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Stone Energy Review Triggers Board Resignation, New Inquiry by Philadelphia Stock Exchange

An independent review of the oil and natural gas reserves booking system used by Stone Energy Corp. has triggered the resignation of board member and former CEO D. Peter Canty and directed management to request the resignations of an unnamed officer and senior manager associated with the reserve estimation process.

Canty was elected CEO of Stone on Dec. 31, 2000, and remained in that role until his retirement in April 2004.

Stone initiated an independent review of its internal booking system after revising downward its proven reserves by 171 Bcfe in October. A month later, it announced it would restate some of its financial statements, and the Securities and Exchange Commission (SEC) launched an informal inquiry of the company (see NGI, Nov. 14). Last Monday, Stone announced it now is cooperating with a new inquiry from the Philadelphia Stock Exchange regarding trading activity prior to the Oct. 6 announcement. Class action lawsuits already have been or will be filed in connection with the reserve revisions, Stone noted.

Among other things, the independent review conducted by the law firm Davis Polk & Waddell found a lack of "adequate internal guidance or training" on the SEC standard for estimating proved reserves, and found top management's "tone" in estimating reserves had been "optimistic and aggressive." There was "evidence that some former members of Stone management failed to fully grasp the conservatism of the SEC's 'reasonable certainty' standard of booking reserves." Also, "some on the Stone technical staff felt pressure to interpret the geological and engineering data in an aggressive manner, and there were several factors that may have prevented or discouraged the technical staff from pushing back against the optimistic tone from the top and the pressure that some perceived with respect to reserve estimation." There also was "evidence of a reluctance to write down proved reserves."

Davis Polk recommended Stone adopt and distribute written guidelines to its staff on the SEC reserve reporting rules and train employees on the requirements. It also recommended Stone continue to emphasize the difference between SEC's standard of measuring proved reserves and the criteria Stone might use in making business decisions. The Lafayette, LA-based producer also has to "institute and cultivate a culture of compliance" to ensure the "contributing factors" don't reoccur. Stone's board, said Davis Polk, was advised to "review, understand and have confidence in the process of reserve estimation," and provide a "heightened obligation to exercise supervisory responsibilities."

Since the review was initiated, Stone has revised several internal processes, which Davis Polk acknowledged. Stone intends to expand the use and scope of reviews and evaluations by outside consulting firms, require approval by the CEO of bookings of more than 5 Bcfe, and mandate training. Stone also has reorganized its management responsibilities on how the reserve estimation process is supervised, and it has formed a reserves committee on its board. Stone said it would "implement all of the recommendations promptly."

In addition to implementing the Davis Polk recommendations, Stone plans to use outside consulting firms to independently evaluate 100% of its reserves, which is expected to be completed in 2006. Also, all of Stone's estimated proved reserves in the Rocky Mountains and about 50% of its Gulf Coast estimated proved reserves will be independently evaluated by outside consulting firms in connection with the preparation of the 2005 audited financial statements.

Outside consulting firms also will review the procedures used by Stone's internal staff in estimating proved reserves for those properties not independently evaluated. The remainder of the Gulf Coast reserves will be independently evaluated by outside consulting firms as soon as it is practicable in 2006, the producer said.

Based on its internal review, Stone plans to restate financial statements from 2001 to 2004 and for the first six months of 2005. Stone will amend its Form 10-K for the year ended Dec. 31, 2004 and its quarterly reports on Form 10-Q for the periods ended March 31, 2005 and June 30, 2005. Stone hopes to file the amended reports and the Form 10-Q for the period ended Sept. 30, 2005 by mid-December.

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