by Tom Bower
The advice received from Cravath’s by Frank Coopman was devastating. Shell, the lawyers in New York warned, was required to substantially downgrade its reserves and to advise the SEC about a “material matter” affecting the company before it revealed the serious breach of rules to the stock market. On December 2, Coopman told van de Vijver about the lawyers’ advice. Failure to comply with the SEC’s regulations, he warned him, would expose the company to prosecution. “This is absolute dynamite,” van de Vijver replied, shocked by the unintended consequence of his campaign, adding, “Not at all what I expected and needs to be destroyed.” His belief that the genie could be pushed back into the bottle, an unlawful act, showed naïveté at best, and at worst raised questions about his motives. After reflection, van de Vijver recorded in an internal memorandum his intention not to be blamed for “a watershed reputational disaster… and I do want to stick to some very firm criteria: the problem was created in the 90s and foremost in 1997–00 and any clean-up must reflect that… I will not accept cover-up stories that it was okay then but not okay with the better understanding of SEC rules now and that it took us two and a half years to come to the right answer.” The “clean-up,” he ordered, should reflect that the problem was created by Watts.
The implications of Coopman’s activities could no longer be ignored. To protect Shell’s relationship with Nigeria, the world’s seventh-largest oil exporter, which shipped 40 percent of its production to the USA, Shell’s accountants had wrongly categorized 60 percent of Nigeria’s oil as “proven reserves.” Van de Vijver suggested keeping the true level of the Nigerian reserves “confidential in view of host country sensitivities.” Shell, he knew, would not want embarrassing revelations to damage its relationship with other members of OPEC, or to undermine the continuing negotiations with the Nigerian government for a $385 million bonus payment. He was too late. Two days later, Shell’s bureaucrats finally understood that containment was impossible. On December 5, chief financial officer Judy Boynton was told for the first time about the problem. “I’m gobsmacked,” she spluttered. “I’ve never come across such duplicity.”
Shell’s board of managers was due to meet for Christmas dinner in The Hague on Monday, December 8. That morning, van de Vijver submitted a 42-page report to the board describing the crisis. His report was not the first time they had been made aware of the situation. Ever since February, he had warned that one billion barrels of the reserves were “no longer fully aligned” with the SEC rules, and that an additional 1.3 billion were at risk because of expiring licenses. Within the corporation, officials had even drafted an “external storyline” and an “investor relations script” to explain the problem. An added complication on that day was that Watts was in Moscow, where he was waiting to meet Putin to discuss a draft decree threatening to revoke Shell’s license in Salym. A telephone call from Jeroen van der Veer warned him that difficulties had arisen that would need to be discussed on his return later that day. This timetable was jeopardized by Putin’s decision at the last moment to meet Watts at his dacha outside Moscow rather than in the Kremlin. As he was being driven at speed into the countryside, Watts was overtaken by the president’s motorcade. On arrival, he and John Barry, the head of Shell’s Moscow office, were filmed being received by Putin and a group of ministers. “They’re revoking the Salym licence,” Watts told Putin. “I’m sure you’re committed to the rule of law and that you won’t think this is impertinent of me, but if that happens we will fight it in the courts.” Putin, Watts believed, understood his threat before the interpreter had finished, but after the translation was completed, he turned to his ministers and said: “I’m sure that a solution to this matter will be found amicably.” To Watts’s relief, Putin provided an escort to speed him to his private jet.
During the flight, Watts could reflect that Shell’s investment in Salym was safe, and that Sakhalin 2, despite internal criticism of tardiness and excessive cost, proved that Shell’s engineers could carry out a long-term plan. Indeed, a laudatory newspaper article would subsequently appear under the headline, “Oil Giant’s Patience Pays Off in Russia.” Watts was proud of his record. Although BP appeared to have outperformed Shell, he believed that his competitor’s investments were risky. Shell’s future was assured by its global brand in gas stations, enhanced by the purchase of the American retail group Pennzoil for $1.8 billion, making Shell the biggest gasoline retailer in the US, with 14 percent of the market. Although profits had fallen, he had consolidated the corporation’s interests in chemicals, natural gas, tar sands and oil wells. He had even cut over 5,000 jobs in the previous two years. He expected to enjoy Christmas and the New Year in the sunshine in Oman.
The whispered conversations during the pre-dinner reception in The Hague ruined Watts’s airborne reverie. Jeroen van der Veer was unusually animated. Until Judy Boynton had arrived in his office that very morning, Shell’s director responsible for chemicals had assumed that van de Vijver was coping with the problem of the overstated reserves. No one, he would explain, had previously explained to him the differences between proven and unproven reserves. Well aware of the unsustainable relationship between Watts and van de Vijver, van der Veer had assembled a committee to resolve the issue. Watts was told about that initiative, and given graphic accounts of van de Vijver’s accusations of lies and concealment, as he joined the 50 guests heading for the chairman’s dinner in the city hall. Protesting his innocence, he said: “This is all news to me. I had no idea that any figure reported to me was wrong.” An argument erupted among Shell’s directors. Each claimed to have worked within his own silo, unaware of events in the rest of the business. All had previously chosen to ignore the intense animosity between the two most senior directors, and some would subsequently claim that even at that late stage, Watts had not informed the conference of managing directors or the audit committee about the full extent of the problem, although Watts would presumably have regarded this as van de Vijver’s responsibility, rather than his own. Jeroen van der Veer, although admitting receipt of documents after July 2002 showing that the reserves did not match SEC definitions, would say, “I did not know about incorrect bookings. I did not appreciate the severity and the magnitude of the problem.” Amid those unconvincing denials, the directors agreed to urgently consider a review, code-named “Project Rockford,” reestimating the reserves in nearly 300 oilfields, 90 percent of Shell’s assets, and disclosing the report to the SEC and the stock exchange. Controversy was inevitable, but the only director to raise the unpleasant question of whether there had been deliberate deception — although there was no evidence of this — was Larry Ricciardi, a New York lawyer and nonexecutive director, who expressed his outrage, hinting that many would suspect that deviousness rather than arrogance lay at the heart of the misreporting. None of the British or Dutch directors agreed. Without concrete evidence of dishonesty, they were unprepared to formally voice any misgivings, or to anticipate the consequences for Shell of the fragmented relationship between Watts and van de Vijver.
Compiling “Rockford’s” conclusions about the overbooking of the reserves ruined Watts’s Christmas holiday. Ostensibly celebrating with the Sultan of Oman, he commuted back to Holland to implement Cravath’s advice that Shell needed to debook 2.3 billion barrels of reserves in accordance with the SEC’s requirement of “absolute certainty.” Uncurious about Cravath’s lack of forensic accounting, and oblivious to the doubts about himself among his fellow directors, Watts obeyed his lawyers and auditors to hastily complete a self-destructive operation. Disturbingly, the Wall Street Journal had hinted at Shell’s predicament. The leaks of the critical reports by Anton Bylondrecht describing the unsatisfactory reserves in Oman and Nigeria were clearly intended to destroy Watts and other managers.
On January 9, 2004, Watts was due to address analysts and the media. Before his appearance, he agreed that Shell should publicly issue a catastrophic admission. A statement was prepared that between 1996 and 2002, 3.9 billion barrels of oil e
quivalent, or 20 percent of Shell’s oil and gas reserves, had been wrongly booked and would be recategorized. Watts had not anticipated the deafening echo as the news ricocheted around the world. Fearing that the British media would enjoy the “blood sport to tear me apart,” Watts decided to duck the challenge. Shell’s spokesman was ordered to explain to the skeptical audience that under the rules it was impossible for Watts to appear publicly in the “closed period” before the financial results were published on February 5. “I’m going into the bunker,” Watts told John Hofmeister. “Are you sure that’s wise?” asked the American. “Hitler went into his bunker and never came out alive.” Watts ignored the advice. No other voice within Shell warned him of the danger. Having crushed too many people with an elbow in the eye or a kick in the shin, Watts lacked friends at that critical moment. He was also incapable of self-criticism. “We’re going to be crucified,” he was told after the meeting. The damning headlines in the media were greeted by his fellow directors with stony faces. As the criticism and questions fell relentlessly on the corporation’s directors, Watts belatedly understood the catastrophe that had befallen him. “I’m the hero,” van de Vijver crowed. “Philip’s the goat.”
On January 16, Watts addressed the staff on the corporation’s website: “It is important to bear in mind that this recategorization was the result of our own internal processes… Based on those reviews, I believe that the individuals concerned worked in good faith to the interpretations in use when the bookings were made following proper processes, and that there is no evidence of misconduct.” There was no consensus about whether Watts was the perpetrator, victim or scapegoat, but all agreed he was isolated. Shell’s spokesmen quietly advised journalists to consider BP’s booked reserves, which during 2000–02 were double its own growth history and double Exxon’s. BP insisted it was not revising its reserves.
The world’s second-largest oil company could still have saved itself if Larry Ricciardi had not demanded an independent inquiry. “We need a forensic investigation to discover the truth,” he said. No oil company had ever exposed itself to such self-examination. Exxon after Valdez had resisted every inquiry, but Shell’s directors, unable to explain that estimating oil reserves had never been an exact science, or that the crisis had erupted because of van de Vijver’s schemes and ambitions, succumbed to the American’s demand for a full investigation. In the post-Enron era, any resistance to an American nonexecutive would have been futile. Davis Polk & Wardwell, a New York law firm, was appointed to conduct a swift review. At that moment Polk was also advising other oil companies how to resist the SEC’s demands. “We’ve unleashed an unnecessary witch hunt,” mourned a British director.
The mood at the company’s annual strategy review in London on January 25, 2004, was acrimonious. Not one person accepted blame, and the directors were divided by their suspicions. Jeroen van der Veer felt neither sympathy for Watts nor trust of van de Vijver, whose stupidity had encouraged Cravath’s “reporting” to the SEC. Van der Veer was certain that Watts could not survive, and expected Polk to deliver the fateful blow. Meanwhile van de Vijver, encouraged by his forceful wife Bernadette, expected the events to deliver the crown. His ambitions were fueled by a simultaneous outburst of detailed descriptions of Shell’s secrets in the New York Times and the Wall Street Journal.
On February 5, Watts and van de Vijver finally appeared in public to present Shell’s annual review. During the long presentation, Watts admitted his mistake in failing to appear on January 9, but refused to resign. “This thing has happened on my watch. I have the will and determination to see us through,” he said. Both men suggested that the reserves problem had only emerged during 2003, rather than in 2002. Van de Vijver described his “shock,” which had sparked the Rockford inquiry, while Watts stated that after the facts appeared “late last year,” “It was a matter of all hands on deck. And I remember writing down the words ‘Get the facts and do the right thing.’” There was, he added, “no evidence of any misconduct.” By giving the impression that the reserves issue had only just arisen, both men unwittingly aroused suspicions about their own conduct. Watts’s submission that “I thought we had booked in good faith and applied SEC guidelines retrospectively” lacked credibility. To the Polk investigators, the directors’ statements had the flavor of a cover-up, although they resisted stating as much as a conclusion. The flaws reappeared at a shareholders’ meeting the following day at the Saint Regis hotel in Manhattan. “I’m sorry I got it wrong,” Watts sighed in a tired voice. His defiance had evaporated. Shell had consistently underperformed over the previous decade, and he offered no hope for the future.
Polk’s interim report, completed with undue speed at the end of February, cast Watts as unreliable. Summoned to a special meeting in The Hague, Shell’s directors read confirmation of van de Vijver’s judgment that the reserves booked during Watts’s era were “aggressive” and “premature,” and had failed to comply with Shell’s own guidelines, and by implication the SEC’s. Watts’s professional “success,” reported Polk, could be attributed in part to his ability to “meet or exceed reserve expectations.” Shell was advised to debook 4.47 billion barrels, or 23 percent of its reserves, in four stages between January 9 and May 24. Other reductions would be made in March. At the end of the meeting, the directors were angry. Watts’s position, they agreed over dinner in a hotel, was untenable. At 8:30 the following morning, March 1, Watts was waiting in his office for the inevitable. Overnight, his resignation letter had been finalized. The demand for his signature was delivered by Ronald Oxburgh, the British nonexecutive chairman of Shell. “Why?” asked Watts. “Misjudgments,” replied Oxburgh. With dignity, Watts signed. “Can I have the company plane to take me back to London?” he asked. “I’d prefer not to queue at the airport.” “No problem,” he was told. Only Ricciardi would challenge, albeit unsuccessfully, the financial terms of Watts’s departure, which included the company’s agreement to finance all his future legal battles.
Oxburgh next called on van de Vijver. The Dutchman had been expecting to be offered the chairmanship, but instead Oxburgh said, “We want your resignation.” Van de Vijver’s face drained. “But I discovered the truth,” he protested. “I led the charge against Watts. This can’t be happening. I don’t believe this.” Oxburgh remained impervious. In tears, van de Vijver telephoned his wife. “But I told the truth,” he shouted. Shortly after, his wife appeared at the office and firmly shut the door while he slumped over his desk. At 10 o’clock, the directors nervously dispatched John Hofmeister to extract a signed resignation. Pushing hard to open the door, he was greeted by an angry Bernadette van de Vijver, who uttered grossly unfounded allegations. Hofmeister issued van de Vijver with an ultimatum: “You have until noon to resign. If you don’t, the record will show that you’ve been removed for cause.” In the aftermath, Chris Fay told Mark Moody-Stuart, “I warned you that Watts was a cover-up guy, that there was a geological mafia cover-up.”
Jeroen van der Veer was appointed Watts’s successor, although he had been party to the mismanagement since 2002. He was, it was decided, the least guilty of the group. Paid one quarter of John Browne’s salary (£2.9 million in 2006), the cost-conscious Calvinist who cycled on the weekends to save gasoline appeared in a crumpled shirt with frayed cuffs and an old tie to utter a suitably morose mea culpa to the public. “It has been a very tough time. This is by far the most difficult period of my whole Shell career… We had all kinds of processes and procedures, audits, signing off letters of representation, external accountants, so there was a whole list of things to make sure that we did not drop the ball. There was a basic belief that nothing major could happen in the company. But it happened.”
Shell’s share price plummeted. Polk’s final report was delivered four weeks later. Quoting e-mails and internal documents, it condemned Watts’s conduct and invited an investigation by the Financial Services Authority (FSA) in London and the SEC. Shell’s directors used Polk’s conclusion as the
basis for blaming Watts for masterminding a conspiracy. In a statement following Shell’s $150 million settlement, the SEC attacked the company as “reckless” for having repeatedly ignored its warnings: “In each case Shell either rejected the warnings as immaterial or unduly pessimistic or attempted to ‘manage’ the potential exposure by, for example, delaying debooking of improperly recorded proved reserves until new, offsetting proved reserves bookings materialised.” Watts believed those conclusions to be untrue. “They produced a report dripping with innuendo to cast me as a scapegoat,” he complained. Refusing to be seen as the villain and condemned to lifelong disgrace, he retaliated. Hiring lawyers in Washington, he subpoenaed the SEC’s correspondence with rival oil companies about their reserves in Kashagan, Nigeria and Norway, the same oilfields as Shell’s. Among nearly one million documents was correspondence showing that in exactly those areas where Shell had debooked reserves, SEC officials had allowed ExxonMobil, Chevron and BP to keep the same reserves booked. Indeed, just before Shell debooked Kashagan in 2004, the same reserves were booked by ExxonMobil, despite the SEC’s orders to debook them. Watts could only speculate about why ExxonMobil, a collaborator in Kashagan like Total, had both stayed silent about its confrontation with the SEC, and refused to offer any help to Shell, its beleaguered partner.