978-0077862213 Chapter 8 Case Royal Dutch Shell Part 2

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Specific SEC Charges

The SEC Complaint alleged the following:

1. As a result of Shell’s knowing or reckless overstatement of their oil and

gas reserves in their financial statements, the group’s commission

filings, specified previously, as well as other public statements,

contained materially false and misleading statements and disclosures.

These filings contained untrue statements of material fact concerning

the company’s reported proved reserves and omitted to state facts

necessary to make the statements made, in light of the circumstances

under which they were made, not misleading. These statements

constitute a violation of Rule 10b-5 of the Securities Exchange Act.

2. Section 13(a) of the Exchange Act requires issuers to file such annual

and quarterly reports as the commission may prescribe and in

conformity with such rules as the commission may promulgate. Rule

13a-1 requires the filing of accurate annual reports that comply with the

SEC’s Regulation S-X. Rule 12b- 20 requires an issuer to include material

information as may be necessary to make the required statements, in

light of the circumstances under which they were made, not misleading.

The following periodic reports that Royal Dutch and Shell Transport filed

with the commission were not prepared in accordance with Rules

promulgated by the commission: Form 20-F for fiscal years 1997-2002.

3. Shell violated Section 12 of the Exchange Act in that it failed to: (1)

make and keep books, records, and accounts, which, in reasonable

detail, accurately and fairly reflect the transactions and dispositions of

its assets; (2) devise and maintain a system of internal accounting

controls suffcient to provide reasonable assurances that (a) transactions

are executed in accordance with management’s general or specific

authorization; (b) transactions are recorded as necessary to permit

preparation of financial statements in conformity with GAAP or any other

criteria applicable to such statements, and to maintain accountability for

assets; (c) access to assets is permitted only in accordance with

management’s general or specific authorization; and (d) the recorded

accountability for assets is compared with the existing assets at

reasonable intervals and appropriate action is taken with respect to any

di9erences.

Royal Dutch and Shell Transport agreed to settle the charges by consenting to a

cease-and-desist order finding violations of the antifraud, internal controls, record-keeping and

reporting provisions of the federal securities laws, and by paying $1 disgorgement and a $120

million penalty in a related action. Shell also has undertaken to commit an additional $5 million

to develop and implement a comprehensive internal compliance programs under the direction

and oversight of the group’s legal director. The companies settled without admitting or denying

the Commission’s substantive findings.

Questions

1. Use ethical reasoning to evaluate the actions of Shell management in this case with

respect to accounting for and disclosing information about proved reserves.

Shell reported overstated proved reserves estimates, and that led to materially misleading

financial statements. Investors (U.S. and global) rely on the accuracy of the financial statement

Using rights perspective, it is not right to mislead the investors by making it look as though the

company is doing better than it really is. Any attempt to intentionally misstate the financial

statements violates the categorical imperative. Using a justice perspective, stakeholder interests

are not fairly represented because the perceived interests of the company are given priority over

the interests of all other stakeholders. Act-utilitarianism requires that the act that creates the

2. In chapter 7 we discussed aggressive accounting and earnings management

techniques. Apply your knowledge from that chapter to the facts of the Shell case

with respect to its proved reserves. Be sure to address specific actions taken that

illustrate aggressive accounting and earnings management.

Shell was most likely trying to maintain its position as an industry leader with income trends and

RRR (reserves replacement ratio), which is a key performance indicator in the oil and gas

industry. As Shell noted in its footnotes after the second restatement of reserves that “The

overstatement of unaudited proved reserves information had the effect of understating the

3. Given the facts of the case, describe the failures in corporate governance, including

internal controls and the relationship between the Group auditor and management

and explain how they contributed toward the financial reporting problems with

proved reserves at Shell.

The failures in corporate governance arose from a decentralized management style, and

inadequate independence of the Group reserves auditor. The failures in internal control arose

from the inadequate training and supervision of the operating unit personnel responsible for

estimating and reporting proved reserves and deficiencies in the internal reserves audit function.

Shell engaged a retired Shell petroleum engineer as Group reserves auditor; he worked part-time

Additional information in the notes to the financial statement explain the causes of the

restatements as: 1) Shell did not update its guidelines for booking reserves timely to remain

current and consistent with the SEC guidelines; 2) executives and employees encouraged the

booking reserves (on a bullish estimate) while discouraging the debooking of previously booked

reserves; and 3) material weaknesses in controls, insufficient resources and training for the

Optional Question

4. The following note to the financial statements of Shell for the fiscal year end

December 31, 2008, appeared in its 20-F filing with the SEC.

Impairment

Other than properties with no proved reserves (where the basis for carrying costs in the

Consolidated Balance Sheet is explained under “Exploration costs”), the carrying amounts of

major property, plant and equipment are reviewed for possible impairment annually, while all

assets are reviewed whenever events or changes in circumstances indicate that the carrying

amounts for those assets may not be recoverable. If assets are determined to be impaired, the

Estimates of future cash flows used in the evaluation for impairment of assets related to

hydrocarbon production are made using risk assessments on field and reservoir performance and

Impairments, except those related to goodwill, are reversed as applicable to the extent that the

Compare the standards followed by Shell that conform to IFRS with those generally

accepted in the U.S. Explain any differences and how such differences might impact the

financial statements.

Below is a chart that highlights some of the differences between U.S. GAAP and IFRS on

impairments:

Impairment Standard

Area

U.S. GAAP IFRS

Assessment of impairment When carrying amount of asset is

not recoverable

End of each reporting period

Indication of Impairment a. Significant decrease in

market value of the asset

b. Significant change in extent

or manner in which an asset

is used

c. Significant adverse change

a. Significant decrease in

market value of the asset

b. Significant change in

extent or manner in which

an asset is used

c. Significant change in the

Recoverability test The difference between Estimated

future net cash flows from the use of

the asset and its eventual disposition

(undiscounted) LESS Carrying

amount of the asset. If this amount

Not used in IFRS

exists, then the present value of

expected future net cash flows are

used instead of fair value.