The US SEC has filed charges against the Canadian entity Penn West Petroleum Ltd. (now renamed Obsidian Energy Ltd.) and three former senior accounting and finance personnel alleging violations of the antifraud, recordkeeping, internal controls, and reporting provisions of the federal securities laws arising from a multi-year accounting fraud.
Penn West prepared the financial statements in question under IFRS. Here are some extracts from the SEC filing:
- Penn West was one of the largest oil producers in Canada, but historically struggled to keep its operating costs—a key financial metric that the investing public looks to when evaluating the financial health of an oil and gas company—under control. As a result, in 2012, 2013, and the first quarter of 2014…Defendants executed a scheme to make the annual and quarterly financial reports that Penn West, a publicly traded company, submitted to the SEC and disclosed to investors tell a different story about the company’s financial condition than the one that actually existed. The object of the scheme was to deceive the investing public by understating Penn West’s publicly reported operating expenses and related financial metrics and making the company appear to be managing costs more efficiently than it actually was. In other words, as a result of Defendants’ scheme, it appeared that Penn West was spending less money to get oil out of the ground than it actually was.
- …Defendants engaged in three principal types of improper accounting practices in furtherance of their scheme:
- First, Defendants improperly moved certain expenses that had been recorded in Penn West’s operating expense accounts to its capital expenditure accounts, a reclassification practice known internally at Penn West as “reclass to capital.” This had the effect of moving the expenses from the company’s income statement, where they appeared as expenses, to the company’s balance sheet, where they appeared as assets, thus lowering the company’s reported operating expenses and making it appear that Penn West was investing capital in support of increased production….
- Second, Defendants improperly moved certain operating expenses to Penn West’s royalty account, a line item on the company’s income statement intended to show money expended paying royalties to the owners of land on which Penn West drilled….
- Third, Defendants improperly took excess operating expense amounts that had been accrued in prior accounting periods, but not expended, which should have been written off, and instead reduced those accruals in subsequent periods to reduce Penn West’s operating expenses and make them appear more consistent over the course of the year….
Penn West first reported in July 2014 on the existence of irregularities in its financial statements, and subsequently restated all the periods affected. It’ll be fascinating to see how this plays out – in particular for how much meat it provides or doesn’t provide to detractors of Canadian regulators and of IFRS. On the first point, the Alberta Securities Commission looked at the same issues but didn’t bring any action, making it easy for a professor cited by the Globe and Mail to ask: “A fundamental question here for Canadian regulators, and for Canadians, is why are we not taking care of our own?” It’s not really a balanced way of posing the question, and I don’t suppose the ASC is really in a position to provide a detailed answer to it, but it may obviously end up having some life if the SEC ends up getting a splashy enforcement result.
On the second point, it might be easy to cast this matter as evidence of the purported inadequacies of IFRS – basically, that it’s too principle-based to stop preparers from doing pretty much whatever they want. At the time of the restatements, Al and Mark Rosen partly cast the issues in this kind of light: “The accounting rules themselves are vague and open to interpretation. So, in the case of Penn West, determining whether an expenditure should be considered an expense or an asset is far from simple.” But the point of the SEC filing is that IFRS was sufficiently clear to indicate the appropriate treatment for these expenses, and that Penn West’s practices were contrary to the standards. On determining an expense versus an asset, the company has already acknowledged in its filings that “little if any analysis was performed at the time of the entries to determine which entries ought to be capitalized,” and that, in some instances, “there appeared to be no contemporaneous support for the decision to reclassify operating expenses as property, plant, and equipment.” The SEC alleges that the former CFO, for one, “ignored reports of internal accounting controls failures that were escalated to him, concealed the accounting fraud scheme from Penn West’s Board and senior management, made misstatements and omissions to Penn West’s independent auditor in his management representation letters, and signed Penn West’s falsified financial statements and false certifications in connection with the company’s periodic SEC filings.” Based on that narrative, these misstatements happened despite what IFRS says, not because of it.
Well, we’ll certainly come back to this in the future…
The opinions expressed are solely those of the author