Annaly Capital Management, Inc. (NLY)’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, Inc. (NYSE:NLY).

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 Capital Management, Inc. (NYSE:NLY)’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 Capital Management, Inc. (NYSE:NLY).

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 Capital Management, Inc. (NYSE:NLY) 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 Capital Management, Inc. (NYSE:NLY)’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.