In the wake of David Sokol's resignation from Berkshire Hathaway and the revelation of his stock purchases ahead of Berkshire's planned acquisition of Lubrizol (LZ), it has become clear that investors need to consider more than just who will succeed
Warren Buffett as chair and CEO. They will also need to seriously consider succession and governance practices on Berkshire Hathaway's board.
The issues with Berkshire's (BRKA) governance should not be news to investors in Berkshire stock. Any new or prospective investor reading the company's March 11 proxy filing should have received the message about Berkshire's governance loud and clear.
As the SEC's investigation of the Sokol matter moves forward, it will be interesting to see whether issues beyond its recent accounting inquiries at Berkshire have caused the regulator any alarm.
What were some of the signposts of an accident waiting to happen at Berkshire?
Using the proxy as a guide, the Berkshire board's risk oversight appears to be very weak. Devoting just three sentences to risk oversight, the proxy says the board "receives reports" at least twice a year about risks that the corporation faces and at least once a year about the company's business segments. It also says the audit committee "discusses" risk assessment and risk policies.
The proxy's section on the audit committee doesn't elaborate on its risk-related discussions. The section does say that the committee "assists the Board with oversight of" the "Corporation's compliance with legal and regulatory requirements."
Let's hope the audit committee is undertaking a serious review of the internal controls process at the firm -- not only the accounting issues cited by the SEC, but also the issues surrounding Sokol's trades.
Unlike most firms with separate committees for compensation and nominating and governance, Berkshire combines the committees into one. And why not? The combined committee only met twice last year and the directors earn no fees for attending those meetings, which suggests that the company does not place significant value on these activities.
The audit committee met five times, a low figure in today's corporate world. It's telling, especially in light of the company's recent accounting run-in with the SEC in which the regulator questioned the lack of write-downs of certain Berkshire securities.
According to the proxy, the board as a whole only met three times last year.
The proxy's descriptions of the board's actions suggest that it is disconcertingly disconnected from the goings on at Berkshire. "Board of Directors' actions were taken in 2010 at the Annual Meeting of Directors … and at two special meetings and upon two occasions by directors' unanimous written consent," the proxy states.
Three meetings in all? Not a very active board, it seems. Then again, the $900 in payments per meeting (a paltry sum) for the non-audit committee members, for a grand total of $2,700 each, isn't much compensation for serving on the board. This could very well be a reflection of how Buffett values the advice and oversight he receives from the board.
The proxy also takes a dismissive tone toward issues that many investors care about.
On separation of the CEO and chair roles: "It is Mr. Buffett's opinion that a controlling shareholder who is active in the business, as is currently the case and has been the case for Mr. Buffett for over the last 40 years, should hold both roles [of Chair and CEO]. This opinion is shared by Berkshire's full Board of Directors. The Board of Directors has not named a lead independent director."
On board nominations: "In identifying director nominees, the Governance, Compensation and Nominating Committee does not seek diversity, however defined," the proxy notes. Certainly, there isn't much diversity in age: the board consists of 12 members, half of whom range in age from 79 to 87. The youngest member is 48.
On say on pay: Berkshire recommends say on pay as infrequently as possible -- every three years -- versus the annual basis investors and their proxy advisors generally prefer.
So yes, the governance issues at Berkshire are clearly spelled out, but the question for investors should be about the future.
What will happen if and when Buffett exits? Will the old style governance model work for investors then? What kind of culture will his successor inherit based on this disengaged board and the tone at the top? How will governance operate? Will a board who meets so infrequently and does so little be able to help Berkshire bridge to the future? Berkshire did not respond to a request for comment on these issues.
It is not just Warren Buffett's successor who will need to navigate the company forward capably. Berkshire will also need the right kind of board to oversee and promote its future. These are the questions that long-term shareholders ought to consider now, as they will serve as the ultimate tests of Buffett's legacy.
