Wednesday, May 2, 2012

More Trouble at Chesapeake

Reuters reported this morning that Chesapeake Energy CEO Aubrey McClendon and Chesapeake co-founder Tom Ward (now CEO of SandRidge Energy) operated a $200 million hedge fund from 2004 to 2008 that bet on commodities, including natural gas. (Reuters also broke the story about McClendon's $1.1 billion of loans associated with his 2.5% working interest in all CHK wells.) The linked article has more specifics, but the upshot is that it creates yet another ethical gray area for McClendon as he struggles to hold onto his CEO position at the company.  Yesterday the board separated the chairman and CEO jobs with McClendon keeping the CEO position. Pressure on the board will continue to mount with this news.

There are at least two issues of concern: 1) having the CEO personally trade in a commodity of which his company is a big producer can present a huge conflict of interest and 2) Chesapeake shareholders expect the CEO of the company to devote all of his business attention to CHK's business. Regarding #2, it should come as no surprise that McClendon has side ventures, including the Oklahoma Thunder NBA basketball team and a proposed high end (and highly controversial) development in Saugatuck Township, Michigan called Singapore Dunes.

While little has been verified about the story, it is yet another embarrassment for Chesapeake, which yesterday announced first quarter earnings below market expectations. Make no mistake, Chesapeake is McClendon's company:  he built it in his image, he is the undisputed (and sometimes micromanaging) leader and he hand-picked the board. But because he lost nearly all of his company shares to margin calls in 2008, so he only owns around 1% of the business.

Yesterday, I described the company as a cauldron of poor corporate governance, and at some point the board might be forced to take action to save the company. Gas prices are going to stay low and CHK is mostly naked (a.k.a. unhedged) and exposed, so don't expect any good earnings news to distract investors. I'm sure the ambulance chasing securities plaintiff lawyers are licking their chops right now. While McClendon is big buds with everyone on the board, at some point the board needs to consider its fiduciary obligations to shareholders. While everyone on the board knew about McClendon's side working interest deal (it was in his employment contract), I would wager that not everyone knew about the side hedge fund. If they were blindsided by this new information, they are likely to be quite angry and embarrassed.

In the meantime, I would expect open letters from the company and its counsel defending McClendon, stating that there was no conflict of interest and that the CEO never took his eye off the road to deal with this little side project.

But the question remains:  when will the pressure on the board grow too great to keep McClendon in the driver's seat? He may ride out this controversy, but I'm sure the board at least will put him on double secret probation.

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