SEC Charges Oil and PR Firms And Their Executives With Fraud

by Dorsey & Whitney LLP
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An energy company, its CEO and the firm’s public relations adviser and its president were named in a fraud action by the SEC centered on false representations concerning oil reserves for a property in Columbia. The representations were used to sell securities and boost the price of the oil company shares, traded on the NYSE MKT. As the fraud unfolded nobody seems to have done due diligence on claims about billion dollar oil reserves in Colombia which are at the center of the fraud claim. In the Matter of Huston American Energy Corp., Adm. Proc. File No. 3-16000 (August 4, 2014).

Huston American, a Texas based energy company, its CEO, John F. Terwilliger Jr. and the firm’s public relations consultant, Undiscovered Equities, Inc. and its president, Kevin T. McKnight, were named as Respondents in the proceeding. In late 2009 Huston American announced that it had entered into a farm-out agreement with the Operator of a property in Colombia’s Llanos Basin. Under the terms of the deal Huston American obtained a 25% non-operating interest in a 345,452 acre oil and gas exploration production area in the Basin known as CPO-4 block.

Prior to the Huston American deal, the Operator obtained the exploration and production rights to the CPO-4 block in 2008 from the Colombian government in exchange for a work commitment. The deal required the Operator to conduct certain tests within six years and pay the Colombian government a royalty for any oil produced from the block.

The Operator spent several months evaluating the CPO-4 block and reviewed prior reports on the area before entering into the arrangement with the government. Based on an extensive, scientific analysis, the Operator estimated that the potential range of the block was from 300 million barrels of oil to a “total potential” of 974 million barrels.

The Operator created a three page summary of its findings in early April 2009 as it searched for a minority, non-operating farm-in partner for the CPO-4 block. The summary stated that the bock had a potential total of 1 billion barrels of oil and 300 million barrels of oil as a risked reserve potential. A 55 page slide deck detailing the basis for the Operator’s estimates was also created. Mr. Terwilliger was furnished a copy of the slide deck which he later described in testimony as “a lot of good work” that conformed to “traditional industry practices.”

Following the execution of the farm-in deal, Huston American publically announced the arrangement. Two weeks later, at the end of October 2009, the Operator delivered the 2010 development for the CPO-4 block to Huston American. It included $31 million of expenses. Huston American was obligated for the first quarter to pay about $5 million which was more than its then current cash and only slightly under its total current assets.

On November 10, 2009 Huston American released an investor presentation. It contained 16 slides about the block, noting the total number of acres involved and representing that it had estimated recoverable reserves of 1 to 4 billion barrels of oil. It did not mention the Operator’s estimates and lacked a reasonable basis, according to the Order.

Just before releasing the investor presentation, Huston American retained Undiscovered Equities. The purpose was to create additional investor awareness. The firm posted to a website promotional articles about Huston American and the CPO-4 block in November. In the posting the public relations firm reiterated the reserve estimates created by its client.

That same month Mr. Terwilliger conducted a series of investor presentation in-person roadshow meetings with institutional investors in Dallas, Detroit and Chicago. During the meetings he repeated and embellished the firm’s claims regarding the CPO-4 block. At one point he stated that the Operator’s estimate for the block was 3.5 billion barrels.

In a subsequent meeting with an investment bank the representations were repeated. The investment bank forwarded the information to its institutional clients. Eventually the investment bank sold 490,000 shares in an offering which raised about $13 million on December 1, 2009.

Early the next year an Independent Research Analyst published a report on Huston American. It reiterated the estimates of the firm and assigned a target price for its stock of $168 per share. The next day the share price for Huston American spiked. Over the period the share price went from $4 to over $20. When two blog posts raised questions regarding the integrity of management and the validity of the estimates, the share price dropped first to $14 and later to about $9.

Subsequently, Huston American withdrew from the project. Over the life of the project Huston American raised and spent over $20 million. Mr. Terwilliger received a significant salary and bonus along with stock options. He later sold his shares for about $1.8 million.

The Order alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b) as well as 20(b). The proceeding will be set for hearing.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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