Chesapeake Investors Punish Board Amid ‘Collapse’ in Confidence

Chesapeake Energy Corp. (CHK) shareholders issued a sweeping repudiation of the company’s management yesterday by rejecting two directors and demanding more influence over the second-largest U.S. natural-gas producer.

Directors V. Burns Hargis and Richard K. Davidson each garnered the support of less than 30 percent of shareholders that cast votes at yesterday’s annual meeting in Oklahoma City. Both men, who are leading a probe of Chief Executive Officer Aubrey McClendon’s personal finances, offered to resign after the vote. The board isn’t required to let them go and said in a statement it would decide later.

Chesapeake’s board and executive team have been contending with an investor revolt after slumping energy prices and criticism of McClendon’s personal dealings with company financiers wiped out $2.6 billion in market value this year. A new group of directors recommended by the company’s two largest shareholders will take control of the board this month as McClendon approaches the end of a 23-year reign as chairman of the company he co-founded.

The rejection of two directors “represents a total and complete collapse of investor confidence,” said Michael Garland, governance expert for the New York City Comptroller’s Office that controls pension funds invested in Chesapeake. In an interview yesterday outside the meeting in Oklahoma City he accused the board of “costly oversight failures.”

Rising Criticism

McClendon, 52, has been under increasing scrutiny from investors and analysts for loans he obtained using personal stakes in company wells as collateral, and for a wrong-way bet on natural-gas prices that worsened a cashflow shortfall. Last month, the company disclosed an unexpected $71 million first- quarter loss and warned it may run out of cash next year.

“Something is out of whack here at Chesapeake,” Gerald Armstrong, a Denver-based shareholder, said during an address to yesterday’s shareholder meeting. “The absence of good governance practices has become more apparent. Accountability is what it’s all about.”

McClendon “might not be here next year,” Armstrong said during a three-minute address in an auditorium on Chesapeake’s corporate campus.

Craig Rhines, investment officer for the California Public Employees’ Retirement System in Sacramento, said he was surprised by the depth of dissatisfaction with Hargis, president of Oklahoma State University, and Davidson, former chairman of Union Pacific Corp. (UNP)

“The vote is extraordinary,” Rhines said in an interview yesterday.

Investor Power

Shareholders also overcame company opposition to three measures intended to dilute the power concentrated in the nine- person board of directors.

A requirement that directors receive a majority of votes cast to be elected received support from 97 percent of voters yesterday. Although that total fell short of the 66.6 percent of outstanding shares required under the company’s bylaws, directors decided to implement the majority-voting standard immediately.

The holders also voted 86 percent in favor of doing away with a requirement that changes to corporate bylaws must be supported by two-thirds of outstanding shares. A measure that would give large, long-term investors the right to nominate candidates for board seats received support from 60 percent of the votes cast yesterday.

Half of the board’s eight non-executive directors are scheduled to be replaced by June 22 under an agreement announced this week with Southeastern Asset Management and Carl Icahn, which together control more than 20 percent of Chesapeake’s common stock. Icahn will appoint one of the new directors and Memphis-based Southeastern the other three. The chairman also will be announced in that time.

Keeping Hargis

Southeastern said in a filing after the meeting that Chesapeake should keep Hargis on the board until the review of McClendon’s finances is completed. Southeastern said it voted against both Hargis and Davidson, and said it hopes the review can be completed within “weeks, not months.”

Chesapeake’s audit committee hired outside counsel Locke Lord LLP earlier this year to assist in its review of McClendon’s loans. The executive perk that allows McClendon to buy stakes of as much as 2.5 percent in almost every well the company drills will be discontinued in 2014.

Risk Taking

Shareholders including Garland criticized the board for failing to rein in what they’ve seen as McClendon’s risk taking and overspending at the company. Vincent Intrieri, a director at Icahn Capital, urged the board to remain open to “all strategic alternatives,” including a sale of the entire company.

“Aubrey, you are a great oil and gas man,” Intrieri said during yesterday’s meeting. He added that even great people need oversight.

Under McClendon’s leadership, Chesapeake outspent cashflow in 19 of the past 21 years as it amassed drilling leases from Appalachia to the Rocky Mountains and made some of the biggest onshore discoveries of the past 20 years, including the Haynesville Shale formation in Louisiana and the Utica Shale in Ohio.

Facing a cashflow crunch that Alembic Global Advisors estimates may exceed $22 billion by the end of next year, Chesapeake sought a $4 billion bailout from Goldman Sachs Group Inc. and Jefferies Group Inc. (JEF) last month in the form of a short- term loan.

Asset Sales

Before yesterday’s meeting began, the company announced plans to sell its pipeline assets for about $4 billion to Global Infrastructure Partners in three cash transactions. Chesapeake will sell its interests in Chesapeake Midstream Partners LP (CHKM) to Global Infrastructure for $2 billion, the company said in a statement. Chesapeake also will raise more than $2 billion by divesting its pipeline development unit and some central U.S. conduits to Chesapeake Midstream.

The pipeline transactions bring Chesapeake’s asset sales total so far this year to $6.6 billion, almost halfway to the upper range of McClendon’s 2012 fundraising goal of $14 billion. He reiterated plans yesterday to reduce long-term debt to $9.5 billion by the end of December.

The largest asset Chesapeake plans to sell this year, a series of oilfields in the Permian Basin in west Texas and New Mexico, has been examined in a so-called data room at Chesapeake’s Oklahoma City headquarters by about 20 energy companies, McClendon said yesterday. Ten more are expected to view the data in coming weeks, he said.

McClendon said in a March interview that he expects the Permian Basin assets to fetch at least $5 billion and that they may be sold in a few pieces rather than as a whole.

Chesapeake was the best-performing energy stock in the Standard & Poor’s 500 Index yesterday, rising 2.9 percent to $18.36 in New York. The shares have fallen 18 percent this year as the impact of tumbling gas prices was compounded by investor distrust stemming from McClendon’s personal financial transactions.

Exxon Mobil Corp. (XOM) is the largest U.S. gas producer.

To contact the reporters on this story: Joe Carroll in Chicago at jcarroll8@bloomberg.net; David Wethe in Houston at dwethe@bloomberg.net

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

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