Where Warren Buffett Went Wrong

Warren Buffett, the billionaire investor known for demanding truth and transparency, should have asked one of his own top deputies a few more questions, corporate-governance experts say. Had he done so, they say, he and his former lieutenant, David Sokol, at Berkshire HathawayInc. mightn't be facing the intense scrutiny they have endured since revelations on Wednesday that Mr. Sokol was buying shares of a chemicals company about a week before he suggested that Berkshire buy the company, which it later agreed to do.

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Mr. Sokol, whose resignation was announced in the Wednesday statement, said he believes he did nothing wrong in making the trades. Mr. Buffett said the men didn't think the purchases were unlawful and Mr. Sokol said they weren't a factor in his decision to resign.

The chain of events has put Mr. Sokol in the hot seat. But attention is also turning to Mr. Buffett. As well known for ethics and integrity as investment prowess, he once told government-securities regulators that company directors should be "Dobermans" in demanding financial disclosure from managers and auditors. Corporate-governance experts are suggesting that Mr. Buffett himself should have asked more questions when Mr. Sokol told him he owned shares in the company, Lubrizol Corp., or elevated the issue immediately to a lawyer or even the board.

They say the incident raises questions about whether Mr. Buffett, who carefully selects managers and then vests them with his confidence, was too trusting with Mr. Sokol. They also say the developments could reveal gaps in Berkshire's internal controls. In most big companies, they say, stock trades or other transactions by executives that pose potential conflicts typically need to be reported or approved by internal auditors or even directors. The conglomerate prides itself on cutting corporate-level red tape and fostering a culture where executives are trusted to police their behavior. The "Code of Business Conduct and Ethics" on Berkshire's website says that for chief executives of a subsidiary, which Mr. Sokol was, a transaction that is a potential conflict should be reported to the chairman of the company's audit committee. It is unclear whether Mr. Sokol's actions would fall under the policy.

Some experts say this week's disclosure could put the matter to rest for all involved, and they praised Mr. Buffett's decision to issue the statement. "It's entirely possible that everything Buffett did was reasonable," says Joseph Grundfest, a Stanford University law professor and former commissioner of the Securities and Exchange Commission. "We need more facts." Berkshire Hathaway didn't immediately respond to a request for comment on the issues.

The issues may prove a black mark for Mr. Buffett who, while honing a squeaky-clean reputation and insisting on nothing less from his employees, has seen Berkshire enmeshed in controversy before. Several years ago, an insurance unit was mired in a federal investigation that resulted in four executives being convicted on criminal charges and the Berkshire subsidiary itself agreeing to a nonprosecution agreement with authorities that involved corporate-governance changes. By Wednesday's account from Mr. Buffett, when Mr. Sokol told him that he owned Lubrizol shares, Mr. Buffett treated it as a "passing remark" and didn't inquire about the timing or extent of Mr. Sokol's trades. (Mr. Sokol had purchased about $10 million in shares a week to 10 days before he recommended the purchase to Mr. Buffett, who, in consultation with his board, made the decision on the acquisition without Mr. Sokol, Mr. Buffett said.)

The SEC is likely to look into the chain of events detailed in Mr. Buffett's statement Wednesday, according to a person familiar with the matter. Corporate-governance experts say Mr. Buffett's actions could raise issues about corporate practices at Berkshire regardless of whether they reflect a legal failure to disclose material information. At issue for Mr. Buffett is whether he glossed over a potential conflict of interest when he first learned of Mr. Sokol's holdings and whether that led Berkshire to withhold information that might have changed investors' view of the deal or of Berkshire itself.

"Buffett should have asked him: Why don't you just give me your whole position, and let me think about it?" said Franklin Edwards, a professor of corporate governance and financial regulation at Columbia Business School in New York. He and others say Mr. Sokol's investment should have been disclosed to Berkshire's audit committee as soon as possible after the issue of a potential deal arose. Securities lawyers and corporate-governance experts said the best choice at that point would have been for Mr. Sokol to sell his Lubrizol shares. The company even then should have considered formally walling him off from discussions about Lubrizol to avoid an appearance of conflict, lawyers said.

Prof. Edwards said the ideal message to Mr. Sokol would have been, "You could either liquidate your position, or we don't do a deal." Had he liquidated, lawyers said, he wouldn't have benefited in his personal account from the rise in Lubrizol's shares. Corporate-governance experts say further that companies, particularly those that make money buying and influencing companies through investments, usually have compliance systems for employees to report personal trades that could pose a conflict.

Berkshire is famous for thin, efficient staffing at the parent company. But, says David Yermack, a finance professor at New York University's Stern School of Business and an expert on corporate transparency, "when you hire lawyers, it does a little bit of good once in awhile."

—Erik Holm and Leslie Scism contributed to this article.

Write to Jenny Strasburg at jenny.strasburg@wsj.com