Image Credit: Christophe Vorlet
By Jason Zweig | April 2, 2011 12:01 a.m. ET
Say it ain’t so, Warren.
Investors were shocked to learn this week that David Sokol, a trusted lieutenant to Berkshire Hathaway Chairman Warren Buffett, had bought nearly $10 million worth of stock in Lubrizol just over a week before he suggested to Mr. Buffett that Berkshire should acquire the company.
Leave aside the obvious point that Mr. Sokol might not have lived up to Berkshire’s high ethical standards. Focus instead on this: If even Mr. Buffett can fail to appreciate a potential conflict of interest under his very nose, then ordinary investors need to realize just how pervasive and insidious conflicts are throughout the financial world.
In the past few weeks alone, a chemist at the Food and Drug Administration was charged with trading on confidential information about drug approvals; a former Goldman Sachs Group director has been accused of leaking secrets to hedge-fund manager Raj Rajaratnam; and Mr. Rajaratnam has gone on trial for allegedly masterminding an insider-trading ring. The director and the hedge-fund manager maintain their innocence; the chemist hasn’t yet been arraigned.
But how could Mr. Buffett, universally regarded as a beacon of integrity, have let Mr. Sokol’s unusual trading occur unchecked?
Although Mr. Sokol resigned on March 28, both he and Mr. Buffett have insisted that he did nothing unlawful; Mr. Sokol has stressed that his resignation had nothing to do with his Lubrizol trades.
“Dave’s purchases were made before he had discussed Lubrizol with me and with no knowledge of how I might react to his idea,” Mr. Buffett said in a news release on Wednesday. “Furthermore, he knew he would have no voice in Berkshire’s decision once he suggested the idea.”
Mr. Buffett said in the news release: “In our first talk about Lubrizol, Dave mentioned that he owned stock in the company. It was a passing remark and I did not ask him about the date of his purchase or the extent of his holdings.”
Mr. Buffett told me on Friday that “everything in [the news release] is accurate.” All he would add is that “I don’t know of anything even remotely material that was omitted from the release.”
Mr. Sokol’s trading falls under what Stephen Bainbridge, an expert on securities at the UCLA School of Law, calls “an enormously gray area of the law.” It also is a reminder that a basic principle of securities law — disclosure cures conflicts — is nonsense.
“Even assuming that [Mr. Sokol] did nothing illegal, [his action] is typical of the kinds of conflicts of interest permitted by our financial system that undermine the integrity of markets,” says Max Bazerman, an ethicist at Harvard Business School and co-author of the new book Blind Spots.
Most people have what Mr. Bazerman calls an ethical blind spot. Faced with a potential conflict of interest, you automatically conclude that it couldn’t possibly offer any temptation to someone of superior character — like you or those closest to you.
One study among doctors, for example, found that 53% felt it was ethical to accept a high-paying consultancy from a pharmaceutical firm. Only 36% felt it might skew their judgments about which medications to prescribe. Yet 62% felt that other doctors’ decisions might be tainted by the same arrangement.
Likewise, a survey of nearly 1,000 Wall Street analysts found that two-thirds have accepted favors from the companies they follow — everything from career advice to reference letters for admissions into private clubs. Analysts who accept such favors generally deny that their integrity has been compromised — yet are twice as likely to maintain their rating after an earnings shortfall by a company that provided them with favors.
Or think of student-loan officers steering borrowers to lenders that secretly offered kickbacks or junkets; credit-rating agencies being paid by the firms they rate; financial advisers accepting trinkets like tote bags and T-shirts from fund companies; auditors examining the books of companies to whom their firms provide consulting services; mutual-fund traders who used to accept gifts from brokers like casino outings and stays at ski resorts. All have maintained that they aren’t conflicted.
In testimony to Congress in 1991, Mr. Buffett said he expected all his employees “to ask themselves whether they are willing to have any contemplated act appear the next day on the front page of their local paper, to be read by their spouses, children and friends, with the reporting done by an informed and critical reporter. If they follow this test, they need not fear my other message to them: Lose money for the firm and I will be understanding; lose a shred of reputation for the firm and I will be ruthless.”
Those are words to live by. But living by them isn’t easy for anybody.
Source: The Wall Street Journal, https://www.wsj.com/articles/SB10001424052748704530204576236922024758718
For further reading:
Books
Definitions of COMPLIANCE, MANAGEMENT, POTENTIAL CONFLICT OF INTEREST in The Devil’s Financial Dictionary
Max H. Bazerman and Ann E. Tenbrunsel, Blind Spots: Why We Fail to Do What’s Right and What to Do about It
Articles
George Loewenstein et al, “Disclosure: Psychology Changes Everything”
Dana Katz et al., “All Gifts Large and Small: Toward an Understanding of the Ethics of Pharmaceutical Industry Gift-Giving”
Zachariah Sharek et al., “Bias in the Evaluation of Conflict of Interest Policies”
Don A. Moore and George Loewenstein, “Self-Interest, Automaticity, and the Psychology of Conflict of Interest”
M.A. Morgan et al., “Interactions of Doctors with the Pharmaceutical Industry”
L. Lewis Wall and Douglas Brown, “The High Cost of Free Lunch”
Jason Dana and George Loewenstein, “A Social Science Perspective on Gifts to Physicians from Industry”
Don A. Moore et al., “Conflict of Interest and the Intrusion of Bias”
James D. Westphal and Michael B. Clement, “Sociopolitical Dynamics in Relations between Top Managers and Security Analysts”
Emily Pronin et al., “The Bias Blind Spot: Perceptions of Bias in Self versus Others”
Emily Pronin et al., “Objectivity in the Eye of the Beholder: Divergent Perceptions of Bias in Self versus Others”
FINRA Report on Conflicts of Interest