Auditing An Oracle
Mel Duvall
Shareholders nearly deify Warren Buffett for the way he manages his diverse holding company, Berkshire Hathaway of Omaha. Theres little doubt that hes squeaky clean in how he operates. But that doesnt necessarily mean that other companies can or should follow the way the avuncular champion of business ethics conducts his own affairs. His approach: handshake deals on billion-dollar acquisitions and near-complete avoidance of technology in combating fraud.
The Oracle of Omaha was in classic form in early May, at his affectionately dubbed "Wood-stock for Capitalists." For three days of worship, 15,000 Berkshire Hathaway shareholders had come to Nebraska to hear Warren Buffetts wisdom on how to place trust and invest money in American companies.
Pausing occasionally for a swig of Cherry Coke, the sharp-witted 72-year-old blasted the lowlifes and criminals who have been unearthed like mealy bugs after a summer storm. "It prevails in almost every place," said Buffett in his no-nonsense style. "And unless there is a countervailing force, it is hard to stop."
He was, of course, referring to the ugly behavior of chief executives, financial officers and other managers of some of the largest U.S. companies. From phony accounting to "obscene" paychecks, Buffett left no doubt that the conduct of corporate America had reached its lowest point in his half-century of investing.
"What we really deplore are the attempts by corporations to solve operating problems with accounting maneuvers," he said in response to shareholders questions. "It catches up with you, sometimes with disastrous results. You might as well face reality immediately."
Buffetts criticisms carry extra weight because Berkshire Hathaway has become a beacon for good corporate governance. Shareholder groups and regulators alike have turned to Buffett for guidance on how to right an industry stuck in a morass of scandals. As recently as two years ago, the so-called sage was chastised for failing to invest in Internet companies because he couldnt understand their business plans or underlying value. Today, his concerns look prophetic.
"Buffett is probably more honest than you or I," said Jack Putnak, a 37-year-old investor from Charleroi, Pa., who arranged a two-week vacation in Omaha around the shareholders meeting. Putnak based his faith on Buffetts practice of paying himself a nominal $100,000 salary and his aw-shucks way of heaping praise on managers while accepting blame for Berkshires mistakes.
Yet, while he may be prophetic, Buffett is not quite the gold standard of good corporate governance his followers hold him up to be. For Buffett, its often a "do as I say, not as I do," approach to management. He cuts deals without following accepted rules for due diligence, gives Berkshire managers such loose reins that they are able to pile up losses for years before he will take action, and eschews many of the rules and technologies companies are deploying to get a firmer grip on financial reporting.
"Theres a difference between how they manage themselves and what they look for in companies they manage," observes George Dallas, managing director of governance services at Standard & Poors in London.
Buffett tells new investors to approach every investment as though it is one of only 25 theyll make in their lives.
He, on the other hand, cuts deals based on gut instinct and without common due diligence such as getting an outside audit. The latest: During two hours in May, he sealed the $1.5 billion purchase of Wal-Marts distributor, McLane Co.
"I literally shook hands and was done," he told reporters. "There was no due diligence."
Buffett argues companies need to be more open with shareholders. Yet he remains secretive about Berkshire Hathaways public investments and in providing details on the operation of Berkshires subsidiaries. In annual reports, for example, Buffett doesnt offer individual sales, profits or expenses for each of his 64 companies; he aggregates most of them, making it hard to tell how any one company is doing.
When Buffett takes over a company, he lets the managers run the subsidiaries as they see fit. "They are the Mark McGwires of the business world and need no advice from us as to how to hold the bat or when to swing," he says. But this hands-off policy has allowed some managers to strike out. The $8.3 billion in underwriting losses so far at General Reinsurance is the most glaring example.
Buffett faults many corporate boards for acting as the lap dogs of chief executives. But his own board has been highly criticized by some investor groups and pension fund companies, such as the California Public Employees Retirement System, for lacking independence. Buffett is both chairman and CEO, and his wife and son are directors.
Buffett says corporations should automatically answer vital shareholder questions. However, other than in general terms, he refuses to talk about his designated successor or successors—undoubtedly, the most important question for investors. He also engages in somewhat risky trading practices, such as Berkshire Hathaways recent purchases of $8 billion in junk bonds, without providing basic data on the companies involved or the terms.
Buffett says CEO pay, which is overseen by board members, is out of control. But he has served as an influential director for some of the corporations that have rewarded their chief executives handsomely. Berkshire is the largest shareholder in Coca-Cola, yet Buffett failed to curb the compensation of CEO Douglas Daft in 2001 that included $48 million in restricted stock and options worth up to $153 million. In his annual report to shareholders in March, Buffett admits this failing:
"Too often I was silent when management made proposals that I judged to be counter to the interests of shareholders."
All that does not seem to matter to shareholders who have profited greatly from Berkshire. From January 1990 to the middle of July, Berkshires stock price grew 757%, from $8,625 to $73,900.
Indeed, while other investors have called for the heads of WorldCom executives, sued HealthSouth for stock fraud and ripped down the name of disgraced Enron from Houstons ballpark, shareholders at the Buffett event were happily buying all sorts of memorabilia with the Berkshire logo—charm bracelets, windbreakers and glass globes.
They came to hear what was wrong with corporate America, and Buffett and longtime friend and business partner Charles Munger rose to the occasion. Munger, known for using the odd expletive, saved his strongest criticisms for the accountants who failed to catch (or sometimes even participated in) financial dirty tricks. "The faithlessness of that profession over the last 20 years has been unpleasant to watch," Munger said.
The prevalence of fraudulent financial reporting is hard to gauge. Accounting firm PricewaterhouseCoopers this year tried to survey several hundred of the largest U.S. companies about financial abuse. Only 91 responded. Of those, slightly more than a third said they had been victims of an economic crime in the past two years with most citing embezzlement or theft. Only two said they were affected by falsified financial statements.
On the same day the PricewaterhouseCoopers report was released, though, far more than two companies were openly fighting financial fraud. On that day in the first week of July, the new auditor of medical giant HealthSouth—none other than PricewaterhouseCoopers—said it found more evidence of potential financial fraud, bringing the damage possibly above $3 billion. Simultaneously, Jerome Schwartz and Leonard Goldner, the chairman and general counsel, respectively, of Symbol Technologies, were forced to resign. The handheld-computer maker is being investigated for accounting fraud. Separately, a federal judge approved a payment of $750 million by telecommunications firm WorldCom to settle an accounting fraud lawsuit brought by the Securities and Exchange Commission.
In Europe, food conglomerate Royal Ahold said its headquarters in the Netherlands and the offices of its accountant, Deloitte & Touche, were raided over the July 4 weekend for evidence of possible irregularities in the way it booked sales at some joint ventures. That follows an alleged $1.1 billion accounting scandal involving its U.S. Foodservice subsidiary. And Paul Allaire, former Xerox chief executive, was barred from serving as a director of a public corporation for five years and agreed to pay a $1 million penalty, among other punitive measures, for overstating profits by $1.4 billion during his watch.
Owners of American companies have been pummeled as a result of the accounting scandals that started with Enron and reached the decadent zenith of Tyco International, amid the worst recession since World War II. The Dow Jones Industrial Average lost 39% of its value in less than three years, falling from 11,750 in January 2000 to 7,197 in October 2002. The value of the technology-stock-heavy Nasdaq market plummeted 78%.
Buffetts Principles
While other investors have been capsized by the financial storm, Berkshire Hathaway stockholders were largely unscathed. Chris Stavrou, a Connecticut shareholder, has attended the annual meetings in Omaha for 18 years. Hes heard all of Buffetts axioms and corny jokes. Still, he wouldnt think of missing a meeting. "Its a little bit the same as why you keep going to church every Sunday," he says. "To be reminded of the principles of smart investing."
Buffett has been a critic of executive paychecks and expensed stock options and has served as an all-around industry watchdog. What goes largely unacknowledged in this love-in is that Buffett often contradicts himself. His somewhat blind trust in his managers and his willingness to do without due diligence on acquisitions run counter to whats considered good operating procedure. And Buffett can simply be wrong, like any human. Berkshires $21.7 billion purchase of General Reinsurance in 1998 has resulted in $8.3 billion in underwriting losses to date.
Where Buffett really stands apart, however, is not just in his unwillingness to invest in technology companies, but his unwillingness to invest in technology for his own company as well. While many firms are turning to information systems to meet new accounting regulations, clean up financial reporting and monitor ongoing business changes, Buffett is not. He relies on fax, phone and mail to receive the financial results of his companies.
Berkshire will do whatever is necessary to comply with new regulations, he says. But more technology and more laws arent needed, he says. Stronger ethics are.
Thats noble and desirable but ignores the spectrum of human nature, says Tim Leech, a former director of risk-management services at Coopers & Lybrand, and now president of risk-management software company CARDdecisions. Leech says Buffett could possibly be a mind reader, with Godlike skills to hire only the most capable, honest people, but his own experience as a forensic accountant points to the contrary.
"Most of the people I have investigated and sent to jail for defrauding large amounts of money, their bosses all thought they were the salt of the earth, incapable of doing something like that," he says. "Youve got corrupt accountants, corrupt management, corrupt lawyers, corrupt investment dealers that are hyping stocks that they know to be dogs … the system has gone all to hell."
Institutional Shareholder Services (ISS), a governance advisory service, recently gave Berkshire a score of just 1.5 out of 100 for the quality of its own corporate governance.
The firm considers 61 variables, such as the independence of the board of directors, executive compensation, how frequently outside auditors are rotated, and whether and how much stock officers and directors own. Some factors are scored together with others. For example, ISS says that a board with both a majority of independent directors and all-independent key committees, such as compensation and audit, will get a higher score than if the company had only one of these.
At Berkshire, there is no compensation committee. Buffett himself sets the compensation for Berkshires officers. Then he proposes his own salary and bonus and the board votes on it.
Of course, Buffetts $100,000 salary wins praise. But thats not enough to negate at Berkshire what would raise eyebrows at other companies: relatives such as wife, Susan, and son, Howard, on the Berkshire board; directors who own large chunks of Berkshire Hathaway stock; and a lack of sophisticated technology relaying financial data to the CEO.
Buffett fans counter that these issues dont matter. The man took an initial kitty of $500,000 and turned it into a holding company worth $110 billion today. Since 1965, the book value of Berkshires shares has grown 22% annually, more than doubling the 10% a year growth of the S&P 500.
As a persistently profitable collection of companies that sell paint, carpet, aviation services, energy, underwear, cooking gadgets, bricks and insurance, Berkshire is a unique entity, they say. It cant be judged by the rules that govern the rest of the corporate realm.
"The board may not be independent on paper, but it works well," says Nell Minow, editor at the Corporate Library. This governance research group gives Berkshire an A on a school-style A to F scale. Minow says Berkshires board works effectively, despite its seeming lack of independence, and she cites Buffetts low salary as responsible. "You have to look at the big picture," Minow says. "[Berkshire is] in a class by themselves."
Critical Change
But Buffett now faces a difficult pass. New regulations from the SEC, the U.S. Congress, the New York Stock Exchange and various other organizations seeking to clean up the business sludge of the past two years demand specific changes intended to make financial reporting clearer and more complete.
New rules in an act sponsored by U.S. Sens. Paul Sarbanes, D-Maryland, and Michael Oxley, R-Ohio, aim to simplify financial reporting and hold senior executives and auditors responsible for the figures they report and how they report them.
While Buffett may say technology isnt necessary to achieve fair and accurate financial reporting, many other companies are acting differently. In a recent survey by AMR Research of 60 Fortune 1000 companies, 85%, said they plan technology changes to comply with the Sarbanes-Oxley Act.
Thats because the new rules require faster disclosure of significant financial events, which is difficult to do with paper or low-tech means such as spreadsheets. Also, top executives, who must vouch for the data their companies put out, now want to see underpinning documentation before signing certification statements. If later convicted of fraud, they face up to 20 years in jail and $5 million in fines for false certification.
External auditors will also have to certify they believe management has systems or processes in place to allow it to state the results are accurate with such confidence.
Former SEC Chairman Arthur Levitt says companies need ethical and sound methods for figuring their financial condition, of course. But its software for gathering and analyzing data that puts those principles into everyday action.
"It will take financial executives working with CIOs to … enable quick and accurate acquisition of data," Levitt said in a teleconference. "I dont see how you could do it without using information technology. Thats fundamental."
AMR predicts up to $2.5 billion in spending on Sarbanes-Oxley information systems and planning this year and next. On average, it will cost $480,000 for software and technology consulting to comply with the law, according to 83 large public companies surveyed by Financial Executives International, a professional association in Durham, N.C.
A key section of the act requires that internal control structures and processes involved in financial reporting be clearly documented, followed and continually audited. That means that companies must not only report the right numbers, they must be able to show how they got those numbers. That includes accounting software as well as transactions recorded in enterprise-resource planning, supply chain, and customer-relationship-management systems. The goal is to guard against tampering or lapses that could introduce errors.
Beyond assurances from Buffett that his company is clean and self-monitoring, it is unclear how Berkshire Hathaway plans to meet those requirements.
Buffetts system is low-tech: He talks with many of the Berkshire chief executives by phone almost every day. He does not have a computer in his office; there is no chief information officer or equivalent among the 16-member staff of Berkshire. Buffett receives financial reports from many of his companies via a fax machine. He has little use for technologies such as real-time business intelligence systems, with which other companies monitor operations to catch problems before they grow Tyco-esque. To date, Berkshire shareholders have not paid for any $15,000 dog-shaped umbrella stands for any company executives personal domain, to anyones knowledge.
Elsewhere, finance and technology managers use Sarbanes-Oxley—and the wide-eyed attention senior executives are giving the act—as a lever to modernize reporting systems.
Principal Financial Group, a $9 billion insurer in Des Moines, Iowa, sees the chance to put in long-coveted automated auditing tools and a database from Paisley Consulting in Cokato, Minn., to track internal controls. Jeff Hall, Principals director of business-risk consulting, then wants to automate even more auditing work, such as identifying and ranking business risks to the whole company. "Nows the time," he says.
Automating fraud detection can be as simple as auditing software that sends e-mail to the finance chief or other designated officers whenever the pay-to address of a regular, outgoing check changes. It could be an alert whenever payments are made to a new type of payee, so that specific managers can see when new entities are being set up. So-called executive dashboards from Hyperion and Cognos can do that.
Matching payments to vendors sounds fundamental but can be overlooked. The Los Angeles school district uncovered $71 million in fraud, including duplicate payments and payments to fictitious vendors using an auditing package from ACL Services in Vancouver, British Columbia. Among other things, the software matched checks issued against purchase-order numbers or specific contracts and found that many checks were written directly to vendors with no such reference documents on file. It also flagged the fact that one employee made 48 budget transfers for $49,999, a dollar below the $50,000 threshold that would have required special approval.
Risk Recognition
The key, says Craig Fink, a fraud investigator at utility firm FirstEnergy, is to compare databases that hold separate facts but together can indicate irregularities.
Fink has done investigations for 27 years, starting as a police investigator and moving to corporate work.
For example, while at General Public Utilities, which FirstEnergy bought in 2001, Fink wrote a database query that compared who was signing out company cars with subsequent expense reports. Several employees had used company cars but claimed mileage for using their own cars. Fink used the discovery to delve into what else those employees were doing. Some had bought personal items on company accounts, he found. "In our theory, a thief is a thief and he will steal from you any way he can," he says. "Once we identified them, we would make their lives an open book."
Many companies lack the internal audit talent to conduct thorough proactive fraud checks, Fink says. "They think, I run an honest company. This is overhead. We never had it before and we dont need it now."
Yet even someone such as Buffett, who contends his best management technique is to cultivate honest executives, will have to supply Deloitte & Touche, Berkshires external auditors, with a complete, verifiable and measurable trail of transactions and internal controls to comply with Sarbanes-Oxley.
And thats across dozens of companies. Big companies, spread worldwide. Underwear maker Fruit of the Loom sells to 10,000 customers and has five distribution centers. Johns Manville is a $2 billion building-products company with 47 factories worldwide. Shaw Industries, the biggest carpet maker in the world, sells 1,600 different floor products to 50,000 retailers and distributors. Berkshires Scott Fetzer home and industrial products company itself owns 21 companies. In all, Berkshire Hathaway entities together own or lease 100 million square feet of property and employ 147,000.
Only software can produce the documentation needed to track the movements at large, complex firms, says Dick Nolan, a Harvard Business School professor specializing in business transformation. "You dont just scale up a spreadsheet," Nolan says, referring to the fact that the simple spreadsheet is the way many companies track and consolidate finances.
Indeed, Deloitte & Touche itself recommends that companies set up internal controls that include a database detailing procedures and information systems related to every accounting mechanism in use. Technology, Deloitte says, can help measure how effective controls are and identify gaps, especially at complex companies with many reporting entities. A corporation with many manual controls is only in the "early stage" of Sarbanes-Oxley compliance, the auditor says.
Lots of software vendors are trying to capitalize, saying they address various aspects of the new regulations. Oracle announced a package in June to manage internal controls. Hyperion and SAS Institute push their analysis software as tools to help CEOs understand their companies better. Auditing-software makers ACL and CaseWare promote their fraud-detection software.
Their postulate: Technology can help prove to the world, or at least to regulators, that youre no Enron.
In response to a Baseline question at the Berkshire Hathaway meeting, Buffett said relatively few changes are planned as a result of the new regulations. In May, for example, he added two non-Berkshire directors to his close-knit group of seven board members. They are two longtime business associates: Tom Murphy, former chairman and chief executive of Capital Cities/ABC, and Donald Keough, chairman of investment firm DMK International and a former Coca-Cola president.
"We have to do certain things because were told to do them by statute, but I dont regard them as improving in any way the reporting system we have here at Berkshire," he says.
Buffetts low-tech information systems and hands-off management philosophy have at times proven costly.
In June 1998, Buffett announced a $21.7 billion deal to buy property and casualty reinsurer General Reinsurance for stock. The acquisition was a good fit with Berkshires other insurance businesses and provided Buffett with more cash to invest.
General Re came with a $15 billion float, which is money that the company holds against its liabilities but does not own. Buffett has invested the floats of Berkshires insurance companies to reap much greater rewards than the company has had to pay out in insurance claims.
The problem was Buffett didnt realize General Re had taken on significant risks and was underpricing much of its policies to gain market share. Stephanie Eakins, a financial analyst at insurance rating service Weiss Ratings, says there is ample technology available to gauge a companys liabilities and risks against its reserves, from something as simple as a spreadsheet to more sophisticated systems such as executive dashboards.
"The tools are there but its up to management to decide whether they want to take action or not," she says.
Buffett did not have an executive dashboard flashing daily alarms about General Res exposure. Losses that began with a $370 million trickle in 1998 swelled to $1.4 billion in 1999. General Re suffered another $1.4 billion loss in 2000, and while he acknowledged several times that changes needed to be made at the subsidiary, Buffett refused to step in and take control. Instead, he steadfastly expressed faith in the experience and leadership of CEO Ron Ferguson.
While the exact events of Sept. 11, 2001, were close to impossible to foretell, Buffett later agreed that it was the job of a reinsurer to anticipate and correctly price policies to prepare for disasters such as terrorist attacks. Largely as a result of damage to the World Trade Center, General Re reported an underwriting loss of $3.7 billion in 2001. Ferguson decided to retire that same year.
Eakins says Berkshire was not alone in failing to keep adequate reserves or increase its premiums. The entire insurance industry found itself in trouble by the late 1990s after a pricing war. However, she says, Berkshire could be blamed for being too slow to react. Buffett agrees.
"Looking at the record, we needed to make a change at Gen Re, but I did not initiate it," Buffett said.
It wasnt the only time Buffett made this mistake. For years he allowed the Dexter Shoe unit to accumulate losses by failing to move production out of the U.S., as the rest of the industry was doing. In 2001, Berkshires shoe group lost $46.2 million because of Dexter. "The ten-for-one wage advantage enjoyed by competitors producing elsewhere in the world finally forced us to act—after our having delayed longer than was rational," he told shareholders.
Clarity in Diamonds
Buffetts management style is plain in his interactions with Borsheims Fine Jewelry, a warehouse-sized store near Omaha that Buffett bought on not much more than a whim in 1988. An apocryphal story is that Buffett walked into the store during the Christmas season to buy a ring and while there, a salesman called out to owner Ike Friedman, "Dont sell Warren the ring, sell him the store!"
Early in the new year Buffett called Friedman to ask if he was interested in selling. According to a retelling of the meeting in a book by Robert Miles, The Warren Buffett CEO: Secrets from Berkshire Hathaway Managers (John Wiley & Sons, 2003), Buffett asked Friedman five questions: "What are sales? What are gross profits? What are expenses? Whats in inventory? Are you willing to stay on?" Based on the answers, Buffett and Friedman shook hands on a deal the same day with no further examination.
Buffett later boasted in a letter to shareholders that Borsheims was bought without an audit, contradicting a most basic rule of corporate governance. He also says Borsheims performance has exceeded his expectations. A purchase price has never been disclosed.
Susan Jacques is now CEO of Borsheims, having started with the company as a $4-an-hour salesperson in 1983. While she agrees Buffett gives her free reign to run the store, she also says he keeps in close contact, sometimes talking to her by phone several times a week during the holiday season. Every January, Buffett gives her a letter with two or three things he wants her to focus on in the coming year, such as increasing sales of a product line like watches or improving Borsheims already low expense-to-sales ratio, which Jacques says is 20% of sales.
Other jewelry retailers spend 50% of sales on expenses. But Borsheims operates only one store, a 50,000-square -foot glittering showcase, and sells its necklaces and rings at bulk discount to other stores. Jacques and Buffett wont disclose Borsheims sales figures, although executives are proud to say only Tiffanys on Fifth Avenue in New York sells more. That store has annual sales of about $200 million.
Borsheim Chief Financial Officer Erin Limas doubles as chief technology officer, responsible for accounting systems, point-of-sale systems and Internet sales.
The company is frugal with technology, Limas says. In 1998, when deciding what e-commerce software to use, Limas did the first thing that came to mind: She called Microsoft Chairman Bill Gates. And he called back.
Buffett and Gates are friends; it was Gates who convinced Buffett to start using a personal computer so the two could play bridge over the Internet. Limas says she spent "no more than $50,000" on Microsofts Site Server 3 Commerce Edition Web software.
Until 2001, Borsheims had no electronic sales terminals or even cash registers on the sales floor. All sales were written up on paper slips then brought to a back room where up to six clerks would punch figures into a retail sales application from Application Systems Corp. (ASC), a Boston firm that makes software for the jewelry industry.
James Porte, president of the Jewelry Marketing Institute, an industry association, says Borsheims, and the jewelry industry as a whole, has been slow to adopt technology. As a result, they have missed out on cost savings and the ability to capture personal information about their customers.
Limas finally brought Borsheims into the modern world by purchasing 25 wireless laptop computers from Dell for the sales floor. Jacques went wireless so salespeople could follow customers around as they shopped and because she didnt want to lose any counter space to machines. She also wanted a unit with a keyboard so Borsheims could record the kind of personal information about clients, such as birthdays and anniversaries, which Porte says fosters loyalty.
The laptops now feed sales information directly into the ASC software and the information is backed up on a Hewlett-Packard AlphaServer. The data entry positions were cut, saving about $60,000 a year, although the clerks were redeployed elsewhere at the store. Borsheims uses accounting software from Great Plains, which Microsoft bought in December 2000.
While financials could be electronically sent to or accessed from Berkshire Hathaways head office, they arent. Instead, Limas has the data printed and delivered to headquarters, a few miles across town. Limas also compiles weekly sales reports to fax to Buffett. From Thanksgiving through Christmas, she faxes updates every day.
Nonelectronic Controls
NetJets, a Berkshire firm that sells fractional aircraft ownership to a clientele of millionaires, sports stars and Hollywood actors such as Arnold Schwarzenegger, is recognized as a technology leader. It recently spent $20 million to build a customer relationship management system that tracks the minutest details about its customers preferences and itineraries. When Buffett boards a plane, the system instructs attendants to have a Cherry Coke waiting by his seat.
But when its time for the $2 billion-a-year subsidiary to report its finances, there are no electronic links to the head office, says CIO Mike Midkiff.
Borsheims and NetJets financials are manually consolidated at Berkshires Omaha headquarters with the rest of the companys subsidiaries every quarter. Its an exhausting task for the 16-person staff. "Every quarter and year-end, my heart goes out to those guys, because theyre working all hours," Limas says.
That system amazes most outside observers. Bruce Nearon, a technology expert at the New York State Society of Certified Public Accountants, says a company of Berkshires size typically has sophisticated financial software consolidating results, such as a suite from enterprise software vendor SAP. Increasingly, he says, outside auditors are being provided with direct access to a companys electronic records so they can more thoroughly trace entries.
The nonelectronic controls over corporate reporting at Berkshire are balanced by a culture that sees only black and white when it comes to accounting. "There is zero tolerance for anything considered unethical or dishonest," Limas says.
"I dont feel any pressure to make up numbers. Besides, if the seasons not going well, Warren already knows that."
Jacques agreed: "Its not that I feel more pressure to be honest as a Berkshire CEO," she said. "We feel its a privilege to work for him and we would never endanger that trust."
Even companies that have adopted advanced financial reporting software arent convinced there are measurable returns for doing so.
Like Berkshire, Fluor Corp., a $10 billion engineering firm in Aliso Viejo, Calif., is known for being thrifty with technology. Fluor spends just 0.2% of its annual revenue on information systems, according to research firm Alinean.
Still, Fluor wanted a clear on-screen view of financial results for its entire North American operations and got it by installing SAPs enterprise software in 2001. Fluor also uses software from Comshare to consolidate financials from SAP with those of its international operations. To meet the CEO and CFO certification requirement of Sarbanes-Oxley, Fluor is installing Paisleys Risk Navigator package. It will map Fluors internal controls and processes, identify weaknesses and provide links to the underlying policies.
While the software provides Fluors senior management with some comfort that it is meeting the new requirements, Controller Victor Prechtl sees it as an added expense with few, if any, concrete benefits. "All of the infrastructure thats going out under Sarbanes-Oxley is going to be expensive to implement and the payback is difficult to evaluate," he says.
Technical Lessons
Many people look to Buffett for investment wisdom and management guidance. But those CEOs who recognize they arent divine in their oracular ability to see who is and who isnt honest to the core will have to supplement those ideas with technology—if they want to comply with new laws and avoid accounting trouble. For every Buffett management lesson, there generally is a technology backup.
Here is a look at some of the Buffetts management principles and whether information systems provide safeguards:
Good seeds turn bad. Buffett believes preventing corporate fraud has more to do with removing the pressures and temptations that can make executives compromise their integrity. However, that does not remove a latent motivation for economic crimes: greed. For that, fraud detection software and a skeptical auditor are required.
Business intelligence resides in individual brains. Buffett has demonstrated that he can manage a $42 billion empire with little more than a phone and fax machine. However,software that can analyze patterns, find impending risks and bring potential problems to the attention of decision-makers can spur faster action, as the General Re case demonstrates.
Technology is a tool, not an answer. Buffett says setting a good example is a better way to ensure legal compliance than is a sophisticated reporting system. Perhaps, but the recent record of financial fraud is leading to a regulatory and accounting environment where electronic records and tamper-proof audit trails are basic requirements.
No one is scandal-proof. In 1991, Buffett was dragged into a mess at brokerage firm Salomon Brothers, where a rogue trader attempted to corner the market in Treasury bills. The trader violated rules barring one firm from bidding for more than 35% of the securities offered at auction. Today, computer programming could have enforced the rules. But when Buffett agreed to become Salomons CEO, he went before Congress, apologized for the employees actions and issued this dictum to other Salomon staff: "Lose money for the firm and I will be understanding; lose a shred of reputation for the firm, and I will be ruthless."
Buffetts forthrightness was credited with saving the company. Therein lies Buffetts greatest lesson: Information systems may be able to detect fraud, once perpetrated, and help track down the culprits.
But managements actions in a crisis will ultimately determine if the company stays in business.
Berkshire Hathaway Base Case
Headquarters: 1440 Kiewit Plaza, Omaha, NE 68131
Business: A collection of companies in businesses as diverse as insurance, underwear, ice cream, bricks, jewelry, flight services and encyclopedias. More than half of revenue is from insurance.
Chairman and CEO: Warren Buffett
Chief information officer: No such position.
Financials in 2002: $42.4 billion in revenue; $4.3 billion profit; EPS $2,795.
Challenge: Buffett has built an empire buying good companies, with great management, at a fair price. Berkshire now must strike megadeals to make any sizable impact on earnings.
Baseline Goals:
Grow stock price 10% a year greater than the Standard & Poors 500.
Redeploy each dollar of retained earnings into a dollar of new business or investment.
Act as example for corporate America in executive compensation and accounting for financial results. Buffetts salary: $100,000 a year.
Give personal fortune of chairman (currently calculated at $30.5 billion) to charity, upon
The Berkshire Player Roster
Chairman and CEO, Berkshire Hathaway
Arguably the worlds greatest investor, Buffett comes off as a pretty ordinary guy. He lives in the same house he bought more than 40 years ago, wears plain and sometimes rumpled suits, and drinks Cherry Coke. In reality, the Omaha native has amassed a personal fortune estimated at $30.5 billion by Forbes. He is decidedly low-tech: He doesnt have a computer in his office and is reputed to not even use a calculator.
Charles Munger
Vice Chairman, Berkshire Hathaway
Like Buffett, Munger is a product of Omaha, and worked at Buffetts grandfathers store, Buffett & Son, in the 1950s. The two didnt become business partners until the mid-1970s, after Munger became a successful attorney. The straight man to Buffetts jokes, Munger is seen as the quiet but brilliant partner. Munger also is chairman of Wesco Financial, a Berkshire company, and a director of Costco Wholesale.
Marc Hamburg
Vice President, Treasurer, Berkshire Hathaway
Hamburg pulls the financials together from Berkshires 60-odd subsidiaries. That task is probably why he is Berkshires highest-paid employee, earning $462,500 in salary in 2002.
Walter Scott, Jr.
Chairman, Level 3 Communications
He was instrumental in convincing Buffett to give up his long-held aversion to technology companies and make a sizable investment in Level 3 Communications in 2002.
Rebecca Amick
Director of Internal Auditing, Berkshire Hathaway
Amick has been responsible for Berkshires internal auditing since 1996, and as such, has the monolithic task of making sure the companys dozens of subsidiaries meet new accounting rules.
Chairman, Microsoft
The two hit it off in 1991 and have since become good friends, bridge partners and even occasionally vacation together. When Gates proposed to his wife Melinda, he had his private jet detour to Omaha so he could pick out an engagement ring at Borsheims, a Berkshire subsidiary.
Malcolm Chace
Chairman, BankRI
One of the Berkshires longest-serving directors, Chace was an original member of the family that owned and operated the Berkshire Hathaway textile mills, purchased by Buffett in 1962.
Former Chairman, Capital Cities/ABC
Murphy was added to Berkshires board of directors in May primarily to satisfy rules of the New York Stock Exchange, which require companies to have a majority of independent directors. The two have been longtime friends.
Chairman, DMK
Like Murphy, Keough was added to the Berkshire board in May. He is a former president of Coca-Cola.
Buffett credits Graham, his instructor at Columbia Universitys business school, with planting the value-investing seeds that grew into the Berkshire empire. Grahams best-known doctrine was to look for "cigar butts"—companies that the stock market had discarded, but still had a few good "puffs" of value left in them. Graham died in 1976.
Contributing EditorMel Duvall is a veteran business and technology journalist, having written for a variety of daily newspapers and magazines for 17 years. Most recently he was the Business Commerce Editor for Interactive Week, and previously served as a senior business writer for The Financial Post.