Chesapeake’s Response is Douchetastic Legalese

Last week I wrote a post about the Chesapeake Energy story where their CEO was making massive investments alongside the company’s normal course of business with borrowed money in accordance with the Founders Well Participation Plan (FWPP)  they had set up.   $CHK claimed that they had disclosed the nature of CEO Aubrey McClendon’s participation, but the notional dollar amounts were never disclosed in the company filings.

Let me be clear about one thing up front:  I do not think that this FWPP story is an “Enron-esque” smoking gun as some have alleged, and I do not think it’s central to any bear thesis on $CHK.   It’s simply another example in a growing list of potentially shareholder-unfriendly actions by a company/CEO that has been a repeat offender in that category.   I actually bought a position in $CHK on Friday morning, sold it out Monday morning, and then bought some CHK stock again later on Monday.  By the time you read this, I may or may not have a position in CHK – I am long at the time I’m typing this.   I’m writing this post because I am awed by Chesapeake’s tone-deaf response to the whole situation.

Chesapeake published a lengthy response to the Reuters investigative story.   Sadly, they take the “Douchetastic Legalese™” approach in their replies.   Here’s what I mean:

1.  Q: More than a dozen academics, attorneys, Wall Street analysts and corporate governance experts who have reviewed the loan agreements say that the mere existence of as much as $1.1 billion in loans taken out by Mr McClendon against his share of the company’s wells raises the potential for conflict of interest in multiple ways. As a result, they say the loans should be disclosed in more detail than is currently provided by the references to “financing transactions” in the annual proxy. What is Chesapeake’s response to this view?

A: The question is improper on a number of levels. First, it does not specify the supposed conflict of interests nor does it include any analysis that reflects the information reviewed by the speaker, the information the speaker considered important, the speaker’s experience in the oil and gas industry or what assumptions were made by the speaker. Thus, one cannot tell if the conclusion was based on a short email with a leading narrative (as we have seen from your emails that have been provided to us), incomplete information or a thorough review of the pertinent information. Second, the concept of an “expert” is that the individual’s reputation and training supports a conclusion that the person’s opinion on a given topic is worthy of respect. That is inconsistent with hiding one’s identity, analysis or bias. Third, disclosure is an intricate regulatory scheme of multiple laws and rules that can be made unworkable by adding multiple disclosures of transaction details just because a small group of shareholders might think it is helpful. This is exacerbated where there are multiple small groups, each with their own special data request to fit their own special agendas.

Notwithstanding the foregoing, we believe that there are no conflicts of interest arising from the “mere existence of the loans.” Loans secured by oil and properties are standard in the industry, and even Chesapeake has substantial loans and obligations that are secured or supported by oil and properties. As a result we do not believe the “mere existence of the loans” changes Mr. McClendon’s alignment with the Company.

Really?  Chesapeake?  That’s the route you’re going here?   Avoid the question and focus on the “expertness” of the inquirer?  “The Question is improper on a number of levels“?   That is Douchetastic Legalese™  Let me make this clear:  when the CEO has borrowed A BILLION dollars to invest alongside the company wells from the same parties who often act as counterparties to Chesapeake itself in financing agreements, it doesn’t friggin’ matter what the questioner’s qualifications are.   Pretend the question is coming from Ma Kettle, who is worried about her 401k plan.   There’s no such thing as an improper question from a shareholder.

Now, I’ve read some comments across the web to the tune of “This is a free country – the CEO is free to take risk if he wants to.”  Absolutely.   The issue here is that the risks taken by the CEO may have an impact on the company.   It is also important to note that McClendon did not borrow from Chesapeake – he borrowed from external parties.   One issue is that these external parties are also lenders to Chesapeake.   It boggles my mind that the company used the defense of  “The number of financial institutions making oil and gas loans is a finite group and virtually all (if not all) have a lending or other economic relationship with Chesapeake.”

Ummm. Yeah – that’s the whole point!   The lenders have an economic relationship with CHK, and the fact that they have another Billion dollars in exposure to the same projects via loans to CEO Aubrey McClendon may have an impact on future lending/business decisions.

I would be remiss if I didn’t note that it appears that CHK’s disclosures are probably letter-of-the-law Kosher here (and also note that I AM NOT A LAWYER) – the sizes of McClendon’s loans are not required to be disclosed due to the structure of the transactions.  However, there’s a reason why people are making such a big deal about the story, and it’s because it looks bad.  It looks like McClendon is making huge bets with other people’s money that could negatively impact shareholders.    A concern pops up in question #7 in CHK’s Q&A:

7. Q: Mr. McClendon could direct the company to make decisions which would benefit him, but which might not be in the company’s best interest or cost the company – specific comment example: “McClendon could someday find himself in a situation that requires him to act on behalf of the (lenders) but hurt Chesapeake’s investors and creditors.” “The reason the loans are or could be a conflict of interest is that the CEO, who is a participant in the FWPP program, is also a decision-maker in how and when Chesapeake allocates capital expenditures. If he led Chesapeake to increase its debt leverage for the purpose of drilling wells, Chesapeake would benefit and he would benefit. But Chesapeake has to pay the debt interest costs; McClendon does not.”What is Chesapeake’s response to these comments?”

A: Not only does this question make vague and ambiguous allegations that Mr. McClendon might do something wrong without specifying what that might be, it ends up contradicting the central thesis of every one of your questions by asserting either that Mr. McClendon does not have any debt or that his lenders don’t charge interest. Moreover, you allege that Mr. McClendon has increased Chesapeake’s leverage or misallocated capital. Those are inconsistent with the Company’s behavior based on the Company’s swift rise to the top of the U.S. E&P industry, its 25/25 debt reduction plan, the actual reduction in absolute debt and relative debt per mcf during this period of low gas prices and the progress made in reducing gas drilling while increasing liquids production. All of those efforts were championed by Mr. McClendon because they were the correct courses of action for the Company.

See that?  That’s more Douchetastic Legalese™.   It’s a perfectly reasonable question because McClendon’s loans appear to be structured in a non-recourse manner that gives his lenders the first chunk of returns and could positively appear to give McClendon the incentive to swing for the fences.   As noted in my prior post, it’s not hard to see how the CEO’s risks and the company’s risks are in fact not aligned.

Aubrey McClendon IS Chesapeake Energy, and I have little doubt that he believes in the natural gas story and wants his company to succeed, but he’s already shown some reckless behavior in the past, which is why stories like this become big deals (achem – name another CEO that got a $500 MM margin call and had to puke out of his own company’s stock.   Name another CEO that borrows a BILLION dollars to invest alongside his company’s normal course of business…)

As noted above, perhaps the most remarkable thing about this story (other than the notional size of the CEO’s borrowing and investments) is the tone-deaf reply by the company.   They battened down the hatches and stuck to their Douchetastic Legalese™ guns, ignoring the concerns of their shareholders and chose to hide behind the defense “Again, any loans are Mr. McClendon’s personal business and not appropriate for review or monitoring by the company or for public comment.”  While this may be legally true, it’s shocking that, after seeing the impact the CEO’s personal borrowings had on the company’s stock (after his massive margin call) back in 2008, Chesapeake Resources doesn’t seem to understand where shareholders are coming from here.

There’s an old gambling saying:

“You can shear a sheep many times, but you can skin him only once.”

Chesapeake should wake up and realize that shareholders are growing increasingly cognizant that they may be getting sheared, and may react by bailing before they get skinned.


Chesapeake CEO Aubrey McClendon Channels George Costanza

Reuters: “The Energy Billionaire’s Shrouded Loans” (pdf)

Chesapeake Responds to Reuters Article on FWPP




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