Wednesday, April 18, 2012

Time for the SEC to institute new disclosure rules on CEO leverage

Here is a challenge for the SEC. Instead of trying to audit thousands of hedge funds and private equity firms, how about instituting some new disclosure rules for public companies. When a CEO has "co-investments" in the assets of the firm and uses material amounts of leverage to make these investments, the shareholders should know about it. In addition to the obvious risks of conflicts, if for some reason the CEO can't meet his/her obligations, it would have a negative impact on the shareholders. This is particularly true if the assets end up being liquidated or the CEO has pledged large amounts of company stock against the loans.
Reuters: Aubrey McClendon, the CEO of Chesapeake Energy Corp, has borrowed as much as $1.1 billion over the last three years against his stake in thousands of company wells - a move that analysts, academics and attorneys who reviewed loan documents say raises the potential for conflicts of interest.

The loans, which haven't been previously detailed to shareholders, are used to fund McClendon's operating costs for an unusual corporate perk that offers him a chance to invest in a 2.5 percent interest in every well the company drills. McClendon in turn is using the 2.5 percent stakes as collateral on those same loans, documents filed in five states show.

The size and nature of the loans raise questions about whether McClendon's personal financial deals could compromise his fiduciary duty to Chesapeake investors, experts who reviewed the documents told Reuters.

Both McClendon and Chesapeake said the loans don't pose any conflict of interest. And they are private transactions that the company has no responsibility to disclose or to vet, Chesapeake said. "There are no covenants or obligations in my loan documents or mortgages that bind Chesapeake in any way," McClendon wrote in an email to Reuters.
Sure there are no covenants and there doesn't seem to be anything illegal about the loans. But this is highly relevant for the shareholders - probably more relevant than many other disclosures CHK makes. Again, the SEC needs to focus on broad investor protections and disclosures, rather than concentrating so much on hedge funds, whose investors represent a tiny fraction of the population. Some of the largest mutual funds such as Vanguard and State Street are the biggest shareholders of CHK. That means that most people's 401Ks probably have exposure.

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