Chesapeake CEO Aubrey Mcclendon Has Borrowed $1.1 Billion Against His Stake in Company Wells, Reuters Has Found

big stakes ar dn er ea n G REUTERS/S

the energy billionaire’s SHROUDED LOANS Chesapeake CEO Aubrey McClendon has borrowed $1.1 billion against his stake in company wells, Reuters has found.

By anna driver and brian grow

SPECIAL REPORT 1 big stakes The energy billionaire’s shrouded loans

april 18, 2012 whose interest will he look out for, his own trial counsel at the Securities and Exchange or Chesapeake’s?” said Joshua Fershee, an Commission (SEC). “That may create a ubrey K. McClendon is one of the associate professor of energy and corporate conflict of interest.” most successful energy entrepre- law at the University of North Dakota. As a result, the loans should have been Aneurs of recent decades. But he The revelation of McClendon’s bout of fully disclosed to Chesapeake shareholders, hasn’t always proved popular with share- borrowing comes as he is scrambling to help the academics, attorneys and analysts said. holders of the company he co-founded, Chesapeake avert a multi-billion-dollar cash NO CONFLICT Chesapeake Energy Corp., the second-larg- shortfall amid a plunge in natural gas prices. est natural gas producer in the United States. It also exposes a potentially serious gap in Both McClendon and Chesapeake say the McClendon, 52, helped cause Chesa- how U.S. regulators scrutinize corporate exec- loans are purely private transactions that peake shares to plummet amid the financial utives, a decade after those rules were tightened the company has no responsibility to dis- crisis when he sold hundreds of millions in the wake of major accounting scandals. close or even to vet. And they disputed the of dollars in stock to raise cash for himself. The loans portend a number of possible view that the deals could create a conflict Later, to settle a lawsuit by shareholders, he problems, the analysts said. McClendon’s of interest. agreed to buy back a $12 million map col- biggest lender is simultaneously a major “I do not believe this is material to Chesa- lection that he’d sold to Chesapeake. investor in two units of Chesapeake. That peake,” McClendon said in an email response His approach to running his company connection raises questions about whether to questions. “There are no covenants or ob- also is renowned: Among other employee Chesapeake’s own financing terms could be ligations in my loan documents or mortgages perks, on-site Botox treatments are avail- influenced by its CEO’s personal borrowing. that bind Chesapeake in any way.” able at its headquarters in Oklahoma City, Chesapeake general counsel Henry Oklahoma. The more information the Hood said in a statement that the clause Now, a series of previously undisclosed company releases to shareholders in the loan agreements questioned by ana- loans to McClendon could once again put the better – particularly when it’s lysts – called “Compliance by Operator” – Chesapeake’s CEO and shareholders at odds. such a large amount of money. is “typical boilerplate language” used in oil McClendon has borrowed as much and gas mortgages. It requires borrowers to as $1.1 billion in the last three years by Mike Breard exercise their rights with operators of wells, pledging his stake in the company’s oil and Oil and gas analyst such as Chesapeake, on behalf of the lender. natural gas wells as collateral, documents Neither the existence of McClendon’s reviewed by Reuters show. Another concern: A clause in the deals loans nor their terms create the possibil- The loans were made through three com- requires McClendon “to take all commer- ity of a conflict of interest, Hood said, in panies controlled by McClendon that list cially reasonable action” to ensure that other part because the company has a first lien on Chesapeake’s headquarters as their address. owners and operators of the wells – includ- McClendon’s share of company wells. That The money is being used to help finance what ing Chesapeake – “comply with…covenants would mean Chesapeake gets paid before could be a lucrative perk of his job – the op- and agreements” of the loans. Such clauses all other creditors in the event that Mc- portunity to buy into the very same well stakes are common in energy-finance deals. But it Clendon defaults on his debt. that he is using as collateral for the borrowings. is rare for the CEO of a major energy com- “Any loans are Mr. McClendon’s per- The size and nature of the loans raise pany to be personally subject to one involv- sonal business and not appropriate for concerns about whether McClendon’s per- ing the corporation that he runs. That means review or monitoring by the company or sonal financial deals could compromise his McClendon could have an incentive to in- public comment,” Hood said. fiduciary duty to Chesapeake investors, ac- fluence Chesapeake to act in the interest of The company has many checks to pro- cording to more than a dozen academics, his lenders, rather than of his shareholders. tect against conflicts, Hood said. Among analysts and attorneys who reviewed the “Basically what you have here is a pri- them: Some of the world’s largest energy loan agreements for Reuters. vate transaction that could potentially im- companies own a share of Chesapeake wells “If Mr. McClendon has $1 billion in pact a public company, depending on the and “monitor the actions of the Company” debt through his own companies — com- manner in which the clause is interpreted via well audits, government filings and par- panies operating in the same industry as and applied,” says Thomas O. Gorman, a ticipation in development plans, Hood said. Chesapeake — he has or could have a high partner at law firm Dorsey & Whitney in He added that Chesapeake now em- degree of risk for conflicts of interest. As in, Washington, D.C., and a former special ploys more than 13,000 people and drills

SPECIAL REPORT 2 big stakes The energy billionaire’s shrouded loans

$500 Beneath the surface million A look at some borrowing by Chesapeake’s CEO $375 million

THE LOANS $225 Loan amounts made to million* Aubrey McClendon

THE COLLATERAL 2008 2009 2010 2011 2012 McClendon secured the loans with his 2.5 percent working interest in new Chesapeake wells drilled each year 1,733 1,003 1,149 1,282 Net new (Color indicates the loan net new wells in supported) wells 2012

3,676 2,206 3,031 2,979 *Collateral not known TOTAL Sources: Financing statements ﬁled in CHESAPEAKE Louisiana and Texas (loans); Securities and WELLS Exchange Commission ﬁlings (wells)

more than 2,000 wells per year, “all of that McClendon has borrowed against his stake in wells it drills. Chesapeake says the which minimizes the ability of any one per- share of company wells, Hood said, but “the well plan is a uniquely powerful incentive son” – McClendon included – “to influence board did not review or approve the trans- because it aligns McClendon’s personal in- actionsMar ongin any single fall well.” actions.” Nor did the company vet the loan terests with those of the company. ChesapeakLess thane Energy four years’s daily ago, share a pricpersonale terms for possible conflicts. “If there were The well plan does not allow McClendon transaction by McClendon did negatively any conflicts of interest,” Hood said, “they to select the wells in which to invest; Chesa- $70 influence the company. would have surfaced by now.” peake says the program is an all-or-nothing 60To buy more Chesapeake stock, Mc- Chesapeake board members contacted de- proposition so that McClendon can’t cher- Clendon borrowed money from his bro- clined to comment. Marc Rome, Chesapeake’s ry-pick only the most profitable wells. kers50 - what’s called “buying on margin.” vice president for corporate governance, did “He has to eat his own cooking here,” In October 2008, just after the finan- not respond to requests for comment. said company spokesman Michael Kehs. October 2008: cial40 crisis erupted with the bankruptcyMcClendon The sells loans reveal how McClendon is us- But because McClendon is using the of Lehman Brothers, he was forcedstock to toing raise an unusual cash. corporate incentive as collat- loans to finance his participation in the well sell30 more than 31 million Chesapeake eral. The perk, known as the Founder Well plan, he defrays his risks. Two of McClen- shares for $569 million to cover margin Participation Plan, grants Chesapeake’s bil- don’s lenders, both private equity firms, in calls20 from those brokers. The company’s lionaire co-founder a 2.5 percent stake in turn spread the loan risks to other investors stock fell nearly 40 percent the week of the profits – and makes him pay 2.5 percent by raising money from state pension funds McClendon’s10 share sales. McClendon of the costs – of every well drilled during and other investors to fund them. Those issued an apology but the company’s each year he decides to participate. insights emerge from a February 2011 0 credibility with many shareholders suf- Today, Chesapeake is the only large document detailing a meeting between 2007 2008 2009 2010 2011 2012 fered significantly. publicly traded energy company to grant McClendon’s largest personal lender and a Source: Reuters Chesapeake’s board of directors is aware its CEO the opportunity to take a direct prospective investor.

SPECIAL REPORT 3 big stakes The energy billionaire’s shrouded loans

ron 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 po- tential to influence management’s perfor- mance and decisions,” the SEC wrote. McClendon’s loans - backed not by stock but by stakes in company wells - aren’t cov- ered 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 ex- pert and author of the accounting-related AT WORK: Chesapeake’s 50-acre campus in Oklahoma City, Oklahoma, boasts a state-of-the-art gym blog re: The Auditors. and offers employees Botox and teeth whitening treatments. REUTERS/Steve Sisney As a result, no SEC regulation precludes McClendon from using his well plan stake as loan collateral. The SEC declined to “If he hasn’t had to put up any of his If Mr. McClendon has comment on the McClendon loans. own money, how is that alignment” of Mc- $1 billion in debt through his TEETH WHITENING Clendon and Chesapeake’s interests, asked own companies — companies Mark Hanson, an analyst with Morning- operating in the same industry Tall and thin, McClendon is a tireless star in Chicago. as Chesapeake — he has or could booster for the oil and gas industry - and Chesapeake says McClendon’s loans are have a high degree of risk for of his company. At an energy conference “well disclosed” to company shareholders. in November in Houston, he sported a tie General Counsel Hood cited two referenc- conflicts of interest. printed with tiny drilling rigs. His daring es in the company’s 2011 proxy. In them, Joshua Fershee deals and stirring speeches to investors have the firm refers to McClendon’s personal Associate professor of energy and corporate law attracted some adoring followers. “financing transactions,” including one in a During one speech last September, Mc- section entitled “Engineering Support” that Legal experts say the size and terms of Clendon said opponents of a controversial discusses McClendon’s use of Chesapeake McClendon’s borrowing are unusual – and drilling technique called hydraulic fractur- engineers to assess well reserves. highlight a gap in regulatory scrutiny of ing were interested in “turning the clock Nowhere in Chesapeake proxy state- American corporate executives. back to the Dark Ages.” ments or SEC filings does the company In the past, major Wall Street banks “What a great vision of the future!” he disclose the number, amounts, or terms of formed separate companies – or special said sarcastically. “We’re cold, it’s dark, and McClendon’s loans. Veteran analysts of the purpose vehicles, just as McClendon has – we’re hungry!” company said they were never aware of the to allow select employees to borrow from McClendon’s investor presentations are loans until contacted for this article. the employer and make investments. The standing-room-only. But he often bristles “We believe the disclosures made by the WorldCom accounting scandal was, in when his business model is questioned company have been appropriate under the part, fueled by more than $1 billion in loans by analysts, frequently arguing that Wall circumstances, particularly since the dis- taken out by former chief executive Ber- Street does not understand the company. closure of the loans is not required in any nard Ebbers that were secured by his shares That tension has intensified as Chesa- event,” Hood said in a statement. of company stock. And energy giant En- peake scrambles to shed more than $10 billion

SPECIAL REPORT 4 big stakes The energy billionaire’s shrouded loans

in debt through the rapid-fire sale of assets But the loan agreements demonstrate The company also says that McClen- amid the lowest natural gas prices in a decade. the extent to which McClendon has lever- don’s share of “related assets” pledged as McClendon continues to treat his em- aged his interests: He has pledged as col- collateral - such as business data and hedg- ployees well. In recent years, he built a 50- lateral almost every asset associated with ing contracts associated with wells - is acre red-brick campus in Oklahoma City his share of Chesapeake wells. Oil, gas and completely separate from similar assets as Chesapeake headquarters. It boasts a land interests, platforms, wells and pipe- owned by Chesapeake. That means Chesa- 72,000 square-foot state-of-the art gym, lines, hedging contracts, geological and peake would not become entangled should visiting doctors who provide lunchtime business data, and intellectual property are McClendon default, the company said. Botox treatments for employees, and den- among scores of well-related assets that can Chesapeake “does not have an interest tists who whiten teeth. be seized should McClendon default. in the (McClendon’s) related assets … and A part owner of the NBA’s Oklahoma Chesapeake said it would be “unaffected Mr. McClendon does not have an interest City Thunder and supporter of charitable by any dispute” between McClendon and in the company’s related assets,” general causes in the state capital, McClendon holds a lender in the event of a default because counsel Hood said in a statement. considerable sway in Oklahoma. Former U.S. of its first lien on oil and gas production, In explaining why Chesapeake’s board Senator Don Nickles and former Oklahoma equipment and land leases. isn’t obligated to monitor McClendon’s Governor Frank Keating, both Republicans, personal loans, Hood cited a September are members of the Chesapeake board. We believe the disclosures 2003 decision by a Delaware Chancery McClendon’s close relationship with the made by the company have Court. The ruling in Beam v. Stewart found board hasn’t left him immune to tensions been appropriate under the the board of Martha Stewart Living Om- with stockholders. nimedia did not breach its fiduciary duty After Chesapeake’s board agreed to buy circumstances, particularly since to shareholders by failing to monitor her McClendon’s map collection in 2008 for the disclosure of the loans is not personal investments. (Stewart served five $12.1 million, shareholders sued. The law- required in any event. months in prison in 2004 following her suit was settled in November 2011, when conviction for obstruction of justice in an McClendon agreed to refund the $12.1 Henry Hood unrelated insider-trading case.) million, plus interest, and hold stock worth Chesapeake general counsel Given the size, scope and complicated 500 percent of his annual salary and bonus. Chesapeake also agreed to hire Rome, the vice president of corporate governance, and an executive compensation consultant to evaluate corporate pay packages. The well participation plan, which was approved by shareholders in 2005 and cannot be discontinued until 2015, has re- mained 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 Chesapeake to let large long-term shareholders put up their own nominees for the board of directors. Key aspects of McClendon’s loans re- main hidden from shareholders. Because promissory notes underpinning the loan agreements are private, the interest rate, the exact amount borrowed and other terms of ENJOYING THE GAME: Actor Rob Lowe (L) and Chesapeake CEO Aubrey McClendon watch the the transactions are not publicly known. Oklahoma City Thunder play the Los Angeles Lakers in February . REUTERS/Steve Sisney

SPECIAL REPORT 5 big stakes The energy billionaire’s shrouded loans

$500 Btermseneath of the loans, theirthe particulars sur conface- wells, the company regularly files a form three years breaks down this way:million Astitute look atimportant some borrowing stockholder by Chesapeainformationke’s CEOcalled a conveyance. In keeping with the$375 In June 2009, McClendon agreed to and therefore should be more fully dis- corporation’s well participation program,million borrow up to $225 million from Union THEclosed, LO saidANS David F. Larcker, a professor of the conveyance grants$225 McClendon a 2.5 Bank, a California lender, pledging his Loanaccounting amounts at Stanford made to University’s Gradu- percent share of each wellmillion* and of the leased share of wells as collateral. Aubreyate School McClendon of Business. land on which it is drilled. In December 2010, he borrowed $375 Some shareholders agree. “While rec- For years, Chesapeake has distributed million from TCW Asset Management, a ognizing (McClendon’s) right to privacy, 2.5 percent shares in wells and land to three private equity firm. the more information the company releases McClendon-controlled companies – Chesa- And in January 2012, McClendon bor- THEto shareholders COLLATERAL the better – particularly peake2008 Investments LP, Larchmont2009 Resources2010 rowed $500 million2011 from a unit2012 of EIG McClendonwhen it’s such secured a large the amount loans of money LLC and Jamestown Resources LLC. Global Energy Partners, a private equity withand related his 2.5 to percent the oil workingand gas business,” said Since he co-founded Chesapeake in firm formed by former TCW executives. interestMike Breard, in new oil Chesapeak and gas researche analyst 1989, McClendon has frequently borrowed It is unclear how much, if any, of those wellsat Hodges drilled Capital each yearManagement in Dallas, money on a smaller scale by pledging his loans have been repaid. which owns Chesapeake shares. share1,733 of company wells as1,003 collateral. Records1,149 Randall Osterberg,1,282 a senior viceNet president new (ColorAs indicatwith aes mortgage the loan on a residential filednet in new Oklahoma in 1992 show a $2.9 mil- at Union Bank who signed the wellsloan inagree - wells 2012 supported)home, state law requires ownership rights lion loan taken out by Chesapeake Invest- ment, declined to comment. TCW and EIG to physical property be recorded with ments, a company that McClendon runs. also declined to respond to questions. county clerks. And in a statement, Chesapeake said Mc- REAL LOSS? Reuters found McClendon’s loan agree- Clendon’s securing of such loans has been ments by following the trail of well and “commonplace”3,676 during the2,206 past 20 years. 3,031At first blush,2,979 what the company tells *Collateralland lease not transfers known from Chesapeake to ButTOT ALin the last three years, the terms and shareholders suggests the well plan is a Sources: Financing statements ﬁled in CHESAPEAKE Louisianathree companies and Texas (loans); that Securitieslist McClendon and as sizeWELLS of the loans have changed substan- money-loser for McClendon. Exchangetheir corporate Commission representative, ﬁlings (wells) according to tially. During that period, he has borrowed In its proxy statements, Chesapeake says state deed records. as much as $1.1 billion – an amount that McClendon lost $116 million in 2009, and In county courts in Louisiana, Texas, coincidentally matches Forbes magazine’s $141.9 million in 2010. Arkansas, Pennsylvania and Oklahoma, estimate of McClendon’s net worth. It’s unclear whether McClendon has where Chesapeake operates thousands of The $1.1 billion in loans during the past suffered any real losses, however. Asked about the calculations, Hood said McClen- Margin fall don’s net loss is a byproduct of his drilling Chesapeake Energy’s daily share price costs being “front end loaded,” while his revenues accrue over many years. $70 “If they are showing that kind of nega- tive cash flow, the wells don’t have value,” 60 said Phil Weiss, oil analyst at Argus Re- 50 search who has a sell rating on the company’s shares. But given that McClendon October 2008: has borrowed more than $1 billion based 40 McClendon sells stock to raise cash. on the value of his well stakes, “I really don’t 30 think (the company’s disclosures) tell me much,” Weiss said. 20 Chesapeake has resisted attempts by regulators to get more information on Mc- 10 Clendon’s well-participation plan before. In 2008, the SEC requested more information 0 about McClendon’s benefits from the well 2007 2008 2009 2010 2011 2012 plan as part of a review of the company’s Source: Reuters 2007 annual report.

SPECIAL REPORT 6 big stakes The energy billionaire’s shrouded loans

From May to October that year, Chesa- DRILLING DOWN: peake and SEC officials exchanged at least A worker at a eight letters and held negotiations on the Chesapeake rig issue. After first refusing to provide more site in South Texas information, Chesapeake ultimately agreed walks past stacks to provide shareholders a chart detailing of drill pipe used well plan revenues and costs, a review of to tap oil and gas. the letters shows. REUTERS/anna Chesapeake’s Hood said in a statement driver that the company’s disclosures are “fully compliant with all legal and regulatory re- quirements.” The chart and other SEC filings contain “all material facts that Chesa- peake was required to disclose,” he said. A spokesman for the SEC declined to comment. McClendon’s biggest personal lender, EIG, has been a big financer for Chesa- A lucrative deal for the CEO’s financier peake, too. In November, Chesapeake raised $1.25 billion from a group of investors includ- The lender behind $500 million worth of “In fall 2008, Mr. McClendon didn’t have ing EIG through the sale of “perpetual Aubrey McClendon’s personal loans is a liquidity to participate in the (well) program preferred shares” in a newly formed entity, private equity firm with headquarters across in 2009, at which point EIG entered into Chesapeake Utica LLC, which controls the street from the White House and the discussions with him and ultimately” formed about 800,000 acres of oil and gas-rich land Chinese government as a minority owner. a special purpose vehicle called Larchmont in Ohio. The sale offers lucrative terms to The firm, EIG Global Energy Partners, Resources, Wade said. EIG investors, paying an annual dividend is run by R. Blair Thomas, an attorney and Through Larchmont, EIG acquired the of 7 percent and royalty interests from oil veteran energy investor. Formerly the Energy rights to all of McClendon’s well stakes for and gas wells, according to analysts. & Infrastructure Group of Trust Company of 2009 and 2010. EIG then set up a new special On April 9, the company announced a the West, EIG spun out of TCW in January purpose vehicle – Jamestown Resources – to nearly identical deal to raise another $1.25 2011. It had $9.5 billion under management control McClendon’s well shares in 2011, with billion from EIG and other investors, in at the end of last year. rights to 2012, Wade said. another new subsidiary called CHK Cleve- Those deep pockets – along with special EIG’s investments have been extremely land Tonkawa. ties to McClendon - have enabled it to profitable. “EIG sweeps 100 percent of the Dividends on preferred shares are contro- bankroll his share of Chesapeake wells, cash flow generated by those projects until versial because they are paid before regular according to minutes of a February 2011 EIG has gotten all of its money back plus a dividends owed to common sharehold- meeting between EIG and the New Mexico 13 percent realized return,” Wade told New ers. “Basically it’s a form of more expensive State Investment Council, the state’s public Mexico investors. EIG also gets a 42 percent debt,” Morningstar’s Hanson said. “It makes investment fund. cut of McClendon’s share of the well profits it appear that it’s not debt, but it sits on top At the meeting, EIG chief operating officer “in perpetuity,” he said. of obligations to the common shareholder.” Randall Wade sought a $50 million investment EIG declined comment. The fact that McClendon’s largest per- from New Mexico. Asked about a prior EIG In February, EIG announced that China sonal lender received favorable terms on its investment in McClendon’s well interests, Investment Corp.(CIC), China’s sovereign wealth Chesapeake investments caused some Wall Wade boasted EIG had known Chesapeake fund, had acquired a minority stake for an Street analysts to call for more information for more than 25 years and “provided pre-IPO undisclosed amount. CIC declined comment. about McClendon’s loans. financing for them in the late 1980s.” “I think the company should disclose Those tight bonds, Wade said, have Reporting By Brian Grow and Anna Driver; editing this information. One reason is that the created other unique opportunities for EIG. by Blake Morrison and Michael Williams

SPECIAL REPORT 7 big stakes The energy billionaire’s shrouded loans

CEO is taking out loans from at least one entity, EIG, which recently provided financing to Chesapeake,” said Joseph All- man, oil and gas industry analyst at JPM- organ in New York, who reviewed the loan agreements. “In the same way that investors want to know the counterparty to significant Chesapeake transactions, they would want to know if one of those firms has significant private dealings with the CEO.” Chesapeake’s Hood acknowledged there could be “some theoretical possibility of a conflict of interest” with the company and its CEO borrowing from the same lender. But because Chesapeake does not believe there is “an actual conflict of interest,” more disclosure is not required, Hood said.

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.” Chesapeake said the SEC’s related-par- INVESTED IN COMPANY: Chesapeake CEO and co-founder Aubrey McClendon has taken out ty rule doesn’t apply to McClendon’s loans personal loans to invest in the company’s oil and gas drilling efforts. REUTERS/Sean Gardner - only to his participation in the well plan. That’s because Chesapeake believes the loans “do not constitute a material trans- scribed the proposal as a way to scrutinize action with Chesapeake or even involve transactions that have played “a recurring Chesapeake,” Hood said. role in financial failures.” The oversight That disclosure gap may be closing. A board declined to comment on McClen- proposed new standard, released for pub- don’s loans. lic comment by the Public Company Ac- For now, said analyst Weiss, Chesapeake counting Oversight Board on Feb. 28, and McClendon are pushing the limits. “If FOR MORE INFORMATION would require auditors to identify and eval- Chesapeake were trying to make things Anna Driver uate “significant unusual transactions” with muddy and unclear without breaking the [email protected] executives connected to publicly traded law, this would be a good way to do it.” Brian Grow firms. The board defined such transactions [email protected] as those “outside the normal course of busi- Reporting by Anna Driver in Houston and Blake Morrison, Investigative Projects Editor ness or that otherwise appear to be unusual Brian Grow in Atlanta; additional reporting by [email protected] due to their timing, size or nature.” Joshua Schneyer in New York; editing by Blake Michael Williams, Global Enterprise Editor Board chairman James R. Doty de- Morrison and Michael Williams [email protected]

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SPECIAL REPORT 8