SandRidge Energy (UNKNOWN:SD.DL) Chairman and CEO Tom Ward has been using the company as his personal playground for too long. And his board has been letting him.
Here's a recent example.
Tom Ward's $5 million wrist-slap
According to SandRidge's 2013 proxy, Tom Ward has to pay the company $5 million over the next four years to settle a third-party lawsuit. Beyond that, the proxy says very little, leaving shareholders guessing about the nature of the lawsuit and why Ward has to pay $5 million to a company he runs. Whether this payout is a consequence of misconduct should concern shareholders.
A troubling tale
Based on a compelling account from Reuters of what probably happened, I believe shareholders should be very concerned. Here's the story it tells.
- Tom Ward used his SandRidge stock as collateral for extensive personal loans. When shares plunged because of the financial crisis, lenders demanded that Ward put up more money as collateral.
- In late 2008, Ward sold his stakes in SandRidge wells to raise the money needed to pay his lenders. During that time, SandRidge was facing financial difficulties of its own and was left with only $636,000 in cash at the end of 2008.
- When SandRidge shares declined further, Ward had to put up more collateral. He borrowed $75 million from George Kaiser, the chairman of BOK Financial, and a charitable trust run by Kaiser. In return, Kaiser received warrants that gave him the right to buy SandRidge shares owned by Ward.
- When Ward's financial situation got even worse, he had to renegotiate the deal. According to the new deal, Ward had to give Kaiser 8.9 million shares and a warrant to buy more SandRidge shares in the future. In addition, Kaiser gained temporary access to SandRidge's financial records. In other words, Ward gave Kaiser access to SandRidge's financial records to facilitate a private deal, and not for the benefit of shareholders.
- An outraged shareholder alleged that Ward improperly profited from these business dealings and filed a lawsuit in late 2010.
- In late 2012, the shareholder agreed to dismiss the lawsuit. On the same day, Tom Ward agreed to pay $5 million to SandRidge to settle a lawsuit. However, SandRidge refused to clarify whether this payment was connected to this particular lawsuit.
A bad omen
I believe this chain of events reflects badly on both Ward and his board.
First, the fact that SandRidge was left with only $636,000 in cash at the end of 2008 helps highlight the problems with the perk that allowed Ward to take a stake of up to 3% in company wells. Compare that with the controversial perk Chesapeake Energy (NYSE:CHK) gave to its former chair and CEO Aubrey McClendon to take a stake of up to 2.5% in company wells.
At SandRidge, this perk helped Ward cherry-pick SandRidge's best assets and facilitate business transactions that were against the best interests of shareholders, even during particularly troubling times for the company. And according to Reuters, he walked away with about $19 million in profit for doing so.
Second, the fact that SandRidge's board allowed Ward to use company records to facilitate a personal financial transaction reflects poor oversight at best, and perhaps even a mentality that SandRidge is Ward's company. I'm worried that this mentality has led to the board's approval of a variety of other questionable dealings at SandRidge that put Ward's private interests at odds with the company's general business interests.
I don't know about you, but I prefer to own companies run by boards that view the company as the property of all shareholders.
A lack of candor
In addition to the other factors, I'm concerned about SandRidge's lack of candor regarding this lawsuit. As Warren Buffett argues, businesses owe their shareholders candor and should clarify "the pluses and minuses important in appraising business value ... [and] tell you the business facts we would want to know if our positions were reversed."
Given the shadiness of the business dealings that appear to have led to the $5 million settlement, it's not surprising that SandRidge's leadership would want to disclose as little as possible about it, and that they'd want disclosures to be scattered across a variety of documents to make it hard for shareholders to gain a clear picture of events. However, I believe the likely motivation behind this lack of candor is a bad sign for shareholders.
On the other hand, the addition of four new board members put up by activist shareholder TPG Axon and the recent elimination of the poison-pill provisions SandRidge adopted in November may offer some hope of a turnaround. If these activists succeed in making further governance improvements, the stock may be worth buying. But without continued, significant improvements, I believe cautious investors should continue to steer clear of the company.
Fool contributor M. Joy Hayes, Ph.D., is the Principal at ethics consulting firm Courageous Ethics. She has no position in any of the stocks mentioned. Follow @JoyofEthics on Twitter. The Motley Fool has options on Chesapeake Energy. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.