching deals, but there you have
it. In any event, Berkshire Hathaway is clearly in a financial position to
exploit the opportunity to acquire Lubrizol. Berkshire Hathaway is in
the business of making acquisitions of promising targets and has an
expectation that when such opportunities are presented to its agents that
it [Berkshire Hathaway] will have first crack at them. Finally, when Sokol acquired $10 million worth of Lubrizol stock a
week before presenting the deal to Buffet, he clearly put his thumb on the
scale and put himself in conflict with Berkshire with respect to doing the
deal. At the very least, he should have recused himself and not taken the lead with respect to the deal.
I think the case that Sokol, by buying ahead of Berkshire
and then pushing the deal on his employer violated his duty of loyalty to the
corporate by usurping a corporate opportunity. So what measure of damages
is appropriate? Disgorgement of the approximately $3 million of profits
he made on his $10 million investment would seem right. He should turn
that over to Berkshire on his way out the door.
Now ... on the question of whether Sokol's trading constitutes
insider trading, I haven't convinced myself to pull the trigger on that yet.
But ... I don't think there is any question that when Citigroup presented
a list to Sokol of potential targets for Berkshire that the content of this
list was material information. I mean ... would a reasonable investor
find it useful to know that of the thousands of companies out there, that
Citigroup was pitching twenty or so to Warren Buffet's guys and that a deal
might be in the offing? Let me venture a guess that if Rajaratnam knew
what Sokol knew, he'd be trading on it and that can't be good for Sokol.
The Deal Professor has some very relevant thoughts on the question of materiality. They're right
on point and worth reading.
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