On Wednesday November 2, 2011, several media outlets reported on the details of the settlement in the shareholders derivative action filed against executives of Chesapeake Energy Corporation. The case, which was filed in state court in Oklahoma in April 2009, was on appeal after the claims were dismissed in February 2010. Under the terms of the settlement, CEO Aubrey McClendon, whose compensation in 2008 included a $75 million bonus (following a six-month period where the company’s share price fell from $74 to $16.17 a share), will buy back an art collection which he sold to the company for approximately $12 million in 2008.

Mr. McClendon, who co-founded the company in 1989, became one of a handful of executives to reach Forbes’ so-called "20-20 Club" for "chief executives [who] have held the top job for at least 20 years and delivered at least a 20% annual return to shareholders during their tenure."

According to Carolina Bolando’s article on Law360.com (available here), shareholders claimed that Mr. McClendon accumulated ownership interests in $190 million worth of gas reserves through the company’s Founder Well Participation Program, by leveraging most of his 33.4 million shares of Chesapeake as collateral in various loans. However, when the share price for Chesapeake fell over 75% in a six-month period in 2008, Mr. McClendon was forced to sell his shares to satisfy margin calls.

According to the lawsuit, Mr. McClendon sought a "massive annual compensation increase" and ultimately received a one-time $75 million payment, which was part of an overall compensation package of $112 million under a renegotiated five-year employment contract (which also included a clawback provision if he left the company early. In addition, as part of that December 2008 contract, Mr. McClendon sold his collection of 500 antique maps from Oklahoma for $12.1 million.

In April 2009, a shareholder, the New Orleans Employees’ Retirement System, filed a derivative action (available here) against the Board of Directors alleging breach of fiduciary duty and corporate waste for the decision to pay Mr. McClendon the $75 million bonus, which it claimed gave him a 433% increase in compensation and marked an enormous increase of the $1.8 million bonus paid to him in 2007.

In February 2010, Judge Twyla Mason Gray of the Oklahoma District Court for Oklahoma County dismissed the Complaint because plaintiffs failed to make a pre-litigation demand on the company (as required in derivative actions). Plaintiffs argued that such a demand was excused because such a demand would be futile since all of the board members participated in the negotiation and approval of the contract with Mr. McClendon. Rather than amend their complaint, Plaintiffs requested that the case be certified for appeal. While on appeal, the parties informed the Court that settlement had been reached.

As reported by Russell Gold of the Wall Street Journal (article here), "Mr. McClendon agreed to buy back, with 2.28% interest, a collection of more than 500 antique maps," but "[m]ost other benefits that Mr. McClendon received in 2008, including a one-time $75 million retention payment, will remain in place … ." The article further pointed out that although the company will recover over $12 million, they will need to pay law firms that filed the case $3.75 million. The settlement must be approved by the Court.

According to Anna Driver of Reuters (article available here), the settlement "places restrictions on senior management’s right to hold company stock in a margin account or make speculative trades with Chesapeake shares." Moreover, the article noted that "Chesapeake had already taken some steps in respect to its governance practices, by hiring "a compensation consultant and a lead independent director this year."

The corporate governance changes did not impress Michael Passoff of Proxy Impact, which advises institutional shareholders on shareholder votes, who was quoted by the Wall Street Journal as asking: "Is there anything here that will change the culture from allowing this to happen again? It doesn’t appear so."

Reuters pointed out that Institutional Shareholder Services ("ISS"), the proxy advisory service opposed the re-election of Mr. McClendon to the Board this year. The article further noted that while "more than 40 percent of the company’s shareholders rejected Chesapeake’s executive pay plan" at the June shareholder’s meeting, Mr. McClendon "was reelected with 78 percent of the vote."


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