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Monday, May 2, 2011

David Sokol, Warren Buffett, And Insider Trading

This story is interesting. David Sokol was one of the people being groomed to succeed Warren Buffett as CEO of Berkshire Hathaway. He was forced to resign in an insider trading scandal.

David Sokol bought a lot of shares of Lubirzol for his personal account. Then, he advised Warren Buffett to buyout Lubrizol, and Warren Buffett followed his advice. David Sokol made approximately $3M off his Lubrizol trade.

David Sokol bought Lubrizol shares, driving up the price. This caused Berkshire Hathaway to pay a higher price for Lubrizol. David Sokol indirectly robbed Berkshire Hathway shareholders.

In effect, David Sokol had a free implied option, on his Lubrizol trade. If Berkshire Hathway bought Lubrizol, he would make a nice profit. If Berkshire Hathaway didn't buy Lubrizol, David Sokol had concluded it was a good investment anyway.

David Sokol knew that Berkshire Hathaway was considering to buy Lubrizol. His job was researching corporations to buy!

"Insider trading" is a crime that cannot occur in a really free market. In a really free market, there's no limited liability corporations. Without the State limited liability perk, it'd be too risky to buy 100 shares of a large corporation; you'd be assuming liability for all potential losses. Without limited liability, there's no stock market and no insider trading.

Some people argue that insider trading should be legal. The insider is doing the rest of the market a favor. The insider moves actual market prices to more accurately reflect the fair price. For example, an insider with favorable information buys, increasing the price, moving market prices closer to the fair price.

Insider trading is illegal, because it makes corruption too obvious. If a CEO gives himself 1M shares in a grant, maybe he's a brilliant leader who deserves it. If a CEO pays $20M on a consulting contract for his friends, you can't prove it was wasted. When a CEO sells shares just before he releases bad news, that's corruption that's obvious to anyone.

There are many ways that a CEO can rob shareholders. This is the Principal-Agent Problem. The CEO acts like the full owner. The CEO isn't the actual owner. The CEO has control, which means he can act like the owner. With control but not ownership, the CEO will always be tempted to line his pockets at the expense of shareholders.

With insider trading, insiders are abusing their power in a flagrantly-obvious manner. There are plenty of other was for insiders to steal from shareholders. This temptation will always exist, due to the Principal-Agent problem.

State thugs declare "Insider trading is illegal!" They treat the symptoms but not the cause. The cause is the Principal-Agent Problem, due to the distinction between ownership and control. Insider trading is a symptom of the Principal-Agent Problem.

Also, the State forces people to invest in the stock market. In a money market account, you get robbed via inflation. Gold and silver are heavily regulated. It's hard to invest in gold and silver. There are many taxes and regulations. Warehouse receipt banking is illegal. By banning and heavily regulating alternatives, the slaves are forced into the stock market, where insiders can rob them. I saw a cynical quote, "Warren Buffett advises people to invest in the stock market, because he can easily fleece stock market investors."

In a really free market, people would be reluctant to buy minority ownership in a business. In the present, the stock market doesn't outperform true inflation (gold/silver).

For another example, the Mets' owners are trying to sell a minority ownership in the team. They are having a hard time finding a buyer. Only a fool would buy minority ownership. There are too many ways the majority owner can rob you.

Assuming current stock market laws are valid, both David Sokol and Warren Buffett broke securities laws. Warren Buffett has cultlike status. He's a big promoter of fake free markets. He advises people to invest in State paper rather than gold or silver. Warren Buffett is politically untouchable. If Warren Buffett were charged with a crime, that would be a huge blow to the public image of the stock market scam.

David Sokol obviously broke insider trading laws. He bought Lubrizol shares while he had inside information, that Berkshire Hathaway might buyout Lubrizol.

If David Sokol is charged with a crime, then Warren Buffett must also be charged with a crime. As David Sokol's boss, Warren Buffett has a responsibility to supervise his subordinates.

At every stock market job I had, my employer demanded a copy of my brokerage statements. This is "Compliance 101". It's an obvious law that everyone should know. You get a copy of employee brokerage statements, and actually read them.

For example, my current employer has a list of stocks I'm not allowed to trade. By looking at my employer's records, I could theoretically gain an unfair advantage. I have access to insider information, from my employer's computer records. The compliance department should read my brokerage statements, and see if I was exploiting inside information.

Warren Buffett should have demanded that David Sokol give him a copy of brokerage statements. Warren Buffett should have actually read those statements. These are basic compliance rules. Everyone in the securities industry should know this.

If David Sokol were determined to steal, there are other loopholes he could use. For example, he could have advised a friend to buy Lubrizol, rather than buying it himself. Then, he would be guilty of insider trading, but not Warren Buffett. If David Sokol did that, he probably would not have been caught.

David Sokol is guilty of violating insider trading laws. Warren Buffett is guilty of "failure to supervise". Warren Buffett is politically untouchable. I predict that neither David Sokol nor Warren Buffett will be prosecuted. If David Sokol is prosecuted, that will make Warren Buffet look foolish.

Warren Buffett heavily hypes the State stock market. If he's obviously dishonest, then it's too obvious that the whole stock market is dishonest. Warren Buffett is politically untouchable.

This makes the prosecution of Raj Rajaratnam a sham. There are two justice systems, one for insiders and one for everyone else.

1 comment:

Anonymous said...

That's interesting. I once knew a manager (ex-banker of course but still in a related business) who had an employee that was stealing in the interest of the company.

Could that manager argue in a court he did not know what his employee was doing?

This manager was slippery. One client told him to his face now that his friend had left the bank, he should try selling his junk to his friend's new place of work! In effect saying his friend put business his way and he took advantage. As his friend would supervise the project he could get away with selling junk.

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