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Aubrey! Come On!

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Reuters had ANOTHER* story today about bad shit that Aubrey McClendon is up to. Here's what's going to happen. I will be all "meh, that is a whole lot of people saying a whole lot of maybes," and will sort-of defend Aubrey, and then tomorrow Reuters will have a "Special Report: Aubrey McClendon Killed Babies and Produced Natural Gas From Their Decomposing Corpses," and at some point enough will be enough. So let's just arbitrarily make that point now. Reuters, you win. Aubrey McClendon, you are a bad man! Jesus.

Anyway, today's revelation is that McClendon "ran a hedge fund" that traded oil and gas from 2004-2008, while also having another job, viz. running Chesapeake. Now McClendon would not be the first person to say that he "ran a hedge fund" to describe sitting in his underwear at a computer managing $10k of his own money, but this thing seems to have been legit, with an inconspicuously bland name (Heritage Management) and $200mm of money, much of it from outside investors. And, look, I know I'll regret this, but here is a catalogue of people saying a lot of maybes:

"If the company needs to make an operating decision which might move the market against the CEO's positions, there's a risk that will influence the decision-making at the top of the company," said Jeff Harris, former chief economist at the market's U.S. regulator, the Commodity Futures Trading Commission, and now professor of finance at Syracuse University.

"Advance knowledge of Chesapeake's activities could be perceived as having insight into the movement of commodities prices, which certainly raises conflict-of-interest issues as well as ethical issues about the ability to enrich himself on non-public information," said Tim Rezvan, oil and gas industry analyst at Sterne Agee in New York. "If correct," Rezvan said, "these disclosures would be even more alarming than the personal loans."

"I would argue, and I think the SEC would argue, that the failure to disclose that you are engaging in this kind of conduct can constitute a securities fraud problem," said Elizabeth Nowicki, a professor at Tulane University. She said a failure by McClendon and Ward to disclose their fund to Chesapeake's shareholders may constitute a "material omission" that could draw SEC scrutiny. "A reasonable investor would want to know that the CEO could be in a situation where he's betting against the interests of the company personally," Nowicki said. "That, it seems to me, is a slam dunk."

So I guess the maybes fall into two categories. One is the insider trading in oil an dgas - "ethical issues about the ability to enrich himself on non-public information" - which, fun fact: not illegal! For sort of obvious reasons: if Chesapeake, say, is going to hedge itself by selling gas forward, it should only sell as much as it plans to produce. But the amount it plans to produce is non-public. So it has to use non-public information. Aubrey doesn't, I suppose, and maybe it's not "ethical" for him to do so, but ... well, I'm less convinced of the moral evil of insider trading than others are. And I think the CFTC would agree, I guess, since they don't ban it.

The other maybe is the conflict of interest: if McClendon was long natural gas in his hedge fund, he might want to reduce CHK production and drive up prices even if that would not be optimal for CHK. Or if he was short natural gas he could push up production uneconomically. Etc. Did that happen? Well, it might have happened. But, also, no:

McClendon's hedge fund partner [and SandRidge CEO Tom] Ward said the two were always careful not to let Chesapeake's decisions influence the hedge fund's endeavors. ... "We did not use any proprietary knowledge of (Chesapeake) trades to make our own individual decisions," Ward said.

Peter Cirino, who helped trade natural gas for the hedge fund, also said he knew of no discussions about what Chesapeake was doing in energy markets: "They were much too smart as individuals," Cirino said of McClendon and Ward. "They would be able to manage that conflict there, if there was one."

And, sure, that is not 100% convincing. "I did not use any knowledge in my brain to make any decisions that I made with my brain" is the sort of thing that is hard to say with a straight face. But my rough guess goes like this: Aubrey thought that he had a comparative advantage at knowing where gas prices were going to go. He used that knowledge with Chesapeake, where he sat on the hedging committee (and, y'know, produced gas and stuff), and at Heritage, where he bought and sold oil and gas contracts. When he had an idea, he used it in both places. If you're good at stuff, why not monetize it in as many ways as possible?

The hedge fund, like the founder well participation program that first got Aubrey in trouble with Reuters, actually probably was aligned more or less with Chesapeake. Of course it created opportunities for conflict - if he had just traded against Chesapeake, well, that seems like a conflict - but my guess is that his bets in one place were in roughly the same direction as his bets in the other place. After all, why would you intentionally do the wrong thing in any of your jobs? Probably running an energy hedge fund makes you a better E&P company CEO, and vice versa. Synergies!**

Still. This is a guy who just really likes betting on energy: owning wells, trading derivatives, levering up CHK stock, whatever. That is probably a guy who should be founding energy companies. I suspect it describes a majority of CEOs of private independent E&P companies. It just doesn't work so well with public company CEOs. Once you take your company public, there is at least an expectation - I mean, Elizabeth Nowicki thinks there's such an expectation, and she thinks that the SEC thinks so too - that it, in the form of your paycheck and equity in the company, will become the primary, or really sole, expression of your interest in whatever business it is in. If that's not how you feel - well, you need to be really clear about that, and the market doesn't always like it when you are. But it likes it even less when you're not.

Special Report: Inside Chesapeake, CEO ran $200 million hedge fund [Reuters]
Chesapeake’s McClendon ‘Deeply Sorry,’ Promises Debt Plan [Bloomberg]

* So ... did Reuters know all this stuff before they started with "hmm Aubrey McClendon got some loans" two weeks ago? Were they just drawing it out to keep things interesting? Implementing Felix Salmon's idea about selling scoops? Like, was Reuters calling a bunch of hedge funds after the first story saying "hey, there's more to come, pay us $100,000 to see the next installment early"? Coming on the heels of Felix's proposal, the timing is suspicious no? That, it seems to me, is a slam dunk. If correct, it would be alarming. Whee.

** Similarly - did the hedge fund take him away from his work? Well, let's stipulate that he was going to manage his PA in some form no matter what. If he'd been forbidden from investing in energy (other than his huge, margined CHK investments ... and the wells), he'd have to go buy things, and as a trader type he'd probably go buy gold or private placements of tech companies or Herbalife distributorships or whatever. Totally legit! No conflicts of interest! But probably takes more of his time than just making oil and gas bets.


The Volcker Rule Will Come Too Late For Kaufman Bros.

If you're a more or less regular consumer of efficient markets hypothesis Kool-Aid then a fun activity is to handicap the probability of various public policy things based on market reaction.* So for instance Obama's budget is going to reduce the tax deductibility of munis! And the muni market didn't care! So, no, Obama is not going to reduce the tax deductibility of munis. You heard it here first, or last, or whatever. (Exercise for the reader: is Obama going to raise the tax rate on dividends?) Since today seems to be Volcker Day hangover it's worth pondering this: