Warren Buffett protegé hit by allegations of illegal stock trading

Questions about whether a senior executive in Warrent Buffett's company acted unethically or even unlawfully is causing some commentators to wonder if the image of the world-famous investor, called the "sage of Omaha," has been tainted.

On March 14, Mr. Buffett’s company, Berkshire Hathaway Co., announced it was buying the chemical company Lubrizol for $9 billion. Unbeknownst to investors, Buffett got the idea to buy Lubrizol from one of his executives, David Sokol, who had already personally purchased shares in Lubrizol.

Once Berkshire Hathaway bought the company, the stock price soared, and Mr. Sokol pocketed an extra $2.98 million in profit.

Did Sokol engage in insider trading? Or perhaps some form of front-running, investing in a stock before the clients buy it? Was it perhaps just a breach of corporate ethics? Or was there is nothing wrong with the transaction at all?

Sokol, once considered an heir apparent to Buffett, resigned from Berkshire on Wednesday. But hardly anyone involved in the securities business thinks that will be the end of the affair.

“The Securities and Exchange Commission [SEC] has a duty to look into it and hopefully determine if it was appropriate,” says Alan Kaufman, a partner at Kelley Drye & Warren, a law firm in New York that specializes in white-collar cases.

Questions about equity markets

The Sokol issue comes at a time when investors are wondering about the fairness of the equity markets.

In New York, a billionaire hedge-fund manager, Raj Rajaratnam is alleged to have made millions of dollars by trading stocks on non-public information. As part of his ongoing trial, a member of the Goldman Sachs board of directors testified he called Mr. Rajaratnam, who ran the Galleon Group, immediately after board decisions with inside information.

In Dallas, the SEC has brought a lawsuit that is still pending against Mark Cuban, the controversial owner of the National Basketball Association's Dallas Mavericks, for alleged insider trading.

“Yes, investors are asking about the fairness of the equity markets, but they should not be overly concerned,” says Anthony Michael Sabino, a professor of business at St. John’s University in New York. “The government is out there with a broom if not a baseball bat – especially the SEC, which is trying to save face after missing the Madoff scandal.”

Was he guilty of anything?

Both Messrs Kaufman and Sabino say it’s too soon to make any judgments on the Sokol situation. “He’s innocent until proven guilty,” says Sabino.

If Sokol worked for a stock broker he would have been charged with “front running,” which is buying shares of a stock before recommending the clients purchase them. However, Kaufman says there is no SEC rule or regulation that applies to private individuals such as Sokol.

It is likely that Berkshire Hathaway, which frequently purchases companies, had its own rules and regulations regarding the trading of stocks.

Sabino says it’s too early to know if Sokol “misappropriated” information from Berkshire Hathaway. The US Supreme Court has ruled misappropriating corporate information is illegal.

Buffett, in a statement, said he did not consider Sokol’s stock purchase “unlawful.”

Impact on Buffett

According to Buffett, Sokol had tried to resign at other times, and he had talked Sokol out of it. He said he had talked to Sokol on Tuesday and received no hint of his intention to resign. “This time, however, I did not attempt to talk him out of his decision and accepted his resignation,” said Buffett in his statement.

However, after the resignation, some talk-show hosts wondered if the affair had tarnished Buffett’s reputation. He is known as one of the most astute investors in the world.

“Warren Buffett is a man very concerned with his legacy,” says Sabino. “He needs to walk the walk as well as talk the talk.”

Sokol immediately went on the offensive after his resignation. On Thursday, he appeared on CNBC to say he had done nothing wrong because he did not have the authority to buy the shares for Berkshire directly and because he did not know if Buffett would agree to buy the company.

Sokol said his resignation was not related to the trades but so he could spend more time with his family.