The SEC’s Office of Investor Education and Advocacy is issuing this alert to educate individual investors about certain risks and possible fraudulent activity involving private offerings of securities for oil and gas ventures.
According to the SEC, the number of fraud cases related to private securities offerings for oil and gas ventures has increased drastically in the past few years. The number of SEC cases has averaged more than 20 per year since 2007. State securities regulators have experienced a similar increase in cases as well. Investing in private placement offerings is risky, and private oil and gas offerings have additional risks to consider.
Due Diligence on Oil and Gas Offerings
Analyzing an oil and gas investment may involve highly technical matters, such as geological findings and new drilling technologies, making it difficult for many individual investors to fully understand. Also, the only information that you have may be coming from the promoter. You may receive a private placement memorandum detailing the venture’s management, its drilling prospects and plans, the terms of the venture and investment, and basic financial statements for the usually new venture. As a start, if you aren’t given anything in writing, then you should be very skeptical.
When faced with an opportunity to invest in a risky private oil and gas offering, it is important to do your research, and there are questions you must ask:
How will my investment be used? Can you estimate how much of the money you raise will be used for each of your needs, such as drilling operations, administrative overhead and broker sales fees? If sales fees will be paid, how are those fees calculated? It is reasonable to expect the company raising the money to have plans for it, particularly if the persons involved have prior industry experience. Otherwise, why are they raising that specific offering amount? If broker sales fees are being paid, you should know that registered brokers are subject to rules and regulations including the amount of sales fees they can charge.
Are you hiring another company to drill or do any other work? Is there any relationship between these companies and the promoters and principals in the venture? How much is the promoter going to make even if we drill a dry hole? The persons involved in the offering can do quite well for themselves when the investment funds are used, for example, to pay themselves or to hire a company they own to do the drilling. They get paid even if the well is dry. Remember too that a promoter who makes his money on the front-end of a deal—that is, from selling the investment to you and benefiting from the proceeds—rather than on the fortunes of the venture—namely the actual production from the well—does not have the same interest as investors like you whose only hope to gain is from a successful well. You should be wary of any oil and gas investment where the promoter’s interests are not aligned with yours.
What is your track record in the oil and gas industry? Have you had experience with this particular well location? Promoters often claim extensive prior experience and success in the industry. These claims were made to stop investors like you from asking questions. Instead, you should try to independently verify any claims and ask for references.
Is there a prior history of drilling where you are drilling? If someone drilled there before, how much did they get out and what makes you think you can get any more out? If the area proved dry before or has not been drilled, why do you think there’s something there? A lot of new oil and gas is found in the U.S. today because of improved ways of drilling, such as hydraulic fracturing (i.e., fracking) and horizontal drilling. These improvements often require specialized expertise and may be expensive.
Did you get a third-party engineering report for the site? Can I see the report? Some operators may employ the expertise of independent third-party engineers and geologists to decide whether it makes sense to drill in an area. If the promoter says there is a report, but doesn’t allow you to see it, you may want to consider it a red flag. You should also consider whether the engineer or geologist is truly independent. Promoters sometimes use reports prepared by the same engineers that sold them the project or by engineers they employ or use repeatedly.
If the offering materials discuss reserves, what types of reserves are being estimated? Who determined these reserve estimates? Were they audited or reviewed by an independent third party? Can I review the audit? The use of terms such as “reserves” makes it sound like a sure thing. However, reserves in the oil and gas industry are not so certain and can vary a lot. Reserves can be “proved,” “probable” or “possible.” Proved reserves are relatively certain. Probable and possible reserves can mean, in short, a 50% to 10% chance of extracting the estimated amount. Some oil and gas ventures do have their reserve estimates audited.
Risk of Private Oil and Gas Offerings
You should be aware that you could lose your entire investment in private oil and gas offerings. They also typically have less liquidity, which means you might have to hold your investment indefinitely.
Some people have used the appeal of “striking it rich” with a gushing well as a basis for fraudulent schemes. The SEC and the states have brought a number of cases involving that turned out to be scams. Investors lost some or all of their investments. Many scams shared the same themes.
The SEC has investigated many oil and gas offerings that claimed they were about to strike oil or gas and they just needed some investment money to pay for drilling and completion. The promoter often doesn’t tell you, however, that he owns the drilling company or plans to hire a driller at far less than what he’s told you the drilling costs will be while pocketing the difference. The promoter makes money from you even if the well comes up dry.
In several cases, the SEC alleged misrepresentations about what the invested funds were going to be used for. Misrepresentations and omissions about uses of investors’ monies included (i) paying big sales fees to brokers, (ii) the nature and size of compensation to the promoter and employees of the venture, (iii) operating and other expenses for unrelated businesses and (iv) using the money to pay for personal items.
Red Flags to watch for:
- Sales pitches referring to recent news events like high oil or gas prices.
- “Guaranteed” returns, including claims that major oil and gas companies are drilling nearby.
- Unusually high rates of return.
- Unsolicited materials
- Sales tactics that pressure you to decide, like “limited” or “once-in-a-lifetime” opportunity.
- Sales pitches touting new technology, especially if it relates to getting higher production out of low-producing wells (or “stripper” wells).
- Salesperson claims to be an investor.
- Being asked to sign documents acknowledging that the securities laws do not apply to the investment.
Investigating Potential Claims Involving Oil and Gas Offerings
The White Law Group is investigating potential securities fraud claims on behalf of investors involving broker-dealers recommending that investors invest in inappropriate oil and gas / energy partnerships and highly speculative private placement investments.
Oil and gas partnerships and private placements are generally risky ventures that are only appropriate for sophisticated investors. Unfortunately, because of the high commissions these products pay to brokers, they are often sold to unsophisticated and retired investors.
The White Law Group’s investigation into the improper sales of oil and gas partnerships and private placements includes, but is not limited to, recommendations to invest in the following:
The White Law Group, LLC is a national securities fraud, securities arbitration, investor protection, and securities regulation/compliance law firm with offices in Chicago, Illinois and Vero Beach, Florida.
For more information on The White Law Group, please visit our website at http://www.whitesecuritieslaw.com.