SOX: a home run for some energy companies
There are still some complaints more than four years after the federal corporate accountability regulations for publicly-traded companies became law. But most oil, gas, and related firms have successfully integrated it into their annual reporting, and some have used it to improve their operations.
Amid great fanfare, the US Securities and Exchange Commission issued new rules this past spring to make it easier for smaller publicly-traded companies to comply with the Sarbanes-Oxley Act of 2002. Several reporting requirements were eased, but oil and gas producers, drilling contractors, and service and supply companies got no respite because their market capitalizations were well above the rules’ $75 million maximum.
“Especially in today’s pricing environment, an oil and gas company can have a pretty good market cap based on its prospects without having very many employees. Therefore an oil and gas producer can become an accelerated filer without having as many financial reporting resources,” observed Jake Vossen, audit partner for oil and gas at Hein and Associates LLP’s Denver office.
“A common complaint among smaller companies like ours is having to follow the same rules as the big multi-nationals. It involves costs and, just as important, manpower. Just using the extra time and personnel to comply is a challenge,” said Steve Taylor, president and chief executive of Natural Gas Services Group Inc., a compression services supplier with headquarters in Midland, Tex.
He told OGFJ that when NGSG’s management realized that the compression services supplier would have to meet Sarbanes-Oxley requirements effective Dec. 31, 2006, it immediately hired consultants to help develop processes and controls. “Once they were finished, however, there was still a continuing demand for manpower and other resources to meet the requirements,” he said.
Smaller oil, gas and related companies apparently are meeting that demand. “All of our clients have made it through, many without material weaknesses. Even if you get a material weakness in the first year, you can still get through. Although several have come close, we have not had any instances when a company hasn’t been able to assemble, document, and test the necessary controls,” said Vossen.
Producers who face earlier deadlines as Sarbanes-Oxley accelerated filers can feel pressure as they await reports of their reserves from independent engineers, he noted. “It’s another layer of processes to be analyzed, and controls are crucial. But it’s generally outside the realm of accounting. The longer it takes to get the reserve report back from the independent engineer, the more challenging it is for an oil and gas producer to comply with Sarbanes-Oxley. Companies in other industries aren’t as reliant on an outside source for such crucial information in their annual reports,” Vossen told OGFJ.
Donald J. Hupp of Wichita Falls, Tex., can view the situation from two perspectives – as a principal in the Hupp, Bauer, Hanson and Lewis accounting firm and as president of Gunn Oil Co. His experience with the Sarbanes-Oxley law is limited because neither Gunn nor Hupp Bauer’s clients in the oil and gas production and related businesses are publicly traded. But he suggested that energy-producing companies have to use solid accounting procedures even when they’re privately held because they usually have partners.
“Accounting is unique in oil and gas,” he explained. “At Gunn, we operate a lot of properties with a joint billing system, where costs are accumulated and individual owners are billed. Whether you’re listed or private, you usually have an operating agreement with other companies where they can audit you any time within two years. That happens frequently, especially if costs rise. That’s when it makes sense, as a non-operating partner, to do an audit and make sure you’re being charged correctly.”
Morris B. “Sam” Smith, chief financial officer for Cano Petroleum Inc. in Fort Worth, agreed that producers kept careful financial records before Sarbanes-Oxley. “Information already needed to be available for partners under joint operating agreements. There also were audits from states for production, property and franchise taxes as well as potentially the federal government,” he said.
Cano was a small business filer at the end of its latest year, so it was going through the Sarbanes-Oxley process for the first time when Smith spoke with OGFJ in July. “That gave us a little extra time, which we needed. As a small organization, we had limited resources. We have spent a lot of hours internally, as well as with outside consultants and the independent accountant, working through the process. We have better documentation on our internal controls, which were already good. The total integration of the flow of information is a little smoother as a result of having gone through this exercise,” he said.
Integrating information from its outside engineer’s year-end reserves estimate was not a big problem because Cano operates on a fiscal year ending June 30 and demand for engineers was not as heavy as at the end of a calendar year, he continued. “A smaller company like ours feels the impact more on its individual employees. Everyone becomes a part of the process and has to be trained in it. It has required some of our operations people to think differently. Our finance employees always were pretty cognizant of internal control issues. Practically all of our people are integrated into the flow of it,” Smith said.
Taylor said that he’s not critical of Sarbanes-Oxley’s intent, but he believes the law’s execution and mechanics could be improved. “As we tried to meet the requirements, we also tried to get additional value by using them to enhance our operations. It does bring a little more structure to your operation. We had adequate controls, but it provided specific steps and new processes that made them better,” he said. OGFJ
“At Gunn, we operate a lot of properties with a joint billing system, where costs are accumulated and individual owners are billed. Whether you’re listed or private, you usually have an operating agreement with other companies where they can audit you any time within two years. That happens frequently, especially if costs rise. That’s when it makes sense, as a non-operating partner, to do an audit and make sure you’re being charged correctly.” – Donald Hupp, Gunn Oil Co.
“A smaller company like ours feels the impact more on its individual employees. Everyone becomes a part of the process and has to be trained in it. It has required some of our operations people to think differently.” – Morris B. “Sam” Smith, Cano Petroleum
No boon to whistle-blowers
Corporate whistle-blowers apparently haven’t had much success since the Sarbanes-Oxley Act became law. Of 947 complaints the US government received by the US Department of Labor from companies’ employees or former employees alleging violations through mid-2007, 70% were dismissed, 15% were settled prior to a ruling, 13% were withdrawn by the complainant, and only 2% received a preliminary finding of merit, according to data compiled by law firm Orrick, Herrington & Sutcliffe LLP.
Information about the number of complaints involving oil, gas and related companies was not immediately available. Of 11 cases involving such firms which went before DOL administrative law judges from 2003 through mid-2007, seven were dismissed, two were settled, one was withdrawn, and one was moved to federal district court, OGFJ’s examination of federal records found. Seven of the cases involved oilfield service and supply companies, three involved major oil companies and one involved a mezzanine finance firm.
“As we tried to meet the requirements, we also tried to get additional value by using them to enhance our operations. It does bring a little more structure to your operation. We had adequate controls, but it provided specific steps and new processes that made them better.” Steve Taylor, Natural Gas Services Group
“The longer it takes to get the reserve report back from the independent engineer, the more challenging it is for an oil and gas producer to comply with Sarbanes-Oxley. Companies in other industries aren’t as reliant on an outside source for such crucial information in their annual reports.” – Jake Vossen, Hein and Associates