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.
The number of fraud cases related to private securities offerings for oil and gas ventures has increased over the last few years. From few in 2005 and 2006, the number of SEC cases has averaged more than 20 per year since. State securities regulators have experienced a similar increase in cases over the past five years. All investing involves varying degrees of risk. Investing in private offerings, however, carries unique risks, and private oil and gas offerings have additional risks to consider.
If you are asked to invest in a private oil and gas offering, you should first consider and investigate who exactly is asking you to invest and think carefully about whether the investment is appropriate for you.
Is the person recommending the investment registered? Most people offering you securities must be registered as a broker with the SEC and must be a member of the Financial Industry Regulatory Authority, or FINRA. You can find out if someone is registered and obtain information about a registered broker by visiting FINRA's BrokerCheck website or calling FINRA's BrokerCheck hotline at (800) 289-9999. If you are working with a registered investment adviser, you may be able to obtain information about the adviser by visiting the SEC's Investment Adviser Public Disclosure (IAPD) website. You can also check with your state securities regulator regarding the person soliciting your investment.
What if I'm not working with a registered broker or investment adviser? If someone who is not registered solicits your investment, that person may be violating the law. One exception from broker registration is available to employees of the company offering the securities and who engage in strictly limited sales activities. If you aren't consulting a registered broker or adviser, you should consider doing so. A registered broker or adviser that is familiar with the oil and gas industry and not connected to the offering can help you analyze the investment. Most importantly, working with a registered broker or investment adviser affords you certain legal protections.
Even if you are working with a registered broker or adviser, it is not a seal of approval. Oil and gas offerings present many investment risks, and working with a registered individual is not a guarantee that the offering is a sound investment. Ask about any prior history of selling oil and gas offerings and if those offerings failed, the vetting or due diligence process for such offerings, and the risks of the particular investment you are considering.
Be particularly cautious if the broker or adviser has a relationship with the promoter of the venture, or otherwise has a personal stake in the transaction. A promoter is the person promoting the offering and is usually the founder of the venture. Ask about any current or prior relationship with the promoter, the extent of their business together, and any personal incentive in the offering. These or similar questions should help alert you to any potential conflicts and biases that may exist in recommending the particular offering to you.
Ask for the "due diligence report." A registered broker that recommends a private oil and gas offering must independently review the investment. The broker may not just rely on the oil and gas promoter for information. Instead, the broker must check the statements and claims about the investment. To know what due diligence your broker performed, ask for a copy of his "due diligence report." This report should outline how the broker evaluated the venture's prospects and claims. However, the broker's investigation is not infallible. See the discussion regarding SEC v. Provident Royalties, LLC below.
Consider whether the investment is appropriate for you. Private securities offerings are generally limited by law to certain institutional and high net worth investors. This limitation exists because of the greater risks involved in private offerings as compared to, for example, investing in publicly traded stock. Private offerings—including private oil and gas offerings—may involve a high degree of risk. You should be aware that you could lose your entire investment. They also typically have less liquidity, which means you might have to hold your investment indefinitely.
The oil and gas industry is often in the news. Because of this, 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 "great opportunities" that turned out to be scams. Investors lost some or all of their investments. Many scams shared the same themes.
Investing to support drilling and completion operations. 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 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 SEC v. Hartmut Theodor Rose, the SEC charged the promoters in an oil and gas venture with soliciting investors' funds to finish drilling while not mentioning that their own geologists said not to go ahead. The SEC alleged the promoters collected over $10 million from 300 investors nationwide.|
Undisclosed use of proceeds. 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.
To illustrate, in SEC v. Wellco Energy, LLC, the SEC alleged the promoters misrepresented that investors' funds would be used for oil and gas wells when, in fact, 58% of money raised went to pay sales fees as well as the promoter's personal mortgage and child support. In SEC v. Petroleum Unlimited, LLC, the SEC alleged misrepresentations were made about the use of investor funds, since only $534,000 of the $2.9 million raised from investors was used for oil drilling. In addition to failing to mention that sales fees equaling 49% and 74% of the investments would be paid, the SEC alleged investor funds also were used to pay the promoter directly and through related companies, like the drilling company. The individuals selling the offerings in both these cases were not registered with the SEC.
In another case, SEC v. Provident Royalties, LLC, Provident raised $485 million through various offerings from at least 7,700 investors nationwide promising high returns and misrepresenting how investor funds would be used. Investors were told that 86% of their funds would be for oil and gas investments. The SEC alleged that, instead and undisclosed to investors, a portion of the investor funds was used to pay dividends and returns of capital to earlier Provident investors. Retail brokers sold the Provident offerings to retail investors nationwide. A number of these brokers have since been sanctioned by FINRA for selling the offerings without having a reasonable basis for recommending the securities.
Overinflated or misrepresented prospects and claims. One common thread among all fraudulent schemes, including those related to oil and gas, are claims that they are about to strike it rich, or that it is likely or even guaranteed that the returns will be too good to pass up. When you hear this sales pitch, you should be very skeptical about high returns with little risk that are just around the corner. Higher returns typically mean higher risks of loss.
In Hartmut Theodor Rose, the SEC alleged that the promoters told investors that oil and gas production was about to start when many of the wells were actually marginal or even dry. They misrepresented the "success" of prior wells to raise funds for new wells and touted the "low-risk" opportunity as "once-in-a-lifetime."
In Petroleum Unlimited, the SEC alleged that investors were told without any reasonable basis that they could expect returns of 14% to 141% a year. Rather, 81% of the money raised was used to pay for expenses other than oil drilling, including huge sales fees.
In SEC v. Hilton, the SEC alleged that the promoter raised $3.3 million from about 176 investors nationwide in several offerings by falsely portraying the success or prospects of various wells and the expected returns for investors
See our Investor Alert detailing common red flags in oil and gas scams for more information.
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.
You should ask questions until you are satisfied with the answers. Don't just accept promises of low risk for high returns. Remember, it is your money and you shouldn't let anyone pressure you into purchasing an investment that you don't understand. Here are some things to ask about and consider if you're thinking about investing in an oil and gas venture:
In SEC v. Sunray Oil Co., the SEC alleged that the promoter touted Sunray's "50 years of experience," but he left out the fact that the company was formed much more recently and his previous company went bankrupt.
In Hilton, the SEC alleged the promoter falsely told potential investors that Exxon Mobil had previously drilled in and abandoned the oil field because it lacked the technology to exploit it, but the venture now had the necessary technology to extract oil from it.
Keep in mind that if the investment opportunity is an outright fraud, the written materials may look legitimate and every question you have about the opportunity may be answered to your satisfaction, but that doesn't make any of it true. It is important to conduct your own independent research. One good way to do that may be to engage an investment professional specializing in oil and gas.
If you have a question or concern about an investment, or you think you have encountered fraud, please contact the SEC, FINRA or your state securities regulator to report the fraud and to get assistance.
U.S. Securities and Exchange Commission
If you want to investigate a venture's operations and wells, you can check with the oil and gas regulatory agency in the state where the venture undertakes its operations. Following is contact information for certain state regulatory agencies.
California Department of Conservation
Kansas Corporation Commission
For our Investor Alert detailing common red flags in oil and gas scams, visit www.sec.gov/investor/pubs/oilgasscams.htm.
For a FINRA investor alert regarding energy stock scams, visit ww.finra.org/Investors/ProtectYourself/InvestorAlerts/FraudsAndscams/p037236.
For a NASAA investor alert regarding oil and gas investment fraud, visit www.nasaa.org/6782/oil-gas-investment-fraud/.
For FINRA's BrokerCheck resource, visit www.finra.org/Investors/toolsCalculators/BrokerCheck/.
For our Investment Adviser Public Disclosure (IAPD) website, visit www.adviserinfo.sec.gov.
For our Investor Bulletin on tips on picking an investment professional, visit www.sec.gov/investor/alerts/ib_top_tips.pdf.
For the SEC release regarding SEC v. Hartmut Theodor Rose, visit www.sec.gov/litigation/litreleases/2009/lr21031.htm.
For the SEC release regarding SEC v. Wellco Energy, LLC, visit www.sec.gov/litigation/litreleases/2009/lr21040.htm.
For the SEC release regarding SEC v. Petroleum Unlimited, LLC, visit www.sec.gov/litigation/litreleases/2011/lr21808.htm.
For the SEC release regarding SEC v. Provident Royalties, LLC, visit www.sec.gov/litigation/litreleases/2009/lr21118.htm.
For FINRA's news releases regarding the sanctioning of brokers in connection with the Provident Royalties offerings, visit www.finra.org/newsroom/newsreleases/2011/P123441 and www.finra.org/newsroom/newsreleases/2011/P125193.
For the SEC release regarding SEC v. Hilton, visit www.sec.gov/news/press/2012/2012-205.htm.
For the SEC release regarding SEC v. Sunray Oil Co., visit www.sec.gov/litigation/litreleases/2006/lr19737.htm.
For additional investor educational information, see the SEC's website for individual investors, www.investor.gov.
The Office of Investor Education and Advocacy has provided this information as a service to investors. It is neither a legal interpretation nor a statement of SEC policy. If you have questions concerning the meaning or application of a particular law or rule, please consult with an attorney who specializes in securities law.