Can Annaly Ever Be Trusted Again?

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Executives of public companies have a hard enough job as it is; the last thing they should have to do is answer to shareholders.

Think about it. Have you ever considered how lonely a private airplane can get? Or what about staying at five-star hotels and eating at the world's finest restaurants (all on the company's tab, of course)? Ever heard the song "Mo' Money, Mo' Problems"?

On top of this, shareholders don't know squat about running a multibillion-dollar company.

What's the big deal if the executive of a publically traded company wants to hire her sister as the chief financial officer of a second publically traded company that it exercises complete control over (heretofore I refer to this as its "subsidiary" even though it isn't technically a subsidiary)? So what if her sister is lacking experience for the role? She's at least as qualified as the chief executive officer of the subsidiary, who, by the way, is the son of a member of the parent company's board of directors.

Now granted, the fact that the subsidiary ended up overstating its publically reported net income by a factor of 2.5 for most of its life doesn't look good. And true, it failed to file its required quarterly and annual financial statements with the SEC for over a year. And yes, the New York Stock Exchange threatened to delist its shares on multiple occasions. And, OK, its share price, adjusted for dividends, is down by more than 60% since it debuted in 2007. But come on, I think we can all acknowledge that we're splitting hairs, here.

To show you just how petty it would be for shareholders to actually care about things like this, take the overstated income. Let's say this publically traded subsidiary reported that it earned $1.1 billion between 2008 and 2011. Then, it turns out, that it only earned $435 million over this time period. The difference is a mere $665 million.

Sure, one way to look at this is to say that the company was completely inept if not criminal in intent, and that everyone who participated in hiring these patently unqualified individuals -- and paying them seven-figure salaries -- should be fired.

Some people may even think that these same executives should be banned from running a publically traded company ever again. Or perhaps that they should, at the very least, have their securities licenses suspended -- as the founder of the parent company did in 1994 (that is, the same year the parent company was founded).

But that's just one way to look at it.

Another way to look at it is this: At least they didn't overstate the company's earnings by a zillion dollars. In that case, yes, even I would acknowledge that there might be grounds for some type of discipline. Maybe, say, a one-week ban from using the company's country club membership, or something along those lines.

But unfortunately, the reality is much harsher than this. It turns out that shareholders aren't indifferent to these types of behaviors. And they've even gone so far as to cast nonbinding votes against executive compensation and the reelection of certain board members at our non-hypothetical parent company.

Granted, these votes were ignored by the executives. But still, they're annoying.

My question to you, in turn, is this: If you were the executives of said parent company, what would you do?

Sure, the securities laws require publically traded companies to disclose things like familial relationships between executives, board members, and underlings. And sure, they require companies to inform investors about how much money top executives get paid. But, certainly, there must be some way to get around these pesky regulations.

Well, it just so turns out that there is. And Annaly Capital Management (NYSE: NLY  ) , the parent company in our nonhypothetical tale, has figured out how -- for the record, the publicly traded subsidiary is Chimera Investment Management (NYSE: CIM  ) .

In a press release issued last week, Annaly announced that it is now an "externally managed REIT, with officers and directors, but no employees." And who, pray tell, is its external manager? I'm glad you asked. The external manager is a private company that's wholly owned by none other than Annaly's now-former cast of executives and directors.

So, with one teeny-tiny exception, Annaly will effectively go on as if nothing happened. As it noted in the press release, "Effective July 1, 2013, Company employees were terminated by the Company and were hired by the Manager."

But, wait a second, what's this exception I speak of?

Oh, that old thing? Under the new structure, Annaly no longer has to disclose who it hires or how much it pays them. If shareholders -- that is, the ostensible owners of the company -- want to know this type of information, then tough you-know-what.

"Now," you say, "but John, Annaly has claimed that its now-former executives have come up with a way to ensure they continue to be aligned with the interest of shareholders even though they now work for a separate company, which, of course, only they own." And yes, indeed they have -- though even if the purported solution was legitimate, it still wouldn't cure the fact that they're corrupting the disclosure requirements.

According to the management agreement between the newly formed management company and Annaly, "each of the executive officers ... must own, respectively, an amount of the Company's shares of common stock equal to at least six times their respective 2012 base salaries."

Sounds pretty good, right?

The problem is that "base salaries" are but a pittance of these executives' overall earnings. In 2012, Annaly's CEO earned a total of $25.8 million, only $3 million of which was designated as a base salary. In other words, while saying they have to own "six times their respective 2012 base salaries" may sound high and mighty, in reality, it looks like one big farce. The $18 million in stock that former-CEO Ms. Wellington Denahan will have to hold is 20% less than her performance bonus alone last year.

In the interest of transparency, it's important to recognize that a majority of Annaly's shareholders did vote in favor of the externalization proposal. But, for reasons I won't get into here, it's my opinion that they did so imprudently and based upon pretexts that may or may not turn out to be in their best interests.

I could literally go on and on about the way that Annaly has, in my opinion, failed to live up to the standards that we, as public shareholders, should be entitled to expect in return for our hard-earned capital.

But I'll spare you.

Let me instead leave you with one thought: If you own shares in this company, I think you are being taken for a sucker. If you had any doubt about this before, then Annaly's decision to externalize its management should negate any uncertainty.

Now, to be clear, this doesn't mean you should sell your shares, at least not immediately. Annaly's stock appears to be in a cyclical trough right now, from which it will likely recover. However, it does mean you should probably think long and hard about whether you're comfortable reinvesting your dividends in the company, and certainly, for the love of all that is holy, you should think particularly hard before entrusting any more of your money to a group of executives that would act in the manner outlined above.

If you're on the lookout for high-yielding stocks, I encourage you to look instead at our special free report outlining nine high-quality dividend-paying stocks. All nine of these companies, unlike Annaly, are legitimate concerns that take their responsibility to shareholders seriously. The free report is called "Secure Your Future With 9 Rock-Solid Dividend Stocks." You can access a copy today at no cost simply by clicking here now.

Read/Post Comments (6) | Recommend This Article (13)

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 July 10, 2013, at 12:41 AM, prginww wrote:

    Wow, so Steve Jobs was a really great CEO because he did what? Umm, all I care about is if they make a profit on agency MBS and can turnover their paper portfolio while the FED screws around printing more bogus fiat currency.

  • Report this Comment On July 10, 2013, at 1:33 AM, prginww wrote:

    Long Rant...

    Dont forget effectively shareholders just created a asset management company with annual revenues of $130-150 million dollars and gave it away to management for free.

  • Report this Comment On July 10, 2013, at 9:30 AM, prginww wrote:

    this coming from John Maxfield, who hasn't produced a single cent from an original idea, nore paid out a single cent to a shareholder...

    woe is NLY who is paying out 40 cents, about 5 cents off it's historic average during a market intervention by the fed to force a low spread we likely will never see again. imagine what they pay out without that pressure that is now behind them.

    woe are the NLY shareholders who also have to put up with the millions they've made from the near 800% return through those dividends and reinvesting those dividends. They also have to put up with 5 star restaurants and the first class air too... what has John Maxfield done for anyone? seriously?

    He tells us to invest in index funds? someone took the time to get up in the morning to tell us that? I would like refund.

  • Report this Comment On July 10, 2013, at 7:45 PM, prginww wrote:

    Reminds me of PBHG when Gary hired his unqualified daughter to run one of the funds (into the ground).

  • Report this Comment On July 11, 2013, at 10:31 PM, prginww wrote:

    Excellent, loved your article.

    I've been in and out of NLY several times, now happily out, but I've never really understood how they can make so much money when, when mtg rates fall, their assets get taken from them through prepayments, and when i-rates rise, they get stuck with them while their value falls.

  • Report this Comment On July 13, 2013, at 10:41 AM, prginww wrote:

    I don't believe you mean "heretofore," which means "previously, up until now." The present tense "prefer" seems to confirm this. You mean "hereafter."

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Related Tickers

9/27/2016 4:00 PM
CIM $16.66 Up +0.10 +0.60%
Chimera Investment CAPS Rating: ***
NLY $10.89 Down -0.03 -0.27%
Annaly Capital Man… CAPS Rating: ****