In the 1620s, Dutch settlers erected trading posts in and around Newark, New Jersey, to stake a business claim in the New World. Last week, still with an eye toward trading issues, Netherlanders landed in Newark once again. Only this time, they took their concerns to the U.S. District Court of New Jersey.
On January 6, a group of 25 Dutch institutional investors filed a securities fraud suit in the Newark court against Royal Dutch Shell plc, its subsidiary Shell Transport and Trading Co., the company’s current chief executive Jeroen van der Veer, and three former executives — including one-time group CFO Judith Boynton. The suit charges that Shell executives knowingly inflated oil and gas reserves, thereby spawning significant investor losses.
Shell is listed on the London Stock Exchange and the Euronext Exchange in Amsterdam as well as the New York Stock Exchange. But the case was probably brought in the United States because American courts have a reputation of being “shareholder friendly,” says lead plaintiffs’ attorney Jay Eisenhofer, a managing partner at Grant and Eisenhofer.
In other words, the well-developed body of U.S. securities law concerning shareholder suits brings more certainty to a plaintiff’s case. In Europe, only a handful of shareholder lawsuits are brought before civil courts, the attorney adds.
The investor group includes most Dutch workers that hold pensions, according to Eisenhofer. It is led by Stichting Pensioenfonds ABP, one of the world’s biggest pension funds (with $230 billion under management). ABP alone represents 2.5 million government and education employees and 35 percent of total Dutch pension fund assets.
The other funds in the group supply pensions to a broad cross-section of industries, such as farming, retail, metal working, and financial services. Other funds represent engineers, health-care workers, casino dealers, and hairdressers.
Beside the sheer number of pension funds involved, the case is significant because its was brought by foreign investors in an American court, reflecting “increasing activism among European investors to seek recovery under U.S. law,” according to Eisenhofer.
The complaint alleges that between 1997 and 2003, Shell executives knowingly overstated the company’s oil and natural gas reserves by an aggregate 33 percent (about 6 billion “barrels of oil equivalent,” the standard metric used to express reserves). The pension funds also charge that the oil company inflated its reserve replacement ratio (RRR) — a key performance indicator in the oil business — and overstated future cash flows by a total of $100 billion over six years.
The suit also alleges that Shell didn’t disclose the overstatements until 2004, by which time investors had bought shares at “artificially inflated prices.” The pension funds — which represent as much as 5 percent of Shell’s total shares — collectively bought more than 200 million shares of Shell ordinary stock between April 8, 1999, and February 3, 2005. They assert that they “suffered extensive losses when the stock tumbled following the disclosures,” according to court documents.
For example, following a January 9, 2004, restatement that dropped proved reserve totals by 20 percent, Shell and Shell Transport stock lost a total of $16 billion of market value as a result of the disclosure, according to the complaint.
This week, a Shell spokesperson commented that the company “contests ABP’s [and other plaintiffs'] claims and will vigorously defend itself against the action.”
For his part, Eisenhofer is confident about the strength of the fraud charges because he thinks that many facts have already come to light. The evidence is substantial that senior managers “knew exactly what they were doing,” he contends. “The smoking guns have already been found.”
The evidence Eisenhofer cites consists of several news reports, financial restatements made by Shell in early 2004, an SEC cease-and-desist order against Shell, and an independent report released in March 2004 by Shell’s audit committee.
Shell disclosed its oil-reserve accounting problems in a series of announcements between January 9 and May 24, 2004, noting that the company would recategorize about 23 percent of the proved reserves it reported as of year-end 2002. The reason for the restatement: The reserve reporting did not comply with the SEC definition of “proved” reserves. (The commission defines such reserves as estimated amounts of oil and gas that are shown “with reasonable certainty” to be recoverable from known reservoirs at costs calculated as of the estimate date.)
At the time, Shell officials noted that the recategorization would not have a material effect on company earnings. They explained that the accounting correction would average $100 million per year for the 2002 and 2003 restatement period, which amounts to less than 1 percent of total earnings for those years.
The lawsuit, however, cites the SEC cease-and-desist order filed in August 2004. The order states that Shell’s inflated proved reserves and its delay in correcting the overstatement resulted from “its desire to create and maintain the appearance of a strong RRR” and failure to comply with SEC reporting guidelines.
The SEC also noted that Shell was warned on several occasions before fall 2003 that reported proved reserves were potentially overstated. In each case, “Shell either rejected the warnings as immaterial or unduly pessimistic, or attempted to ‘manage’ the potential exposure” by delaying the accounting restatements, according to the commission.
Meanwhile, an independent report commissioned by Shell’s audit committee revealed that as early as 2001, Shell executives were familiar with SEC oil reserve reporting rules (issued in 1978) and aware that “the company’s reserve numbers were not in full compliance with these rules.”
Since April 2004, when Shell management accepted the findings of the audit committee report, the company has made several reserve reporting control improvements recommended by the independent investigator. For instance, external experts will be involved in the annual audit and reporting of reserves to assure proper attention is paid to SEC guidelines. Further, Shell’s business CFOs will have a clear reporting responsibility to the group CFO to strengthen reserve reporting oversight.
Boynton stepped down as group CFO in April 2004, but remained with the group until she left the company in December 2004. She could not be reached for comment at press time.
Along with Boynton, the suit also names current Shell chairman Jeroen van der Veer, former CEO Phillip Watts, and former chairman of Shell Transport Mark Moody-Stuart as individual defendants. A Shell spokesperson said that van der Veer wouldn’t comment on the case beyond Shell’s official statement. Watts resigned from Shell and Moody-Stuart retired in 2004. Neither could not be reached for comment.
The lawsuit also names Shell’s European auditors, PricewaterhouseCoopers and KPMG, as co-defendants in the case for their “repeated failure to spot the company’s internal control weaknesses and other accounting problems.” PwC and KPMG press officials each said their firm didn’t wish to comment at this time.
Shell is the subject of four civil investigations, including probes by the SEC and England’s Financial Services Authority. Shell has already paid $120 million in fines to the SEC.