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How Do You Know It's Time to Run From a Stock? Here's How.

The headline from Forbes' Francine McKenna reads: "Chesapeake Energy: CEO McClendon Serves Himself First." I think she nailed it.

The sad part though is that the "me first" attitude of Chesapeake's (NYSE: CHK  ) CEO isn't news. Or, at least, it's not new news.

For years, Aubrey McClendon has intermingled personal and business expenses, receiving outlandish pay packages, sweetheart investment deals and, of course, that infamous $12 million map debacle. In May of last year, I shared this regarding McClendon's historical pay and perks:

For the five years ending in 2010, Chesapeake handed over $193 million in total pay, including a gargantuan $112 million jackpot in 2008. And if all of this isn't enough to make your blood boil, consider that the massive 2008 payday was during the same year that McClendon got battered for stacking up his stock holdings on margin. It was also in 2008 that the company infamously spent $12 million to buy a set of historical maps from McClendon and became a founding sponsor of the Oklahoma City Thunder -- an NBA team that McClendon owns nearly 20% of.

But the current kerfuffle isn't simply over what McClendon is being paid. Rather, it's over $1.1 billion in loans that Reuters uncovered that McClendon used to finance a company perk known as the Founder Well Participation Program, or FWPP. The program allows McClendon to invest directly in Chesapeake's wells, buying up to a 2.5% interest and paying all applicable costs.

Last summer, I took a closer look at this program and suggested that it may be far more worrisome than the kingly sums that the company pays McClendon for his CEO duties:

Shareholders may look at this arrangement and brush it off because it seems pretty fair. McClendon pays well costs out of pocket and he gets a share of the spoils.

But I think it's silly to assume that McClendon is simply tapping his piggy bank to pay these costs. Between 2005 and 2010, Chesapeake's total debt more than doubled, from $5.5 billion to $12.5 billion. Combine that with McClendon's stock-margin debacle, and it's clear that the man is not afraid of a little debt.

Reuters tracked down the fire, but even at that point I smelled smoke:

As I noted above, it's as if McClendon has his own little company here, and it's quite possible he's using a lot of borrowed money to stock that company with pieces of Chesapeake assets.

What's the big deal?
In Reuters' report, McClendon was quoted defending his great perk and the financing arrangements he used to sustain it.

"I do not believe this is material to Chesapeake," McClendon said in an email response to questions. "There are no covenants or obligations in my loan documents or mortgages that bind Chesapeake in any way."

And in its filings, Chesapeake claims that having the FWPP in place at all is a good thing because it motivates McClendon and better aligns him with shareholders.

We believe the FWPP fosters and promotes the successful development and execution of the Company's strategic business plan by ... aligning the financial rewards and risks of Mr. McClendon with those of the Company more effectively and directly than other performance incentive programs maintained by many of the Company's peers.

But the question that investors should have been asking themselves all along is: If the goal is to align McClendon's interests with shareholders and the company as a whole, why isn't he just buying Chesapeake stock? Now that we know that McClendon has been facilitating his FWPP participation by leveraging himself to the hilt, it makes the idea of "alignment with shareholders" laughable. This isn't shareholder-friendly aligning of interests -- this is a gambler making the most of the public markets to make huge, leveraged bets for himself.

It's a joke, but if you want to be the punch line...
But the bottom line is that although some of the details here are new, the core of the issue -- that Aubrey McClendon runs Chesapeake Energy for his own benefit and without regard to public shareholders -- shouldn't be news to anyone.

In the past, at least shareholders could hang on to the fact that McClendon owned a reasonably large stake in the company -- 5.7% of shares outstanding as of 2007. But even that was revealed as a mirage. It turned out that McClendon had levered up to buy that stake and he lost the vast majority of it when the market went south. Today, he owns roughly one half of one percent of the company's shares.

Yet through all of this, many shareholders have stuck around, so it seems pretty unlikely that this most recent revelation will do much to shake what could probably be best termed "The Cult of McClendon."

And I'll admit it, it may all work out in shareholders' favor. Investing isn't a game of absolutes -- it's about probabilities. Even when the odds are long, sometimes those three cherries come up and you hit the jackpot. But for most people, consistently betting on those long odds will end up being a bank-account-draining experience.

Aubrey McClendon has proven himself to be a big-swing gambler and a CEO who makes sure that he's always by himself at the front of the line when it comes to divvying up the spoils. For some investors, perhaps the gamble on the gambler seems worth it. But considering the way that McClendon conducts himself with regard to Chesapeake, I think it's unlikely that the odds are in shareholders' favor.

Motley Fool newsletter services have recommended buying shares of Chesapeake Energy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Matt Koppenheffer does not have a financial interest in any of the companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.

Read/Post Comments (17) | Recommend This Article (70)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 19, 2012, at 4:00 PM, mradamman wrote:

    if the percentage was 100% instead of 2.5% then investors would have been completely defrauded.

    This seems akin to the PUDA fraud in China. There the CEO sold the company out from under shareholders and shareholders were left holding an empty frame.

    This seems to be a similar technique but with a smaller percentage of the company at the stake.

  • Report this Comment On April 19, 2012, at 4:54 PM, TMFPennyWise wrote:

    Matt, Well written article with lots of good points.

    I wish I had read your research before I bought CHK (because I wanted to invest in the Utica Shale prospects here in Ohio) but didn't see them 'til now--and I guess there isn't a message board devoted to CHK?

    I especially like your point about if A. McC. wanted to 'align himself' with the company he should buy his company's stock. I haven't read that elsewhere and it might be worth a Letter to the Editor at Forbes' to point it out. I was a little tired of reading the company lawyer's constant reference to 'Aubrey aligning himself' with company in the Q & A posted on the CHK website.

    Keep the the great reports. J.

    This will be interesting to watch play out.

  • Report this Comment On April 19, 2012, at 6:39 PM, kmet312 wrote:

    Dating back 1 calendar year, Aubrey's reported insider transactions:

    June 10, 2011 purchase 10,000 shares at $29.45

    June 30, 2011 acquisition 1,327 shares at $29.69

    July 1, 2011 disposition 91,767 shares at $30.10

    July 1, 2011 acquisition 232,560 shares at $0

    July 2, 2011 disposition 35,658 shares at $30.10

    August 3, 2011 disposition 1,160 shares at $0

    August 9, 2011 purchase 8,600 shares at $29.00

    Sept. 21, 2011 disposition 2,000 shares at $0

    Sept. 30, 2011 acquisition 7,265 shares at $25.55

    Nov. 25, 2011 purchase 11,000 shares at $22.76

    Dec. 16, 2011 disposition 2,500 shares at $0

    Dec. 31, 2011 acquisition 1,514 shares at $22.29

    Jan. 2, 2012 disposition 69,218 shares at $22.29

    Jan. 3, 2012 acquisition 296,615 shares at $0

    Jan. 3, 2012 disposition 26,063 shares at $23.60

    Jan. 4, 2012 disposition 46,913 shares at $23.86

    Mar. 30, 2012 acquisition 7,040 shares at $23.17

    For what it's worth, my take on this:

  • Report this Comment On April 20, 2012, at 2:40 AM, jekoslosky wrote:

    Thanks, Matt. Exactly why I dumped my CHK stock earlier this year.

  • Report this Comment On April 20, 2012, at 11:54 AM, JohnMaxfield37 wrote:

    Matt, well said.

    Of course, whether CHK shareholders are doing well or not isn't the ultimate issue, as that reckoning will come if McClendon is acting improperly -- ask Tyco's shareholders how that all worked out for them.

    The issue, in turn, is simply whether McClendon is acting in an improper way. And this isn't a function of shareholder return. It's a function of right and wrong. Ethical and unethical. Legal and illegal.

    At the very least, there's a significant appearance of impropriety here. And in my humble opinion, a highly paid corporate executive like McClendon has a legal duty to avoid these.

    Being a lawyer, I don't use the term "duty" lightly.

    Look at it this way, this appearance, in and of itself, clouds the company's reputation. And because he's hurting the company's reputation in exchange for personal gain, he's going against the responsibilities of a fiduciary in spirit if not by the letter.

    At the end of the day, if McClendon wanted to plunder the company he founded, he shouldn't have taken it public.

  • Report this Comment On April 20, 2012, at 12:06 PM, KurtEng wrote:

    Good article. I also dumped all my CHK stock earlier this year and I certainly don't regret it now.

  • Report this Comment On April 20, 2012, at 12:16 PM, cmstripling wrote:

    I work for a large commodities trading co, mentioned McClendon to one of our Natgas traders, his response, "That guy is a f- snake oil salesman. I'll never do business with him."

    Pretty much swore off CHK since that.

  • Report this Comment On April 20, 2012, at 12:57 PM, mkloppel wrote:

    All of you act as if this program were something slipped between the company board and AMc in the dead of night in an alley way, its been public knowledge for almost 20 years! Not his financing ofhis part, but the progam.

    And the fact that he mortgaged that stake in order to finanance it (for a limited period of time), on HIS credit, should give all of you reason to jump for joy.

    Not only was he confident enough about the aquisitions and expansions the company was making but so was an investment company who was willing to front him the cash.

    Lets not also forget that he gets 2.5% of the PROFIT from those wells he helps finance, profit doesn't come from him ignoring or neglecting his responsibility to CHK it will come from him making the right decisions.

    So how is any of this bad for me and my investment in CHK? Give me something tangible which AMc has done in the past which intended to defraud the company and/or the public or which was criminal and maybe we can talk.

  • Report this Comment On April 20, 2012, at 1:13 PM, woodNfish wrote:

    Good article. It is obvious that McClendon is a crook. What he is doing may be legal, but he is still a crook.

    I used to own some CHK because Cramer raved about them and loved the CEO, but I dumped it because it kept declining. Cramer is no longer a fan either, but he hasn't been explicit about why. This brings up another point about stock advisors like Cramer and Motley Fool. Both of them heavily promote "renewable" "green" crap and MF is always "long term, buy and never sell" stupidity and never tells readers to trail stops. That lack of advice they should be giving ends up hurting anyone who blindly follows MF advice.

    The green crap is garbage that can't exist without a phony government subsidized market. And natural gas prices are so low there is no money in it, I don't care how "clean" it is.

  • Report this Comment On April 20, 2012, at 1:57 PM, kmet312 wrote:

    CNN Money article from earlier today:

    The hits just keep on coming.

  • Report this Comment On April 20, 2012, at 3:23 PM, Calimesa wrote:


    Good article but what are you trying to say. I hear two things; buy but don't buy and sell but don't sell. Are you trying to make me work for my decision on CHK? LoL. After reading the article about A.M. taking out the 'loan' I decided to strike CHK from my watch list. Now after reading your article & resulting comments and the CNN Money article cited above I'm leaning to put CHK back on my Watch List. It's hard for me to decipher if the market is greedy or not right now on CHK. Low natgas prices just means a better opportunity for long term investors as long as the natgas companies you invest in can weather the storm. Natgas is going to be a big player in our future. Ok rambling over, I'll take a wait and see what happens in the next few months before deciding CHK's final fate in my portfolio.

  • Report this Comment On April 20, 2012, at 3:45 PM, ibuildthings wrote:

    CHK has been one of those "wonder" stocks for me for years, and a reason that I don't ignore technicals. I "wondered" why despite the 5 fool stars, it hasn't gone anywhere in years. All the great reasons to rise in value, yet it doesn't..

  • Report this Comment On April 24, 2012, at 2:18 PM, TMFKopp wrote:


    What was it that I wrote that made you think I'd be interested in buying CHK shares?

    I'm sorry if the article was unclear for you, but, in short, CHK shares will *not* be considered for my personal portfolio until the company's governance is seriously overhauled.


  • Report this Comment On April 27, 2012, at 12:01 PM, eba1925 wrote:


  • Report this Comment On April 28, 2012, at 9:33 AM, Minow wrote:

    That's why you never rely solely on the story, earnings reports, or fundamentals because as we all know by now, information can be manipulated------learn how to read a chart and the technical indicators and you will spot these ticking time bombs!

  • Report this Comment On April 28, 2012, at 10:35 AM, ilovesumm wrote:

    If it walks like a duck ......

  • Report this Comment On April 30, 2012, at 2:01 PM, dj555 wrote:

    hear hear woodnfish

    If you time these stock spruikers

    reports well including fools you

    can make money-- shorting them.

    Garbage, how can fool craft all this

    nonsense about the new super efficient

    fuel replacement spark plug--

    look at the Statements the Company

    has NEVER made a profit.

    If you read this claptrap you are indeed a fool if you make money from such a dispicable

    bunch you ve been lucky thats all.


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