| Fraud remains a serious risk for companies in the | | | | funds. Companies should take prevention steps |
| energy industry. This publication, which is derived | | | | to help ensure that conflicts of interests do no |
| from the June 18, 2009 Webcast “Fraud Risk | | | | interfere with the normal procurement process. |
| Management,” will highlight the national and | | | | Oil and Gas Reserve Valuations |
| industry results from KPMG Forensic’s | | | | Companies should consider reserve valuations an |
| Integrity Survey 2008-2009 and address fraud | | | | ongoing risk. Oil and gas reserve valuations are |
| and misconduct in the energy sector. | | | | estimates derived from reserve engineering |
| KPMG Integrity Survey 2008-2009: Background | | | | reports, but they are often difficult to estimate |
| and Methodology | | | | given the fact that the reserves are not easily |
| The KPMG Integrity Survey was initially | | | | measured. Despite the presence of strong |
| undertaken to help clients measure risks, | | | | expertise, valuing reserves still proves to be |
| strengths, and weaknesses associated with their | | | | subjective and open to potential misstatement. |
| ethics and compliance programs. These | | | | In addition, industry analysts often place higher |
| challenges include the kind of ethics and | | | | values on reserves, increasing the pressure to |
| compliance risks that they perceived occurring in | | | | misstate reserves in a down economy. The SEC |
| their organization, how well they view their ethics | | | | has looked at oil and gas reserve valuations given |
| and compliance programs working in terms of | | | | that they are significant estimates for some |
| actually having an influence on the behaviors and | | | | companies, and effective prevention steps should |
| decisions of employees, and where they see | | | | be taken to help ensure reserves are valued |
| some of the root causes of any shortcomings. | | | | appropriately. |
| The survey is not only a way to understand what | | | | Revenue Recognition |
| is happening nationally and across different | | | | Revenue growth is important to increasing |
| industries, but it is also a tool that organizations | | | | shareholder value, but a difficult economy could |
| can use to compare their results against these | | | | increase the pressure to recognize revenue |
| external benchmarks. | | | | improperly. Special attention should be |
| The key findings in the survey are that the | | | | considered in the areas of meter reading and |
| prevalence of fraud and misconduct within | | | | unbilled revenue calculations for the utilities |
| organizations remains high and the nature of the | | | | sector. Improperly recorded gains can also come |
| misconduct remains serious. Pressures, | | | | from the sham sales, when companies sell assets |
| incentives, inadequate resources, and job | | | | with the intent to repurchase them. A strong |
| uncertainty are major drivers of misconduct. | | | | corporate governance strategy can help ensure |
| Whistleblower mechanisms are gaining traction, | | | | revenue recognition issues are minimized. |
| but risks of silence remain. Finally, ethics and | | | | Misappropriation of Costs between Regulated and |
| compliance programs continue to have a | | | | Nonregulated Businesses |
| favorable impact on employee perceptions and | | | | Misappropriating costs of a nonregulated business |
| behaviors. The report on the results of the | | | | with a regulated business can be used to increase |
| KPMG Integrity Survey as well as the Integrity | | | | the regulated affiliate’s revenue, as the |
| Survey – Energy and Natural Resources | | | | regulated affiliate can pass costs through to |
| Results are available on the Global Energy Institute | | | | customers. This could involve action from state |
| Website at | | | | and federal regulators. It is critical to financial |
| Specific Risks to the Energy Industry | | | | reporting that companies appropriately classify |
| Energy companies face specific risks, as the | | | | these costs. |
| perceived changes in the current economic | | | | Valuation of Derivative Instruments |
| environment have heightened the focus on the | | | | There is a heightened focus on the valuation of |
| regulatory environment. This includes an | | | | derivative instruments. Energy and commodity |
| increased focus on market manipulation, violations | | | | derivative contracts must be recorded at fair |
| of the Foreign Corrupt Practices Act (FCPA), | | | | value. This creates a level of subjectivity in the |
| conflicts of interest, oil, and gas reserve | | | | valuation of these contracts, which can increase |
| valuations, revenue recognition, misappropriation of | | | | the company’s risk of inappropriately |
| costs between regulated and nonregulated | | | | overstating gains and understating losses. |
| businesses, valuation of derivative instruments, | | | | Derivative contracts for energy or commodity |
| environmental compliance regulations, and royalty | | | | contracts could be deliberately manipulated within |
| payments. | | | | the financial statements. Prevention programs |
| Market Manipulation | | | | can assist the company in effectively valuing |
| Market manipulation is an intentional act to | | | | these instruments. The SEC and the CFTC are |
| manipulate commodity prices through the forces | | | | looking at changing the regulations to require a |
| of supply and demand. This may include wash | | | | derivative contract to be traded via an |
| trades, manipulation of prices between affiliates, | | | | exchange. Customized instruments unsuited to |
| false index reporting, transactions predicated on | | | | such treatment would be subjected to more |
| false information, collusion for the purpose of | | | | record-keeping under the proposed changes. |
| manipulating the market, withholding generating | | | | Environmental Compliance Regulations |
| capacity, and cornering the market. | | | | Complying with the environmental regulations is |
| Market manipulation has always been the purview | | | | becoming a routine aspect of the regulatory |
| of the Federal Energy Regulatory Commission | | | | profile energy companies. Environmental |
| (FERC) and the Commodity Futures Trading | | | | regulations are extremely costly, even for |
| Commission (CFTC). The Securities and | | | | regulated entities with cost recovery, and there |
| Exchange Commission (SEC) and the Federal | | | | may be pressure in a down economy to allow |
| Trade Commission (FTC) are additional governing | | | | some noncompliance with these regulations. |
| bodies with recent authority over market | | | | False reporting of environmental compliance may |
| manipulation. | | | | also be a consideration when requirements have |
| Over the past few years, there has been a | | | | no be fully satisfied. Environmental liabilities can |
| heightened awareness of market manipulation and | | | | involve subjective estimates open to manipulation, |
| there have been more fines and enforcement | | | | and companies need to ensure that the reporting |
| actions. Companies in the energy industry should | | | | is accurate. They need to look at their |
| be aware of the penalties associated with this | | | | estimates and the changes and ensure that their |
| misconduct, they should ensure that they have a | | | | methodology is documented. Companies also |
| compliance program in place, and they should also | | | | need to ensure that there is some clear direction |
| ensure that they have a process in place to test | | | | or communication of why any changes have been |
| that program. Companies should be able to | | | | made. Prevention programs can assist the |
| show a regulatory body that they are monitoring | | | | company in managing these regulations |
| the program. | | | | effectively. |
| Violation of the FCPA | | | | Royalty Payments |
| Energy companies with international business | | | | There is an increase in the number of claims |
| activities should be aware of potential bribery and | | | | related to royalty disputes, as royalty calculations |
| corruption actions that could violate the FCPA. | | | | can sometimes be vague and misinterpreted. |
| Companies should ensure that they have a | | | | Management may calculate royalty payments in |
| compliance program as well as processes in place | | | | an inappropriate manner as commodity prices |
| to test those programs. Companies should also | | | | fluctuate. Companies should have prevention |
| consider potential mitigation activities that could | | | | programs in place to assist the company in the |
| lead to a reduction in the occurrence of these | | | | managing these obligations effectively. |
| violations, and they should strengthen reaction | | | | Conclusion |
| mechanisms for detected violations. | | | | Fraud remains a serious risk for companies in the |
| Conflicts of Interest | | | | energy industry, and there is a heightened focus |
| New Contracts and new vendors may open | | | | on the regulatory environment. Surveys allow |
| energy companies to new conflicts of interests | | | | companies to gather diverse viewpoints and |
| between company decision makers and potential | | | | compare results internally and over time, and they |
| new vendors. An example of a potential conflict | | | | are also an early warning mechanism and |
| of interest may be a kickback or payment made | | | | identification of areas of concern. Companies can |
| to an insider with the intent to coerce a decision | | | | use the KPMG Integrity Survey as a tool to |
| regarding a specific vendor and/or contract. | | | | compare their internal survey results against |
| Conflicts of interest may pose new risks, in | | | | these external benchmarks. |
| particular with the stimulus package and federal | | | | |