Berkshire Hathaway Chairman Warren Buffett was not
exaggerating when he stated at the opening of the company's March 30, 2011 press
that the release "will be unusual." Not only did Buffett disclose the
resignation of David Sokol
as Chairman and CEO of several subsidiaries, but the release also revealed that
Sokol had acquired shares of Lubrizol before bringing the idea to Buffett that
Berkshire should acquire Lubrizol. (Berkshire had announced its
intention to acquire Lubrizol just days earlier.)
As odd and inexplicable as were the events described in
the March 30 Berkshire press release, the story became even odder and more
inexplicable as information
came out that Sokol acquired Lubrizol shares after specifically discussing
-- apparently as a representative for Berkshire -- with investment bankers
that possibility that Lubrizol might be an appropriate acquisition target for
Berkshire. Sokol also apparently acted as a representative for Berkshire in
connection with negotiations with Lubrizol about a possible Berkshire
Given the high-profile and sensational nature of these
allegations, it was perhaps inevitable that litigation would follow. Indeed, a
lawsuit was duly filed in Delaware Chancery Court on April 18, 2011. The
complaint, which can be found here,
presents a shareholders' derivative claim against Berkshire, as nominal
defendant, as well as against Sokol and against the twelve individual members
of Berkshire's board - including not only Buffett, but his chum Charlie Munger and his
fellow billionaire Bill Gates.
The complaint asserts two substantive claims, one against all of the individual
defendants for breach of fiduciary duty and one against Sokol for disgorgement.
As a Berkshire shareholder myself as well as a long
time Buffett devotee, I have to admit I winced - hard-when reading
the March 30 press release. Just the same, the lawsuit makes me uneasy too.
Perhaps my long devotion to Buffett biases my view. I confess that I have been
unable to bring myself to write about the lawsuit until now because of my
conflicted feelings. I do have to admit that the complaint does make for some
interesting reading. The time line of events portrayed in the complaint does
not reflect well on Sokol, to say the least.
The Complaint is less compelling when it tries to detail
the specific harms these events have caused the Company. Among other things,
the Complaint cites credit analysts to the effect that these events "could
result in a negative credit rating for Berkshire" and that have "flagged
concerns over the Company's lack of traditional corporate
infrastructure." The Complaint also cites the decline in Berkshire's share
price that following the March 30 disclosure.
One threshold problem the claimant will face is showing
that the requisite demand on Berkshire's board would have been futile. In order
to try to establish demand futility, the complaint alleges that the board could
not be relied upon to "take proper action on behalf of the Company" due to
their "inter-related business, professional and personal relationships" as well
as "debilitating conflicts of interest" arising from "prejudicial entanglements
and transactions which compromise their independence." (Francine McKenna's blog
post about the demand futility issue on her Accounting Watchdog blog at
Forbes.com can be found here.
But assuming for the sake of argument that the plaintiff
can overcome the demand futility hurdles there is the question of whether or
not the plaintiff can hope to prevail on the merits.
Over at the Delaware Corporate and Commercial
Litigation Blog (here),
esteemed fellow blogger Francis Pileggi has assembled a host of helpful links
and commentaries about the lawsuit. (I would be remiss if I did not also
mention here my thanks to Francis for his blog's provision of a link to the
Complaint, as well.) Among the more interesting sources he cites is UCLA
Law Professor Stephen
Bainbridge's thorough analysis of the possible merits of the claim, which
can be found here
Among other things, in the second of his two posts,
Professor Bainbridge expressly raises the problems that the plaintiff will have
meeting the demand futility test. More interestingly, in both posts, Bainbridge
elaborates on the view that the disgorgement claim against Sokol seems to be
supported under existing Delaware case law.
Professor Bainbridge's analysis is interesting and
persuasive. But it doesn't answer what is for me the even more interesting
question this lawsuit presents, which relates to the breach of fiduciary duty
claim alleged against the Berkshire directors. Can the directors - or any one
of them (say, for example, Buffett) possibly be held liable for failing to take
actions that allegedly could have prevented supposed harm to the company?
I guess I have too much of a practical habit of mind. Or
perhaps it is just because I am a Berkshire shareholder. But I do have to
wonder what this lawsuit ultimately is going to produce, other than the
generation of massive amounts of legal fees (as if that were something that
would be in any company's interest). Sure, sure, if Professor Bainbridge is
right, the disgorgement claim against Sokol might be meritorious, in which case
Sokol would have to disgorge h is trading profits to Berkshire. Even so, the
most that would garner for the company is about $3 million or so, as I
understand it, at the cost of God know how much in legal fees (plus of course
the payment of plaintiff's attorneys fees -- or at least so
the plaintiff's attorneys' hope).
If all this case is about is the disgorgement claim, this
sure seems like an enormous waste of everybody's time. (Indeed, Sokol could
save himself and everyone else a whole lot of aggravation if her were to just
take out his checkbook and write Berkshire a check for his trading profits.)
Of course, there is always at least the theoretical
possibility of damages for the breach of fiduciary duty claim against the other
directors. It is only really conceivable to even think about this possibility
by overlooking the highly speculative nature of the alleged harms the company
sustained and the evanescence of the share price decline. And even then
-- perhaps others can form a picture of say, Buffett, paying money to
Berkshire, but it would take a lot more to persuade me that that could happen
here and if it could that it would remotely make sense.
One other possibility that does come to mind is that, if
the case gets that far, perhaps the resolution of this case, like the
resolution of many shareholder derivative lawsuits, will include the company's
agreement to adopt certain corporate governance reforms. There would be
something highly ironic about Berkshire, of all companies, taking on, say,
board oversight obligations. However, the original source of the irony is in
the events that led to all of this, which is that, at least as the plaintiff
would have you believe, Buffett failed to follow the company's own existing
internal guidelines on these types of matters.
There would be something ironic indeed if Berkshire were
to have to implement more "traditional governance infrastructure." I appreciate
irony as much as anybody. But as a shareholder I do wonder whether that would
actually be good for the company.
One final thought. To paraphrase a recent post on the Deal
Journal blog (here)
-- You don't suppose there might be a question or two about all of this at next
week's meeting of Berkshire's shareholder, do you?
Where are Today's Tsunami Stones?: The
April 21, 2011 New York Times has a fascinating article entitled
"Tsunami Warning for the Ages, Carved in Stone" (here).
The article is about the small village of Aneyoshi, Japan, where an aging stone
marker set into the hills warns "Do not build your homes below this point!"
Village residents say this warning kept their homes safely out of reach
of the deadly tsunami last month.
There apparently are hundreds of these stones scattered
throughout Japan. Sadly, in modern times, residents came to put more faith in
advanced technology and higher sea walls, and many of the warning were ignored.
The stones were meant to communicate a critically
important message. But their very existence suggests something deeper. The
people who put those stones up were capable of thinking very concretely about
future generations. They were able to envision the people 80 or 100 years in
the future who might need to know what they knew. The erection of the tsunami stones
was an act of incredible foresight and incredible generosity.
Toward its end the article quotes a Japanese scientist as
saying "We need a modern version of the tsunami stones." The scientist was
thinking specifically about potential harm from future tsunamis. But I think
the need for warnings to future generations is not limited just to Japan and
not just to tsunamis. There are so many things that future generations will
need to know. I wonder whether we are able to look forward as those who built
the original tsunami stones did. What are we willing to do to protect those
unborn people who need to know what we have seen? I sometimes worry that we are
incapable of thinking about the needs of those who will be living their lives
80 or 100 years from now.
And then finally, there is the lesson of the tsunami
stones that were disregarded. As long as people insist on building in flood
planes, for example, there will be people who suffer because they choose to
disregard the evidence. And as someone who works in the insurance industry, I
know all too well how significant economic activity can be carried out in
complete obliviousness to the stark warnings of the past. . The landscape of
the insurance industry is littered with its own version of tsunami stones yet
the warnings of the past are so often disregarded.
other items of interest from the world of directors & officers liability,
with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.
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