The Guardian: When holes appear below the line
Edmond Warner
Saturday April 24, 2004
Shell always seemed so safe; now it is mired in one of Europe's most dramatic scandals
What to make of the report of Davis Polk & Wardwell to the Shell group audit committee? Or, more specifically, of its executive summary, as the rest of the report has been reserved for private consumption lest it prejudice any possible criminal or other legal proceedings.
For those who have missed one of the most dramatic corporate governance scandals of recent times, the pertinent facts can be brutally summarised thus.
In January the Anglo-Dutch oil group announced that its estimates of its oil reserves in the ground could not be relied upon with as much certainty as previously thought. Its reserves had been over-egged to the tune of almost 4bn barrels of oil. In short order, Shell's shares plummeted, its chairman and head of exploration and production both resigned, independent counsel was tasked with poking through the wreckage and, on publication of its report, Shell's finance director tendered her resignation.
This has all been so shocking for investors because, in an industry prone to hype and manipulation, Shell has always been regarded as the most conservative and dependable of organisations. Its hybrid structure, with twin boards in Britain and the Netherlands, has been assumed cumbersome by outsiders but something that worked for the Shell and Royal Dutch twins because of their cautious approach.
From its London boardroom window Shell's directors have long been able to gaze across the river at the Houses of Parliament. I've always pictured them looking down their noses at the antics of politicians as they steered their corporate supertanker. Now, though, we have DP&W's report littered with quotes from caustic emails and spiky memos to give the lie to this imagined corporate idyll.
The report makes it clear that Shell's reserves had been overstated for some time before the company made a clean breast to the market at the start of this year. It is evident that great tension existed between senior management as a result. The investigators have also uncovered a number of organisational failings which contributed both to the existence and the persistence of the problem.
Where the report is silent, however, is on the roots of the issue. We know the how, but we don't know the why. Sir Philip Watts, Walter van de Vijver and Judith Boynton, the departed executives, were each "represented by their respective individual counsel" during the investigator's interviews. We are only likely, it seems, to get to the "why" of Shell's over-egging if either investors or regulators choose to seek redress in court.
The most caustic and spiky correspondence quoted by DP&W comes from the pen or keyboard of Mr van de Vijver, head of exploration and production. Anyone who has worked at the heart of a major quoted company will hear echoes of their experiences in his references to pressures on the company to meet external expectations, and pressures on the individual to meet his boss's expectations.
These influences are, obviously, interrelated. In the case of Mr van de Vijver it seems that his personal targets revolved around the replenishment and growth of the company's oil reserves, which were in turn a key metric by which the City measured its achievements. Having stepped into the shoes of his boss, the chairman, and being subject to review by him, it is little wonder that the question of unproven reserves crackled between them like electricity.
The head of exploration wrote that he was "sick and tired about lying about the extent of our reserves issues". The chairman, after the problem became public, claimed: "I remember writing down the words 'get the facts and do the right thing'." The finance director, it is reported, "took virtually no action ... to inquire independently into the underlying facts".
The report to Shell's audit committee contains a series of proposed remedies to the structural flaws which it has unearthed. Most of them relate to organisation, processes and controls. They are likely to give some comfort to investors but are unlikely in themselves to prove sufficient to restore confidence in what was once the archetypical "sleep-easy" investment.
Structural change will not in itself ensure the necessary overhaul of Shell's business culture.
If, as Mr van de Vijver suggests, "the unspoken rule within the company is that you are not supposed to go directly to individual board members or group audit committee", then no amount of organisational tinkering will be enough.
The very last remedy proposed to Shell's audit committee is arguably its most important. But it might also miss the mark. Titled "culture of compliance", it recommends management emphasises "forcefully and frequently" to staff that they must raise all integrity and compliance concerns with internal audit or legal.
While an effective whistleblowing code is one thing, it is only one element of an effective business culture. Investors will look to Shell's management to convince them that - from the top downwards - the organisation is committed to doing the right thing. If the cultural flaws run deep, this may take years.
Edmond Warner is chief executive of IFX Group
http://www.guardian.co.uk/business/story/0,3604,1202292,00.html