How Annaly Is Obfuscating Facts to the Detriment of Shareholders

The audacity of the executives at the high-yielding mortgage REIT Annaly Capital Management (NYSE: NLY  ) never ceases to amaze me. Among other transgressions -- click here to see a full list -- they pay themselves patently exorbitant salaries. They disregard majority shareholder votes related to the election of directors and executive compensation. And they use nepotism to fill the top positions at their publically traded subsidiary Chimera Investment Corporation (NYSE: CIM  ) -- which, not coincidentally, remains entrenched in a massive accounting blunder.

But even I was surprised to read its most recent proxy statement filed earlier this week. As my colleague Amanda Alix noted yesterday, nuzzled amongst the usual assortment of proxy votes for the company's upcoming shareholders' meeting on May 23 is a seemingly innocuous proposal to change the company's management structure, from one that's internally managed by Annaly's executives, to one that's externally managed by a company owned by Annaly's at-that-point former executives.

What's the difference? While Annaly claims that it will save the company $210.9 million over the next five years and bring it into alignment with the likes of American Capital Agency (NASDAQ: AGNC  ) , Invesco Mortgage Capital (NYSE: IVR  ) , and Two Harbors Investment Corp. (NYSE: TWO  ) , the true reason appears a little less noble. As an analyst explained to Bloomberg News, "the motivation for the change was probably that it means the pay of individual executives will no longer be disclosed."

Remember what I said about exorbitant pay and shareholder votes? In 2011, its chief executive officer and chief operating officer made $35 million each. And while that figure declined to $25 million last year, it still dwarfed that of executives at the largest and most esteemed financial companies in the world, including JPMorgan Chase and Wells Fargo, which have balance sheets 18 times and 11 times larger than Annaly's, respectively. In addition, when a majority of Annaly's shareholders reacted to this last year by voting to hold say-on-pay votes on an annual basis -- which, mind you, are nevertheless nonbinding -- Annaly decided otherwise in direct contradiction of its shareholders' expressed desires.

This is why I was particularly entertained by Annaly's explanation of how the interests of its shareholders will be aligned with the interests of the executives running the company. If the proposal is approved, Annaly has promised to "institute a stock ownership requirement under which our five most senior executive officers, over the next three years, own an amount of our shares of common stock equal to at least 6 times their 2012 base salary which represents an aggregate ownership of $38.7 million."

This is comical, if not verging on dishonest. At Annaly, as at many other financial companies, base salary is a relatively negligible portion of overall compensation. As the mortgage REIT itself acknowledges (emphasis mine): "[W]e pay for performance by structuring compensation so that the majority of cash compensation is comprised of discretionary bonuses linked directly to the value of our stockholders’ equity."

So how did this play out for Annaly's "five most senior executive officers" in 2012? As you can see below, their cumulative base salary was $6.45 million. As the company noted correctly, this equates to one-sixth of the $38.7 million stock ownership requirement. But if you take bonuses into consideration, the total compensation shoots up to $55.37 million. That's 43% more than the proposed requirement!

So, are the executives at Annaly lying? No. Not officially, at least. But they are obfuscating the facts, and one must assume they're doing so purposefully. If Annaly truly cared about honesty and transparency, as it purports to, then this is how the relevant paragraph in its proxy statement would read (the italicized portion is my addition):

What steps can we take to align our interests with those of the employees of our Manager?

If the Management Externalization Proposal is approved, we will institute a stock ownership requirement under which our five most senior executive officers, over the next three years, own an amount of our shares of common stock equal to at least 6 times their 2012 base salary which represents an aggregate ownership of $38.7 million. It's important to remember, however, that base salary represents a minority of total compensation. Once bonuses are included, the cumulative figure for our five most senior executive officers increases to $55.37 million, or 43% more than the proposed stock ownership requirement.

Do you see how that changes the context? We're not talking about splitting hairs here. This is a material and critical distinction. Annaly argues that investors needn't be concerned about the alignment of executives because the latter will be more vested financially in the company itself than in their salaries. But as we've seen, that simply isn't true -- or it is true, but only if you define "salaries," as Annaly did, to exclude the lion's share of remuneration. It reminds me of former President Clinton's quandary over the meaning of "is."

In sum, although Annaly's executives have proposed this change for the ostensible purpose of saving money, I would counsel shareholders against accepting this explanation at face value. The reality is that Annaly's executives want to have their cake and eat it, too. That is, they want the benefits of access to the public capital markets without the associated burden of disclosing their patently ridiculous compensation amounts.

To anyone who cares about transparency and bona fide corporate governance, this is revolting.

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  • Report this Comment On March 21, 2013, at 6:39 PM, jonkai3 wrote:

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    This is comical, if not verging on dishonest. At Annaly, as at many other financial companies, base salary is a relatively negligible portion of overall compensation

    ------------------------

    and thankfully so, you see their Compensation is dependent on how well they do... if they increase a SHAREHOLDERS book value, then they get paid more....

    meaning you are trying to shoot yourself in your own foot... if NLY had paid out half of what they did in 2012, that would have meant that the shareholders value of the company was cut in half.... any bells and whistles going off there for you John?

    what you should have wished for is that Management was paid for instance $100 million instead of $35 million... they only way that could happen is if management increase a SHAREHOLDERS actual value of the company by three times...

    get it? you have been telling people to sell NLY, which lost anyone following your advice a great deal of money...

    you told people to sell CIM, which lost anyone following your advice a great deal of money.....

    you have management fees completely backwards to what you should wish management fees were...

    it is as if you have zero idea of how these companies work?

    So management wants to save the SHAREHOLDER $300 million over 5 years... and now you are yet screaming bloody murder again??? to what end? all i can tell your thoughts are good for is to do the exact opposite. because anyone that has, has made a great deal of money... as I have.

  • Report this Comment On March 21, 2013, at 6:51 PM, jonkai3 wrote:

    ------------------

    the true reason appears a little less noble. As an analyst explained to Bloomberg News, "the motivation for the change was probably that it means the pay of individual executives will no longer be disclosed."

    ----------------------

    and as usual, the Bloomberg writer doesn't have a clue about what she is talking about.

    the reason for doing this is because of tax reasons, they can not write off expenses paid to top execs, when they do it this way, they can write off some of the expense, there by saving on an expense, meaning more profits for shareholders.... duhh....

    what is particularly funny is that NLY said exactly how much they are going to get paid... 1.05% of NLY's equity value...

    good forbid NLY is able to double their book value, there by doubling Shareholders value, and gasp... doubling their compensation...

    instead of complaining about people getting rich to your detriment, how about you make as much as they do, by buying some stock, because if they double their compensation, you just doubled your value of shares...

    any of this sinking in yet?

    and even more funny is this is exactly how NLY has paid management their entire history... the only reason they are making this much now, is because they did double NLY's book value and equity... duhh..... guess what happen to shareholder's Value including dividend reinvestment... they have made over 800% return on their money...

    stop complaining about being poor, and figure out how to read their financials.... FOR THE PAST FIFTEEN YEARS for gods sake....

  • Report this Comment On March 21, 2013, at 10:16 PM, techy46 wrote:

    In 2011, Annaly's chief executive officer and chief operating officer made $35 million each. And while that figure declined to $25 million last year, it still dwarfed that of executives at the largest and most esteemed financial companies in the world, including JPMorgan Chase and Wells Fargo

    Most esteemed financial companies in the world including JPM Chase and Wells Fargo? Well, well and which companies brought us the Great Recession? It sure wasn't Annaly was it. BAC, C, GS, JPM and WSFC should've been nationalized in March 2008.

  • Report this Comment On March 22, 2013, at 12:25 PM, jonkai3 wrote:

    also if you want to know if the move is good for shareholders or not,

    the market will tell you in the price of the shares... see what the market treats those shares like since March 18th at 6:00am when the management proposal was released....

    obviously lowering expenses in the business is and always was good for shareholders.

  • Report this Comment On March 22, 2013, at 1:09 PM, gaucho420 wrote:

    I own NLY and I appreciate their management skills, as it brings a lot of value to the company, but you have to truly choose to overlook this compensation issue for it to not matter.

    I believe the compensation is much too high and it tells me that while management is certainly concerned about the company's performance, they are even more concerned about their own pay. A $30 million plus package is absolutely ridiculous and it reminds me of Countrywide, which has similar management and similarly high returns to investors (albeit in stock appreciation), only to see the company collapse, because in the end....the salaries to the execs were much more managed than the company itself.

    I'm not suggesting NLY is Countrywide, not by a long shot. But anyone who dismisses these salaries as a non-event is being naive or choosing to overlook an obvious red flag. This is a warning flag and for me, while I'm still long, it adds yet another reason to get out as soon as I smell a real sense of trouble.

    Any company that suggests hiding its compensation from its shareholder, by creating an entity that does not need to answer to shareholders, is telling me that it needs to hide something that I would probably disagree with.

  • Report this Comment On March 22, 2013, at 1:16 PM, gaucho420 wrote:

    And this argument that shareholders and investors know best, due to stock price, IS A FARCE.

    I'll go back to Countrywide, because I ALSO WORKED THERE! What I saw on the inside, while the stocks was climbing the charts, did not match the stock's performance. It was an amateur, BS run company, filled with idiots who anywhere else would be fit to be admins, let alone be folks making high stakes financial decision.

    Anyone able to add 2 cents together and the courage to speak the truth could see that Countrywide was headed towards bankruptcy. I quit within 7 months of working there, as it became crystal clear the only place the company was heading was total failure. This was 2004! Well before the collapse, yet it was clear as day.

    Unless you were on the inside, you would have never known. So again, while I'm not suggesting NLY is Countrywide, shareholders do not know exactly how companies operate and must trust management to make the right decisions.

    And sometimes? The management does not make the right decision and shareholders feel the pain when its much too late.

  • Report this Comment On March 22, 2013, at 1:45 PM, Wiseinvestors wrote:

    Why is this still owned by Motley Fool then per the disclosure?

  • Report this Comment On March 22, 2013, at 6:49 PM, dsandman999 wrote:

    One should always check up on management and realize there really only 2 reasons for things to show up on a proxy sent by management. Is is to reduce the pain and one is to increase the gain, and there is no assumed "for share holders" at the end of those statements.

    You do need to judge them on their track record which is pretty good the last 5 years. But to those thinking of doubles and 800%, they have not happened in 5 years. Learn to look at a stock chart. You have to go back to 2002 to get anything more than a double, counting dividends and a number of us lost a good deal of money when NLY crashed in 2005 and again in 2007. The stock has not recovered to where I bought it yet though the dividends have hit the levels of those timeframes.

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