Risk & Compliance

Energy Firm Settles Overstated Reserves Case

The company fraudulently bulked up its reported reserves by 35 percent over five years.
Kate PlourdJuly 11, 2008

On Friday the Securities and Exchange Commission settled with El Paso Corp., its subsidiaries, and five former employees on charges they fraudulently inflated the energy company’s oil and gas reserves.

The ex-president of El Paso’s Exploration and Production business, Rodney Erskine, agreed to pay a $75,000 penalty, while former senior vice president Randy Bartley and former vice presidents Steven Hochstein, John Perry, and Bryan Simmons will pay $40,000 each.

The SEC alleged that Erskine aggressively pushed to maximize oil and gas reserves, which prompted the vice presidents to overstate reserves in a number of ways.

The company, according to the SEC, improperly recorded reserves as proved (which the SEC defines as the amounts of crude oil, natural gas, and natural-gas liquids it can estimate with a “reasonable certainty to be recoverable in future years from known reservoirs”) without the required supporting geological or engineering data, and improperly assigned proved reserves to unproved reservoirs. It also gained information suggesting that certain fields were not producing as predicted but did not adequately investigate the reasons or reduce the estimates, the SEC claimed.

The SEC alleged that El Paso’s weak internal controls were partly to blame. In 2001 Erskine implemented a reporting structure in which reserve estimates were made in the geographical districts and certified by the district vice presidents. This change contributed to the failure to detect overstated reserves, the commission said in its complaint. The CFO of the Exploration and Production business was not held accountable for the mistakes.

“Although proved reserves are estimated, that does not mean anything goes,” the director of the SEC’s division of enforcement, Linda Chatman Thomsen, said in a statement. “Today’s action emphasizes the Commission’s commitment to ensuring transparency and uniformity when companies report that information to investors.”

Because of the overstated reserves, the company in 2004 had to restate its financial statements for 1999 through 2002 and the first nine months of 2003. The restatement reduced the company’s oil and gas reserves by more than 35 percent and reduced earnings by $1.7 billion.

The case was settled at a time when the SEC’s rules for how companies can report oil and gas reserves are in the process of reformation However, SEC assistant regional director Jeff Cohen told CFO.com that the case would not have been affected had the new rules the commission proposed last month been in effect at the time of the improper conduct.

The new rules would require energy companies to report more information about their reserves and allow them to report probable and possible reserves, rather than only proved reserves. Resources such as oil sands could be reported as oil and gas reserves as well.

One of the six proposed rules would allow companies to use new technologies as long as they were deemed to produce empirically reliable conclusions about reserve volumes. Another change would give companies the option to provide an audit of their reserve reporting, based on criteria from the Society of Petroleum Engineers.