The Securities and Exchange Commission has opened an informal inquiry into Chesapeake Energy Corp's controversial program that granted Chief Executive Aubrey McClendon a share in each of the natural gas producer's wells, a source familiar with the matter said on Thursday.
That inquiry, being led by the SEC's office in Fort Worth, Texas, comes after Reuters reported about loans McClendon had obtained on those wells that raised concerns about a potential conflict of interest by the company's CEO.
Chesapeake said it would end the program that gives McClendon a 2.5 percent stake in every one of the company's thousands of wells in 2015, when the shareholder approval of the program that started in 2005 expires.
The company said in a statement earlier on Thursday that its directors had never reviewed or approved McClendon's mortgages on stakes in those wells, reversing its prior assertions that its board of directors was "fully aware" of McClendon's financing transactions around the well ownership stakes.
"The board of directors did not review, approve or have knowledge of the specific transactions engaged in by Mr. McClendon or the terms of those transactions," the company said.
Ratings agency Standard & Poor's said on Thursday the turmoil surrounding the well ownership program and McClendon's personal transactions could hamper the company's ability to meet "massive external funding requirements stemming from its currently weak operating cash flow."
S&P lowered its credit rating for Chesapeake - which has been junk grade for some time - one notch to "BB" from "BB-plus" and said another cut could occur within a few months.
Chesapeake shares ended Thursday down 3.1 percent at $17.56 on the New York Stock Exchange, bringing the decline so far this year to about 20 percent.
The company's recently issued 6.775 percent note due March 15, 2019, the most active issue on Thursday, was down 0.5 to 0.75 point following the S&P downgrade, according to traders.
Reuters reported on April 18 that McClendon, who founded the company, had borrowed as much as $1.1 billion in the last three years against his ownership stakes in wells that he received under the company's "Founder Well Participation Program."
The majority of the borrowing came from an investment management firm that is also a major financier of Chesapeake itself.
On Thursday, McClendon disclosed that as of the end of 2011, he owed $846 million on loans taken out against his well stakes. But the company did not disclose the total amount McClendon has borrowed, or whether his outstanding debt has risen since the end of last year.
The loans had been previously undisclosed to shareholders, analysts and academics said, raising concerns that McClendon's personal financial deals could compromise his fiduciary duty to Chesapeake.
An informal inquiry is the first step taken by the SEC before it launches any full investigation into potential wrongdoing by a company.
One major shareholder questioned whether the company's new statements had been prompted by the SEC probe.
"It seems somewhat coincidental that the board has acted this way today, and the SEC announces its inquiry. You wonder if they didn't have the news," said David Dreman, chairman of Dreman Value Management LLP, which owns about 1 million Chesapeake shares.
'FULLY' VS 'GENERALLY'
Critics of the company have long complained the company's board acted a little more than a rubber stamp for McClendon, one of the energy industry's most visible leaders.
McClendon founded Chesapeake in 1989 and quickly built the company into one of the nation's fastest-growing producers of natural gas. It is now the second-largest U.S. natural gas producer behind Exxon Mobil Corp.
Chesapeake said "the statement last week that 'the Board of Directors is fully aware of the existence of Mr. McClendon's financing transactions' was intended to convey the fact that the Board of Directors is generally aware" that McClendon had used the well ownership stakes as security for the loans.
One analyst said Chesapeake's new statement did not provide any reassurance that it was addressing the issues.
"How can this make me more comfortable?" said Phil Weiss, an analyst with Argus Research. "Either you're fully aware, or you're not. ‘Fully' and ‘generally' are two entirely different words."
Chesapeake board members declined to comment in specific terms on why they reversed course on McClendon's stakes in the wells and how the company's general counsel could describe the board as fully aware of the CEO's related loans if they had "no knowledge" of them as the board said in a statement.
"All of this is a work in progress," Frank Keating, a Chesapeake board member and former governor of Oklahoma, said in an email.
But an investor said the move was a step in the right direction, and that it showed the company was listening to shareholders' complaints.
"It's basic due diligence that sadly wasn't being done before," said Jake Dollarhide, chief executive of Longbow Asset Management in Tulsa, Oklahoma, which owns Chesapeake shares. "It shows the free rein that McClendon had."
McClendon disclosed additional information about his ownership stakes in the wells, and the board is reviewing the CEO's financing arrangements.
The CEO listed his share of Chesapeake's proved natural gas reserves at 810 billion cubic feet equivalent, or slightly more than 5 percent of the company's total. That equates to about 12 days' supply for the United States based on 2011 consumption.
The Oklahoma City, Oklahoma-based company has been at the leading edge of the shale gas industry and holds vast acreage in the fields discovered in recent years that are expected to yield decades of fuel for the United States.
But the steep jump in natural gas output has sent prices for the fuel plummeting to their lowest level in decade, squeezing profits and pressuring share prices for Chesapeake and many of its peers.
Debt rating firm Fitch Ratings said on Thursday it had revised its outlook to "stable" from "positive" for Chesapeake, which has $13 billion in rated securities, largely because of the low natural gas prices.