CASE STUDY: BERKSHIRE HATHAWAY – THE
FALL OF DAVID SOKOL
HUMAN RESOURCE MANAGEMENT
Presented To:
Prof. Meryl James
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Presented By:
Sai Vilas Deshmukh
19030241065
Sucharitha Ellendula
19030241066
Garima Saini
19030241067
Geetanjali Sharma
19030241068
Himani Maurya
19030241069
Jaya Chaudhary
19030241070
CASE SUMMARY
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Berkshire Hathaway - formed in 1952 by the merger of
Berkshire Fine Spinning Associates and Hathaway
Manufacturing Company.
The company began to increase in size, despite of its
simple governance structure and its chief principle –
“trust” under the leadership of Warrant Buffet as the
CEO. They believed that it is an organization running
on partnership among various firms based on trust.
•
In 2010, Sokol was entrusted to shortlist companies
for acquisition.
•
Sokol proposed Lubrizol among the list of chemical
companies provided by Citigroup. Warren on his
advice, purchased it for $9 billion in cash.
•
He had purchased shares of Lubrizol days before the
acquisition proposal, there by making a personal
profit of $3 million in the deal.
The breach of Code of Conduct on various fronts had
resulted in huge criticism and questions on the
corporate governance of the company.
•
•
•
Berkshire Hathaway used to invest in companies
which seemed to be profitable, but there was no
formal investment committee to perform due
diligence on finance based decisions and had
negligible controls on transactions.
In 2011, the sudden resignation of David Sokol, the
star performer of the company raised a controversy.
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•
Firm’s succession plan was also one of the issues
raised after this incident as Sokol was a front-runner
in line of the potential successors after Buffett.
•
This resulted in suspicion raised over the policies and
procedures of Berkshire Hathaway and the corporate
governance based on the value of trust was
1)Should more internal controls be introduced within the
company?
◼ Internal controls are the mechanisms, rules, and procedures implemented by a company
to ensure the integrity of financial and accounting information, promote accountability
and prevent fraud.
◼ Berkshire Hathaway is a multinational conglomerate. Given the size of the organization, a
very simple governance structure is followed by the organization. This governance is
simply based on trust.
◼ In this case study, David Sokol was able to pull out such huge scandal so easily was due
to incorrect and simple governance based on trust in the organization. There were not
enough internal controls in the organization which could have detected such scandals in
the organization at first place.
◼ In 2011, the scandal came to light and the report related to this scandal was published on
in end of April 2014. This report criticizes the purchase of shares by Sokol. It also explains
how this purchase as was a breach and against the policies and state laws.
◼ If there were correct controls in place in the organization, this scandal could have been
avoided and the loses to the organization could have also been avoided.
◼ Hence, it is necessary to have more internal controls within the company.
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2) Has Sokol or other executives engaged in similar trading
previously, but these were simply undetected due to
Berkshire’s lack of internal controls?
◼ It is evident from the case study that Warren Buffett got the information about the role of
Citigroup in the merger of Berkshire and Lubrizol only after the merger and through a
representative of the Citigroup who came to congratulate Buffett.
◼ It is a high possibility that such cases and instances of insider trading might go
undetected.
◼ Also there is no formal investment committee to perform due diligence on capital
allocation decisions, insider trading and fraud can easily happen.
◼ Simple structure does encourages people to do work more enthusiastically but at the
same time there should be strong internal controls that discourage executives to commit
fraud.
◼ There are many factors along with the simple governance like the idea of operating
through trust and lack of internal controls(approving payments, audit, proper authority)
that led to the merger of the Berkshire and Lubrizol and ultimately to the Fall of David
Sokol.
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3)Does Berkshire need to reform the board and confer real
power upon it to monitor CEO and his decisions?
Situation◼ Warren Buffett is the
current CEO
◼ The decision for
acquisition of Lubrizol
was technically mostly
between Warren Buffett
and David Sokol.
◼ David claims that his
Lubrizol purchases were
not unlawful in any way.
◼ This scandal highlighted
several questions for
the governance system.
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Solution◼ A board of directors is a team of people
elected by a corporation's shareholders
to represent the shareholders' interests
and ensure that the company's
management acts on their behalf.
◼ It can monitor and suggest the CEO, in
making the decisions affecting to the
organization and help in uplifting the
reputation of the organization.
◼ This would lead to a speculated and
collective decision based on an
intellectual discussion comprising of
various perspectives and knowledge of
consequences also predicting the future
market situations.
Has David sokol committed an unethical act? In light of the
SEC’s dropping its probe,was Sokol unfairly treated by
Berkshire Hathaway and commentators?
Yes david sokol has definitely committed an unethical act and this can be proved by following
points:
◼ Berkshire's Insider Trading Policies and Procedures were violated by sokol as he was
having the material information about the company and even than traded with public
companies which is forbidden.
◼ Berkshire's code of conduct was violated as sokol bought the lubrizol's share knowing
that the Lubrizol's board would consider Berkshire's interest and there is high possibilty of
merger between these two companies. He should have stopped trading as the code
prohibited him from trading.
◼ The code was also violated as sokol took the opportunity to personally benefit himself
from Berkshire's acquisition.
◼ Sokol should have disclosed about his trading to warren buffett with timings and amount
but he didn't disclosed everything , this is how he failed to fulfill his duty of full disclosure
under the law of Delaware.
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Did the current corporate governance practices in Berkshire
Hathaway play a part in the events leading to the incident?
How can these practices be improved to prevent such
situation from recurring?
The simple governance structure of Berkshire which was based in trust played a major part
for this incidence to take place and decisions on how to reinvest free cash flows generated by
business units are made entirely by buffett rather than the involvement of BOD aswell.
◼ There should have been formal investment committee to perform due diligence on capital
allocation decisions.
◼ consultation regarding operating decisions should be taken with the headquaters and
budgets and long term review for the plan should be made
◼ Due diligence should be conducted before any acqusition and Board of Directors should
be involed in taking decisions and not solely a single person.
◼ Proper internal controls must be implemented to check the violation of any code of
business conduct and held person accountable for any mis conduct.
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4)c.How can firms strike an appropriate balance between the amount
of freedom allotted to and the extent of monitoring over star
executives like David Sakol?
● The freedom allocated to the star performers must be coupled with the set of
policies,procedures in place to prevent incidents like this.
● Also, practices like Segregation of duties and Job rotation should be performed to
prevent the critical decisions being in the control of single entity.
● Also, since companies investing activities,mergers and acquisitions not only play a major
role in company’s reputation and financial strength , a separate team who are highly
skilled in those areas must be employed and proper research must be done before taking
such vital decisions.
● Periodic Audits must takes place to ensure that the company's activities are compliant to
company’s norms and legal regulations.
● Multi layered sanctioning will help companies to preserve integrity of data of managerial
decisions. If critical decisions are managed by multiple authorities,then the chances of
occurrences of that these kind of illicit acts will be low.
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4)d)Why do investors worry about Berkshire’s succession planning? How can the board of
directors address such issues?
● Sokol had been widely viewed as a front-runner in the line of potential successors and
after this incident,even though Buffet has reassured the public that Berkshire has
identified an internal candidate, the issue is still a cause of anxiety because Buffett had
been diagnosed with Prostate Cancer.
● Doubts regarding the effectiveness of selection process after sudden resignation of Sokol.
● Lack of competent and capable candidates for backup.
● A clear succession plan must be formulated which is highly essential for good governance
which would help the company to execute a seamless transition of power to a competent
and viable candidate .
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