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SEC Tells Chesapeake, CEO to 'Retain Certain Documents'

Chesapeake Energy Corp. and CEO Aubrey K. McClendon were notified last week by the Securities and Exchange Commission (SEC) that the Fort Worth, TX, regional office has launched an informal inquiry and "requested that the company and Mr. McClendon retain certain documents." The inquiry "should not be construed as an indication that any violation of the federal securities laws has occurred." The company and McClendon said they "intend to cooperate" in responding.

Before the inquiry was officially disclosed by Chesapeake late Thursday, the flamboyant industry cheerleader spoke publicly for the first time on Wednesday during a conference call to discuss the company's lackluster first quarter financial and operational performance (see related story). The 52-year-old, subject of intense shareholder and media scrutiny, appeared to take it on the chin for more than an hour with energy analysts, who never once asked the company chief any tough questions about apparent financial indiscretions.

McClendon, who was knocked off his perch as chairman of the board early Tuesday, perhaps understated the "unprecedented scrutiny" of the company and of himself. Instead he promised shareholders that the management team is focused on becoming a U.S. oil-weighted giant. He opened with an apology -- not for any of his alleged indiscretions, but rather for the misinformation.

"I'm deeply sorry for all of the distractions of the past two weeks," McClendon said at the opening of the conference call. "There has been enormous and unprecedented scrutiny of our company, and of me personally. And a great deal of misinformation has been published and uncertainty created...Mother told you not to believe everything you hear and read for good reason..."

The SEC announcement, and downgrades by many energy analysts and one respected debt rating firm, was one of many in a jam-packed news week for the Oklahoma City-based operator and its lanky CEO.

U.S. Sen. Bill Nelson (D-FL) asked the Department of Justice to launch an investigation of the corporation for possible price manipulation and fraud. In a letter to Attorney General Eric Holder on Friday, Nelson said he was "deeply concerned" about the financial and trading activities of senior management at the company and the "potential implications of those activities on energy prices and American consumers."

Because Chesapeake "is the second largest producer of natural gas and accounts for 5% of U.S. natural gas production," its size and magnitude "ensures that its activities play an influential role in the industry -- and market." He asked that the Financial Fraud Enforcement Task Force investigate whether Chesapeake executives "committed fraud or violated any other criminal or civil laws that could undermine the integrity of our oil and gas markets and cause harm to American consumers."

Nelson's request followed a report by Reuters last week indicating that McClendon may have run Heritage Management Co., a private commodities hedge fund, for at least four years, from 2004 to 2008, which for a period listed Chesapeake headquarters as its mailing address. The report suggested that the fund, apparently founded by McClendon and SandRidge Energy Inc. CEO (and Chesapeake co-founder) Tom Ward, may have influenced McClendon's running of Chesapeake.

Sen. Bernie Sanders (I-VT) said the probe into Heritage raised questions about conflicts of interest and also about a lack of transparency into the derivatives.

"We now know that one of the wealthiest energy CEOs in this country was moonlighting as a major oil and gas speculator in the summer of 2008 when prices were skyrocketing," said Sanders. "Speculators, particularly CEOs of major energy companies, should not be allowed to make a fortune by jacking-up oil and gas prices in the energy futures market. It is time for federal regulators to do their job, obey the law, and crack down on excessive energy speculation as required by the Dodd-Frank Act. We also have got to prevent the obvious conflicts of interest that this report exposes and make our energy markets more transparent.

"Under current law, CEOs are required to let the public know when they buy and sell large shares of their own company's stock, but trading in energy futures and derivatives is kept hidden from the American public. This is simply unacceptable. The American people have a right to know this information."

In addition to stripping McClendon of his chairmanship, Chesapeake also is terminating early the Founder Well Participation Program (FWPP), which has given McClendon the sole contractual right to receive a 2.5% stake in every well the company has drilled since 1993. The FWPP was to end at the end of 2015 but now will end on June 30, 2014 (see NGI, April 30; April 23).

Chesapeake confirmed in late April that McClendon had mortgaged his well stakes with lenders, some of which have business relationships with the corporation. He reportedly has received loans from private equity firm EIG Global Energy Partners, as well as Wells Fargo & Co., Bank of America Corp. and Goldman Sachs Group Inc. None of the firms have commented publicly on their relationship with McClendon and Chesapeake.

"I am completely supportive of the board's plans to separate the positions of chairman and CEO and to bring an independent chairman onto the board," said McClendon in response. "This action reflects our determination to uphold strong corporate governance standards and will also enable me to focus my full time and attention on execution of the company's strategy, the implementation of our transformation into a major oil producer and the completion of our asset monetization and joint venture objectives."

The board plans to name an "independent, nonexecutive chairman in the near future," the company said. The nominating and corporate governance committee "is considering potential candidates with no previous substantive relationship with Chesapeake and will be soliciting input from major shareholders." McClendon has "waived any rights he might have under his employment agreement as a result of no longer serving as chairman."

Memphis-based Southeastern Asset Management, the largest stakeholder at 13.6%, stepped in last week to take a more active role going forward. The investment company will be involved in the search for a nonexecutive chairman, said President G. Stanley Cates.

"The bottom line is, there are positives and negatives of partnering with McClendon, as with anybody, and in our opinion the positives strongly outweigh the negatives, and the negatives have been very actively addressed," Cates said during a Southeastern shareholder meeting.

Southeastern Chairman O. Mason Hawkins said the board "made the right decision by ending the FWPP early and seeking an independent chairman. Aubrey was right to recognize that these actions are in the best interests of the company and its shareholders. We support management's continuing efforts to unlock and deliver the value embedded in Chesapeake's assets."

Chesapeake's lead independent director Pete Miller, CEO of National Oilwell Varco, said separating the roles of chairman/CEO improves corporate governance and terminating the FWPP would "eliminate a source of controversy, both of which should send a positive signal to the market and improve shareholder value."

The charges about the hedge fund question whether a CEO playing the market for himself might be neglecting his obligation to his shareholders to maximize company profits or might be profiting in his trading from advance market knowledge gained in his management position.

"A key issue in all of this is disclosure," said NGI's Patrick Rau, director of Strategy & Research. "The SEC is a stickler about disclosing any perceived conflict of interest." Rau, a former Wall Street analyst, questioned whether there has been full disclosure, and if not, from whom was the company's compliance unit taking orders.

As to whether McClendon could have influenced the natural gas futures market, "it is generally believed that there is no insider information when it comes to commodities, because commodities markets are as close as it comes to being perfectly competitive. In perfectly competitive markets, all producers are price takers, and therefore cannot impact the price themselves. So while a producer couldn't impact the overall market, he might personally profit from advance information," Rau said. He stressed, however, that there has been no proof nor confirmation of the hedge fund allegations made by Reuters in its lengthy report last week.

Another question is why have shareholders put up with a joint CEO/Chairman for so long. "A CEO should never be in charge of a board of directors. One of the main reasons for an independent board is to provide a check and balance on the CEO," Rau said. Because Chesapeake co-founder Ward could also have been involved in the hedge fund, "Look for investors to put SandRidge under a tight microscope in the weeks ahead."

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