Chesapeake Energy Corp. shareholders are being urged by the manager of a group of New York City pension funds to vote against the only two board members up for reelection this year for failing to monitor financial activities of CEO Aubrey McClendon.

The City of New York Office of the Comptroller, which represents pension funds that control 1.9 million shares of Chesapeake, said in a letter to shareholders that it opposes the reelection of Oklahoma State University President V. Burns Hargis and former Union Pacific Corp. CEO Richard K. Davidson. Both also serve on Chesapeake’s audit committee.

“We are particularly disturbed by the audit committee’s failure to review, approve or disclose Mr. McClendon’s personal loans secured by company wells,” wrote New York City Comptroller John C. Liu, who oversees the $122 billion pension fund. Liu also criticized McClendon’s right to invest in every well the company has drilled, noting that “his investment time horizon, risk appetite and liquidity needs may conflict with those of the company.”

Chesapeake shareholders previously have overwhelmingly voted in favor of McClendon’s sole participation in the Founder Well Participation Program, which is to be scuttled in 2014 (see Daily GPI, April 27; April 28, 2009).

Chesapeake currently has a nine-member board, and only a few stand for reelection every year, as required under Oklahoma law, where the company is incorporated. Chesapeake backed the board reelection structure as an “essential takeover defense,” which some believe makes it less vulnerable to outside interests.

In his letter Liu also asked shareholders to support the pension funds’ proposal that would require Chesapeake to include board candidates nominated by large shareholders, arguing that it would make the company more responsive.

“We believe adopting the proposed proxy access bylaw would make Chesapeake’s board more responsive to share owners, more thoughtful about whom it nominates, and more vigilant in its oversight,” Liu wrote.

“Revelations since mid-April of substantial, previously undisclosed liabilities, transactions and conflicts of interest involving Chesapeake and its CEO have heightened our concerns and fueled a 27% decline in its share price. Share owners urgently need new directors who are willing and able to exercise strong, independent oversight of Aubrey McClendon, a willful CEO with a penchant for risk.”

In a filing responding to Liu, Chesapeake stated that the proposal would encourage “the wrong type of board responsiveness” and give power to special interests.

According to regulatory filings, several large hedge funds and investment firms have sold most or all of their positions in Chesapeake since the beginning of this year, including S.A.C. Capital Advisors LP (91%), Millennium Management LLC (86%), Fidelity Management & Research Co. (59%), Two Sigma Investments LLC (98%), Adage Capital Advisors LLC (57%), and Highbridge Capital Management LLC (100%).

On Friday after the markets had closed the board, roundly criticized for the lavish perquisites it receives, said it had adopted a new compensation arrangement for outside directors, which reduces compensation by 20% and eliminates the use of fractionally owned aircraft for personal travel.

Under the new arrangement, which took immediate effect, outside directors are to receive total annual compensation of $350,000, comprised of $100,000 cash and $250,000 equity, which the board said was “at or below the average director compensation of the company’s peers.”

Chesapeake’s annual meeting is scheduled for June 8. However, several shareholders have filed a federal lawsuit asking for an injunction to postpone the meeting until Chesapeake discloses more information on McClendon’s compensation and third-party debts. A hearing is scheduled for May 30.

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