Friday, May 06, 2011

Buffett Flunks Crisis Management 101

Candor is one thing, but appearing out of touch with the fact set is another.

How else to explain the reputational hit that Warren E. Buffett’s Berkshire Hathaway company has suffered in recent weeks?

Buffett, known as the “Oracle of Omaha” and one of the richest men on the planet, may be a brilliant investor, but when it comes to crisis management skills, he probably needs a serious refresher course.

By now, the story is well-documented. On March 30, David L. Sokol, 54, long considered a leading candidate to succeed Mr. Buffett, suddenly resigned from Berkshire Hathaway.

It seems that Mr. Sokol purchased thousands of shares in Lubrizol, a lubricant company, two months before Berkshire announced a $9 billion deal to acquire the outfit. As one might expect, when the Berkshire deal was announced, the shares shot up 27 percent over a two-week period. Mr. Sokol made a cool $3 million on paper.

Like most alleged insider cases, the circumstances of the stock purchases remain murky. If we’ve learned one thing from all the Wall Street shenanigans, it’s that it takes time and research to unravel the timeline and understand what really happened.

This emerging crisis should have immediately set off an alarm for Mr. Buffett to “hold his fire” when the news stories about the resignation began to break. In my view, that is crisis management 101.

Instead, what happened? In a statement the same day, Mr. Buffett said, “Neither Dave nor I feel his Lubrizol purchases were in any way unlawful. He has told me that they were not a factor in his decision to resign.” Mr. Buffett went on to say that Mr. Sokol’s “contributions have been extraordinary.”

For a man with such acclaimed business acumen and successful track record of strategic investment decisions, this unfortunate episode was an unfathomable rookie mistake for Mr. Buffett. How could someone with his stature simply accept Mr. Sokol’s word that there was no self-dealing involved? Did Mr. Buffett really think that Mr. Sokol would say he was guilty of insider trading?

If he was practicing disciplined crisis management, what Mr. Buffett should have said was: “Mr. Sokol has resigned from Berkshire Hathaway. We will immediately begin a comprehensive review of the circumstances surrounding his resignation, including recent stock trades, and report our findings to the public and authorities as soon as possible. We will also cooperate with any regulatory investigation that might ensue.”

Mr. Buffett has since explained himself, but I’m not buying it. In a business column on May 3 in The New York Times, Mr. Buffett was quoted as saying, “I felt that if I’m laying out a whole bunch of facts that are going to create lots of problems for him for years to come, that I also list his side of the equation in terms of what he’d done for Berkshire.”

The Times column also quoted Mario Gabelli, a nationally-acclaimed investor and major shareholder in Berkshire, as saying the Sokol episode was “irrelevant” and derided it as “a good story for the media.” Mr. Gabelli also said he, like Mr. Buffett, simply cares about the company’s cold, hard numbers.

While I agree that financials are always paramount, I disagree that this episode means nothing to the reputation of Mr. Buffett and his company. What Mr. Sokol did may not ultimately be proven to be “technically” wrong, but anyone with a sense of fair play realizes that it does not pass the smell test.

New Legs to the Story
Unfortunately for Berkshire, the Sokol mess erupted just a month before the annual meeting, a time when senior executives at any company are most exposed. Instead of quieting down, negative media coverage ticked up several notches, with both sides contradicting each other.

On April 27, a report issued by the audit committee of the Berkshire Board accused Mr. Sokol of misleading the company about his personal stake in Lubrizol. “His misleading incomplete disclosures to Berkshire Hathaway senior management violated the duty of candor he owed the company…Mr. Sokol may have failed his fiduciary duty under the law of Delaware.”

What a stark turnaround from Mr. Buffett’s initial comments.

Things got even uglier when Mr. Sokol’s lawyer, Barry W. Levine, got involved and disputed many major assertions in the audit report. “…Mr. Sokol had told Mr. Buffett ‘twice, not once’ about his ownership of Lubrizol shares before Mr. Buffett began discussions with the company.”

A more stunning revelation was the audit report stating that, “Mr. Buffett and the company did not have the full story in March.” This begs the question: Why would Mr. Buffett make the statements he made without knowing all the facts?

I believe Mr. Buffett’s apparent knee-jerk reaction to this issue and the subsequent fallout has tarnished his pristine reputation.

I continue to be shocked at the apparent lack of crisis management planning in some of the world’s largest companies. It wasn’t that long ago that Tony Hayward, the disgraced BP chief, said publicly, “The company’s contingency plans were inadequate and we were making it up day-to-day.”

Berkshire Hathaway, a company that generated nearly $18 billion in cash from operations last year and currently has more than $38 billion to spend on future acquisitions, erred badly in communicating its reaction to what has become a major scandal.

What happens next isn’t clear, but according to published reports, the Securities and Exchange Commission is already investigating Mr. Sokol’s trading. In fact, we now know that Mr. Buffett called the SEC himself and laid out the pattern of trading.

Berkshire Hathaway may face lawsuits from shareholders who want Mr. Sokol to forfeit his trading profits because of the negative publicity and damage to the company’s reputation. And the audit report said the company is considering whether to pursue “possible legal action against Mr. Sokol to recover any damage the company has sustained, or his trading profits.”

In the final analysis, the lack of a coherent and well-planned crisis communications strategy is what’s most surprising.

Mr. Buffett is fond of saying: “Lose money for my firm, and I will be understanding. Lose a shred of reputation for the firm, and I will be ruthless.”

Still, even in his latest interview with the Times, Mr. Buffett has not publicly taken Mr. Sokol to the woodshed. It may be the only way to truly end this chapter and move on.

Betrayal cannot go unanswered.

Joe M. Grillo, partner at Nicolazzo & Associates, contributed to this blog.

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