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The Problem With Pledging, Part II

We recently wrote about the perils of directors and officers pledging shares in their own company. We highlighted some examples and discussed possible ramifications. In this post, we will take a deeper dive into some of the data we’ve compiled with respect to the pledged shares of beneficial owners.

As mentioned in our previous post, the Securities and Exchange Commission requires public companies to report, either in a 10-K or in a proxy statement, whether shares have been pledged or held in margin accounts by directors and executive officers. (See Rule 403(b)(3) of Regulation S-K, 17 CFR §229.403(b)(3).) We recently performed a review and analysis of 10-Ks and proxies in order to collect data on which companies have pledged shares, specifically, by whom and how many.

A close examination of proxy statements over months or years can show a company’s pledging policy change over time. A number of companies explicitly state a change in policy, although in these cases past pledges are often grandfathered in. Some companies that allow pledging have nevertheless demonstrated efforts to lower the amounts of shares pledged.

For example, an April 2012 proxy statement for Atlantic Tele-Network Inc. reported that Cornelius B. Prior, Jr., Chairman of the Board of Directors, who owned 4,485,070 shares (28.9% of class), held 3,121,611 of these shares in a margin account. A more recent proxy statement from April 2014 shows that Mr. Prior now beneficially owns 4,516,090 shares (28.39% of class) but has only 563,612 shares pledged as collateral for outstanding loans and 500,550 shares held in a brokerage margin account, about a two-third reduction of the amount previously pledged. The footnotes also indicate that “there are currently no outstanding margin loans in this account.”

While the large amount of Mr. Prior’s pledged shares was newsworthy in prior years, the decrease in pledged shares is also noteworthy and could indicate a positive response to shareholders’ concerns and an acknowledgement of the risks of pledging.

Similarly, an August 2014 proxy statement filed by FedEx stated that “[t]he number of shares pledged by Mr. Smith has decreased by 626,000 during the last year and by 1,186,000 over the last two years.” Other companies have followed suit and made similar disclosures in their proxies of reductions in pledged shares. These are all indications that many companies, while allowing pledging, also acknowledge the risks involved.

On the other side of the spectrum, a review of proxy statements reveals many companies that explicitly prohibit pledging or do not have any shares pledged. According to proxy statements filed this past year, some of the largest companies do not have pledged shares, including Apple Inc. and Exxon Mobil Corp. In its March 2014 proxy statement, Google Inc. explicitly stated “[n]o employee, including named executive officers, or director may engage in short sales of Google securities, hold Google securities in a margin account, or pledge Google securities as collateral for a loan.” A number of other companies, from Harley Davidson Inc. to Krispy Kreme, also explicitly prohibit pledging or disclose that there are no shares pledged or held in margin accounts.

So who are some of the notable pledgers? The table below shows ten pledging arrangements among Russell 3000 companies, mined from 2014 proxies and 10-Ks.

As one can see from the chart above, there are some big companies with a substantial number of shares pledged.

Liang Zhang, Director and CEO of Synutra (NASDAQ: SYUT), beneficially owns 36 million shares of the company, which represented nearly 63% of the outstanding shares as of that date. In this case, the shares are actually owned by Beams Power Investment Limited, all of which are pledged to certain lenders under a facility agreement. Liang Zhang, according to the disclosure, has dispositive and voting power over investments by Beams: his wife is its sole shareholder and director.

T. Boone Pickens, on the Board of Directors at Clean Energy Fuels Corp. (NASDAQ: CLNE), has pledged 79% of his shares in the company, which are held as collateral in margin accounts.

Elon Musk, CEO of Tesla (NASDAQ: TSLA), has pledged 29% of his 35 million shares beneficially owned, or about 8% of the company’s total shares outstanding. In this case, his shares are pledged as collateral to secure certain personal indebtedness. Interestingly, both TSLA and CLNE have significant short interest, as does Black Diamond (NASDAQ: BDE).

Our review of 10-Ks and proxies reveals hundreds of companies that have pledged securities.  Our comprehensive data analysis provides a useful way to determine a company’s pledging status and, moreover, the amount of shares at risk.

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