The revelation that the CEO of Chesapeake Energy Corp. (NYSE: CHK), Aubrey McClendon, was borrowing money from a private equity firm that did business with Chesapeake to finance his personal stake (2.5%) in the company’s operations may or may not be a conflict of interest. But on the issue of the company’s, and McClendon’s, failure to disclose the fact of the loans points a finger at the real culprits here — Chesapeake’s board of directors.

McClendon himself is chairman of the nine-member board. Other directors include:

• Two former politicians – Former governor and US Senator Frank Keating, a director since 2003, and former US senator Don Nickles, a director since 2005.
• Two retired CEOs – Lou Simpson, former CEO of Geico Insurance Co. (part of Berkshire Hathaway Inc. (NYSE: BRK-A)), and Richard Davidson, former chairman and CEO of Union Pacific Corp. (NYSE: UNP), a director since 2006.
• One university president – V. Burns Hargis, President of Oklahoma State University, and a Chesapeake director since 2008.
• Three energy company executives – Lead independent director Merrill A. “Pete” Miller Jr., CEO and chairman of National Oilwell Varco Inc. (NYSE: NOV) and a director since 2007; Charles Maxwell, a senior energy analyst among other accomplishments, and a director since 2002; and Kathleen Eisbrenner, a director since 2010 and currently CEO of Next Decade, a company founded in 2010 to promote the development of an export market for US liquefied natural gas.

Chesapeake’s board is also very well compensated. According to the company’s most recent proxy statement, filed in April 2011, Ms. Eisbrenner, the newest board member, received stock and cash worth worth $248,670. The longest serving director of the company, Charles Maxwell, received total compensation of $467,026, and the most highly compensated of the directors, former Governor Keating, received $623,433.

The proxy statement also touts the independence of the board:

In 2011, the Board of Directors, through its Nominating and Corporate Governance Committee, evaluated the independence of each director in accordance with the NYSE corporate governance standards … During this review, the Committee considered transactions and relationships between the Company (and/or any of its executive officers) and each director or any member of his immediate family. Based on this review, the Committee affirmatively determined that all directors, other than Mr. McClendon due to his employment with the Company, are independent.

But that’s not a widely held position. In an amended proxy statement filed in May 2011, a shareholder group argued against the re-elections of McClendon and Nickles:

ISS [Institutional Shareholder Services] cites an “apparent unresponsiveness of directors to the shareholder franchise” and “failure to address significant compensation issues” as primary bases for its recommendation to withhold votes with regard to the election of Mr. McClendon, the Company’s co-founder, Chairman and Chief Executive Officer, and Senator Nickles, an independent director and chairman of our Nominating and Corporate Governance Committee.

The compensation issues that ISS refers to are related both to McClendon and the other directors. In late 2008, Chesapeake bought McClendon’s antique map collection for $12.1 million at a time when McClendon had already sold more than 30 million shares of Chesapeake shares to meet a margin call. In January of this year, a district court in Oklahoma ordered McClendon to pay back the company, with interest, and to pay $3.75 million in fees and expenses to plaintiffs in the suit.

Last year’s proxy statement does allude to McClendon’s well participation program and notes that in 2008, the board signed a new five-year contract with McClendon which included a one-time well cost incentive award of $75 million spread over the length of the contract.

But there is no mention of the $1.1 billion that McClendon has borrowed to fund his portion of operating costs. Chesapeake maintains that there is no obligation for the company to reveal the loans or for the company’s board to review them, citing a Delaware court’s ruling in a 2003 case involving Martha Stewart.

The company has said it will file its 2012 proxy statement by the end of this month. Perhaps then we’ll find out if the board will continue to line-up behind anything McClendon chooses to do or if it will act responsibly with the majority of shareholders interests. The board’s history strongly suggests that they’ll continue to protect McClendon and his interests just as before.

Paul Ausick

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