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MarketWatch: Ex-oil executive Philip Watts challenges SEC in appeals court

By Siobhan Hughes
Last Update: 8:11 AM ET Nov 28, 2006

WASHINGTON (MarketWatch) — Sir Philip Watts, who resigned as chairman of what is now Royal Dutch Shell PLC (RDSA) after an oil-and-gas-reserves overbooking controversy, is tangling with the Securities and Exchange Commission in a court case that may have implications for key tools in the SEC’s regulatory arsenal.

In a legal challenge filed in the U.S. Court of Appeals for the District of Columbia Circuit, Watts is seeking to force the SEC to respond to subpoenas of the commission and three members of the staff. The SEC has resisted the subpoenas, asserting that its employees are shielded because of the need to ensure frank, open discussions within federal regulatory agencies and to protect the quality of agency decisions.

Watts claims he could be on the hook for billions of dollars if he loses a securities-fraud class-action lawsuit launched after Shell announced a reserves downgrade in 2004 that cumulatively slashed almost one-fourth of its oil and gas reserves. He wants to show that what regulators have called a fraud at Shell was merely a response to a changing regulatory environment. In the process, his tactic of subpoenaing SEC staff, if enforced by the court, could potentially become a powerful tool to question the clarity of SEC regulations and the legitimacy of the informal staff guidance used to flesh out those rules.

“To the extent that you do that, you have reduced what should be negotiation and discussion and deliberation to a record that is going to have a chilling effect and limits the ability of people to use the process for what it should be used for,” said James Doty, a securities lawyer who was general counsel of the SEC in the early 1990s.
A three-judge panel of the U.S. Court of Appeals for the District of Columbia Circuit is scheduled to hear oral arguments in the case on Dec. 7.
The court has heard cases involving SEC subpoenas before, but hasn’t ever issued blanket statements explaining how the SEC must respond, according to securities lawyers.

Complaints About Staff Guidance

The SEC staff issues guidance through bulletins, so-called no-action letters, and other means. Frequently, the purpose is to fill in details about regulations issued years earlier, before changes in the marketplace created new questions about a rule’s meaning. Without informal guidance, the SEC would have to formally vote on many more policy matters, slowing down business.

Businesses have long complained that SEC staff guidance has the effect of commission policy without being approved by the five-member commission. They say the informal guidance process denies businesses a chance to have a say in regulation, and holds them to rules that aren’t formally approved.

Some people within the agency agree. Last December, SEC Commissioner Paul Atkins, a Republican, said in a speech that “we should not foster a regulatory environment that relies on informal guidance as a basis for enforcement action.” He noted “the heavy toll” that enforcement actions can take, such as leading to “groundless private lawsuits.”

Few people are likely to share those sentiments as much as Watts. Watts was forced out of his company in March 2004, two months after Shell announced it had overstated its proven oil and gas reserves by 20%. Company stock lost 7.5% of its value immediately after the announcement. Watts was named in civil litigation. The following year, Watts received a Wells notice, a warning that the SEC staff planned to recommend charges, according to one of his lawyers.

Watts argues that, in 2000 and 2001, the SEC staff issued interpretive guidance that tightened the requirements for counting oil and gas reserves on its books. Shell enacted more restrictive internal guidelines as a result, which ultimately led to the revisions announced in 2004, according to his court filing. Much of what regulators called Shell’s overbooking occurred while Watts was head of Shell’s exploration and production unit, which he led between 1997 and 2001. Watts argues that, during the years before the SEC staff guidelines, the SEC and Shell were aligned in their thinking.

An SEC lawsuit and an internal company report outline other dimensions of the reserves overstatement. In August 2004, Shell agreed to pay a $120 million penalty to settle charges that it had overstated its reserves by 4.47 billion barrels and delayed correcting the figures. (Proven reserves reflect the amount of oil and gas that an energy company believes it has in the ground.)

More recently, the SEC appeared to take a different tack. The SEC staff closed a formal investigation of Watts and announced it wouldn’t take action against him in connection with the reserves overbooking, his lawyer announced two months ago.

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