Exclusive: After McClendon’s trades, Chesapeake board gave blessing By Joshua Schneyer and Jeanine Prezioso Posted 2012/05/08 at 6:08 am EDT NEW YORK, May 8, 2012 (Reuters) In its latest employment contract with CEO Aubrey McClendon,Chesapeake Energy Corp gave him permission to trade commodities forhimself after he already had begun doing so. Giving the CEO explicit license to play the markets represented anextraordinary incentive that enhanced one of corporate America’smost generous compensation plans and reinforced the uniquetreatment afforded to McClendon by Chesapeake. Oil and gas producers say they typically prohibit such trading byexecutives because of the potential for conflicts of interest.Indeed, Reuters found that McClendon, 52, was granted greaterleeway to participate in external ventures than were his toplieutenants. The 2009 contract did, however, limit McClendon in at least oneway: Months after his personal hedge fund shut down, the agreementexplicitly banned McClendon from taking an active role in any hedgefund.
The contract raises new questions about what Chesapeake boardmembers knew of McClendon’s personal investments, and whether hisdealings might be at odds with his fiduciary responsibilities ashead of the second-largest natural gas producer in the UnitedStates. It isn’t clear why Chesapeake changed the contract. Two boardmembers declined to comment, and Chesapeake spokesman Michael Kehssaid only that McClendon’s employment contracts “fall under boardreview.” Through a personal spokesman, McClendon also declined tocomment. Some lawyers and commodity-trading analysts said they were troubledby provisions in McClendon’s agreements with the company.
At aminimum, they said, McClendon could be distracted from his job atChesapeake by his outside business activities. They also said McClendon could have used privileged Chesapeakeinformation to advance his own trading. “This is edge-of-the-universe contract language,” said Saul Cohen,a retired securities lawyer who formerly served as general counselat investment bank Lehman Brothers. Last week, Chesapeake’s board stripped McClendon of hischairmanship after Reuters reported that he had taken $1.1 billionin personal loans against his stakes in Chesapeake wells during thepast three years. Desiccant Rotor Dehumidifier
The loans, which came mostly from aninvestment-management company that also did business withChesapeake, hadn’t been disclosed to shareholders. The Securitiesand Exchange Commission and the Internal Revenue Service havelaunched inquiries. Reuters subsequently reported that McClendon partially owned andhelped run a $200 million private hedge fund from withinChesapeake’s Oklahoma headquarters. The fund, Heritage ManagementCompany LLC, operated between 2004 and 2008 and traded McClendon’sown cash in markets including natural gas and oil, the samecommodities that Chesapeake produces. On Friday, Senator Bill Nelson, a Democrat from Florida, asked U.S.Attorney General Eric Holder to investigate McClendon’s privatecommodity trading for potential fraud, insider trading or commodityprice manipulation. Portable Desiccant Dehumidifier
HEDGE FUND RESTRICTION The 2009 contract, which extends for five years, is McClendon’sfirst to include a specific mention of hedge funds or commoditymarket investments, part of a new sub-section governing the typesof investments he could pursue. It says McClendon is allowed to trade a range of financialinstruments such as commodities – including “short positions, longpositions or positions in options” in both futures andover-the-counter markets. It also states that McClendon could put cash into a “passiveinvestment entity,” including a hedge fund, provided it “does notactively engage in (exploration and production) activities,” and”for which the Executive does not directly or indirectly provideinput, advice or management.” Why Chesapeake made the changes remains unclear. The revisionscould indicate they were aware of McClendon’s personal hedge fundand worried that such a side business might run afoul ofshareholders, according to legal experts who reviewed McClendon’scurrent and prior contracts. The former head trader at the Heritage hedge fund, Peter Cirino,said McClendon and Chesapeake co-founder Tom Ward spent significantamounts of time managing Heritage between 2004 and 2008. Low Temperature Dehumidifier Manufacturer
That oftenincluded daily communications between McClendon and Heritagetraders, weekly strategy calls that could be “exhaustive,” frequentmeetings with traders in New York and occasionally in Oklahoma, andmeetings or calls between McClendon and investors, Cirino said. Chesapeake’s board hasn’t said whether it knew about Heritage orwhether it vetted the hedge fund’s trading for any conflicts. Wardsaid he couldn’t recall whether the fund was disclosed. Even thoughthe company still allows McClendon to trade in commodities, the2009 agreement does signal that it was tightening its grip to somedegree. “In 2004, they had a contract that was not nearly as long, notnearly as precise,” said John Coffee, a contract law professor atColumbia University.
“It looks like the board learned somethingover the years and was increasingly beginning to restrict hisactivities,” Coffee said of McClendon. TRAIL OF REVISIONS Reuters reviewed McClendon’s employment contracts with Chesapeake,filed with securities regulators, since 1997. In that time, thecontracts have been revised or amended about a dozen times, for avariety of reasons. Some of the revisions relate to the controversial Founders WellParticipation Program, which allowed McClendon to buy as much as a2.5 percent share in all wells that Chesapeake drills. In the wakeof the Reuters investigation into McClendon’s personal borrowing,Chesapeake’s board announced it would discontinue the program in2014.
One example of the changes comes in a section of the contractcalled “outside activities.” Initially, that section imposed ablanket ban on McClendon serving as an officer, general partner ormember of an outside enterprise. It did not differentiate betweenpublic or private firms. In July 2001, that ban was relaxed. The new contract said he couldbecome a “general partner or member of any corporation,partnership, company or firm,” so long as the activity was a”passive investment” that involved “minimal” time. It barred himfrom any role in a “public” company.
In July 2005, shortly after Heritage was established, the contractwas again revised. The new contract said he could not “engage inactivities which require such substantial services” that McClendonwould be “unable to perform the duties assigned to the Executive inaccordance with this Agreement.” It also said he could not “serveas an officer or director of any publicly held entity” but made noother mention of external management roles. That text remains in place in the last contract, which took effectMarch 1, 2009. The new text addressing commodity trading and hedgefunds also has been in place since then. McClendon’s contract gives him more latitude for outside venturesthan his subordinates are allowed.
Chesapeake’s contracts with at least four other senior executivessay the executives may not “engage in other business activitiesindependent of” Chesapeake. They specifically ban the executivesfrom serving “as a general partner, officer, executive, director ormember of any corporation, partnership, company or firm.” PAY TO STAY During 2008, a year in which McClendon still operated the Heritagehedge fund, Chesapeake’s board awarded him the biggest pay packageof any Fortune 500 CEO. It was worth around $112 million. A groupof shareholders later sued, calling the pay package too generous. The company also gave McClendon a $75 million cash bonus that year- the same year that margin calls from his brokers forced McClendonto unload more than 90 percent of his Chesapeake shares.
Hesuffered a $2 billion paper loss, and his selling contributed to an88 percent fall in Chesapeake’s share price from its all-time highof $74 that year. In its disclosure statement of January 7, 2009, Chesapeakeexplained why it chose to compensate McClendon as it did: “Becauseof other entrepreneurial opportunities that exist in the industryand Mr. McClendon’s reduced Company stock holdings, theCompensation Committee focused on providing a retention incentiveto Mr. McClendon that the Compensation Committee believed would beeffective for multiple years without issuing substantial equityawards at current stock prices, which the Compensation Committeeviews as depressed.” The company didn’t elaborate on that statement.
(Additional reporting by Sarah N. Lynch in Washington and JonathanLeff in New York; editing by Blake Morrison).