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.