Oil Industry Fraud: Black Gold Flowing into the Wrong Pipelines

By Sullivan, Carol | Journal of Business and Accounting, Fall 2017 | Go to article overview

Oil Industry Fraud: Black Gold Flowing into the Wrong Pipelines


Sullivan, Carol, Journal of Business and Accounting


INTRODUCTION

According to the Association of Certified Fraud Examiners (ACFE, 2016) Report to the Nation, a typical organization loses 5% of revenue due to fraud. The total estimated loss due to occupational fraud is $6.3 billion. The loss per case was more than $1 million in 23% of the cases and 58% of the victim organizations had not recovered any of the fraud losses. The oil & gas industry had more than the average fraud in the areas of corruption and had many instances of fraud related to financial statement fraud, billing, and expense reimbursements The purpose of this research is to examine fraud in the oil & gas sector and provide suggestions related to prevention and detection of future fraud.

LITERATURE REVIEW

Zakaria, Nawawi, and Salin (2016) found that internal control weaknesses can be major factors for fraud to be committed in the oil and gas companies. Mintz and Barrett (2005) described how oil and gas prices have caused energy industry fraud to be on the "top 10 threats to investors" list and cites Ponzilike pitches for oil wells that either don't exist or that produce very little. Och, Christensen, and Byington (2004) described schemes such as identity theft, shortmeasuring, and price gouging as frauds targeting consumers as victims. Skousen and Wright (2009) studied the role of the Foreign Corrupt Practices Act regulations and compared the fraud performance of U.S. companies with non-U.S. companies. They found a statistical difference between the two types of firms with the nonU.S. firms having lower fraud scores. Wilks, L. and F. Lozano (2013) assert that an anti-fraud program would be helpful in creating an environment where employees know that they can and should report suspected fraud in the energy industry.

SPECIFIC INDUSTRY RISK

Because of unique characteristics in the oil industry operations, there is a higher than average propensity for fraud. According to the EY Global Fraud Survey2014, key risks are summarized in Table 1 below:

The Securities and Exchange (SEC) issued an investor alert and provided "red flags" association with private oil & gas investing as follows:

* Sales pitches focused on highly publicized news like high oil or gas prices

* "Can't Miss" wells

* Unsolicited materials

* Abnormally high rates of returns promised

* Sales pitches like "limited" or "once-in-a-lifetime" opportunity

* Sales pitches touting new technology as it related to getting high production out of the currently "low-producing" wells

* Salesperson claiming to be an investor

* Being asked to sign documents acknowledging that the securities laws do not apply to the investments

While most people know much about Enron, the next section of the research will provide specific information related to less publicized oil cases.

INTERESTING "BLACK GOLD FRAUD" CASES

Shell Reserves Fraud - Settled in 2004

Overstated oil reserves can be a big problem in terms of financial statement fraud as employees and executives inflate the reserves in order to keep their jobs, receive bonuses, or motivate stock appreciation. In 2004, Royal Dutch/Shell agreed to pay about $150 million to settle allegations (from both U.S. and British regulators) that it overstated oil reserves significantly. Also under the settlement, Shell agreed to invest another $5 million to establish an internal compliance program under Shell's legal director as well as the Securities and Exchange Commission (SEC)."Shell's overstatements of its oil reserves, which occurred over an extended period, mandate a strong enforcement response, including imposition of significant civil penalties, to deter Shell and others from engaging in similar misconduct," Harold Degenhardt, administrator of the SEC's Fort Worth, Texas, office, said in a statement. According to the SEC, reserves were overstated by about 23% and future cash flows were overstated by $6.6 billion. …

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