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Can Annaly Capital Management, Inc. (NLY) Ever Be Trusted Again?

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Executives of public companies have a hard enough job as it is; the last thing they should have to do is answer to shareholders.

Think about it. Have you ever considered how lonely a private airplane can get? Or what about staying at five-star hotels and eating at the world’s finest restaurants (all on the company’s tab, of course)? Ever heard the song “Mo’ Money, Mo’ Problems”?

Annaly Capital Management, Inc. (NYSE:NLY)On top of this, shareholders don’t know squat about running a multibillion-dollar company.

If the executive of a publically traded company wants to hire her sister as the chief financial officer of a second publically traded company that it exercises complete control over (heretofore I refer to this as its “subsidiary” even though it isn’t technically a subsidiary)? So what if her sister is lacking experience for the role? She’s at least as qualified as the chief executive officer of the subsidiary, who, by the way, is the son of a member of the parent company’s board of directors.

Now granted, the fact that the subsidiary ended up overstating its publically reported net income by a factor of 2.5 for most of its life doesn’t look good. And true, it failed to file its required quarterly and annual financial statements with the SEC for over a year. And yes, the New York Stock Exchange threatened to delist its shares on multiple occasions. And, OK, its share price, adjusted for dividends, is down by more than 60% since it debuted in 2007. But come on, I think we can all acknowledge that we’re splitting hairs, here.

To show you just how petty it would be for shareholders to actually care about things like this, take the overstated income. Let’s say this publically traded subsidiary reported that it earned $1.1 billion between 2008 and 2011. Then, it turns out, that it only earned $435 million over this time period. The difference is a mere $665 million.

Sure, one way to look at this is to say that the company was completely inept if not criminal in intent, and that everyone who participated in hiring these patently unqualified individuals — and paying them seven-figure salaries — should be fired.

Some people may even think that these same executives should be banned from running a publically traded company ever again. Or perhaps that they should, at the very least, have their securities licenses suspended — as the founder of the parent company did in 1994 (that is, the same year the parent company was founded).

But that’s just one way to look at it.

Another way to look at it is this: At least they didn’t overstate the company’s earnings by a zillion dollars. In that case, yes, even I would acknowledge that there might be grounds for some type of discipline. Maybe, say, a one-week ban from using the company’s country club membership, or something along those lines.

But unfortunately, the reality is much harsher than this. It turns out that shareholders aren’t indifferent to these types of behaviors. And they’ve even gone so far as to cast nonbinding votes against executive compensation and the reelection of certain board members at our non-hypothetical parent company.

Granted, these votes were ignored by the executives. But still, they’re annoying.

My question to you, in turn, is this: If you were the executives of said parent company, what would you do?

Sure, the securities laws require publically traded companies to disclose things like familial relationships between executives, board members, and underlings. And sure, they require companies to inform investors about how much money top executives get paid. But, certainly, there must be some way to get around these pesky regulations.

Well, it just so turns out that there is. And Annaly Capital Management, Inc. (NYSE:NLY), the parent company in our nonhypothetical tale, has figured out how — for the record, the publicly traded subsidiary is Chimera Investment Corporation (NYSE:CIM).

In a press release issued last week, Annaly Capital Management, Inc. (NYSE:NLY) announced that it is now an “externally managed REIT, with officers and directors, but no employees.” And who, pray tell, is its external manager? I’m glad you asked. The external manager is a private company that’s wholly owned by none other than Annaly Capital Management, Inc. (NYSE:NLY)’s now-former cast of executives and directors.

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