Oil & Gas Investment Schemes-Fraud
Contributed by: Lucas Trevant-Global Advocates
Securities regulators around the country warn that oil and gas investment schemes are alive and well. Rising oil prices have created a increased interest in investments in energy-related business ventures.
There certainly exist legitimate oil and gas investment opportunities, while involving varying degrees of financial risk. However, as in most any other investment opportunities, it is not unusual for illegitimate promoters to attempt to take advantage of investors by engaging in fraudulent practices.
Although some of these con artists have moved on to more lucrative venues since the end of the oil boom in the mid-1980s, many continued to loiter on in the oil field. Now with the regular instability of oil prices, some of these snake oil salesmen have found their way back to these kinds of scams. When there is a highly publicized economic circumstance, which creates an possibility for money to be made legitimately, scam artists follow in the trending shadow to take advantage of the circumstances.
WHAT ARE OIL AND GAS INVESTMENTS?
Oil and gas investments come many forms, to include limited partnership interests, ownership of fractional undivided interests in leases, and general partnerships. Tax consequences and investor liability vary according to the type of product. Real general partnerships in which investors actively participate in the operations of the venture are not considered securities. A general partner, however, is personally liable for debts of the partnership.
In a drilling limited partnership, an oil or gas company may sell partnership units to investors and use the proceeds it raises to lease property and drill wells. In return for managing the project, the sponsor company generally takes an upfront fee that averages about 12-18% of a person’s investment (commonly referred to as tangible and intangible drilling costs) and also shares in a percentage of any revenue generated. In return, the promoter offers the investor the prospect of a substantial first year tax write-off and quarterly cash distributions from the sale of any oil and gas the partnership finds until the wells go dry.
Drilling partnerships have always been a wager, but recently, they have proven somewhat riskier than usual. This type of investment is very speculative, is a highly illiquid investment and can have a long holding period.
FRAUDULENT MARKETING TECHNIQUES
Fraudulent oil and gas deals are frequently structured with the limited partnership (or other legal business formation) in one state, the operation and physical presence of the field in a different state, and the offerings made to possible investors in states other than the initial two states. Thus there is less chance of an investor visiting a well site or a nonexistent company headquarters. Such a structure also makes it complicated for law enforcement officials in remote jurisdictions and victims to detect and expose the fraud.
While the majority of oil and gas investment opportunities offered may be legitimate, there have been many fraudulent ventures in recent years perpetrated by scam artists with no connection to a legitimate oil and gas company and with no track record of successful operations.
Even genuine oil and gas investments almost always bear a high degree of risk. Potential investors must realize the distinct possibility that they could lose the entire investment even in legitimate ventures.
RED FLAG WARNINGS
Sales pitches focused on highly publicized news. Scam artists read the headlines and will often use a highly publicized news item, like volatile gas prices, to lure potential investors and make their “opportunity” sound more legitimate.
“Can’t miss” wells. Every investment carries some degree of risk, so you should be skeptical of any oil and gas investment opportunity pitched as completely safe, with minimal risk.
Cold calls from someone you don’t know. Many fraudulent oil and gas offerings are conducted by unregistered persons who use general solicitation and high-pressure sales methods.
Unsolicited materials. Be especially careful if you receive unsolicited materials about an investment. Simply ignoring investment-related “junk” faxes, emails, voice-mail messages and regular mail may be your best strategy.
Limited opportunities. Scam artists often try to give you the impression that the “opportunity” they are promoting is scarce, hoping you will hand over your money hastily before doing any due diligence. This is an exclusive private deal open only to a special chosen few investors.
High rates of return. Compare promised yields with current returns on well-known stock indexes. Any investment opportunity that claims you’ll get substantially more could be highly risky
Tips or secrets. A promoter may discourage you from talking about the opportunity with someone you trust, like a loved one, attorney or financial professional.
The Salesman; has personally invested in the project.
The Promoter; has succeeded on every well drilled so far.
A Fantastic “discovery”; in an adjacent field or drilling property.
A large, well known oil company; is planning to operate in the area;
BOILER ROOMS & WEB/EMAIL PHISHING
In order to draw the interest of potential investors, unscrupulous promoters frequently use the Internet and “boiler room” offices with banks of phones staffed by salespeople with little to no experience in energy exploration, but plenty of background in high-pressure sales. Their methods include repeated unsolicited calls to possible investors, hyping the profitability of the bogus project. Some swindlers use glossy brochures and marketing materials. Also, beware of unsolicited oil and gas promotions on the internet and through “phishing” e-mails. State and Federal securities regulators caution potential investors to beware of the following claims in a typical high-pressure sales pitch, whether through unsolicited telephone calls or e-mail messages:
HOW TO AVOID BEING SCAMMED
Securities regulators counsel potential investors not to be afraid to ask the difficult questions when being solicited for any type of investments. People wanting to invest oil and gas are encouraged to consider oil exploration companies that are well known and listed on the Stock Exchange.
One can reduce the risk of being swindled if you resist pressures to make rushed, uninformed investment decisions. There are several steps you should seriously consider before parting with your hard earned money. Securities regulators have developed a checklist of five key areas to consider before investing.
1. The Registration Requirements. Ask if the offering is filed with the securities commission in your home state or the state where the promoters are located. If so, contact the state agency for any information it may have available. If the promoter indicates that the offering is exempt from registration requirements in a particular state in where offers and sales are made, inquire as to which of the exemptions is claimed and the terms of the exemption.
Contact the state securities agency to confirm that the offering is indeed exempt. If the promoter claims a security is not involved at all, find out why and contact the state securities agency and confirm whether it really is a security being offered.
2. The Salesperson. If it is a legitimate deal, the salesperson will not be reluctant to provide you answers questions or written explanations. Request the name of the salesman offering you the security, where he is calling from and his background, specifically in other oil or gas ventures. Ask what compensation the salesperson will receive.
Contact your state securities agency to inquire if the promoter or salesperson has been sanctioned for previous violations of securities laws.
3. The Company. Ask the names of the principals of the company or the general partners offering the security, their backgrounds and experience in the energy industry, and how long they have been associated with the company. Find out the history of the company, its capitalization, assets and retained earnings. What contingent liabilities does it have from other ventures? Does it have sufficient funds to cover unexpected costs? Is the tax treatment of the investments, as claimed by the promoters, supported by the IRS?
Find out the entity’s or general partners’ history in drilling operations. In particular, ask how long it has been in the oil and gas business, the number of wells drilled, the number of wells completed as producing wells, and whether the company retained its interests in the wells it drilled. Determine if conflicts of interest involving the promoter are disclosed. All the above information should be contained in a prospectus or “offering documents” that the promoter must furnish investors before they hand over their funds.
4. The Investment. Make sure funds raised are kept in a separate escrow account until used and that they won’t be commingled with other moneys. Also, be certain the money will not be used for purposes other than what they are designated. Ask how much money is to be raised and the cost per fractional interest. Ask how much of the money will pay for advertising, salaries, sales commissions and any estimated profit to the company. Ask what type of conveyance document will be provided after any investment is made.
Assuming the well is completed, ask what the completion costs will be for each investor, including bonus commissions to be paid (the purpose and amount), and whether investors may be obligated to pay in more money in the future. Ask what tax incentive might be available if a dry-hole is encountered and for intangible drilling costs. Finally, evaluate the risk involved in making the investment. Is the well to be drilled a wildcat (drilled in territory not known to be productive) or is the drilling to be done in an area of proven oil reserves?
5. The Lease. Secure a legal description of the property on which the project is to be drilled. How and when was it acquired? Is the principal selling the lease to the venture at the acquisition cost, and if not, how much profit is being made? Ask for a description of surrounding property, including local well completions and a geologist reports on the area. You will want to know if the lease is already in default and whether there is any overriding royalty or landowner’s royalty or other leasehold burden being paid.
Ask for a disclosure of the person(s) selling the lease, the cost of the lease and any relationship between the lessor and the operator. Secure a statement of the depth of the well to be drilled and an indication of when drilling is to begin. Insist on seeing a copy of the operator’s contract with the promoter.
FURTHER QUESTIONS TO ASK BEFORE INVESTING
The checklist of questions to ask and information one should obtain is long and it will take time and perhaps you may spend more money for outside consultation before you feel comfortable risking your money in the venture. It is always prudent to seek the advice of a neutral expert before committing funds to any investment deal. Be sure to consider the following additional questions:
- Who will be responsible for payment of taxes? Will they be paid out of the investor’s share?
- What is the location of available pipelines, or what method will be used to ship and sell any product?
- What is the name and address of the operator? What is her/his experience with ventures of this type? What are the terms of the agreement with the operator, including the compensation terms?
- How will the decision be made for completing the well or abandoning it? Who will make that decision? What is to become of funds received from the salvage value of equipment on the lease?
WHERE TO TURN FOR HELP
The securities administration in your state is responsible for informing and protection of investors. If you have questions about an investment, contact your securities commission. You can locate your securities commission by visiting;
It is always a good idea to contact your securities commission before you invest.
If you have been a victim of fraudulent scheme, anywhere in the world then it’s time to real justice and recover your losses.
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