Public Companies Update October 2004

6 SHELL FINED £17M BY FSA FOR MISSTATEMENT OF OIL RESERVES
This article follows on from the discussions on the misstatement of oil and gas reserves in our July Public Companies Update a copy of which can be found here

In August 2004, the FSA fined The Shell Transport and Trading Company Plc and The Royal Dutch Petroleum Company NV (together "Shell") £17 million for market abuse and breach of the UK Listing Authority's Listing Rules and the SEC imposed a civil penalty of $120 million, as a result of the dramatic recategorisation by Shell of 4,350 million barrels of oil equivalent earlier this year.

6.1 Shell misstatements
The SEC requires that issuers of securities only disclose estimates of oil and gas "proved reserves" in SEC filings, as defined in SEC Rule 4-10. The FSA found that Shell overstated its proven reserves for the years from 1997 to 2002 on a number of bases, including due to revising its petroleum and hydrocarbon reserves guidelines and specifically in relation to reserves in Nigeria, Brunei, Oman and Gorgon, an undeveloped frontier gas field off Australia.

The Shell Group Reserves Auditor produced several reports on Shell's proved reserves between 1999 and 2001, which warned of possible overstatements and in 2001 advised Shell to review its reserve guidelines and align them with Rule 4-10.

The FSA found that by mid 2000 Shell had information indicating that the proved reserves figures reported to the market for at least the previous 3 years may have been overstated, however no action was taken to assess the accuracy of its proved reserves. Between January 2002 and September 2003 more information came to light from both internal and external sources that Shell had breached Rule 4-10, which eventually resulted in Shell's first announcement to the market in January 2004.

6.2 Market Abuse
Section 118(1) of the Financial Services and Markets Act 2000 (the "Act") defines market abuse as: "behaviour…which…
(a) occurs in relation to qualifying investments traded on a market to which this section applies;
(b) satisfies any one or more of the conditions set out in subsection (2); and
(c) is likely to be regarded by a regular user of that market who is aware of the behaviour as a failure on the part of the person or persons concerned to observe that standard of behaviour reasonably expected of a person in his or their position in relation to the market."

The condition in subsection (2) relevant to Shell is that "the behaviour is likely to give a regular user of the market a false or misleading impression as to the supply of, or demand for, or as to the price or value of, investments of the kind in question". Shares in Shell traded on the London Stock Exchange are qualifying investments and dealing in such shares is behaviour in accordance with section 118(1) above. A "regular user" means "a reasonable person who regularly deals on that market in investments of the kind in question".

In its decision against Shell, the FSA also had regard to the guidance on the regular user and on false or misleading impressions as set out in the Code of Market Conduct issued by the FSA under section 119 of the Act.

The FSA found that the behaviour of Shell in the period 1997 to 2004 that amounted to market abuse was the dissemination of false or misleading information through its announcements of its hydrocarbon reserves and its reserves replacement ratios, its failure to put in place or maintain adequate internal guidelines or controls, and its failure to follow indications and warnings that its disclosed proved reserves were false or misleading.

6.3 Breach of the Listing Rules
Listing Rules 9.3A and 17.24A provide that listed issuers:
"must take all reasonable care to ensure that any statement or forecast or any other information it notifies to a Regulatory Information Services or makes available through the UK Listing Authority is not misleading, false or deceptive and does not omit anything likely to affect the import of such statement, forecast or other information".
The FSA found that Shell failed to take all reasonable care to ensure that its proved reserves and reserves replacement ratio which it announced to the market in the period 1998 to 2003 were not misleading false or deceptive and did not omit anything likely to affect the import of that information.

6.4 Conclusion
Although dwarfed by the SEC fine, the £17 million financial penalty imposed by the FSA initially seems large by UK standards. However, taking into account the size of Shell, it is not as staggering as it may first appear.

Details of Charles Russell's energy team can be found at http://www.cr-law.co.uk/services/energy/index.asp

If you require further information on any matter covered in this note, please contact your principal contact at Charles Russell or Simon Gilbert, Katy Knight, Clive Hopewell or Alexander Keepin (London), Francis Rundall or Richard Norton (Cheltenham) or Catherine Drew or Geoff Sparks (Guildford) on 0207 203 5000.

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