Monday, April 30, 2012

More Shoes to Drop?

To Recap - What we know so far:

1. Chesapeake Energy has a Founders Well Participation Program (FWPP) which allows the participants to purchase 2.5% interest in each well

2. McClendon borrowed $1.1 billion using his stake in thousands of company wells as collateral

3. McClendon has 4 personal corporations: Chesapeake Investments, Arcadia Resources, Jamestown Resources, and Larchmont Resources.  The loans were made through three of the companies controlled by McClendon that list Chesapeake's headquarters as their address.  Chesapeake has distributed 2.5 percent shares in wells and land to three McClendon-controlled companies — Chesapeake Investments LP, Larchmont Resources LLC and Jamestown Resources LLC.

4. 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.

5. June 2009 - $225 million from Union Bank, a California lender, pledging his share of wells as collateral.

 December 2010 - $375 million from TCW Asset Management, a private equity firm.

January 2012 - $500 million from a unit of EIG Global Energy Partners, a private equity firm formed by former TCW executives.

In March 2011, Chesapeake sold producing wells and lease acreage in Arkansas to BHP Billiton for $4.75 billion. Chesapeake said at the time that McClendon and two companies he owns personally were “parties to the purchase agreement.”

Documents filed with the Second Circuit Court of Appeals disclose that Chesapeake Energy has structured VPP’s in such a way that the sale and passing of title of reserve volumes is passed directly to the banks. The recorded conveyances confirm this.

This, of course, provides the banks and hedge funds ownership status in the event of a Chesapeake bankruptcy. In short, because the banks own title to the covered assets, the reserves are no longer a part of the debtors estate in bankruptcy and therefore legal entanglement is avoided in paying creditors claims.

 The banks and hedge funds now carry these assets on their balance sheets and Chesapeake has removed them from their balance sheet.

6. Chesapeake has resisted attempts by regulators to get more information on McClendon's well-participation plan before. In 2008, the SEC requested more information about McClendon's benefits from the well plan as part of a review of the company's 2007 annual report.

From May to October that year, Chesapeake and SEC officials exchanged at least eight letters and held negotiations on the issue. After first refusing to provide more information, Chesapeake ultimately agreed to provide shareholders a chart detailing well plan revenues and costs, a review of the letters shows.

7. In November, 2011, Chesapeake raised $1.25 billion from a group of investors including EIG through the sale of “perpetual preferred shares” in a newly formed entity, Chesapeake Utica LLC, which controls about 800,000 acres of oil and gas-rich land in Ohio. The sale offers lucrative terms to EIG investors, paying an annual dividend of 7 percent and royalty interests from oil and gas wells, according to analysts.

On April 9, 2012, 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.”

8. NY state's $140 billion pension fund owns close to 3 million shares in Chesapeake. Scrutiny over the company has caused its shares to drop considerably over the last month, from $24.24 on March 28 to $17.72 on Friday.

9. EIG raised money for its most recent investment fund from 19 institutional investors, including some of the largest U.S. public pension funds, according to a private equity research firm.

The list of state pensions that put money into the $4.1 billion EIG Global Energy Partners fund include ones from Alaska, Connecticut, Louisiana, Maryland, Minnesota, Missouri and Texas, according to research firm Preqin. Other large investors in the EIG Energy Fund XV were insurance giant MetLife and a Teamsters pension plan.

10. 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 Chesapeake.

11.  Statements from Chesapeake as to how much Chesapeake's Board of Directors (BOD) actually knew about the loans is fuzzy.  First statement said the BOD were "FULLY AWARE" of the existence of the loans, this was "clarified" with a statment the BOD were "GENERALLY AWARE", and later stated the BOD didn’t know about specific transactions.

12.  To date, several law firms have announced investigations into the loan deals

13.  To date: Shareholders filed a lawsuit against Chesapeake management in Oklahoma City federal court last week — just one of at least five suits that attorneys across the country said they plan to pursue. The lawsuits allege that Mr. McClendon’s mortgaging put the company at risk and that when the loans were revealed, stock prices fell sharply, representing a decline of more than $1 billion in market value.

The lawsuits target the board of directors and Mr. McClendon, a larger-than-life figure in an industry used to swagger.

He drank a $400 bottle of wine during an interview with Rolling Stone magazine earlier this year. At an energy summit in Ohio last October, he seemed impervious to critics concerned about drilling’s environmental effects.

“I’m the biggest fracker in the world. I’ve done it 16,000 times since 1989, and I’m proud of it,” he said.

14. BOD has said it would end a program allowing its chairman and CEO to buy stakes in the company’s wells and review loans McClendon obtained by using those investments as collateral.  The actual date of ending the FWPP is not known.

The fact that the company will have to pay Mr. McClendon to end this program early will further enrage shareholders and activists alike and will lead to further analysis on the company's dealings. It must be pointed out however that SandRidge Energy (SD) did pay their CEO (a former Chesapeake exec) to end their program a few years back. The news is not going to be getting better in the next few days, simply louder.

Side Note:  CEO of Sandridge is Tom Ward.  Ward was a co-founder of Chesapeake Energy, and became it's Chief Operating Officer.  Ward left Chesapeake in 2006 when he managed to accumulate enough stock in Sandridge to take it over.

15. Securities Exchange Commission (SEC) has opened an informal inquiry into Chesapeake and McClendon's loans.

16. Standard and Poor (S&P) downgraded Chesapeake's rating from BB+ to BB.  The cost of insuring Chesapeake's debt has jumped. As recently as mid-March, it cost just over $400,000 to insure Chesapeake debt with a face value of $10 million.  As of Friday(4/27/12) lunchtime, it cost $627,000—similar to the $605,000 cost of insuring a $10 million slug of the sovereign debt of Egypt

17. Chesapeake's stocks went from $19.12/share opening on 4/18/12  to 17.58/share ending 4/27/12

18. In explaining why Chesapeake's board isn't obligated to monitor McClendon's personal loans, Hood cited a September 2003 decision by a Delaware Chancery Court. The ruling in Beam v. Stewart found the board of Martha Stewart Living Omnimedia did not breach its fiduciary duty to shareholders by failing to monitor her personal investments. (Stewart served five months in prison in 2004 following her conviction for obstruction of justice in an unrelated insider-trading case.)

19. EIG Chief Executive R. Blair Thomas sent a letter to some investors this week defending the firm’s loans to McClendon and blames the media for "making something out of nothing".

20. Reuters making some WorldCom comparisons:

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.

Chesapeake Energy's earnings report is due out this week.

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