Annaly Capital Management's Bloodless Coup


I've been meaning to write about this for some time, but have put it off because, frankly, I feel slightly sullied every time I write about Annaly Capital Management . Of all the companies that I follow, I believe it to be the least honest and forthcoming with shareholders. And lest there be any doubt about this, its decision to "externalize" its management team, taken at last month's annual shareholder meeting, confirms this opinion.

For those of you that haven't followed this story, let me give you a brief recap. At the beginning of April, Annaly's executives asked investors to vote in favor of a "management externalization proposal," under which the job of managing the mortgage REIT would pass to a newly created entity known as Annaly Management Company.

Because the new entity would be wholly owned and staffed by Annaly's current executives, the proposed structure appeared on its face to be more clerical than anything else. That is, the individuals responsible for running the company wouldn't change; they'll just no longer be employed by Annaly directly, but rather by the independent management company. Thus, as opposed to paying executive salaries directly, Annaly would simply pay the management company the equivalent of 1.05% of its consolidated stockholders' equity.

Why would Annaly do this? The purported rationale is that the new structure will save approximately $210.9 million over the next five years. And it's for this reason analysts have spoken favorably, albeit naively, about the proposal, which is set to take effect in July.

At this point, you're probably wondering what in the world could be wrong with this. Aren't lower expenses a good thing? Yes. Of course they are. But there's more to this story than meets the eye.

It's my opinion that any expense reductions -- which, for reasons I won't get into here, I believe to be suspect on their face -- have nothing to do with this proposal. The real reason Annaly's executives want to separate the management team is because it will allow the company (and thus the people that run it) to sidestep a number of disclosure requirements mandated by federal securities laws.

The starting point to understand this is the fact that Annaly pays its executives well -- very well. In 2012, its now-former CEO Michael Farrell took home $32 million, and current CEO Wellington Denahan took home $25.8 million. In 2011, each cleared $35 million.

How do we know this? We know this because under the Securities Exchange Act of 1934, a company is obligated to disclose the salaries of its highest-paid executives.

Now, admittedly, this wouldn't typically be a problem. A company can and should be allowed to pay its executives what its board of directors (which purportedly represents shareholders) determines to be appropriate.

But there's a catch.

Following the wave of corporate fraud that led to the downfall of Enron and Worldcom, among others, the Sarbanes-Oxley Act began requiring companies to hold so-called "say-on-pay" votes every one to three years. The point was to give shareholders a nonbinding vote on whether or not they agreed with executive compensation levels. The frequency of the votes, moreover, would be decided in a separate nonbinding vote.

To get back to Annaly, at its 2011 annual meeting, the company's shareholders voted overwhelmingly in favor of holding annual say-on-pay votes. But in direct contradiction of this, Annaly's board, which is chaired by its CEO, voted instead to hold the votes every three years. (As a side note, its shareholders also voted against reelecting two board members, who were subsequently reappointed by the company anyway.)

Why would Annaly contradict the expressed desire of its stockholders? While it's impossible to read their minds, the results of this year's say-on-pay vote offers a hint: 113 million shares voted in favor of 2012 executive compensation levels while 289 million voted against them. Thus, a full 72% of the votes cast objected to how much its executives earn.

So, what's this have to do with the management externalization proposal? Under the new structure, Annaly will no longer be obligated to disclose how much its executives get paid, as that will be the responsibility of the management company, which, in turn, is privately owned and under no obligation to do so.

Even though I've written about Annaly a lot over the last two years, I still continue to be surprised by its executives' efforts to usurp a larger piece of the corporate pie than they would otherwise be entitled to if they took their fiduciary duties and disclosure responsibilities seriously. To anyone that holds this stock, I encourage you to think long and hard about continuing to do so. And for those of you considering an investment in Annaly, take this as a warning. You may make money from this investment (or you may not), but it won't be because of its executives, rather it will be in spite of them.

To learn more about Annaly and the problems I've identified in the past, check out the articles below:

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