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Sokol, Buffett and the duty of candor

by Robert Teitelman | Published April 29, 2011 at 2:58 PM

They're gathering in Omaha. Tomorrow the multitudes will congregate about the Sage of Omaha, Warren Buffett, and his sidekick Charlie Munger, to discuss the state of Warren's world, which has been a little patchy lately. The rented journalists will field questions. And Warren and Charlie will do the two-step. Of course this year is a bit different for capitalists, and not just because there's an Ayn Rand movie playing. This year, Warren is in a little hot water over his former heir apparent, fixer-upper and acquisition scout David Sokol and whether he a) did or did not violate some legal and fraternal trust by not revealing to Warren (who did not ask, twice) that he had brought Lubrizol shares and talked to an investment banker and b) whether Warren has a succession problem, a governance problem or an age problem.
This is unprecedented, at least in Warren-land. And given that Buffett may be the greatest PR person this side of the Dalai Lama (no knock on either of them), with a deep reserve of trust and decades of superhuman share performance to feed off, seeing how he responds to the questions that every newspaper this side of the Daily Bugle is offering up to him should be a fascinating display of crisis management. (See here and here.)

I have no questions myself, or at least none that aren't obvious, unless they involve certain trade secrets about See's Candies. But what's striking is just how slick and hard PR can be in Warren's world when it's threatened. It is a small thing, but, to me, a revealing glimpse of the iron fist within the velvet glove. It was buried within the press release that announced Thursday -- fortuitous timing, of course -- the results of the Berkshire Hathaway audit committee investigation into the Sokol affair, which, no surprise to Warren watchers, was actually executed by the fine lawyers from Munger's old Los Angeles firm, Munger Tolles & Olson. The lawyers did, of course, talk to Buffett, but failed to get to Sokol, who, according to a New York Times source who is a "Berkshire director and lawyer" (wink wink: This means it's either Charlie Munger or Munger Tolles partner Ronald Olson, probably the latter), "quickly retorted that Mr. Sokol had declined to make himself available."

That little back-and-forth provides ammo for the contention that Buffett is a monument of candor while Sokol, who turns out to be a manager who's as mean as Ebenezer Scrooge, is not. And that brings up a wondrous example of legal nuance. The report argues, "Under Delaware law, corporate representatives owe their company a duty of loyalty. The duty of loyalty includes a duty of candor, which requires them to disclose to the corporation all material facts concerning corporate decisions, especially decisions from which they might derive personal benefit." Rhetorically speaking, this is a masterpiece of threat and insult. Sokol is not just dodgy, he's disloyal and -- perhaps the worst cut of all -- less than transparent.

That line of argument should also make lawyers prick up their ears. Delaware watchers are very familiar with the state's articulation of a fiduciary's duty of loyalty; and quite a bit of case law has been adjudicated to outline its subtleties and limits. But a duty of candor? Is there a new duty in the pantheon that includes care, good faith and loyalty? In fact, the case law on candor is quite small and a little stale; and the discussion of a "duty of candor," which sounds like something Oprah Winfrey would undertake, is difficult to find. A quick check by our crack legal team suggests two cases, both involving disclosure matters by directors, Malone v. Brincat in 1997 and Stroud v. Grace in 1994. In Malone v. Brincat, which involved a shareholder suit against Mercury Financial for inadequate disclosure of its financial condition, Judge Randy Holland of the Delaware Supreme Court offers up precedent, including the Stroud case, that suggests that "candor requires no more than the duty to disclose all the material facts when seeking shareholder action." In an even earlier case, Lynch v. Vickers Energy Corp. in 1978, the court argued that in a tender offer a majority stockholder "owed a fiduciary duty ... which required 'complete candor' in disclosing fully."

More broadly, Delaware did once wrestle with the notion of a duty of candor as a subset of a duty of care, not loyalty, when companies were talking to their shareholders in a merger situation involving a vote (the Berkshire case didn't involve a shareholder vote). That's important because directors can be indemnified under a duty of care but not loyalty, which probably explains why Berkshire tried to slide candor under loyalty. Delaware pursued this gambit in a continuing attempt to harmonize state and federal law under a duty of candor. Boy, are we deep in the weeds now.

In fact, a nonlegal sense of all this is that "candor" and "full disclosure" seem to be pretty synonymous, but that a new full-fledged "duty of candor" does not appear likely to appear on the Delaware stage. What a relief for those already struggling with the metaphysical nuances of care, loyalty and good faith. All this has little to do with whether Sokol did anything wrong or not. We only have, of course, one side of this dispute -- and a side that is clearly pressing him for some kind of settlement and using the threat of Delaware to extract it. But it's important to wonder what a far more expansive "duty of candor" might mean, and how it might cut both ways, both to Sokol and to Buffett. What we suspect, however, is the Sokol case probably is not so monumental as to convince the good jurists to include such a "duty of candor" into the corporate law. - Robert Teitelman

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Tags: Charlie Munger | David Sokol | Munger Tolles & Olson | Sage of Omaha | Warren Buffet

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