ER BIG STAKES DN AR N G ea 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.