April 1, 2011
More on David Sokol and Insider Trading: Now a Harder Case
Yesterday, I indicated that, based solely on the facts in the Berkshire Hathaway press release, it was unlikely that David Sokol violated Rule 10b-5. (See that post for the full chronology.) My argument was that, based solely on those facts, Sokol did not have any material nonpublic information at the time of the trade.
The Wall Street Journal today reported additional facts that make that conclusion a little more uncertain. As I reported yesterday, most of Sokol’s trading occurred on January 5-7, before he discussed a possible deal with the Lubrizol CEO and before he even broached the possibility of an acquisition of Lubrizol with Warren Buffett. But, according to the Journal, on December 13, before Sokol bought any Lubrizol stock, he met with investment bankers from Citigroup and asked them to set up a meeting with Lubrizol’s CEO. The investment bankers contacted Lubrizol on December 17 and told Lubrizol that Berkshire Hathaway was interested in Lubrizol.
Those additional facts, which were not disclosed in the Berkshire Hathaway release, make the question of materiality a little murkier.
As I indicated yesterday, the Supreme Court's opinion in Basic says that materiality depends on a balance of the probability that an acquisition will occur and the magnitude of the transaction if it does occur. These additional facts affect the probability portion of the analysis. When Sokol purchased on Jan. 5-7, the possibility of the Lubrizol deal was more than just an unexpressed idea in his head that Berkshire should acquire Lubrizol. Investment bankers were involved and Lubrizol had already been approached. The involvement of investment bankers is one of the facts specifically flagged by Basic as relevant in determining whether a possible acquisition is material. The information Sokol had when he traded still might not be material, but these additional facts make his argument on that issue more difficult.
It’s also interesting that the Berkshire Hathaway press release didn’t include the additional details reported by the Journal.
April 1, 2011 | Permalink
What if an additional fact was that 90% of the time that Sokol mentioned a company to Buffet Berkshire purchased it? What if the percentage was 50%? What if the percentage was 10%? I would argue that the first two make it material but the third does not.
Posted by: Tom LoSavio | Apr 1, 2011 8:37:54 PM
That could be relevant to the materiality determination. But I'm not sure you should so easily discount the 10%. Given the magnitude of the transaction to Lubrizol and the other facts we know that affect probability (investment banker involvement; a meeting set up with Lubrizol), even 10% could add to a determination of materiality.
Posted by: Steve Bradford | Apr 2, 2011 6:01:57 AM
The full chain of events is that the Citi investment bankers sent Buffett a packet of public information on specialty chemical companies and perhaps other stocks. It is very likely that Citi bankers were doing this on Spec ... since Buffett doesn't pay investment bankers to scout deals.
Sokol then met with Citi and expressed interest in LZ. However, it appears to me that at that time, the investment bankers were simply working on their own and weren't being paid by Berkshire nor did they working for LZ to market the company.
As far as materiality, $3 million x 1% = $30,000.
It seems like materiality should be, perhaps 10% of something, but should that something be Sokol's net worth or Sokol's salary or what?
To normal people $30k is a lot, but for Sokol it is a weeks pay.
The probability of the deal occurring is directly related to the quality of the deal. Therefore, if Sokol thought it was really a great deal, then why would he care if Berkshire bought it or not. Fundamental investors believe that price eventually converges to value and Buffett wouldn't over pay for the business and that the stock would then reach the same level regardless of a merger.
In which case, the potential gain from an acquisition would only be the time value of the profits -- which might occur 6 months or a year earlier. Or, so 20% x 5% x $3 million or back to $30,000.
Posted by: Nick Carroway | Apr 2, 2011 11:34:20 PM
As far as why the Berkshire press release didn't cover the December meetings in detail -- this was primarily Buffett's document providing information involving Berkshire. It is understandable that Berkshire wanted to limit the disclosure to verifiable information that didn't have to be qualified by, "according to David".
The press release already included one of those quotes, referring to David stating that his resignation had nothing to do with LZ.
Posted by: Nick Carroway | Apr 2, 2011 11:45:28 PM
Nick, just one comment on your first post. The probability/magnitude materiality determination doesn't relate to the amount of Sokol's profits (1% x $3 million), but to the magnitude and probability of the possible Berkshire/Sokol deal to Lubrizol, the company whose stock he bought. If your 1% figure is correct, then we're talking 1% of $9 billion. For a lot of reasons, including those in my posts and the other things you mention, it might not be material, but the calculation in your first post has nothing to do with the issue.
Posted by: Steve Bradford | Apr 3, 2011 5:31:38 AM