Statement of Grounds for Reference to the Tribunal

Statement of Grounds for Reference to the Tribunal

IN THE FINANCIAL SERVICES AND MARKETS TRIBUNAL

Between:-

Sir Philip Watts

Applicant

-and-

The Financial Services Authority

"the FSA"

STATEMENT OF GROUNDS FOR REFERENCE TO THE

TRIBUNAL

TABLE OF CONTENTS

Section

Summary

The FSA's Final Notice identifies and prejudices the Applicant

The FSA has breached section 393 of the FSMA

The FSA's findings are flawed

The Applicant refers the matter to the Tribunal

Background

Statutory rights of third parties to fairness

The FSA's Final Notice identifies and prejudices the Applicant

Shell's announcements on reserves

Shell's "inadequate internal controls"

Revisions to Shell's Guidelines in 1998

"Indications" in 2000 and 2001

"Warnings" in 2002 and 2003

The FSA has breached section 393 of the FSMA

The FSA's reasons are flawed

Shell's reserves estimation involved subjective judgments

Reasonable belief that internal controls were adequate

Care taken in implementing 1998 Reserves Guidelines

EP's response to the January 2000 presentation was reasonable

No "warnings" that reserves information was misleading

Reference to the Tribunal

Relief sought

SUMMARY

1. On 24 August 2004, just four months after the commencement of its investigation into the matter, the FSA publicised a Final Notice issued to the "Shell" Transport and Trading Company, p.l.c ("STT") and the Royal Dutch Petroleum Company NV ("Royal Dutch") ("the Final Notice") (Tab 1) imposing a financial penalty of 17 million for market abuse and breach of the Listing Rules in respect of alleged misstatements of the proved reserves of the Royal Dutch/Shell Group of Companies ("Shell"). On the same day, the United States Securities and Exchange Commission (SEC) publicised an administrative cease and desist Order against STT and Royal Dutch ("the SEC Order") (Tab 2) and obtained a financial penalty of $120 million.

2. In issuing the Final Notice the FSA has breached its duties under section 393 of the Financial Services and Markets Act 2000 ("FSMA") by making findings which both identify and prejudice the Applicant and by unfairly denying him his right to make representations and review material in respect of the FSA's findings prior to their publication. In doing so the FSA has also unfairly pre-judged matters that remain in issue in its ongoing investigation in relation to the Applicant.

The FSA's Final Notice identifies and prejudices the Applicant

3. Despite not referring to the Applicant specifically by name, the reasons for the FSA's decision contained in the Final Notice relate to matters which identify the Applicant. The Applicant can readily be identified by reference to other publicly available and easily accessible sources, including in particular, the SEC Order and the Executive Summary of the Davis Polk & Wardwell ("Davis Polk") report on its investigation into Shell's proved reserves recategorisations. As the FSA and SEC collaborated in issuing their respective decisions, it is apparent that the FSA had prior knowledge that the Applicant would be identified in the SEC Order.

4. In addition, the FSA's Final Notice and the SEC Order criticise "EP management" only for the period after the Applicant became head of the Exploration and Production ("EP") business of Shell and criticise the Committee of Managing Directors ("CMD") of Shell for the period after the Applicant became Chairman of CMD. This is despite the fact that a substantial portion of the proved reserves which were de-booked in 2004 had been booked before the Applicant became head of the EP business.

5. The matters which identify the Applicant are highly prejudicial to the Applicant and there was no reasonable basis for the FSA to conclude otherwise. As more fully set out below, the Applicant has been identified and prejudiced by the FSA's statements regarding:

5.1 Shell's announcements on reserves;

5.2 Shell's "inadequate internal controls";

5.3 revisions to Shell's Guidelines in 1998;

5.4 "indications" in 2000 and 2001; and

5.5 "warnings" in 2002 and 2003.

6. Corporate entities act and can engage in market abuse only through individuals. Therefore, the FSA's Final Notice identifies and prejudices the Applicant to the extent that it attributes to Shell facts and activities publicly known to have been associated with the Applicant. The FSA cannot evade the fairness protections afforded to the Applicant under section 393 of the FSMA simply by avoiding the explicit naming of the Applicant in the Final Notice.

7. The Applicant has also been the subject of extensive damaging comment in the media which has associated him with the findings in the Final Notice. For example:

7.1 The Daily Telegraph reported on 28 August 2004 at page 34 as follows:

"Neither the SEC nor the FSA named individuals in their reports, which explained the reasons for their respective $120m (67m) and 17m fines against Shell, but they hardly needed to.

Their reports go back much further than the report that Shell itself commissioned from US law firm Davis Polk & Wardwell, and by implication, embrace those former executives That report concentrated on Sir Philip Watts " (Emphasis added).

7.2The Mail on Sunday reported on 29 August 2004 at page 4 of the business supplement as follows:

"DAMNING reports from financial regulators on both sides of the Atlantic last week made clear that Shell had known it was overstating oil reserves as long ago as 2000, but ploughed on in the most cynical way to keep its investors happy.

The company's most senior executives were involved in this brazen deception. Three, including disgraced former chief Sir Philip Watts, have been ousted."

The FSA has breached section 393 of the FSMA

8. Despite requesting copies of any notice from the FSA on 26 July, 29 July and 17 August 2004, the FSA refused to disclose any notices to the Applicant prior to the publication of the Final Notice. These requests were made for the express purpose of advising the Applicant as to his statutory rights under section 393 of the FSMA.

The FSA's findings are flawed

9. If the Applicant had been given the opportunity to make representations the opinions expressed by the FSA that relate to him would have been shown to be fundamentally flawed, due in part to the fact that they are based on an investigation that the FSA has yet to complete. In particular (subject to obtaining disclosure of evidence from the FSA in the Tribunal proceeding and without prejudice to any additional matters that the Applicant may seek to raise):

9.1 The FSA states that Shell's announcements of proved reserves throughout 1998 to July 2004 were false or misleading, that it either knew or ought to have known they included reserves which were non-compliant with SEC Rule 4-10 and that it failed to put in place or to maintain adequate internal guidelines and adequate internal controls. These concluded opinions do not take any or adequate account of the following:

(a) the judgments required to apply Rule 4-10, which defines proved reserves as those "estimated quantities" of oil and gas "reasonably certain" to be recoverable in the future from "known reservoirs under existing economic and operating conditions, i.e., prices and costs as of the date the estimate is made." The application of this rule requires inherently subjective judgments by oil and gas producers;

(b) the "guidance" of 31 March 2001, relied upon by the FSA in describing Rule 4-10's requirements, is non-binding staff guidance for which the SEC expressly "disclaims responsibility";

(c) the annual reviews undertaken within Shell of its own internal guidelines for assessing proved reserves, which included assurance from Shell's EP business and from Shell's external auditors that the guidelines complied with SEC requirements (including, in particular, the revision of the Shell guidelines in September 1998); and

(d) the annual process established within Shell for the assessment and disclosure of proved reserves, which included review by the EP Group Hydrocarbons Resource Coordinator, the Group Reserves Auditor and Shell's external auditors as well as formal assurances provided by EP executives.

9.2 The FSA's view that "Shell did not follow-up indications in 2000 and 2001 that its disclosed proved reserves were false or misleading" is inaccurate as it relates to the Applicant in that it is based on an internal presentation on 31 January 2000 to a meeting of EP management (which, at the time, included the Applicant). In particular:

(a) the FSA's suggestion that the Reserve Replacement Ratio ("RRR") of 37% in that presentation was "robustly rejected and on 11 April 2000 Shell announced an RRR for 1999 of 56%" is unfair and misleading in that it suggests that the Applicant disregarded the figure of 37% not on the merits but out of a desire simply to report a higher RRR figure;

(b) in fact, the 56% figure was based on reasoned judgments to accept most but not all of the "recommendations" in the presentation. Those judgments were reviewed by Shell's external auditors and, as far as the Applicant is aware, have not been called into question by Shell's subsequent restatements of proved reserves;

(c) contrary to the FSA's findings, the presentation contains no reference to production forecasts in Nigeria being "reverse engineered" solely to support reserves figures. The recommendations in the presentation concerning Nigeria were accepted by EP management; and

(d) with respect to all the recommendations made in the 31 January 2000 presentation, the Applicant acted in good faith.

9.3 The FSA's finding that "Shell did not follow up warnings in 2002 and 2003 that its disclosed proved reserves were false or misleading" is inaccurate in that it is based on information provided to the Applicant in the "internal Shell memorand[a]" prepared by EP and dated 11 February 2002, 18 July 2002 and 17 July 2003 which went to the CMD and are...