What does it say about a publicly traded company which allows its Chief Executive Officer (CEO) to trade company promised work and contracts with vendors for personal loans? Does it say any more (or any less) if the same CEO trades seats on the Board of Directors for personal loans? Does it say anything about a company which somehow produces a white-washed internal investigation of a CEO’s conduct claiming there was nothing illegal found but, only three years later, the Securities and Exchange Commission (SEC) brings a Complaint in federal district court against said CEO for selling Board seats for bailout loans, taking personal loans from vendors in exchange for sweetheart contracts; all the while never disclosing any of the above to the board of Directors, shareholders or other stakeholders. Finally, what is a conflict of interest in any of these scenarios.
Equally important, what does it say about the company that allowed all of the above to happen and then claimed after an internal investigation that there was nothing illegal found and continued to allow the CEO to stay in place? How about the law firm which conducted the investigation, what did this do for their reputation? It would probably not surprise you to find out the company did not have a Chief Compliance Officer (CCO) but did have a Chief Financial Officer (CFO) who took no action against the CEO, other than allowing him to stay in place. Finally, it probably would not surprise you to find out the company went bankrupt and the shareholders were left holding the bag of very dirty linen.
The company involved was Energy XXI, Ltd (EXXI) and its former CEO John D. Schiller Jr. The company went into bankruptcy in 2016 emerging as a new entity, Energy XXI Gulf Coast, Inc. (EGC). The SEC announced in a Press Release that Schiller had agreed to settle the case without admitting or denying the charges, by paying a $180,000 penalty and not serving as an officer or director of a public company for five years. The Complaint has been filed in federal district court in Houston and is awaiting a ruling by the Court.
The Complaint details how conflicts of interest (COI) can rot a corporation from the inside out, benefitting the senior executives involved in the conduct and those outsiders involved; all to the detriment of the employees and shareholders of the entity. Schiller was a high flying oil company CEO who could not bring himself to live on his paltry salary of only $14.5 millionannually (reported by the Houston Chronicle). According to the Complaint, Schiller “maintained an extravagant lifestyle that required him to spend millions per year on expenditures relating to his mansion, a sprawling ranch, racehorses, and generous donations to Schiller’s alma mater, Texas A&M University.” Since the aforementioned $14.5 million in annual salary was not enough to pay for all this, beginning “in March 2010, Schiller opened a margin account that was secured with his stock portfolio, the majority of which was EXXI stock. By February 2014, he had borrowed over $23 million against the margin account and the account was highly leveraged.”
2014 was when the trouble began. In what the SEC termed “related party transactions”, Schiller approached the owners of three EXXI vendors for personal loans and “obtained $7.5 million in personal loans from three company vendors. Following their loans, EXXI awarded these vendors new business and/or better terms on existing business. Schiller failed to disclose the loans to EXXI.” In extraordinarily dry language the Complaint noted, “As a result of the loans, Schiller had a material interest in the vendors’ business with EXXI because he received the loans in exchange for future EXXI business or favorable terms of business to the vendors.”
Vendor A
According to the Complaint, “Schiller needed a loan from the owners of Vendor A because he had spent too much money and reached his limit on funds that could be borrowed against his pledged securities in margin accounts. Contemporaneous emails reflect that the owners of Vendor A believed that the loan to Schiller was being given in exchange for EXXI business.” Schiller took three draws from Vendor A, in February and May 2014, totaling $2 million and in exchange, Schiller directed that approximately $7.5 million in contracts be directed to the company after the loans were made.
Vendor B
Vendor B was a broker and provider of oil rig service vessels in the Gulf of Mexico, who procured boats for EXXI pursuant to a Master Service Agreement (MSA). Vendor B and EXXI had a pre-existing business relationship going back to 2010, wherein Vendor B charged EXXI 10% of the boat rental as a brokerage fee which was higher than what other brokers charged. Payments to Vendor B constituted a significant part of EXXI’s total budget for capital expenditures. In August 2014, Schiller asked for and received a $3 million loan from the owner of Vendor B so he could make a margin call.
EXXI’s procurement department wanted to reduce the company’s reliance on Vendor B as the company had developed in-house capabilities to manage its transportation needs. Moreover, Vendor B’s brokerage fee was above prevailing market rates. In August 2014, the senior company officer in charge of procurement sought to renegotiate the MSA to reduce Vendor B’s brokerage fee to between 3% and 5%. However, after Vendor B’s personal loan to Schiller, Schiller directed the procurement department to increase its offer to Vendor B to a rate of 6%. The Complaint went on to state, “From the time of the loan until November 1, 2015, when Vendor B ceased brokering EXXI boats, EXXI chartered approximately $39 million in offshore service vessels and paid Vendor B associated brokerage fees.”
Vendor C
But the February, May and August loans were not enough and Schiller needed yet another loan to avoid a margin call in September 2014. According to the Complaint, “Schiller, through an intermediary who served as the financial adviser for both Schiller and the owner of Vendor C, approached the owner of Vendor C for a loan. According to Vendor C, the intermediary advised that, in exchange for a loan, Schiller would make Vendor C the exclusive liftboat provider for EXXI and enhance Vendor C’s prominence in the industry.” Vendor C made two personal loans to Schiller of $1.5 million in both September and October 2014. Thereafter, Schiller personally directed company procurement representatives to award business to Vendor C.
Loan for Board Seat
Yet Schiller’s seemingly inexhaustible need for continued cash was never ending. This led to him approaching Norman Louie (Louie), a portfolio manager at EXXI’s largest shareholder Mount Kellett Capital Management LP. While Louie was under consideration for an independent Board of Director position at EXXI, Schiller approached him initially for a $2 million loan, which he needed “the next day”. The loan was made but for an undisclosed reason it was increased to $3 million. Neither Schiller nor Louie disclosed this loan at any time during the Board of Director selection and vetting process; Louie was later elected to the company’s Board of Directors. Schiller did not require Louie to go through the full Board vetting process but never made a disclosure on that issue either.
Was Schiller an evil person, a sociopathic narcissist who did not think the rules applied to him or just someone who got in way over his head? Most probably a combination of all three. Yet one thing that can be said with certainty is that the company’s compliance function and COI regimes did not work one iota during the entire process. If a potential executive comes before your company for vetting and they have EXXI in their professional experience, you should tread very carefully.
When a CEO engages in such blatant conflicts, it certainly does not say much (positive) about a company’s culture, other than it is not focused on doing business ethically and in compliance with federal securities laws. As this is a Complaint filed in federal district court, it will be interesting to see if the judge believes a fine of $180,000 and five-year ban from serving as an officer or director of a public company is enough redress for violating the law to obtain $10 million in personal loans.
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