Special Report: Inside Chesapeake, CEO ran $200 million hedge fund
NEW YORK |
(Reuters) - As chairman and CEO of Chesapeake Energy Corp, Aubrey McClendon has been a powerhouse in the vast U.S. natural gas market, directing the company's multibillion dollar energy-trading operation and setting output targets for America's second-largest producer.
Behind the scenes, a Reuters investigation has found, McClendon also ran a lucrative business on the side: a $200 million hedge fund that traded in the same commodities Chesapeake produces.
On Tuesday, two weeks after Reuters reported that McClendon has taken up to $1.1 billion in loans against his stakes in Chesapeake oil and gas wells, the company stripped McClendon of the chairmanship and reiterated that it's reviewing details of the loans. A statement quoted McClendon, who will stay on as CEO, saying that the move will enable him to focus his "full time and attention on execution of the company's strategy."
But for at least four years, from 2004 to 2008, McClendon's attention extended well beyond his job at Chesapeake.
During that time, said a veteran trader who helped run McClendon's private hedge fund, the Chesapeake executive engaged in "near daily" communications and "exhaustive" calls to help direct the fund's trading.
The fund, Heritage Management Company LLC, was started by McClendon and Chesapeake co-founder Tom Ward. The hedge fund listed Chesapeake's headquarters in Oklahoma City as its mailing address, documents show. Heritage's staff included an accountant who was simultaneously employed by Chesapeake. The fund also earned McClendon and Ward management fees and a cut of profits from outside investors.
There is no evidence that McClendon or Ward used inside knowledge gleaned from Chesapeake in their hedge fund trading. Neither the company nor McClendon would comment, and Ward said he saw nothing wrong with the arrangement.
But experts on energy trading, corporate governance and commodity-market regulation said they were stunned by the latest revelation.
"An executive's first responsibility is to shareholders and the betterment of their investment," said Carl Holland, who ran the trading-compliance department at former U.S. oil major Texaco. "Personal trading in the commodity around which the CEO's business is based would be a clear no. We would never have tolerated that, ever."
Thomas Mulholland, a risk-management consultant to oil and gas producers for Golden Energy Services in St Louis, said such matters are "taken very seriously by energy companies, and there are strict codes against it. Even if there is just a whiff of impropriety," he said, "it can be enough to lead to a termination."
The commodities markets are less regulated than equity markets, where corporate executives are prohibited from trading stock in their own companies based on undisclosed financial information. In commodities markets, insider trading isn't illegal unless price manipulation can be proven.
Nonetheless, personal dealing in energy markets is typically forbidden by oil and gas companies for a variety of reasons.
In Chesapeake's case, McClendon would have been aware of major decisions that could affect natural gas prices before that information became public. Accounting for 5 percent of U.S. natural gas production, Chesapeake holds tremendous sway over markets. On January 23, the company announced sharp output curbs in response to low prices. In response, U.S. natural gas futuressurged by 8 percent the same day.
"If the company needs to make an operating decision which might move the market against the CEO's positions, there's a risk that will influence the decision-making at the top of the company," said Jeff Harris, former chief economist at the market's U.S. regulator, the Commodity Futures Trading Commission, and now professor of finance at Syracuse University.
Another potential problem is known as "front-running." That's when a trader buys or sells a commodity in advance of a client's or his company's orders. In theory, McClendon's first-hand knowledge of Chesapeake's own plans to trade would enable him to profit by trading ahead of Chesapeake - a move that could raise costs for the company.
"Advance knowledge of Chesapeake's activities could be perceived as having insight into the movement of commodities prices, which certainly raises conflict-of-interest issues as well as ethical issues about the ability to enrich himself on non-public information," said Tim Rezvan, oil and gas industry analyst at Sterne Agee in New York.
"If correct," Rezvan said, "these disclosures would be even more alarming than the personal loans."
A securities law professor said the very existence of the hedge fund could prompt a securities investigation.
"I would argue, and I think the SEC would argue, that the failure to disclose that you are engaging in this kind of conduct can constitute a securities fraud problem," said Elizabeth Nowicki, a professor at Tulane University. She said a failure by McClendon and Ward to disclose their fund to Chesapeake's shareholders may constitute a "material omission" that could draw SEC scrutiny.
"A reasonable investor would want to know that the CEO could be in a situation where he's betting against the interests of the company personally," Nowicki said. "That, it seems to me, is a slam dunk."
An SEC spokesman declined to comment.
It remains unclear whether McClendon received permission from Chesapeake's board to run a hedge fund and actively trade in the commodities markets for himself, or whether his trading continues. Chesapeake and McClendon's personal spokesman declined to comment.
Chesapeake also declined to say whether employees would be prohibited from operating such a hedge fund or trading their own cash in oil and gas markets. The issue isn't clearly addressed in a code of ethics published on Chesapeake's website.
Two Chesapeake board members contacted by Reuters declined comment. "Given litigation, we are constrained in what we can say," said Chesapeake spokesman Michael Kehs, who was referring to shareholder lawsuits filed in the wake of the Reuters report on McClendon's personal loans.
Oil and gas markets are secretive, and trading positions are almost never made public. McClendon's hedge fund partner Ward said the two were always careful not to let Chesapeake's decisions influence the hedge fund's endeavors.
Ward, who continues to trade his own personal cash in commodity markets and is now CEO of oil and natural gas driller SandRidge Energy, said he doesn't know whether Chesapeake's board knew of the hedge fund he ran with McClendon. But he said he sees "no conflict of interest."
"We did not use any proprietary knowledge of (Chesapeake) trades to make our own individual decisions," Ward said.
Peter Cirino, who helped trade natural gas for the hedge fund, also said he knew of no discussions about what Chesapeake was doing in energy markets: "They were much too smart as individuals," Cirino said of McClendon and Ward. "They would be able to manage that conflict there, if there was one."
Today, McClendon leads the three-man team that oversees Chesapeake's trading in oil and gas for the purposes of hedging, or offsetting the risk of unfavorable price swings. When Reuters asked McClendon last year whether he traded for himself in energy markets, McClendon said: "No, no, no. I'm part of Chesapeake's hedging committee."
That committee has helped Chesapeake "lock in" high prices for the gas it sells. This year, the company has not hedged. It told investors in a presentation that it doesn't expect natural gas prices - near 10-year lows - to continue falling.
The company's own trading has been a big success. "The bottom line is that Chesapeake has delivered $8.4 billion in realized hedging gains to shareholders since 2006," said Kehs, the company spokesman. "That's extraordinary shareholder value added through innovation and by far the best record in the oil and gas industry."
After Reuters disclosed McClendon's $1.1 billion in loans, Standard & Poor's cut Chesapeake's debt rating, citing "shortcomings" in corporate governance. The SEC and the Internal Revenue Service have begun probes in the wake of the loans report.
Chesapeake shares rose more than 7 percent on Tuesday on the news that McClendon is being replaced as chairman. After the stock market closed, the company reported a first-quarter net loss of $71 million. Its shares fell 5 percent in after-hours trading and are down almost 20 percent this year.
BIRTH OF HERITAGE
A search of Chesapeake's public filings turned up no disclosure of McClendon's hedge fund, Heritage.
Reuters traced its roots to Delaware, where it was registered in 2004 by Corporation Trust Company, a firm that helps companies incorporate. Another filing in New York, where Heritage employees executed many of the fund's trades, lists its mailing address as Chesapeake headquarters in Oklahoma.
A Heritage telephone number listed in several business directories was answered "Chesapeake Energy" by a person who said she hadn't heard of the fund. The fund is also listed in a database compiled by the National Futures Association, which doesn't disclose its owners.
Heritage also shared at least one employee with Chesapeake: John D. Garrison. Garrison, an accountant listed as executive business manager for Chesapeake Energy in federal election campaign donation filings and as a Chesapeake employee since 2004, handled the hedge fund's bookkeeping, Cirino said. The arrangement is not illegal.
Business directories including Dun & Bradstreet also list Garrison as Heritage's chief financial officer. Garrison declined to comment when a reporter visited his home near Oklahoma City.
Heritage was born when commodity trader Cirino and four other traders went searching for capital to start a hedge fund, Cirino said. Through industry contacts, they landed a coveted audience with McClendon and Ward, already famed Oklahoma drillers before becoming pioneers of the shale-gas boom.
The Chesapeake founders, Cirino recalled, agreed to seed the fund with a total of $40 million of their own cash. But McClendon and Ward insisted on full ownership and involvement in the fund's trading strategy, Cirino said.
"They took a leap of faith to invest money in us, so we knew we were on the line," said Cirino, Heritage's former head trader and risk officer. "That they were in charge was made very clear."
The fund's trading wasn't limited to energy markets. It bet on a variety of goods, from natural gas to cocoa and coffee. It even had a cattle trader in Oklahoma.
As Heritage racked up stellar returns of between 15 to 25 percent a year, McClendon and Ward decided to open the hedge fund to outside investors, including friends and associates, Cirino said. When Ward left Chesapeake in 2006, he retained his stake in the fund.
By 2007, Heritage was managing around $200 million, Cirino said. That enabled Ward and McClendon to profit in another way: by charging outside investors a management fee equal to 2 percent of assets and pocketing 20 percent of the fund's profits. It's a typical structure in the hedge fund industry, known as "2 and 20."
Cirino and Ward's recollections differ on at least one point. Ward said he didn't interact with the fund's outside investors. Cirino recalled that "every investor I was involved with either met with McClendon and Ward or at least spoke with them by phone before investing." The hedge fund's healthy gains were a lure, but "the cachet of those two individuals certainly also helped," Cirino said.
In addition to weekly Monday conference calls and regular emails, the two owners met frequently with traders in New York and occasionally in Oklahoma, Cirino said.
In 2007, as the price of natural resources surged on booming demand from China and other fast-developing countries, commodity traders with a successful track record were popular on Wall Street. After three years of double-digit returns, the fund's traders told McClendon and Ward they wanted an equity stake, Cirino said.
But the executives weren't ready to cede control, Cirino said, and the traders left to open their own shop, Perennial Capital LLC, a $200 million fund that has no financial ties to McClendon or Ward. Cirino said the departure was amicable.
At Heritage, all of the money from external investors was returned by 2008, Cirino said. McClendon and Ward continued to operate the fund during that year, Ward said, but by 2009, Heritage traded no more.
What happened next to McClendon's commodity-trading ventures is unclear.
By June 2008 - as natural gas and oil prices were peaking, and just before the financial crisis - McClendon and Ward both held huge positions in natural-gas derivatives, according to confidential trading data disclosed last year by U.S. Senator Bernie Sanders, an independent from Vermont.
The trading information was assembled as part of a CFTC inquiry into derivatives markets and their impact on real-world energy prices. McClendon and Ward were among only a handful of individual investors identified by the CFTC. Most of the other players were big corporations.
The data indicated McClendon and Ward were betting that the rally of 2008 would continue. By purchasing derivatives, they controlled nearly identical positions in natural gas worth around $2.3 billion apiece, according to Reuters calculations based on closing futures prices as of June 30, 2008. McClendon held oil contracts worth another $240 million, the CFTC data showed.
Of 300 banks, hedge funds, energy companies and other traders identified in the CFTC survey, only four held larger bullish bets in natural gas.
Oil fell by more than 75 percent between July and December. Natural gas futures dropped almost 60 percent.
It isn't clear how McClendon and Ward's investments fared. McClendon would not discuss his trading. Ward said he could not recall the outcome of his own trades in 2008.
McClendon suffered a well-documented personal cash crunch later that year, however.
In early 2008 McClendon held a big position in Chesapeake stock purchased with borrowed money. Later that year, margin calls from his brokers forced McClendon to unload more than 90 percent of his Chesapeake shares and suffer a $2 billion paper loss. His selling contributed to an 88 percent fall in Chesapeake's share price from its all-time high of $74 that year. Chesapeake has since restricted "leveraged" trading in the company's shares by its executives.
Months later, McClendon became one of the highest paid CEOs in America for the year, receiving a total compensation package worth $112 million. The payout included a one-time cash bonus of $75 million to help him meet requirements for paying the costs of his personal stakes in Chesapeake-owned wells.
(Additional reporting by Sarah N. Lynch, Brian Grow, Anna Driver and Roberta Rampton. Editing by Blake Morrison and Jonathan Leff.)
What follows are the prior stories from Reuters in lead up to the story above.
Exclusive:By Brian Grow and Anna Driver
board member lent money to CEO
(Reuters) - As Chesapeake Energy Corp.'s board of directors moves to distance itself from loans taken by CEO Aubrey McClendon, documents reviewed by Reuters show that at least one former board member had undisclosed personal financial ties to him in the past.
Now-retired board member Frederick Whittemore lent money to McClendon in the late 1990s, the documents show, even as Whittemore helped determine how much the CEO should be paid to run
This week, the energy giant reversed an earlier statement that its board was "fully aware" of up to $1.1 billion in personal loans that McClendon has taken in the last three years. "The board of directors did not review, approve or have knowledge of the specific transactions engaged in by Mr. McClendon or the terms of those transactions," the company said.
In June 1998, documents filed in
Whittemore, now 81, did not respond to messages left at his office and home.
Ron Hutcheson, McClendon's personal spokesman, acknowledged the existence of the loan but said the deal between Whittemore and McClendon ended in March 1999. He did not say whether the debt was repaid.
Provided with a copy of the financing documents and asked for comment, former
Although nearly 14 years old, the McClendon-Whittemore deal raises a number of concerns, some analysts said. Among them: whether a board member who helps determine McClendon's salary should have a separate, private financial relationship with the CEO he oversees.
"For an independent board member on the compensation and corporate governance committees to be doing a deal with the CEO, that's something that would be inappropriate governance and that should be disclosed," said David Larcker, a corporate governance specialist and professor of accounting at the Stanford University Graduate School of Business.
Whittemore, who worked for more than 20 years at Wall Street giant Morgan Stanley and its predecessors, was chairman of the American Stock Exchange from 1982 to 1984, according to a biography compiled by Forbes.
Because the underlying loan agreement is private, the total value and precise terms of the financing agreement between McClendon and Whittemore remain unclear. The documents reviewed by Reuters refer to a "Security Agreement dated effective
A summary of the collateral pledged by McClendon shows he granted Whittemore all "right, title and interest" in a company called Chesapeake Investments LP. That firm was established and run by McClendon. It was regularly used to hold stakes McClendon acquired in each new oil or gas well drilled by
The well investment program is a unique perk that
Given the dearth of details on the loan, some analysts weren't certain what to make of the arrangement.
"On this specific issue, it's difficult to say whether there is a conflict - unethical or even questionable - from my viewpoint, unless you knew what assets were underlying the debt obligation," said Raymond Deacon, a managing director at investment bank Brean, Murray, Carret & Co in Boston. "If (McClendon) was using company assets as collateral or interests in his ownership of wells, I think there is a clear conflict and it should have been disclosed."
The moves come in the wake of a Reuters investigation last week that showed McClendon has borrowed as much as $1.1 billion in the last three years to fund the costs of well stakes granted to him by
Investors and analysts have criticized
(Editing by Blake Morrison and Michael Williams)
UPDATE 9-US SEC starts probe of Chesapeake CEO's well stakes
Apr 26 2012
* Company says board never reviewed McClendon loans
* Program to give CEO well stakes to end in 2015
* S&P lowers its credit rating
* Shares close Thursday down 3.1 pct
By Ernest Scheyder and Brian Grow
NEW YORK, April 26 (Reuters) - The U.S. Securities and Exchange Commission has opened an informal inquiry into Chesapeake Energy Corp's controversial program that granted Chief Executive Aubrey McClendon a share in each of the natural gas producer's wells, a source familiar with the matter said on Thursday.
That inquiry, being led by the SEC's office in
The company said in a statement earlier on Thursday that its directors had never reviewed or approved McClendon's mortgages on stakes in those wells, reversing its prior assertions that its board of directors was "fully aware" of McClendon's financing transactions around the well ownership stakes.
"The board of directors did not review, approve or have knowledge of the specific transactions engaged in by Mr. McClendon or the terms of those transactions," the company said.
Ratings agency Standard & Poor's said on Thursday the turmoil surrounding the well ownership program and McClendon's personal transactions could hamper the company's ability to meet "massive external funding requirements stemming from its currently weak operating cash flow."
S&P lowered its credit rating for
The company's recently issued 6.775 percent note due
Reuters reported on April 18 that McClendon, who founded the company, had borrowed as much as $1.1 billion i n the last three years a gainst his ownership stakes in wells that he received under the company's "Founder Well Participation Program."
The majority of the borrowing came from an investment management firm that is also a major financier of
On Thursday, McClendon disclosed that as of the end of 2011, he owed $846 million on loans taken out against his well stakes. But the company did not disclose the total amount McClendon has borrowed, or whether his outstanding debt has risen since the end of last year.
The loans had been previously undisclosed to shareholders, analysts and academics said, raising concerns that McClendon's personal financial deals could compromise his fiduciary duty to
An informal inquiry is the first step taken by the SEC before it launches any full investigation into potential wrongdoing by a company.
One major shareholder questioned whether the company's new statements had been prompted by the SEC probe.
"It seems somewhat coincidental that the board has acted this way today, and the SEC announces its inquiry. You wonder if they didn't have the news," said David Dreman, chairman of Dreman Value Management LLP, which owns about 1 million
'FULLY' VS 'GENERALLY'
Critics of the company have long complained the company's board acted a little more than a rubber stamp for McClendon, one of the energy industry's most visible leaders.
Chesapeake said "the statement last week that 'the Board of Directors is fully aware of the existence of Mr. McClendon's financing transactions' was intended to convey the fact that the Board of Directors is generally aware" that McClendon had used the well ownership stakes as security for the loans.
One analyst said
"How can this make me more comfortable?" said Phil Weiss, an analyst with Argus Research. "Either you're fully aware, or you're not. 'Fully' and 'generally' are two entirely different words."
"All of this is a work in progress," Frank Keating, a
But an investor said the move was a step in the right direction, and that it showed the company was listening to shareholders' complaints.
"It's basic due diligence that sadly wasn't being done before," said Jake Dollarhide, chief executive of Longbow Asset Management in
McClendon disclosed additional information about his ownership stakes in the wells, and the board is reviewing the CEO's financing arrangements.
The CEO listed his share of
The Oklahoma City, Oklahoma-based company has been at the leading edge of the shale gas industry and holds vast acreage in the fields discovered in recent years that are expected to yield decades of fuel for the
But the steep jump in natural gas output has sent prices for the fuel plummeting to their lowest level in decade, squeezing profits and pressuring share prices for
Debt rating firm Fitch Ratings said on Thursday it had revised its outlook to "stable" from "positive" for Chesapeake, which has $13 billion in rated securities, largely because of the low natural gas prices.
Exclusive: CEO's sales of
well stakes raise questions at
(Reuters) - Chesapeake Energy Corp's chief executive came under fire last week after Reuters reported that he used his stakes in company wells to take out as much as $1.1 billion in personal loans.
Now, Reuters has found, CEO Aubrey K. McClendon has employed another way to cash in on a perk unique to the company he runs: He sold his share of two large energy plays at the same time the company divested its interest.
Analysts say the deals, which generated $6.5 billion in proceeds, pose a potential conflict because of the possibility that they could have been timed and structured to suit McClendon's personal interests, rather than those of the company he runs.
"I can imagine a scenario where Aubrey is suffering some financial distress and might want to get a deal done - and it's not the best price for the company," said Joseph D. Allman, oil and gas industry analyst at JPMorgan in
McClendon's deals stem from his involvement in an incentive, unique to
Reuters reported last week that McClendon had used his stakes in thousands of
In the two asset sale deals, one in 2011 in
The precise amounts earned by McClendon on those deals remain unclear. That's because
After Reuters asked
"From time to time, Mr. McClendon has sold (well plan) interests separately and concurrent with sales by the Company of its interests in the same properties," the company wrote. "(During 2011, Mr. McClendon advises that he realized $ million from such sales, net of his $ million share of deal costs. According to Mr. McClendon, his net investment in these properties was $ , including lease costs and well costs paid to the Company, less revenues paid by the Company.)"
The company's proxies have also mentioned a third way in which McClendon has monetized his well interests: He has sold future oil and gas production from his share of
The sales of future energy production by McClendon prompted one analyst to say he believed such deals were a new risk for conflict of interest.
"If the CEO entered into a (volumetric production payment) for well interests, Chesapeake would not be able to shut in the well due to poor economics (i.e., $1.90 natural gas) without compromising the CEO's VPP transaction," said Tim Rezvan, an oil and gas industry analyst with Sterne Agee, who had downgraded Chesapeake shares last week on news of McClendon's loans. "It could present a conflict of interest between CEO Aubrey McClendon and VPP participant Aubrey McClendon."
In August, Reuters was first to report on another opaque personal transaction: how McClendon cashes in on the well plan by selling his share of the oil and gas alongside the company.
The one deal previously disclosed by
The filing said McClendon and his affiliates received the same deal terms as
The other deal - in which
In response to questions from Reuters in August, a company spokesman said that "similar to the BHP transaction, Mr. McClendon and
McClendon has elected to take a 2.5 percent interest in
In its proxy statements,
More pay days from well sales may be in the pipeline for McClendon.
A prospectus seen by Reuters shows that
A projected price for the sale could not be determined. The deal, which was expected to close in December 2011, has not been completed. Harrison Williams, an Albrecht executive named in the prospectus, did not return a call seeking comment.
Because McClendon is selling his personal well interests controlled by his own companies, he effectively becomes an additional - and potentially competing - participant in
"If your CEO is no longer a partner, but a third party, it can introduce all sorts of problems," said Charles Elson, a corporate governance expert and professor of law at the
(Reporting by Brian Grow and Anna Driver; editing by Michael Williams and Blake Morrison)
Special Report: Chesapeake CEO took $1.1 billion in shrouded personal loans
(Reuters) - Aubrey K. McClendon is one of the most successful energy entrepreneurs of recent decades. But he hasn't always proved popular with shareholders of the company he co-founded, Chesapeake Energy Corp., the second-largest natural gas producer in the
McClendon, 52, helped cause
His approach to running his company also is renowned: Among other employee perks, on-site Botox treatments are available at its headquarters in
Now, a series of previously undisclosed loans to McClendon could once again put
McClendon has borrowed as much as $1.1 billion in the last three years by pledging his stake in the company's oil and natural gas wells as collateral, documents reviewed by Reuters show.
The loans were made through three companies controlled by McClendon that list
The size and nature of the loans raise concerns about whether McClendon's personal financial deals could compromise his fiduciary duty to
"If Mr. McClendon has $1 billion in debt through his own companies — companies operating in the same industry as
The revelation of McClendon's bout of borrowing comes as he is scrambling to help
It also exposes a potentially serious gap in how
The loans portend a number of possible problems, the analysts said. McClendon's biggest lender is simultaneously a major investor in two units of
Another concern: A clause in the deals requires McClendon "to take all commercially reasonable action" to ensure that other owners and operators of the wells - including Chesapeake - "comply with…covenants and agreements" of the loans. Such clauses are common in energy-finance deals. But it is rare for the CEO of a major energy company to be personally subject to one involving the corporation that he runs. That means McClendon could have an incentive to influence
"Basically what you have here is a private transaction that could potentially impact a public company, depending on the manner in which the clause is interpreted and applied," says Thomas O. Gorman, a partner at law firm Dorsey & Whitney in Washington, D.C., and a former special trial counsel at the Securities and Exchange Commission (SEC). "That may create a conflict of interest."
As a result, the loans should have been fully disclosed to
Both McClendon and
"I do not believe this is material to
Neither the existence of McClendon's loans nor their terms create the possibility of a conflict of interest, Hood said, in part because the company has a first lien on McClendon's share of company wells. That would mean
"Any loans are Mr. McClendon's personal business and not appropriate for review or monitoring by the company or public comment," Hood said.
The company has many checks to protect against conflicts, Hood said. Among them: Some of the world's largest energy companies own a share of
He added that
Less than four years ago, a personal transaction by McClendon did negatively influence the company.
To buy more
WELL INVESTMENT PLAN
The loans reveal how McClendon is using an unusual corporate incentive as collateral. The perk, known as the Founder Well Participation Plan, grants Chesapeake's billionaire co-founder a 2.5 percent stake in the profits - and makes him pay 2.5 percent of the costs - of every well drilled during each year he decides to participate.
The well plan does not allow McClendon to select the wells in which to invest;
"He has to eat his own cooking here," said company spokesman Michael Kehs.
But because McClendon is using the loans to finance his participation in the well plan, he defrays his risks. Two of McClendon's lenders, both private equity firms, in turn spread the loan risks to other investors by raising money from state pension funds and other investors to fund them. Those insights emerge from a February 2011 document detailing a meeting between McClendon's largest personal lender and a prospective investor.
"If he hasn't had to put up any of his own money, how is that alignment" of McClendon and
"We believe the disclosures made by the company have been appropriate under the circumstances, particularly since the disclosure of the loans is not required in any event," Hood said in a statement.
THROUGH THE CRACKS
Legal experts say the size and terms of McClendon's borrowing are unusual - and highlight a gap in regulatory scrutiny of American corporate executives.
In the past, major Wall Street banks formed separate companies - or special purpose vehicles, just as McClendon has - to allow select employees to borrow from the employer and make investments. The WorldCom accounting scandal was, in part, fueled by more than $1 billion in loans taken out by former chief executive Bernard Ebbers that were secured by his shares of company stock. And energy giant Enron used off-balance-sheet entities to hide debt from investors. New accounting and corporate governance laws and regulations banned such transactions or required their disclosure.
In September 2006, the SEC revised its related-party transaction rules to require companies to disclose when executives pledged corporate stock as collateral for loans. "These circumstances have the potential to influence management's performance and decisions," the SEC wrote.
McClendon's loans - backed not by stock but by stakes in company wells - aren't covered by the SEC rule. "Because they have decided to compensate him with a business interest, it kind of falls through the cracks," says Francine McKenna, an accounting expert and author of the accounting-related blog re: The Auditors.
As a result, no SEC regulation precludes McClendon from using his well plan stake as loan collateral. The SEC declined to comment on the McClendon loans.
Tall and thin, McClendon is a tireless booster for the oil and gas industry - and of his company. At an energy conference in November in
During one speech last September, McClendon said opponents of a controversial drilling technique called hydraulic fracturing were interested in "turning the clock back to the Dark Ages."
"What a great vision of the future!" he said sarcastically. "We're cold, it's dark, and we're hungry!"
McClendon's investor presentations are standing-room-only. But he often bristles when his business model is questioned by analysts, frequently arguing that Wall Street does not understand the company.
That tension has intensified as
McClendon continues to treat his employees well. In recent years, he built a 50-acre red-brick campus in
A part owner of the NBA's Oklahoma City Thunder and supporter of charitable causes in the state capital, McClendon holds considerable sway in
McClendon's close relationship with the board hasn't left him immune to tensions with stockholders.
The well participation plan, which was approved by shareholders in 2005 and cannot be discontinued until 2015, has remained unaffected.
Disgruntled investors continue to launch challenges. On March 13, New York Comptroller John C. Liu and the $113 billion New York Pension Funds called on
Key aspects of McClendon's loans remain hidden from shareholders. Because promissory notes underpinning the loan agreements are private, the interest rate, the exact amount borrowed and other terms of the transactions are not publicly known.
But the loan agreements demonstrate the extent to which McClendon has leveraged his interests: He has pledged as collateral almost every asset associated with his share of
The company also said that McClendon's share of "related assets" pledged as collateral - such as business data and hedging contracts associated with wells - is completely separate from similar assets owned by
In explaining why
Given the size, scope and complicated terms of the loans, their particulars constitute important stockholder information and therefore should be more fully disclosed, said David F. Larcker, a professor of accounting at
Some shareholders agree. "While recognizing (McClendon's) right to privacy, the more information the company releases to shareholders the better - particularly when it's such a large amount of money and related to the oil and gas business," said Mike Breard, oil and gas research analyst at Hodges Capital Management in
As with a mortgage on a residential home, state law requires that ownership rights to physical property be recorded with county clerks.
Reuters found McClendon's loan agreements by following the trail of well and land lease transfers from
In county courts in
Since he co-founded
But in the last three years, the terms and size of the loans have changed substantially. During that period, he has borrowed as much as $1.1 billion - an amount that coincidentally matches Forbes magazine's estimate of McClendon's net worth.
The $1.1 billion in loans during the past three years breaks down this way:
In June 2009, McClendon agreed to borrow up to $225 million from Union Bank, a
In December 2010, he borrowed $375 million from TCW Asset Management, a private equity firm.
And in January 2012, McClendon borrowed $500 million from a unit of EIG Global Energy Partners, a private equity firm formed by former TCW executives.
It is unclear how much, if any, of those loans have been repaid.
Randall Osterberg, a senior vice president at Union Bank who signed the loan agreement, declined to comment. TCW and EIG also declined to respond to questions.
At first blush, what the company tells shareholders suggests the well plan is a money-loser for McClendon.
In its proxy statements,
It's unclear whether McClendon has suffered any real losses, however. Asked about the calculations, Hood said McClendon's net loss is a byproduct of his drilling costs being "front end loaded," while his revenues accrue over many years.
"If they are showing that kind of negative cash flow, the wells don't have value," said Phil Weiss, oil analyst at Argus Research who has a sell rating on the company's shares. But given that McClendon has borrowed more than $1 billion based on the value of his well stakes, "I really don't think (the company's disclosures) tell me much," Weiss said.
From May to October that year,
A spokesman for the SEC declined to comment.
McClendon's biggest personal lender, EIG, has been a big financer for
On April 9, the company announced a nearly identical deal to raise another $1.25 billion from EIG and other investors, in another new subsidiary called CHK Cleveland Tonkawa.
Dividends on preferred shares are controversial because they are paid before regular dividends owed to common shareholders. "Basically it's a form of more expensive debt," Morningstar's Hanson said. "It makes it appear that it's not debt, but it sits on top of obligations to the common shareholder."
The fact that McClendon's largest personal lender received favorable terms on its
"I think the company should disclose this information. One reason is that the CEO is taking out loans from at least one entity, EIG, which recently provided financing to Chesapeake," said Joseph Allman, oil and gas industry analyst at JPMorgan in New York, who reviewed the loan agreements. "In the same way that investors want to know the counterparty to significant
CLOSING A GAP
McClendon's personal loans highlight a gap in current SEC rules governing disclosures of related-party transactions, say accounting experts. The SEC requires disclosure of any transaction over $120,000 involving a company and a related party, such as the CEO, directors and certain family members, "with direct or indirect material interest."
That disclosure gap may be closing. A proposed new standard, released for public comment by the Public Company Accounting Oversight Board on February 28, would require auditors to identify and evaluate "significant unusual transactions" with executives connected to publicly traded firms. The board defined such transactions as those "outside the normal course of business or that otherwise appear to be unusual due to their timing, size or nature."
Board chairman James R. Doty described the proposal as a way to scrutinize transactions that have played "a recurring role in financial failures." The oversight board declined to comment on McClendon's loans.
For now, said analyst Weiss,
(Reporting by Anna Driver in Houston and Brian Grow in Atlanta; additional reporting by Joshua Schneyer in New York; editing by Blake Morrison and Michael Williams)