Sunday Telegraph: Shell in the path of a legal whirlwind
The oil giant has published its own assessment of its reserves debacle, but, says Grant Ringshaw, investors and regulators are still gunning for it
Royal Dutch/Shell, the Anglo-Dutch oil giant, had hoped to find some peace after its very public confession last week about how it misled investors for years over the magnitude of its reserves. But the authorities, especially in the US, might not be keen to absolve a company whose conservative image turned out to be skin-deep.
The release last Monday of a damning report by Davis Polk & Wardwell, a firm of independent lawyers, confirmed that Shell's top executives knew about the overstatements in 2002 - almost two years before they were made public in January this year.
The report presents a vivid portrait of a bitter feud between the oil giant's top two executives - Sir Philip Watts and Walter van de Vijver, who were both forced to resign last month - over how to handle the explosive secret.
For government regulators and class-action lawyers, it offers a startling insight into the events leading up to January 9, when Shell stunned investors by revealing that it had overstated its reserves by 25 per cent. Following later revisions it has now emerged that the overstatement was 29 per cent.
So, how serious is the legal threat to Shell and its current and past directors? Well, last week it emerged that the US Department of Justice has stepped up its investigation into possible crimes committed by the company.
Shell also faces probes by the US Securities and Exchange Commission, the Financial Services Authority, the Dutch regulator and Euronext, the European bourse operator, raising the prospect that the company and its executives could face charges as well as fines and damages running into billions of dollars.
Meanwhile, 15 multi-billion-dollar class action lawsuits have been launched after the overbooking scandal wiped billions of dollars off the combined market value of Shell Transport & Trading and Royal Dutch. At the peak of the share price fall, the capital loss was $22bn (£12.5bn).
The class actions have dragged in past executives who now chair leading FTSE100 companies. Sir Mark Moody-Stuart, the former Shell chairman who chairs the mining giant Anglo American, Paul Skinner, the chairman of Rio Tinto, and Maarten van den Bergh of Lloyds TSB are all named as defendants.
Although the Justice Department's more active role is a blow for Shell, there is no suggestion of criminal wrongdoing by the company or current and past executives.
According to one senior US litigator last week, the summary report was a "map for regulatory action against Watts and van de Vijver and a plea by Shell for leniency".
Legal experts say that the SEC and the Justice Department's immediate focus will be to decide whether Shell executives intended to defraud investors by manipulating data that would have an impact on the company's share price and financial position.
At the centre of the probe will be the tug of war between Watts, the Shell chairman from June 2001, and van de Vijver, the head of exploration and production who succeeded Watts in this role.
According to the Davis Polk report, Watts and van de Vijver engaged in a "pointed dialogue" over more than two years. Van de Vijver repeatedly raised concerns that reserves booked during Watts's term as exploration head between 1997 and 2001 "were 'aggressive' or 'premature' " and not compliant with Shell's guidelines for booking and, "implicitly, SEC rules".
In February 2002, van de Vijver warned in a note to Shell's committee of managing directors that the reserves were 2.3bn barrels higher than they should have been.
Van de Vijver realised that Shell's statements on reserves and the reserve replacement ratio (RRR) - the rate at which used oil and gas is replaced by new finds - were highly market sensitive.
On November 8 2003 - the day before he wrote an e-mail to Watts complaining that he was "sick and tired of lying about the extent of our reserve issues" - van de Vijver sent this e-mail to another colleague: "As you know 2003 RRR is the most important share price 'influencer'; also as expectations are high and they do not know that we are still paying for aggressive reserve bookings . . . in the past."
Last week van de Vijver defended his role. Speaking through his lawyer, he insisted he had been "outspoken" and "persistent" in arguing that the reserves issue needed to be examined. But legal experts say he needs to explain why he complained only to Watts, rather than to non-executives or outside regulators.
David Becker, a former general counsel at the SEC who now works for Cleary Gottlieb Steen & Hamilton, a leading law firm, says the authorities tend not to show leniency to someone who simply complains to their immediate boss while allowing alleged wrongdoing to continue.
As for Watts, who has appointed Crowell & Moring, a respected and fearsome Washington law firm, he has remained silent since being ousted from the company.
Shell has pledged to co-operate with regulators and government investigators. It has little choice. "The lesson of the corporate scandals that have swept America is that if you want to survive you have to lie down and play dead and make whatever sacrifice is demanded at the altar of the US government," says Frank Razzano, a former chief trial lawyer with the SEC and erstwhile US assistant district attorney who now works for the law firm Dickstein Shapiro Morin & Oshinsky.
The oil company's crisis could not have come at a worse time. In the wake of the string of corporate scandals that swept the US, government prosecutors and regulators have become much tougher on companies and individuals.
The SEC has only civil powers but it can impose huge punishments, including swingeing fines (WorldCom, the collapsed telecoms giant, had to pay $750m) and demands that companies pay massive sums in damages to investors. The regulator can also ban individuals from serving as directors of public companies and force them to repay allegedly ill-gotten gains.
The multiple probes also mean that Shell executives could face prosecution in various countries, though extradition issues are complex. The US regulators cannot force non-nationals to pay fines or come to the US for interviews and would have to rely on the co-operation of foreign governments. But they have great sway over the company since the shares trade in the US.
But perhaps the biggest anxiety for the company is the Justice Department's decision to step up its investigation. The parallel criminal and civil probes create a special set of legal difficulties for individuals, according to Razzano.
"If you have potential criminal exposure, the one thing anyone knows is that you can slam the door in the FBI's face and take the fifth amendment and preserve your right to silence. The big problem is that the SEC has the power to force individuals and executives of companies to give evidence and can pass that to the DoJ," he says. "The real issue is that if you claim the fifth amendment during an SEC investigation there is an inference drawn that you are guilty."
Meanwhile, the Sarbanes-Oxley reforms designed to crack down on corporate wrongdoing have substantially increased penalties for individuals involved in corporate fraud. Under the Sarbanes-Oxley Act the penalty for certifying an annual report that is later proved to be misleading is up to 10 years in prison. If an individual "wilfully" misleads, the penalty can be as much as 20 years in jail.
Sentencing guidelines are based on an "offence level" points system. For example, fraud carries six points, while 26 points are added if investors' losses are more than $100m. If the offence harms more than 50 people or organisations, another four points are racked up. If the action has a substantial impact on a financial institution, this can add a further four points.
To put this into context, a total of 40 offence points would result in a jail term of between 24 and 30 years. Razzano estimates that if - and it is a big if - Shell executives were to face criminal charges, the number of offence level points could be as high as 40.
The system is not just theoretical. Last month Jamie Olis, a middle ranking executive at Dynegy, the energy company, was sentenced to 24 years in jail over his role in a $300m accounting fraud.
The scale of Shell's legal woes remains to be seen, but one thing is clear - Watts and van de Vijver are unlikely to be taking their holidays in America this year.