Chesapeake Board Backtracks on What it Knew on CEO Loans

Chesapeake Energy Corp. (CHK)’s board backed away from a week-old endorsement of Chairman and Chief Executive Officer Aubrey McClendon’s practice of using personal stakes in company wells to secure loans, pledging now to investigate the transactions.

While directors were “generally aware” that McClendon had used his interests in company-operated wells as collateral for personal loans, it didn’t review or approve any of the individual transactions, Oklahoma City-based Chesapeake said in a statement today.

The disavowal appears to contradict an April 18 statement by Chesapeake General Counsel Henry J. Hood that directors were “fully aware of the existence of Mr. McClendon’s financing transactions.” The U.S. Securities & Exchange Commission has opened an informal inquiry into the practice, Reuters reported today, citing an unidentified source familiar with the matter. A spokesman for the commission declined to comment.

“This is the board responding to the uproar,” Mark Hanson, a Chicago-based analyst at Morningstar Inc. (MORN), said in a phone interview today. McClendon’s “vision has been an asset for the company but he’s got a penchant for overreach. If they could figure out a way to pair his vision with a shorter leash, that would be ideal.”

Photographer: F. Carter Smith/Bloomberg

Aubrey McClendon, chairman and chief executive officer of Chesapeake Energy Corp. Close

Aubrey McClendon, chairman and chief executive officer of Chesapeake Energy Corp.

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Photographer: F. Carter Smith/Bloomberg

Aubrey McClendon, chairman and chief executive officer of Chesapeake Energy Corp.

The next step for the board should be to separate the chairman and CEO positions to minimize McClendon’s influence over a panel that is supposed to watch over him, Hanson said.

McClendon’s Finances

Chesapeake fell 3.1 percent to $17.56 at the close in New York. The shares have dropped 24 percent this month, heading for the worst monthly loss since 2008, the last time McClendon’s finances affected company business.

McClendon was forced to sell almost all his Chesapeake stock in late 2008 when the global financial collapse triggered margin calls, accelerating a decline that wiped out more than half the company’s market value.

Standard & Poor’s reduced its rating on Chesapeake to BB from BB+ with a negative outlook. “Turmoil resulting from these developments could hamper Chesapeake’s ability to meet the massive external funding requirements stemming from its currently weak operating cash flow and continuing aggressive capital spending,” S&P said.

For most of the past 23 years, McClendon has purchased stakes of as much as 2.5 percent in every well the company has drilled. The Founders Well Participation Program, established to tie the CEO’s fortunes to company performance, requires McClendon to cover drilling costs and operating expenses proportionate to the size of his stake in each well.

His share of such costs was $973 million for the 2009 to 2011 period, the company said in an April 20 filing.

Outstanding Loans

Directors plan to review any loans McClendon obtained from entities that do business with Chesapeake, according to the statement today.

McClendon got a $1 billion line of credit with EIG Management Co. LLC, according to a Nov. 18 deed filed in Brooke County, West Virginia.

EIG Management is a unit of EIG Global Energy Partners LLC, which participated in a $1.2 billion preferred-shares purchase in a Chesapeake subsidiary on April 9.

McClendon has borrowed money to cover his share of drilling costs on company wells. He personally had $846 million in outstanding loans related to the well-participation program, according to a separate statement today.

Gas Reserves

Three McClendon-controlled companies -- Arcadia Resources LP, Larchmont Resources LLC and Jamestown Resources LLC -- control the equivalent of 810 billion cubic feet of gas in company-operated wells, according to the statement.

The board said today that it and McClendon have agreed to negotiate an early termination of the well-investment program that was scheduled to expire at the end of 2015.

“The borrowings and the lack of prior disclosure has focused a spotlight on the company’s board of directors and its oversight of the company,” Sean Sexton, managing director at Fitch Inc., the Chicago-based credit-rating company, said in a note today. “Given this recent news, Fitch believes stakeholders will have a higher level of expectations for disclosure and transparency going forward.”

To contact the reporter on this story: Joe Carroll in Chicago at jcarroll8@bloomberg.net

To contact the editor responsible for this story: Susan Warren at susanwarren@bloomberg.net

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