Here’s a chronology derived from the Berkshire Hathaway news release :
1. December 14: Sokol purchased 2,300 shares of Lubrizol.
2. December 21: Sokol sold those 2,300 shares.
3. January 5, 6, and 7: Sokol purchased 96,060 shares of Lubrizol, pursuant to a 100,000-share limit order he had placed.
4. Jan. 14 or 15: Sokol for the first time discussed with Warren Buffett the idea of purchasing Lubrizol. Buffett was skeptical.
5. Jan. 24: Buffett sent Sokol a short note indicating his skepticism about acquiring Lubrizol.
6. Jan. 25: Sokol discussed a possible purchase with James Hambrick, the CEO of Lubrizol.
7. Subsequent to Jan. 25, Sokol reported his discussion with Hambrick to Buffett and the Berkshire Hathaway board approved the purchase.According to the Wall Street Journal, the profit on Sokol’s 96,060 shares would be $3 million.
... One is liable for trading on nonpublic information only if that information is material, and Sokol doesn’t appear to have had any material information when he purchased the stock—at least if we accept the Berkshire Hathaway account.
According to Berkshire Hathaway, Sokol had not suggested the Lubrizol acquisition to anyone prior to his purchases. He approached Buffett a week after his last purchase and the matter did not go to the full board until much later. Thus, the only nonpublic information Sokol could have had at the time of the trades was knowledge that he intended to suggest the Lubrizol acquisition to Buffett.
Was that material? Fortunately, Basic v. Levinson, decided by the United States Supreme Court in 1988, addresses this very question: whether information about a possible acquisition is material. Basic says that one must consider both the probability that the acquisition will occur and the magnitude of the transaction if it does occur.
It’s pretty clear that the magnitude of the Lubrizol transaction, if it did occur, was fairly high: it was a $9 billion deal offering a substantial premium above the pre-deal price of the Lubricol stock.
But the probability at the time Sokol purchased was extraordinarily low. Basic says to consider “indicia of interest in the transaction at the highest corporate levels.” Some of the indicia Basic points to are “board resolutions, instructions to investment bankers, and actual negotiations between the principals or their intermediaries.”
If one accepts the Berkshire Hathaway account, nothing even close to that had happened when Sokol bought his stock. The Berkshire Hathaway board had not even discussed the Lubrizol deal, much less approved a resolution to negotiate with Lubricol. Sokol himself was not even a director of Berkshire Hathaway. As far as is known, no one had contacted an investment banker. And, at the time of the trades, there had been no negotiations. Sokol himself didn't talk to Lubrizol until after the stock purchases. Under Basic standards, the probability was virtually nil.
Basic says to weigh the probability and magnitude together to determine materiality, and the magnitude is high, but magnitude alone certainly can’t be enough if there is absolutely nothing to establish probable corporate interest in the deal. A thought in one employee’s head (unless, perhaps, that employee were Warren Buffett himself) does not make a possible acquisition material.
Good analysis.
