Behind the BRK-A: Directorships & Double Standards

By Nick Slepko - May 9, 2012 | Tickers: BRK-B, BRK-A, GE, GS | 0 Comments

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The unassuming and savvy Warren Buffett has been able to deflect pressure from Berkshire Hathaway (NYSE: BRK-A)(NYSE: BRK-B) over the years, however, now in his twilight, an anxious public and a predatory media are beginning to ask the hard questions since his recent activities with Goldman Sachs (NYSE: GS), GE (NYSE: GE), and Bank of America have left his followers less well-off than Buffett himself.  No doubt Berkshire Hathaway has a smorgasbord of financial talent from which to choose, but the real test will be if the Chosen One(s) will be able to get away with as much as the kindly Opa of Omaha.  On the whole, Buffett seems to have been a technically above the board guy, unfortunately, in his waning years he appears to be manifesting the early stages of Late-in-Life-Henry-Ford-Derangement Syndrome.

Sadly like the Twilight Saga, Buffett has spent years developing a world and articulating its rules, but in the closing chapters he seems to ignore all his conventions in the hopes of producing a rousing spectacle for his audience (and making some quick cash grabs in the process). He continues to deviate from the script he spent half-a-century writing – and the decline in value of Berkshire seems well-deserved especially since shareholders have (literally) elected to remain in the dark about the most fundamental matters concerning Berkshire’s near-term existence.  Maybe the crowd is intuitively right, it doesn’t matter, the BH ship is going down no matter who gets selected when the trustees play spin the Coke bottle at the funeral parlor.

From going into technology with his 5.5% bite of IBM to splitting his B-shares, cardinal rule after folksy adage is being tossed to the wayside.  Of more concern to the broader public is that Buffett has occupied the space that J.P. Morgan and Andrew Mellon (also a financial prodigy and a fan of coke) held during their generations: honest broker and final arbiter of the American economy.  Unfortunately, what has been characterized by the media and Buffett himself as placing his seal of faith on Goldman and GE has gone a long way to tarnish his reputation as a long-haul value investor and made him look more like a hard-nosed raider (though a number of pre-Buffett-controlled-Berkshire employees might argue that was always the case…)

Of more material concern is that Berkshire Hathaway has had to make repetitive investments to secure earlier infusions of cash into companies like Goldman and GE.  Along with similar issues with Bank of America, these significant missteps have been born of major derivations from the Buffett philosophy and appear more like measures to prime his pump of public adoration.  While Buffett is the first to admit that he’s made mistakes over the years, the disturbing trend is that he’s been making them at a much higher frequency recently and it has begun to underscore his aversion to conflict and revealed that he is not the most discerning judge of character.

Buffett stated at his recent annual meeting that,

Those [GE and Goldman] deals have not been key to Berkshire…They’re not remotely as important as buying Coca-Cola stock [in 1988]…The values in Berkshire that have been accumulated by some special security transaction are really just peanuts compared to buying businesses like Geico, or Iscar or BNSF…It’s not a key to Berkshire’s future.

While it may be true that railroads, insurance, and manufacturing are the keys to the Berkshire kingdom, the $8 billion he has sunk into GE and Goldman are not peanuts when evaluated in light of his Coca-Cola investment.  While his holdings in Coke are presently nearly twice his GE-Goldman investments, his initial $1.3 billion he put into Coke over twenty years ago represented a similar proportion of his holdings as his recent GE-Goldman move.

Setting aside his recent, notable, and frequent departures from his oft-quoted bromides, Buffett’s activities with his long-term investments recall passages from the famous 1979 article Dictatorships and Double Standards written by President Ronald Reagan’s architect of foreign policy Ambassador Jeane Kirkpatrick where she presciently described how irrational collections of entities disintegrate for lack of a leader to hold them together:

No idea holds greater sway in the mind of educated Americans than the belief that it is possible to democratize governments, anytime and anywhere, under any circumstances...Decades, if not centuries, are normally required for people to acquire the necessary disciplines and habits. In Britain, the road took seven centuries to traverse…The speed with which armies collapse, bureaucracies abdicate, and social structures dissolve once the autocrat is removed frequently surprises American policymakers.

Like an omnipotent autocrat, Buffett has overseen his long-term investments, yet it is likely that his benevolently decentralized (and dangerously lax) oversight has failed to establish any sort of institutional framework at Berkshire Hathaway to pass along.  Rather his approach shows a lack of real governance and is the breaking dawn of realization that Berkshire’s board members are all likely to be vegetables or dead soon too.  Half of the board is over eighty years old – and among the remainder are Bill Gates’ blowhard father, Little Buffett the farmer, a medical academic, and a Yahoo.  Munger’s inability to stay awake for meetings and the frequent absences of board members (in particular those on the audit committee) should all be red flags.

Although individual parts of Buffett’s conglomerate may be good individual buys, the entire Berkshire Hathaway edifice recalls a checklist prepared in 1985 by the famous anti-corruption crusader James Treadway which outlined the characteristics of companies that promote a lack of accountability and thus create a high probability of financial fraud.  In 2011, Big 4 accounting watchdog Francine McKenna did an amazing job of matching Treadway’s observations of problematic companies with recent statements in Buffett’s official writings that should give every shareholder pause, especially:

[Treadway:] 7. The falsifications were large, simple, and direct. Expenses were improperly shifted from one accounting period to another. Goods ready for shipment, sometimes not even manufactured, were accounted for as sales in the current period, even though not actually shipped or manufactured until a succeeding period. False statements were made to auditors. Multiple sets of expense records were kept. Shipping invoices and bills were altered, with third parties sometimes enlisted to assist.

[McKenna:] Buffett once criticized derivatives, for which there are particularly complicated rules and often difficult to determine values, as “financial weapons of mass destruction”. Now he likens them to insurance and counts on the contracts to juice his earnings.
…
[Buffett] Operating earnings, despite having some shortcomings, are in general a reasonable guide as to how our businesses are doing. Ignore our net income figure, however. Regulations require that we report it to you. But if you find reporters focusing on it, that will speak more to their performance than ours.
…
[McKenna] Contrast that tough talk with their actions when questioned by the S.E.C. about the declining values of some of their equity investments. Warren Buffett and Berkshire Hathaway had to be dragged kicking and complaining to recognize those significant unrealized losses. They resisted taking others.

Antithetical to the Buffett-Munger style of distancing themselves from ultimate responsibility for their major transgressions (Salomon Brothers, DOJ/AIG, Rivers, Sokol…) is the Truman buck standard where allowing something to happen is the same as actually creating it.  Even assuming Buffett is all sunshine and posers, once he’s gone his failure to create a tangible firm succession plan (which grows more immediate by the day) to be administered by a halfway lucid group of stewards gives the sense that no one is going to have the codes needed to disarm the football McKenna details if events conspire to go critical mass.

Next in Behind the BRK-A: Buffett, Please
Previously in Behind the BRK-A: Butterface Halfway

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