The last issue of the DPA Correlator contained an article addressing the fact that fractional undivided interests in oil and gas or other mineral rights are securities by definition under federal and most state laws. Since many petroleum geologists either work for publicly-held companies or deal in the promotion and/or operation of ventures involving fractional undivided interests in oil and gas properties (fractional overriding royalties, working interests of varying types, etc.), the professional activities of many petroleum geologist fall within the purview of the securities laws regardless of whether this fact is recognized. This month, I wish to address a fairly new federal securities law issue that affects our professional opinions regarding prospects, reserve estimates, and projections of project economics, namely forward-looking statements.

A “forward-looking statement” is defined in Section 27A of the Securities Act of 1933, as amended, and means:

  1. a statement containing a projection of revenues, income (including income loss) , earnings (including earnings loss) per share, capital expenditures, dividends, capital structure, or other financial items;
  2. a statement of the plans and objectives of management for future operations, including plans or objectives relating to the products or services of the issuer;
  3. a statement of future economic performance, including any such statement contained in a discussion and analysis of financial condition by the management or in the results of operations included pursuant to the rules and regulations of the Commission;
  4. any statement of the assumptions underlying or relating to any statement described in subparagraph (A), (B), or (C);
  5. any report issued by an outside reviewer retained by an issuer, to the extent that the report assesses a forward-looking statement made by the issuer; or
  6. a statement containing a projection or estimate of such other items as may be specified by rule or regulation of the Commission.”

The foregoing definition covers much of what we, as petroleum geologists, provide professional opinions on: identification of prospects that should be explored and/or developed; the AFEs for such exploration, development and subsequent operations; the estimation of reserves both in total quantity and deliverabilities; estimates of product prices, projected expenses, revenues, income, etc. Some of us provide these opinions as part of a public company’s management, or provide the opinions relied on by a public company’s management. Others of us provide these opinions as reviewing or auditing consultants. All these opinions involve our estimates of what will happen in the future and thus are forward-looking statements.

The only thing one can be sure about predictions of the future (forward-looking statements) is that they will be in error in some way. Where the estimates are quantitative, they will be too high or too low. Only occasionally, and by coincidence, are estimates exactly right.2

There are attorneys who seek out instances where investors have been provided with false or misleading statements, that is estimates of future performance that are wrong by being too high or too low, and sue those responsible for making the statements including the professionals (the geologists and engineers) who provided the basis for the statements made.3 Whether you regard these attorneys as bottom-feeding suckers and leaches or white knights defending the rights of helpless victims depends on which side of the litigation you are on.

The Securities and Exchange Commission would like public companies and their advisors, including geologists, to provide investors with forward-looking information and worked with Congress to provide a safe harbor from such lawsuits for those making or supplying the basis for forward-looking statements. In order to claim the safe harbor, one must comply with all of the specific provisions of the safe harbor. They are:

1. In general. Except as provided in subsection (b), in any private action arising under this title that is based on an untrue statement of a material fact or omission of a material fact necessary to make the statement not misleading, a person referred to in subsection (a) shall not be liable with respect to any forward-looking statement, whether written or oral, if and to the extent that—

A. the forward-looking statement is—

i. identified as a forward-looking statement, and is accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement; or ii. immaterial; or

B. the plaintiff fails to prove that the forward-looking statement—

i. if made by a natural person, was made with actual knowledge by that person that the statement was false or misleading; or

ii. if made by a business entity, was—

I. made by or with the approval of an executive officer of that entity, and

II. made or approved by such offi-cer with actual knowledge by that officer that the statement was false or misleading.

The first requirement of the safe harbor is identifying forward-looking statements as such. Do not assume that everyone recognizes (or cares to recognize when filing a lawsuit) that reserve estimates, etc. are inherently forward-looking. Explicitly include in your reports a “Forward-looking Statements” section that specifically identifies the forward-looking information as such. Remember, the legal profession is known for “i” dotting and “t” crossing. The inclusion of the explicitly named “Forward-looking Statements” section deprives them of a cheap shot at you.

The second requirement of the safe harbor is inclusion of “meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement.” Meaningful cautionary statements are not boiler-plate standard paragraphs copied from one report to the next.4 Even though some subject headings will be common from one report to another (for example, geologic uncertainty and fluctuations in prices and costs), fill in the details in each report from scratch because each property, project, and company is different. For example, Clinton Formation wells in southeast Ohio have high completion rates but their economics are risky while Eocene targets in Mississippi are noted for their small size and have unusually low completion risks for development class wells. Even where you are reporting on the same property for the same company on an annual basis, the relative importance and nature of the cautionary changes can change. For example, there are times when drilling rigs can only be obtained months in advance at very high rates and other times when rig operators are begging for work. The potential impact of project price changes on reserve quantities varies from year to year. Remember, meaningful cautionary language should be in plain, simple language.

The forward-looking statement safe harbor rules do not apply to a variety of situations that are commonly encountered in the petroleum business. These exceptions include initial public offerings, statements made regarding offerings by or operations of limited partnerships, limited liability ventures, or direct participation programs (for example, the classic, plain vanilla “quarter working interest for a third of the AFE” oil and gas promotion). However, in such cases disclosure of risk factors is required and using material cautionary statementtype disclosures is an excellent way of meeting these requirements.

Editor’s note: comments on, discussions of, and questions about this and other aspects of the impacts of the securities laws on geologic practice are welcomed.
Your comments can suggest other topics of interest.

Footnotes:

1 Mr. Abbott was a geologist for the Securities and Exchange Commission for 21 years prior to becoming a consultant. He continues to keep up with those aspects of the securities laws that affect geologic practice. He is not a lawyer and this article does not contain legal advice. Questions regarding the application of securities laws to particular situations should be discussed with securities counsel.

2 One problem with computer generated projections is the degree of calculating precision, which can be expressed to the nearest cent, barrel, MCF, or fractions thereof. Such numerical precision misleadingly suggests a corresponding accuracy of projection. In fact, the accuracy of the projection is limited to the number of significant figures in the least precisely measured parameter in the calculations like porosity, permeability, and water saturation, which may be only 2 or 3 significant digits. Therefore estimated parameters should likewise be rounded to the corresponding number of significant digits.