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Reuters Special Report: Inside Chesapeake, CEO ran $200 million hedge fund

Chesapeake CEO Aubrey McClendon for at least four years ran a hedge fund that traded in the same commodities his company produces.
BY JOSHUA SCHNEYER, JEANINE PREZIOSO AND DAVID SHEPPARD Modified: May 2, 2012 at 8:20 pm •  Published: May 2, 2012

As chairman and CEO of Chesapeake Energy Corp, Aubrey McClendon has been a powerhouse in the vast U.S. natural gas market, directing the company's multibillion dollar energy-trading operation and setting output targets for America's second-largest producer.

Behind the scenes, a Reuters investigation has found, McClendon also ran a lucrative business on the side: a $200 million hedge fund that traded in the same commodities Chesapeake produces.

On Tuesday, two weeks after Reuters reported that McClendon has taken up to $1.1 billion in loans against his stakes in Chesapeake oil and gas wells, the company stripped McClendon of the chairmanship and reiterated that it's reviewing details of the loans. A statement quoted McClendon, who will stay on as CEO, saying that the move will enable him to focus his “full time and attention on execution of the company's strategy.”

But for at least four years, from 2004 to 2008, McClendon's attention extended well beyond his job at Chesapeake.

During that time, said a veteran trader who helped run McClendon's private hedge fund, the Chesapeake executive engaged in “near daily” communications and “exhaustive” calls to help direct the fund's trading.

The fund, Heritage Management Company LLC, was started by McClendon and Chesapeake co-founder Tom Ward. The hedge fund listed Chesapeake's headquarters in Oklahoma City as its mailing address, documents show. Heritage's staff included an accountant who was simultaneously employed by Chesapeake. The fund also earned McClendon and Ward management fees and a cut of profits from outside investors.

There is no evidence that McClendon or Ward used inside knowledge gleaned from Chesapeake in their hedge fund trading. Neither the company nor McClendon would comment, and Ward said he saw nothing wrong with the arrangement.

But experts on energy trading, corporate governance and commodity-market regulation said they were stunned by the latest revelation.

“An executive's first responsibility is to shareholders and the betterment of their investment,” said Carl Holland, who ran the trading-compliance department at former U.S. oil major Texaco. “Personal trading in the commodity around which the CEO's business is based would be a clear no. We would never have tolerated that, ever.”

Thomas Mulholland, a risk-management consultant to oil and gas producers for Golden Energy Services in St Louis, said such matters are “taken very seriously by energy companies, and there are strict codes against it. Even if there is just a whiff of impropriety,” he said, “it can be enough to lead to a termination.”

The commodities markets are less regulated than equity markets, where corporate executives are prohibited from trading stock in their own companies based on undisclosed financial information. In commodities markets, insider trading isn't illegal unless price manipulation can be proven.

Nonetheless, personal dealing in energy markets is typically forbidden by oil and gas companies for a variety of reasons.

In Chesapeake's case, McClendon would have been aware of major decisions that could affect natural gas prices before that information became public. Accounting for 5 percent of U.S. natural gas production, Chesapeake holds tremendous sway over markets. On January 23, the company announced sharp output curbs in response to low prices. In response, U.S. natural gas futures surged by 8 percent the same day.

“If the company needs to make an operating decision which might move the market against the CEO's positions, there's a risk that will influence the decision-making at the top of the company,” said Jeff Harris, former chief economist at the market's U.S. regulator, the Commodity Futures Trading Commission, and now professor of finance at Syracuse University.

Another potential problem is known as “front-running.” That's when a trader buys or sells a commodity in advance of a client's or his company's orders. In theory, McClendon's firsthand knowledge of Chesapeake's own plans to trade would enable him to profit by trading ahead of Chesapeake — a move that could raise costs for the company.

“Advance knowledge of Chesapeake's activities could be perceived as having insight into the movement of commodities prices, which certainly raises conflict-of-interest issues as well as ethical issues about the ability to enrich himself on nonpublic information,” said Tim Rezvan, oil and gas industry analyst at Sterne Agee in New York.

“If correct,” Rezvan said, “these disclosures would be even more alarming than the personal loans.”

A securities law professor said the very existence of the hedge fund could prompt a securities investigation.

“I would argue, and I think the SEC would argue, that the failure to disclose that you are engaging in this kind of conduct can constitute a securities fraud problem,” said Elizabeth Nowicki, a professor at Tulane University. She said a failure by McClendon and Ward to disclose their fund to Chesapeake's shareholders may constitute a “material omission” that could draw SEC scrutiny.

“A reasonable investor would want to know that the CEO could be in a situation where he's betting against the interests of the company personally,” Nowicki said. “That, it seems to me, is a slam dunk.”

An SEC spokesman declined to comment.


It remains unclear whether McClendon received permission from Chesapeake's board to run a hedge fund and actively trade in the commodities markets for himself, or whether his trading continues. Chesapeake and McClendon's personal spokesman declined to comment.

Chesapeake also declined to say whether employees would be prohibited from operating such a hedge fund or trading their own cash in oil and gas markets. The issue isn't clearly addressed in a code of ethics published on Chesapeake's website.

Two Chesapeake board members contacted by Reuters declined comment. “Given litigation, we are constrained in what we can say,” said Chesapeake spokesman Michael Kehs, who was referring to shareholder lawsuits filed in the wake of the Reuters report on McClendon's personal loans.

Oil and gas markets are secretive, and trading positions are almost never made public. McClendon's hedge fund partner Ward said the two were always careful not to let Chesapeake's decisions influence the hedge fund's endeavors.

Ward, who continues to trade his own personal cash in commodity markets and is now CEO of oil and natural gas driller SandRidge Energy, said he doesn't know whether Chesapeake's board knew of the hedge fund he ran with McClendon. But he said he sees “no conflict of interest.”

“We did not use any proprietary knowledge of (Chesapeake) trades to make our own individual decisions,” Ward said.

Peter Cirino, who helped trade natural gas for the hedge fund, also said he knew of no discussions about what Chesapeake was doing in energy markets: “They were much too smart as individuals,” Cirino said of McClendon and Ward. “They would be able to manage that conflict there, if there was one.”

Today, McClendon leads the three-man team that oversees Chesapeake's trading in oil and gas for the purposes of hedging, or offsetting the risk of unfavorable price swings. When Reuters asked McClendon last year whether he traded for himself in energy markets, McClendon said: “No, no, no. I'm part of Chesapeake's hedging committee.”

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