The Dodd-Frank Act is more commonly described as “that Wall Street reform law Congress passed last year”—but compliance officers know the law also imposes a slew of new rules on all public companies, and re-grades the regulatory landscape for several industries well beyond banking.

THE PANELISTS

The following executives participated in the Feb. 16 roundtable regarding compliance and risk in the energy sector.

John England,

Partner, Oil & Gas Practice,

Deloitte

Howard Friedman,

Senior Manager,

Deloitte

Morgan Frontczak,

Senior Counsel, Ethics & Compliance Group,

Weatherford

William Hederman,

ERS Director,

Deloitte

Keith Hennessee,

Chief Compliance Officer,

National Oilwell

David Louw,

Head of Compliance,

Macquarie Energy

Brian Moffatt,

Chief Compliance Officer,

Pride International

Deanna Reitman,

Director, Commercial Trading & Compliance,

Chevron

Keith Sappenfield,

Director, U.S. Regulatory Affairs, Midstream, Marketing and Fundamentals,

EnCana Oil and Gas

Donna Stephan,

Compliance Officer,

Shell Trading North America

Terry Stringer,

Director, Ethics & Compliance,

El Paso Corp.

Daniel Trujillo,

Deputy General Counsel, Director of Compliance,

Schlumberger

John Wooldridge,

Senior Counsel, Audits & Investigations, Legal Compliance Group,

Baker Hughes

Charlie Wright,

VP, Internal Audit,

Devon Energy 

For More Information on Compliance Week Roundtables

One primary victim: the energy sector.

Because so many oil and gas companies engage in extensive hedging transactions (to offset potentially wild swings in energy prices, as we're all seeing at the gas pump right now), the energy sector now finds itself dragged along in the Dodd-Frank Act's march to regulate derivatives trading. What's more, energy companies have a long, storied past of problems with the Foreign Corrupt Practices Act, which leaves them all the more exposed to other governance changes included in Dodd-Frank to stamp out such bad habits.

At an editorial roundtable hosted by Compliance Week and Deloitte in Houston last month to talk about the challenges of implementing Dodd-Frank, compliance officers from 11 major oil and gas companies admitted that they were, well, still in the dark about how the law might affect their business. The Securities and Exchange Commission is still wrapping up major provisions of Dodd-Frank such as expanded whistleblower protections; the Commodities Futures Trading Commission is sending ominous signals about how strict it may be in deciding which companies deserve an “end-user exception” from onerous new rules for disclosing derivatives trading.

Not surprisingly, each compliance officer's primary worry depending on the business of his or her company. Most “upstream” companies (the ones doing the drilling) were more concerned about new whistleblower rewards tempting employees to ignore internal compliance hotlines in favor of running to the SEC with reports of corruption. Their “downstream” counterparts (that primarily sell and deliver energy) fretted more about the CFTC's looming disclosure rules for derivatives trading.

Fears about the SEC's new whistleblower program are widespread. Participants in the roundtable, however, said the energy industry is particularly susceptible to workers running to regulators because the potential payouts for FCPA settlements are huge—and under the Dodd-Frank Act, a whistleblower could collect as much as 30 percent of that sum.

“I think the energy industry could be a principal target for whistleblowers, simply because the FCPA settlements in the oil industry dwarf the FCPA penalties against anybody else,” said Keith Hennessee, chief compliance officer of National Oilwell Varco, which provides equipment used in drilling for oil and gas.

Despite growing concerns about the new whistleblower program, several roundtable participants said they don't believe employees fully understand what the provision offers. Most still said the prudent approach is to assume the worst anyway. “My approach is that they're well aware of the law,” one executive said.

That heightened exposure to regulatory risk is driving some innovative approaches to keep employees using in-house corruption hotlines. One roundtable participant said his company is adjusting its approach to internal investigations, crafting questions more carefully so employees won't deduce what the investigation might be about. Another said his company is considering whether to offer a bounty program of its own, paying employees to bring allegations to the company first.

On the Trading Desk

Downstream energy companies had a whole other realm of compliance headache to address: the CFTC's push to regulate derivatives trading. Under Dodd-Frank, large swaths of the derivatives industry will now need to be cleared through regulated clearinghouses or trading facilities, so unchecked risk won't build up in the financial system and spark a repeat of the 2008 financial crisis.

Yes, energy companies will be exempt from that regulation, which is primarily intended for the banking industry—but only if a trade falls within whatever end-user exemption the CFTC ends up crafting. Without that exemption, energy companies must abide by additional margin requirements (as opposed to trading with counterparties or brokers on credit), effectively forcing them to raise more capital or to forego a hedging transaction entirely.

“Energy wasn't the point of the legislation. This is all collateral damage and unintended consequences,” Bill Hederman, a director in Deloitte's energy regulatory compliance practice, said during the roundtable.

“These kind of operational issues are ones that are going to take some real time and effort and planning and, frankly, some real dollars to fix.”

—John England,

Partner, Oil & Gas Practice,

Deloitte

The question for the CFTC, Hederman explained, is whether to allow energy companies to continue hedging as usual, or whether the risks in financial derivatives are so great that energy companies are going to be stuck with the additional costs. “I think that's very much up in the air,” he said. “We probably won't know that until July.”

While compliance officers await that clarity, they must also convince the rest of their companies that change is coming and senior leaders should prepare. “Our mindset is that we are not about to create work for ourselves,” one executive admitted. Because the company has not encountered serious trouble before, management's thinking tends to be, “They can't really mean us, so stop telling me about it, because you're really starting to sound like an alarmist.”

Hederman sympathized. “It's hard to operationalize a moving target,” he said, “and that's kind of where we're at.”

The CFTC is also expected to require energy firms to begin reporting their financial transacting activities to both regulators and exchanges. Each swap, for instance, must be reported to a registered swap data depository and must include a description of the swap, volume, and price.

National Oilwell Chief Compliance Officer Keith Hennessee, Terry Stringer, director of ethics and compliance at El Paso, and Schlumberger Compliance Director Daniel Trujillo listen in on the discussion.

The panelists heard from Donna Stephan, chief compliance officer at Shell Oil. Howard Friedman, senior manager with Deloitte, is at right.

Many roundtable participants, however, said their companies don't have the ability to deliver the daily trading records the CFTC may soon require. Even if they did, the proposed “near real-time” reporting (no more than 15 minutes after the swap is executed) isn't nearly long enough to validate the thousands of transactions oil and gas companies make every day. “Knowing your position real-time every day, the value of it—options, for instance—is an issue,” said Donna Stephan, compliance officer of Shell Trading.

Deloitte's energy team said that may be the biggest challenge of all for energy companies: retooling their IT systems to capture those trades, and training employees to report the necessary data (after careers spent doing deals by phone, instant message, or scribbles on paper) in a timely fashion in the first place.

“These kind of operational issues are ones that are going to take some real time and effort and planning and, frankly, some real dollars to fix,” said John England, a partner at Deloitte and leader of the oil and gas practice. “It's just a whole different level of scrutiny, processes, and control that you have to have. The reporting requirements are such that I think it's going to require some changes in technology around the reporting elements of trading.”

Hederman agreed. “It will probably be a major change to many of their reporting and data gathering systems,” he said.

Strategic Implications

Another looming issue is whether the CFTC's trading regulations will fundamentally alter how energy companies hedge overall. In the words of Terry Stringer, director of ethics and compliance at El Paso Corp.: “Are we going to be able to hedge our risks in a way that we've been doing it today, or will we have to alter our future business plans due to cash constraints?”

The fear is that CFTC regulations might lead financial firms to standardize the type or size of hedging they do, while most energy traders have specific hedging needs. That could leave energy companies without their usual counter-parties for a hedge, and they would be stuck dealing with new counter-parties or not hedging at all.

Joining the conversation is Deanna Reitman, director, commercial trading & compliance, at Chevron. At right is John Wooldridge, senior counsel, audits & investigations, Baker Hughes.

England said the requirements might send some hedging activities overseas, since many players want to avoid a highly regulated market. “I think there's something real there,” he said. Energy companies might also buy more physical products to hedge pricing swing, rather than financial instruments.

As always, roundtable participants also worried that they won't have enough staffers with the expertise to manage the coming change. “The concern is that we now need somebody who is able to interpret the rules, operationalize them fairly quickly, and put the monitoring in place that's going to be required,” Stringer said. That person would also work with all of the various departments, “which means they would have to have a broad understanding of operations throughout the company,” she added.

El Paso isn't alone in its concerns. Stephan said Shell has devised its own training program, after a year of largely fruitless searches for talent. Charlie Wright, vice president of internal audit at Devon Energy, said the energy sector now faces a “double whammy” of new regulation and too few people to manage it.

Energy companies “are working hard to stay in compliance,” Hederman said, “but the uncertainty and the pace of change are making it critical that they stay informed and involved—because if they wait until these things settle down, it will be too late for them to respond in a timely way.”