Retired businessman John Wynne, one of the founders of Duke Realty Corp., is the latest executive to get burned after using company stock as collateral for a multimillion-dollar loan in his investment account.
Duke shares have fallen 74 percent from their 2007 peak, shriveling the value of company stock he put up as collateral for an account at Merrill Lynch, Securities and Exchange Commission filings show.
The investment community is abuzz that margin calls led Merrill to sell millions of dollars of Wynne’s shares—a scenario he did nothing to swat down during a phone interview with IBJ.
"I am not going to confirm or deny it," said Wynne, 75, who retired as Duke’s chairman in 1999. "I am not going to comment."
A margin call occurs when the value of shares in an investor’s portfolio falls, and he has to put up more collateral or sell off shares to pay back the loan. Margin agreements give brokerages the right to cash in shares without the borrower’s OK—something they’ve done with increasing frequency in recent weeks, out of fear stock prices would fall further.
For an executive like Wynne, who built his wealth over decades, margin sales are a double whammy. Not only do sales in the depth of a bear market cash in stock at a historically low price. They also trigger a big capital-gains tax hit, since the stock had a low tax basis. Wynne, an attorney, had been holding shares since he, Phil Duke and John Rosebrough founded the company by buying the then-ailing Park 100 industrial park in 1972.
Margin calls became a big headache in corporate America this fall, as the bear market pulled stocks lower than many executives ever thought possible. Just this month, at least three dozen companies have announced insider sales due to margin calls. Among the biggest: Aubrey McClendon, CEO of Oklahoma-based Chesapeake Energy Corp., sold nearly his entire stake in the company for $569 million.
Investment firms typically allow customers to borrow up to half the value of their holdings. Tapping that credit allows executives to spend freely without having to liquidate shares, which would trigger taxes.
Filings with the SEC show Wynne is not the only former Duke executive to borrow from Merrill Lynch using his Duke shares as collateral, though it’s not clear how widespread the practice was. Duke spokesman Joel Reuter said the company was not privy to the details of such arrangements, since it was not a party to them.
An SEC filing this spring shows that on Feb. 14 Wynne put up an additional 16,351 Duke shares as collateral for his Merrill Lynch loan. At the time, the stock price was about $22, making the new collateral worth $360,000. The stock has since fallen by nearly half, to $12.
It’s not clear from records how much Wynne borrowed from Merrill Lynch, or the total number of shares he put up as collateral. Records say the Merrill borrowing dates back to at least November 2003. At that point, Wynne had pledged 210,686 shares. The stock then traded for about $31 a share, making the collateral worth more than $6.5 million.
Such borrowing can look brilliant in bull markets, when many stocks climb ever higher. Some executives use leverage as an investment strategy, potentially juicing returns.
In times like these, however, it ratchets up the anxiety. At Emmis Communications Corp., for instance, founder and controlling shareholder Jeff Smulyan has put up nearly all his 5 million company shares as collateral for a personal bank loan, the company’s June proxy statement shows. Smulyan, the CEO, has had to up his collateral over the past year, as the company’s share price tumbled.
"If Mr. Smulyan defaults on the line of credit and the pledge is foreclosed, the sale of shares … could result in a change in control of the company," the proxy states.
Since the proxy was filed, the value of Emmis shares has slid another 78 percent.
No worries, Smulyan told IBJ last month.
"We’re working on a plan to deal with that," he said, declining to elaborate. "It’s not an issue for this company or me."
Conseco Inc. co-founder Stephen Hilbert found himself in a corner in early 2000, after the company’s declining stock price spawned margin calls in his investment accounts.
The company’s board came to his rescue. It extended a $23 million loan to Hilbert so he would not have to cash in a block of Conseco stock—a move that would have rattled investors as they awaited release of 1999 financial results.
Such high-stakes borrowing by executives is far from unusual in corporate America. Entrepreneurs who built their own companies tend to keep the faith to the end, business observers say. That’s often a positive trait, but also can expose them to an irrational level of risk.
Like the rest of us, they didn’t foresee the market’s going down as much as it has. But their penchant for borrowing made the consequences even more dire.