Financial Times: Human failings and hyperbolic e-mails

By Clay Harris

20 April 04

Royal Dutch/Shell's top executive committee was warned that a big slice of its proved reserves was not compliant with Securities and Exchange Commission rules in February 2002, almost two years before the oil and gas group announced the over-statement.

The first warning, in a note from Walter van de Vijver, forced out last month as head of exploration and production (EP), was revealed on Monday in a summary of an independent report to Shell's internal audit committee. The full 450-page report by Davis Polk & Wardwell, the US law firm, was not published at the request of the regulators still investigating Shell. But Aad Jacobs, audit committee chairman and non-executive of Royal Dutch, said it gave a "fair and balanced report of what happened".

It reveals that Sir Philip Watts - also forced out last month - and Mr van de Vijver were at war with each other virtually from the moment Sir Philip ascended to Shell's top executive position and the latter succeeded him as head of exploration and production.

Their tension was based on Mr van de Vijver's view that bookings of reserves during Sir Philip's tenure had been "aggressive" or "premature" and non-compliant with Shell's own guidelines and SEC rules. Events showed that Mr van de Vijver was "in the main correct," the report said.

According to Davis Polk, the two men engaged in a "pointed dialogue" for two-and-a half years. Lord Oxburgh, non-executive chairman of Shell Transport and Trading, spoke on Monday of "ill-considered hyperbolic e-mail chatter".

The edited extracts of the report give unusual insight into how the reserves crisis developed at Shell and will test Lord Oxburgh's contention that "today's story is about human failings, not structural deficiencies".

Davis Polk noted a perception, within Shell and in the market, that "Sir Philip's own success could be attributed, in part, to his ability to meet or exceed reserve expectations".

Other executives and employees had "varying degrees of exposure to the debate" between Mr van de Vijver and Sir Philip but "by both responsibility and authority [they] were uniquely placed to address these issues. [They] were viewed as the most powerful forces in management."

Mr van de Vijver's February 2002 note to the committee of managing directors said up to 2.3bn barrels of proved reserves were exposed because of non-compliance. Sir Philip wanted another report to be made to the CMD. But on May 28 2002, before that could happen, he directed Mr van de Vijver by e-mail to leave "no stone unturned" to achieve a 100 per cent reserve replacement ratio for 2002, "a result inconsistent with significant de-booking," Davis Polk said.

Mr van de Vijver's note to the CMD on July 22 2002 failed to address the non-compliance with SEC rules. It illustrated, said the report, "a strategy 'to play for time' in the hope that intervening helpful developments would justify, or mitigate, the existing reserve exposures". On September 2, he told the CMD "the market can only be 'fooled' if credibility of the company is high, medium and long-term portfolio refreshment is real and/or positive trends can be shown on key indicators". But Shell was "caught in the box" on all three and faced a "negative spiral".

After a private dinner, Sir Philip re-affirmed the 100 per cent RRR target, and Mr van de Vijver responded: "I must admit that I become sick and tired about arguing about the hard facts and also cannot perform miracles given where we are today."

Mr van de Vijver told his staff: "We finalised our [business] plan submission and could easily leave the impression that everything is fine." The reality was "we would not have submitted this plan if we were not trying to protect the group's reputation externally . . . and could have been honest about past failures," including reserves manipulation.

On November 9 2003, after receiving what he considered an unfairly critical performance review from Sir Philip, Mr van de Vijver responded by e-mail: "I am becoming sick and tired about lying about the extent of our reserves issues and the downward revisions that need to be done because of far too aggressive/optimistic bookings." Late last year, Shell began the probe that resulted in the January disclosures.

A memo from EP staff on December 2 2003 to Mr van de Vijver said 2.3bn barrels were non-compliant, about the same amount identified almost 22 months previously. It concluded the 2002 SEC filing was "materially wrong" and "not to disclose it would constitute a violation of US securities law . . . and increase any potential exposure to liability within and outside the US". Mr van de Vijver immediately e-mailed one of its authors: "This is absolute dynamite, not at all what I expected and needs to be destroyed." It was not.

Mr van de Vijver's lawyers said the report did not describe the "extraordinary efforts" he had made to examine some of the reserves issues. The results of reviews he had ordered had not been ready until late 2003, partly explaining the timing of disclosures. Some of his graphic e-mails had been taken out of context "despite the benefit of two personal interviews".

Davis Polk said: "The booking of 'aggressive' reserves and their continued place on Shell's books were only possible because of certain deficiencies in controls."The internal reserves audit was done by an "understaffed and undertrained" ex-employee. "He acquiesced in or attempted to assist Shell in 'managing', rather than de-booking, non-qualifying reserves. Assuming vigorous efforts made entirely in good faith, a single, part-time, former employee could not constitute an effective check on 'aggressive' reserve bookings."

Judy Boynton, who lost her job on Monday as chief financial officer, was "not effective" in her compliance function. She took "virtually no action . . . to inquire independently into facts." The report said her "ability to act effectively in a compliance function was somewhat impaired because, until recently, none of the business units' CFOs reported to her . . . on the issue of reserves, it may be that her responsibility exceeded her authority".

"External" checks were also frustrated, the report said. "Outside directors and [the group audit committee] were not presented with the information that would have allowed them to identify or to address the issue." Lord Oxburgh said: "The committee had tried to get hold of the information for a long time but had failed."