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For Berkshire, resignation raises tough questions

By Josh Funk

Associated Press

Published: Thursday, March 31 2011 4:02 p.m. MDT

OMAHA, NEB. — Warren Buffett is a called an oracle and a cult hero not just because he's made himself one of the world's richest people, but because he comes across as folksy and, above all, honest.

Now, he's found himself in the unusual position of having to explain a top Berkshire Hathaway executive's questionable behavior.

The situation: A key executive thought to be a potential successor to the 80-year-old Buffett persuaded Buffett to buy a chemicals company that the executive had personally invested in. The executive, David Sokol, saw his investment grow by $3 million, or 29 percent, after Berkshire bought the company, Lubrizol.

Berkshire announced Sokol's resignation late Wednesday.

On Thursday, the company's stock fell 2.1 percent as investors worried whether the incident would tarnish Berkshire's sterling reputation or become a distraction for the company.

Sokol's actions may not have been illegal, experts say, but are still likely to attract the attention of investigators. And for a company that has carefully cultivated a squeaky-clean reputation, it is a rare black mark.

"For a company that prides itself so much on its reputation for integrity, you can't do stuff that doesn't look right," says Meyer Shields, an analyst at Stifel Nicolaus.

Both Buffett and Sokol have said the transaction had nothing to do with Sokol's resignation. But in an unusual two-page letter announcing the resignation, Buffett laid out a timeline of events that suggests that Sokol used his influence in Berkshire to recommend a deal that would benefit him personally.

This was the third time Sokol tried to resign in recent years. The other times Buffett convinced him not to. This time, Buffett didn't even try.

Sokol's sudden resignation raised alarms for investors because Sokol was seen as one of four possible successors to Buffett. While it is unclear if Sokol was indeed a candidate given his earlier resignation attempts, the issue of succession at Berkshire has long been a nagging concern for investors.

The Securities and Exchange Commission declined to comment. Sokol said in an interview with CNBC Thursday morning that he has not been contacted by investigators and that he had done nothing wrong.

Buffett declined Wednesday to answer questions about Sokol's resignation beyond what he said in his statement. And Buffett did not respond to questions Thursday about whether Sokol's actions had hurt Berkshire's reputation.

Lubrizol officials also declined to comment on Sokol's resignation or his stock purchases beyond the information disclosed in filings with regulators. But Lubrizol CEO James Hambrick did send a brief note to employees to reassure them that Sokol's resignation won't jeopardize the deal.

Jacob Frenkel, a former SEC enforcement lawyer now at the firm Shulman Rogers in Rockville, Md., says Sokol's actions likely do not constitute insider trading. Because Berkshire hadn't made an offer to buy Lubrizol at the time Sokol bought shares, it appears Sokol wasn't using significant confidential information — the definition of illegal insider trading.

But Steve Thel, a professor of business law at Fordham Law School said the Supreme Court has found that even if the chance of success of an acquisition was small, the potential impact if it did succeed was big enough to make the information significant.

For now, at least, Frenkel said the issue is mainly a problem of appearance.

For Buffett and Berkshire, appearance means a lot.

Every two years Buffet sends a letter to his managers reminding his managers to guard the firm's reputation "zealously." In his 2010 letter he repeated a favorite saying of his: "We can afford to lose money — even a lot of money. But we can't afford to lose reputation — even a shred of reputation."

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