DISPUTE RESOLUTION: Securities Litigation: Securities Litigation and the Energy Sector by Paul R. Bessette, Michael J. Biles and R. Adam Swick

by King & Spalding

Throughout the past ten years securities litigation has made front-page news in the energy sector. Federal securities class action filings against energy companies specifically have increased in the past three years. While most cases involve false reporting, this article looks at trends regarding securities cases against energy companies, including issues about reserve estimate disclosures, safety disclosures, hydraulic fracturing, solar companies, and Chinese companies. This article also discusses some various examples of recently filed class actions against companies in the energy industry.

Oil and Gas Reserves

Prior to 2010, predominant cases involved a series of class actions concerning the calculation and reporting of oil and gas reserves, especially over what was reported as “proved” reserve estimates. These actions were perhaps not surprising given the subjective nature of reserve accounting and its importance to the market’s valuation of oil and gas companies.

An early example was In re Triton Energy Ltd. Sec. Litig., in which the plaintiffs alleged that Triton improperly classified certain of its reserves as “proved” in violation of disclosure requirements.[1] Plaintiffs argued that the standards for “proved” reserves by the Society of Petroleum Engineers and the SEC required the existence of a financial commitment to develop reserves to be considered “proved.”[2] The court held that the allegations were sufficient to support a claim that Triton made an “untrue statement of material fact.”[3] Another example is In re TETRA Tech., Inc. Sec. Litig.,[4] in which the court dismissed a claim based on an alleged overstatement of reserves since plaintiffs failed to allege “that the reserves were intentionally overestimated or by how much they were overestimated.”[5]

On December 29, 2008, the SEC announced a change to modernize reserve reporting requirements to help investors better evaluate the value of their investments.[6] The new rules became effective January 1, 2010. Major changes included: (1) reporting oil and gas reserves using an average price based upon the prior 12-month period rather than year-end prices; (2) permitting the use of new technologies to determine proved reserves if those technologies have been demonstrated empirically to lead to reliable conclusions about reserve volumes; and (3) allowing companies to disclose their probable or possible reserves to investors to give them a more complete picture of a company’s capital expenditure and development plans.[7] The new rules also allow companies to include oil and gas located farther from wells in calculating proved undeveloped reserves, or PUDs.[8] Additionally, the rule change has allowed these companies to reduce their finding and development costs since they are now divided across a much larger reserve estimate.[9]

According to some commentators, the rule change made it easier for producers, especially shale gas producers, to inflate reserve numbers while lowering reported costs, concluding that the new rules—when viewed together—amount to a more relaxed reporting standard.[10]

Many industry and federal officials have questioned whether companies are taking advantage of the new rule by over-reporting reserves to increase their company’s value and attract additional investors.[11] In June 2011, federal lawmakers called on the SEC, the Energy Information Administration, and the Government Accountability Office to investigate whether gas producers were painting an accurate picture of the amount of gas their wells can produce to their investors.[12] As part of this process, the SEC subpoenaed companies, including Goodrich Petroleum Corporation, Quicksilver Resources Inc., and Exco Resources, Inc.[13] The states of Maryland and New York began their own investigations as well. The New York attorney general’s office subpoenaed Range Resource Corp., Goodrich Petroleum Corp., and Cabot Oil & Gas Corp. over their reserve estimates.

The results of these investigations have yet to be seen. If any developments come from the subpoenas, then securities class actions and derivative suits will likely follow and we could see more cases like those focused on false reserve reporting prior to 2010.

The prolonged decline in natural gas prices in the United States adds an interesting layer to the issue. Reserve estimates involve the amount of gas that is technically and economically recoverable. And companies are valued according to their reserves. The continued decline in gas prices will likely make the production of some reserves not economically recoverable that once were. A problem could develop because some gas companies have hedged their sales for the near future, meaning that they are still selling gas at pre-collapse prices. From the perspective of plaintiffs’ lawyers, companies could be tempted to find ways to “make up” for the decline in gas prices in calculating and reporting reserve estimates, which may increase their risk of litigation.

Safety Policies

Three opinions were issued early this year in securities class actions based on allegations that B.P., PLC, Massey Energy Co., and Transocean Ltd. misrepresented their safety records which artificially inflated their stock prices.[14] In the B.P. case involving the Deepwater Horizon explosion and spill, the Southern District of Texas dismissed a complaint where the allegations focused on a company’s commitment to safety.[15] The court stated that general statements about corporate safety goals and commitments were not actionable because they were too vague.[16] Concrete, identifiable corporate goals must be stated to be actionable.[17]

The case involving Massey in the Southern District of West Virginia arising out of the Upper Big Branch Mine collapse reached a different result. The court denied defendants’ motion to dismiss claims based on general statements about safety accomplishments and goals because the company repeatedly tied its safety record to its financial performance in public filings.[18]

In the case involving Transocean, the Southern District of New York found that undisclosed safety violations that may have contributed to the Deepwater Horizon explosion were not actionable.[19] To allow such a claim “would be to permit a claim based on fraud by hindsight.”[20]


Hydraulic fracturing or “fracking” continues to be a hot-button issue for many oil and gas companies. Fracking involves injecting water, sand, and other chemicals under high pressure directly into shale formations. Generally, fracking is controlled by individual states.

Although the SEC is not regulating fracking in a specific way, in mid-2011 the agency began questioning shale producers regarding their fracking procedures.[21] The initiative shows the SEC’s interest in investigating and ultimately requiring greater disclosures about fracking to help investors. Based on the information that the SEC has obtained from its initial questions about fracking, the SEC has been requiring certain disclosures from companies through the comment-letter process. To show the type of information the SEC thinks is important, below are a few examples of the SEC’s requests.

  • The SEC asked Eagle Rock Energy Partners LP (NASDAQ EROC) to disclose material “specific operational and financial risks associated with hydraulic fracturing in addition to ‘uncontrollable flows of oil or natural gas or well fluids.’”[22]
  • Puissant Industries, Inc. (PSSS.OB) was requested to disclose “expenditures to comply with applicable regulatory requirements” regarding fracking and how Puissant will “contract appropriate drilling and hydraulic fracturing teams.”[23]
  • The SEC requested Carbon Natural Gas Company (NASDAQ CRBO) to, “in light of public concern over the risks relating to hydraulic fracturing, please review your disclosure to ensure that you have disclosed all material information regarding your potential liability,” including applicable policy limits and deductibles of relevant insurance coverage as well as indemnification obligations to third parties performing hydraulic fracturing.[24]
  • Halliburton Company (NYSE HAL) was recommended to disclose “the operational and financial risks stemming from your hydraulic fracturing operations, and to better explain your role in the hydraulic fracturing process.”[25]

Following the SEC’s lead, the New York attorney general sent subpoenas to five oil and gas companies—Talisman Energy Inc. (NYSE TLM), Chesapeake Energy Corp. (NYSE CHK), E.O.G. Resources, Inc. (NYSE EOG), Baker Hughes Inc. (NYSE BHI), and Anadarko Petroleum Co. (NYSE APC)—requesting information regarding disclosures about the environmental risks of fracking.[26] Aside from increased disclosure, what will ultimately result from the SEC’s and New York attorney general’s investigations is not known at this time.

While the SEC and individual states have debated how to regulate fracking, other federal agencies have recently issued proposed rules regarding fracking. On May 4, 2012, the U.S. Department of the Interior’s Bureau of Land Management (BLM) issued proposals covering fracking on federal and tribal lands that would enlarge BLM’s review and approval authority as well as require various additional disclosures.[27] Various organizations, including the Independent Petroleum Association of America, Western Energy Alliance, and the American Petroleum Institute, have criticized the proposals as being unnecessary and duplicative, ultimately making it harder for producers to obtain permits, having a negative effect on investment and jobs.[28] Likewise, the Environmental Protection Agency (EPA) issued proposed fracking rules that will take effect in 2015. The EPA’s rules will require companies to trap the “flowback” of liquids and gases that result from fracking.[29] The delay to 2015 was requested by energy firms citing a current lack of equipment necessary to trap the flowback on the 13,000 wells drilled each year. How companies disclose and follow these upcoming rules could lead to shareholder litigation and increased SEC involvement.

Next month, Part II of this article will examine Solar Companies, Chinese Companies, and Recently Filed Class Actions.

[1] In re Triton Energy Ltd. Sec. Litig., No. 5:98-CIV-256, 2001 WL 872019 (E.D. Tex. Mar. 30, 2001).
[2] Id. at *3.
[3] Id. at *9-11.
[4] In re TETRA Tech., Inc. Sec. Litig., No. 4:08-cv-0965, 2009 WL 6325540 (S.D. Tex. July 9, 2009).
[5] Id. at *21-27.
[6] SEC Modernizes Oil and Gas Company Reporting Requirements to Provide Investors with More Meaningful and Comprehensive Disclosure, SEC Press Release, Dec. 29, 2008, available at www.sec.gov/news/press/2008/2008-304.htm.
[7] Id.
[8] Marc Folladori and Jeff Dobbs, Studies Show Further Guidance Needed on Revised Oil and Gas Disclosure Rules, Oil & Gas Financial Journal, December 1, 2010.
[9] See, e.g., Ian Urbina, SEC Shift Leads to Worries of Overestimation of Reserves, New York Times, June 27, 2011, available at www.nytimes.com/2011/06/27/us/27gasside.html?pagewanted=all.
[10] Id.
[11] Id.
[12] Ian Urbina, Lawmakers Seek Inquiry of Natural Gas Industry, New York Times, June 28, 2011, available at www.nytimes.com/2011/06/29/us/politics/29naturalgas.html.
[13] Id.
[14] In re BP P.L.C., Sec. Litig., Case No. 10-2185, 2012 U.S. Dist. LEXIS 17787 (S.D. Tex. Feb. 13, 2012); In re Massey Energy Co. Sec. Litig., Case No. 10-00689, 2012 U.S. Dist. LEXIS 42563 (S.D. W. Va. Mar. 27, 2012); Foley v. Transocean Ltd., Case No. 10-5233, 2012 U.S. Dist. LEXIS 37882 (S.D.N.Y. Mar. 20, 2012).
[15] In re BP P.L.C., Sec. Litig., Case No. 10-2185, 2012 U.S. Dist. LEXIS 17787, at *138-140 (S.D. Tex. Feb. 13, 2012).
[16] Id.
[17] Id.
[18] In re Massey Energy Co. Sec. Litig., Case No. 10-00689, 2012 U.S. Dist. LEXIS 42563, at *47-54 (S.D. W. Va. Mar. 27, 2012).
[19] Foley v. Transocean Ltd., Case No. 10-5233, 2012 U.S. Dist. LEXIS 37882, at *32-33 (S.D.N.Y. Mar. 20, 2012).
[20] Id.
[21] Deborah Solomon, SEC Bears Down on Fracking, The Wall Street Journal, Aug. 25, 2011.
[22] SEC Comment Letter dated December 7, 2011 to Eagle Rock Energy Partners, L.P. Definitive Proxy Statement on Schedule 14A filed April 27, 2011, available at www.sec.gov/Archives/edgar/data/1364541/000000000011070634/filename1.pdf.
[23] SEC Comment Letter dated June 23, 2011 to Puissant Industries, Inc. regarding Amendment No. 1 to Registration Statement on Form S-1 filed May 27, 2011, available at www.sec.gov/Archives/edgar/data/1511618/000000000011038583/filename1.pdf.
[24] SEC Comment Letter dated September 9, 2011 to Carbon Natural Gas Company Registration Statement on Form S-1 filed August 2, 2011, available at www.sec.gov/Archives/edgar/data/86264/000000000011054005/filename1.pdf.
[25] SEC Comment Letter dated November 16, 2011 to Halliburton Company Form 10-K for Fiscal Year Ended December 31, 2010 filed February 17, 2011, available at www.sec.gov/Archives/edgar/data/45012/000000000011066592/filename1.pdf.
[26] Deborah Solomon, SEC Bears Down on Fracking, The Wall Street Journal, Aug. 25, 2011.
[27] Nick Snow, DOI Releases Draft Fracking Rules for Onshore Public, Tribal Lands, Oil & Gas Journal, May 4 2012, available at www.ogj.com/articles/2012/05/doi-releases-draft-fracing-rules-for-onshore-public-tribal-lands.html.
[28] Id.
[29] Tennille Tracy, First Fracking Rules Unveiled, The Wall Street Journal, April 18, 2012.

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