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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.
