Moody's Weighs In on Sokol, Cites Succession Risk

 This just in -- Moody's cites Sokol resignation as a risk to Berkshire because of "governance challenges that may impact credit quality." There are several issues on the table whether specifically raised by Moody's or not:

> Recent events have been a huge embarrassment to Berkshire, exposing the need for more stringent vetting and oversight of possible CEO candidates.

> Berkshire/Buffett do not have a clear successor. This throws the company's future leadership and capital allocation into doubt at a critical time.

> Berkshire's "informal" style of risk management, essentially handled by one person, Buffett, without a general counsel or other corporate staff, is being questioned by Moody's. It has always been clear that after Buffett, Berkshire was going to have to transition to a more conventional internal control structure. What Moody's comment suggests is that external demands may prompt this to happen sooner, which will tie up time, attention, and resources. Simple examples: right now senior management does not have to report their stock trades to Berkshire; likewise there is no system in place to review them. This is likely to change. There undoubtedly will be a look at whether Berkshire's procedures to enforce other aspects of its Code of Conduct are adequate -- it is clear that Sokol violated the Code of Conduct. If an inquiry had not been made of him about the Lubrizol stock in connection with the SEC filing, he (apparently) would never have reported it.

> The succession process is informal and nontransparent, because it is designed to keep Buffett's options open. While this goal is understandable, the result has been murky guesswork and hints about candidates whose qualifications are mostly unknown. The process needs more rigor and transparency.

> (Assuming they're sane) managements of companies that are selling themselves to Berkshire must be negotiating with Buffett about who will run the company after he is gone. These discussions (may) have been casual before the Sokol departure, but will probably be a lot less casual now. This means that succession actually becomes an operational challenge for Berkshire, not just a governance issue.

> Likewise, if Berkshire has made deals with companies that it has acquired to the effect that such-and-such person will become CEO or that some other person will not, it becomes problematic if this were to conflict with what is being represented to shareholders (that there are four candidates, etc.) Thus, there may be additional issues  that go beyond simple transparency with how to frame disclosures and whether current disclosures are enough.

> It is unclear whether the board is actually in charge of governance when it comes to succession. (For example, nearly all of the board apparently met Todd Combs for the first time after he was hired.) While many investors take for granted that Buffett, as the largest voting shareholder, has the right to make this pick, the board as a whole is the actual fiduciary and it has the legal responsibility. The board ultimately will be held accountable and it needs to take charge.