Chesapeake Energy Corp. shares tumbled 5.5 percent Wednesday After a published report showed that CEO Aubrey McClendon has borrowed up to $1.1 billion against his stake in Chesapeake wells.
Reuters reported Wednesday that the loans were to fund McClendon's investment in Chesapeake's Founder Well Participation Program, under which McClendon can take a 2.5 percent stake in every well drilled by the company.
Sources quoted in the article questioned whether McClendon's personal debt level on the company wells has created a conflict of interest and whether the company should have more thoroughly disclosed the financing deals.
Chesapeake has denied conflict or wrongdoing in the matter.
“The Founders Well Participation Program (FWPP) has been in place since the company's founding and was reapproved by shareholders by a wide margin in 2005,” Chesapeake said in a statement Wednesday. “The terms and procedures for the program are clear and detailed in every proxy for all shareholders to see.”
Under terms of the program, McClendon can buy into a stake in all the company's wells, but he cannot choose to participate only in some of the wells.
While the well participation program has been included in Securities and Exchange Commission filings, Chesapeake has not disclosed that McClendon has used his stake in the wells as collateral for loans. Records discovered by Reuters show McClendon has borrowed up to $1.1 billion, which is the same amount Forbes estimates to be McClendon's net worth.
Chesapeake said the program is legal and ethical and that it provides an additional incentive for McClendon to work hard for the success of the company.
“Loans secured by oil and gas assets are commonplace in the industry and have been employed by Chesapeake corporately during its 23-year existence and by Mr. McClendon during the 20 years the FWPP has been in existence, thus increasing the alignment of interest between Mr. McClendon and the company because both have loans and pay interests on the capital provided through such loans,” Chesapeake General Counsel Henry J. Hood said in a statement.
The news drew a wide range of reaction Wednesday on Wall Street. The company's stock price dipped more than 10 percent early in the day before recovering to a loss of 5.5 percent, or $1.06 a share, to close at $18.06. The price drop erased nearly $640 million of the company's value of $11.6 billion.
Chesapeake was the second most actively traded stock on Wednesday with more than 93.5 million shares changing hands, more than five and a half times the average volume of almost 16.9 million shares exchanged.
Industry analyst Fadel Gheit dismissed the controversy.
“It could appear as something not politically correct, but it is not illegal or unethical,” said Gheit, an analyst with Oppenheimer in New York. “As a shareholder, I might frown on it. I might not like it, but it has no negative impact on my view of his management skills.”Gheit said McClendon told him the numbers in the Reuters story were exaggerated.
Analyst Mike Breard agreed that the loan is McClendon's personal business, but he said it still should have been more thoroughly disclosed.
“If he borrowed $2 million to build a house, that's not anyone's business. But when it's $1 billion and it involves oil and gas with Chesapeake, that's to some extent the stockholders' business,” said Breard, a research analyst with Hodges Capital Management in Dallas. “It's just a scale kind of thing. I guess a billion dollars isn't as much to Aubrey as it would be to me.”
At least five law firms throughout the country — including one led by the former attorney general of Louisiana — on Wednesday launched investigations into whether Chesapeake and its directors violated state or federal regulations by not fully disclosing the details of the well participation program.
Chesapeake's directors reaffirmed their support for the well program Wednesday.
“The board of directors is fully aware of the existence of Mr. McClendon's financing transactions and the fact that these occur is disclosed in the proxy,” the directors said in a statement Wednesday. “Additionally, the total amount of his cost obligations and revenue attributable to the FWPP for each year are detailed in the proxy. The Founders Well Participation program fully aligns the interests of Mr. McClendon with the company, and the board of directors supports this program as does the majority of its shareholders.”
While the disclosure does not specifically state that McClendon may use his stake in the wells as collateral for loans, Chesapeake director and former Oklahoma Gov. Frank Keating said that was the clear intention of the program, considering the company participated in more than 2,000 wells in 2011 alone.
“Obviously it's assumed that Aubrey, as the participant, would on occasion borrow money to pay for these developmental costs,” Keating said. “From an ethical and a business standpoint, it's certainly constructed properly and it was approved by the shareholders. I have full faith in Aubrey McClendon.”