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Green Mountain Margin Call Latest Sign Market Is Stuck in 1929

Investors may want to push for regulators to ban the practice outright given the problems that have arisen at Green Mountain and Chesapeake, among others.

The Dodd-Frank overhaul of securities laws gives investors the ability to advocate that violations of company policy -- such as Stiller's sale -- are a breach of federal securities laws. Currently, Section 955 of the 2010 Dodd-Frank Act requires that the SEC write rules for disclosures related to corporate policies on margin accounts, a task yet to be completed by the SEC, though an SEC spokesman said the regulator has existing disclosure laws related to executive stock holdings

In the fall of 2008, McClendon of Chesapeake Energy sold "substantially all" of his 33.4 million shares at a $2 billion paper loss after he faced margin calls related to loans he used to buy more of the Oklahoma City-based company's stock. That year, Chesapeake Energy disclosed that it gave McClendon a $75 million cash bonus. As of its 2011 proxy statement, Chesapeake Energy said it's banned the use of margin accounts by corporate executives.

In early 2009, Goldman Sachs said in a proxy statement that it spent tens of millions of dollars to bail out two senior executives who faced similar margin calls in the fall of 2008. Goldman bought back stakes in some internal investment funds from Jon Winkelried, its former co-chief operating officer, and Gregory K. Palm, its general counsel -- two of the bank's largest shareholders at the time. Goldman bought $19.7 million of hedge fund and private equity investments from Winkelreid and $38.3 million from Palm.

According to Goldman Sachs's 2012 proxy, its top executives are prohibited from hedging any shares of common stock. Green Mountain said it banned the practice starting in 2012; however, Stiller and another director's accounts has existed prior to the change.

When Berkshire Hathaway (BKR.A) made a $5 billion investment in Goldman shortly after the partner-bailouts, the Warren Buffett-run company stipulated that the bank's top four executives couldn't sell more than 10%of their stock for three years. In recommending pay packages for TARP recipients such as Goldman, Kenneth Feinberg mirrored those concerns.

"We were very careful in making sure that there were no options and there was no collateralized use of stock unless it could be redeemed over a three year period," says Feinberg.

While recent margin-based sales are different from Depression-era scandals raised by bank heads who shorted their company's stock, they may represent a lingering fault -- and fault line -- in current corporate governance and securities laws.

Famously, National City Bank chairman Charles E. Mitchell was indicted on tax evasion charges after selling all of his stock to his wife in 1929 to eliminate his income tax liabilities. Mitchell's sale and the short sales of Chase National Bank shares by its head Albert H. Wiggin came amid a stock market meltdown that would last for years and which stemmed from policies of speculation that were promulgated by both bank heads.

Robert Scully Jr. uses Mitchell and Wiggin as a historical background for present-day Dodd Frank executive pay reforms in a Jan 2011 paper for Federal Lawyer published on the SEC's Web site. "Not much has changed in the law of executive compensation over the last 80 years," he writes.

At the time, Sen. (Va.) Carter Glass, a namesake of the now repealed Glass Steagall Act of 1933, called Mitchell the man "more responsible than all others put together for the excesses that have results in this economic disaster." In 1933, Mitchell was indicted for tax evasion and was grilled by Ferdinand Pecora in a Senate commission to investigate the 1929 stock market crash.

While Mitchell was eventually cleared of charges relating to his share sales, more explicit rules in a Dodd Frank rewrite of securities laws may bind corporate executives to their insider trading policies and limit their ability to use margin accounts. Such rules may also remove investor exposure to the potential for conflicts of interest and distressed insider sales that have been a part of recent share tumult.

The New York Times wrote at the time of Mitchell's acquittal, "the Federal Building, scene of much human drama and tragedy in past years, has never witnessed a more dramatic scene." That drama is still playing out today.

For Green Mountain and Chesapeake Energy, large insider share sales and the prospect of improper executive investments linger as just one of many concerns. Green Mountain shares have tumbled on weaker than expected earnings and allegations of improper accounting. Meanwhile, a Reuters investigation recently revealed that Chesapeake CEO McClendon has taken billions in additional loans tied to his holdings in company oil and gas wells. The SEC is currently also looking into whether a commodity trading fund run by McClendon breached insider trading laws.

For more on Chesapeake Energy, see ways Chesapeake Energy can be saved from itself and why its largest shareholder has recommended that the company consider a sale for more on how it can initiate a share turnaround.

-- Written by Antoine Gara in New York
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