What’s Warren Buffett’s Issue with Compliance?

The European Union’s Whistleblower Directive requires all but micro companies and the public sector to implement a whistleblower protection system and organization – admittedly a huge task! But there might be valid reasons to do it right. The Directive is detailed and strict adherence to the EU-GDPR is required.

Berkshire Hathaway (BH) released its annual report stating earnings of around USD 81 billion, and Chairman Warren Buffett had a few concerns – notably the recognition of unrealized gains in listed holdings. He warned that the stock market tends to go up and down, whereas BH seeks intrinsic value in its holdings.

Secondly, and rather amazingly, the youthful 89-year-old CEO and Chairman of the Board (Dual Role) questioned why the CEO is in USA screening for potential board members – the board is supposed to supervise the CEO! This is an issue in several US listed companies, but insofar as Mr. Buffet – as he states – has 99% of his net worth in BH equity, there is no real agent problem.

Governance vs. Compliance

The Dual Role set-up decreased in the US S&P500 companies from 77% in 2001 to 46% in 2018, while only 9% of Euro Stoxx 600 companies had a Dual role in 2018.

The Finnish Hex Corporate Governance Code 2020 is now enforceable and requires the Board Nomination Committee to pay attention to the sufficient quality of prospective Board Members, especially those presented as candidates for Audit Committee membership. Now why am I writing about Governance, when my focus is generally on Compliance?

Governance is management’s duty with respect to the firm’s primary goal – to make profit within the area of business defined in its statutes, whereas Compliance is adherence to a set of relevant laws, regulations and internal policies, whilst striving towards the primary goal.

What did Mr. Buffett mean?

What Mr. Buffett eloquently describes in his letter to BH shareholders is indeed a control environment weakness, which is, however, quite obvious to the trained eye. As an investor, you either trust the CEO and the Board to discharge their duties, or not. Some would probably prefer a bit of control, but in the absence of a binding rule in the US, the investor can make a judgement call.

Bear in mind, though, that issues stemming from a CEO gaining virtually unlimited powers after admirable commercial success have occurred – for example, in Tyco:  Tyco’s CEO & Chairman grew the company’s market capitalization from USD 3 billion to 120 billion from 1992 to 2001. The CEO then resigned and was arrested in 2002, at which time Tyco’s MCAP plummeted by 90%. In the aftermath, the CEO was given a prison sentence together with the CFO, while most of the Board were acquitted.

Significant differences between US and European whistleblower regulations

Another item Mr. Buffett addresses is his expected death, with an addendum on the expected death of his co-director and board member, aged a respectable 96 years! BH has two further Board members, whose age is probably not of any interest. Despite Mr. Buffett’s dry humor, the issue is prudently covered by how he explains the contents of his will – his executors have binding instructions on how the Buffett estate will release its significant interest in BH over a period of almost 20 years.

So what is the takeaway from this? Whilst the US regime allows for apparently uncontrollable centralization of power, there might be other mitigating factors to curb the risk. I’d risk a bet on the rather harsh (from a European standpoint) US Whistleblower Protection System taking the edge off power centralization-induced risks. The EU Whistleblower Directive, on the other hand, is a quite well-balanced and, if properly implemented, rather magnificent tool to channel possibly vital information on Compliance to the management.

Hence, KPMG has invested heavily in its capability to deliver the WB channel and services as an outsourced service.