By Karen Savage
Next week, Exxon will face what could be the company’s biggest threat yet: a trial in New York Supreme Court to determine whether it defrauded investors by deliberately misleading them about the risks posed to its business by climate change.
New York Attorney General Leticia James alleges that Exxon violated the Martin Act, her state’s powerful anti-fraud statute. James alleges Exxon committed fraud, deceiving investors by using one set of numbers to calculate climate risk to shareholders while it used different numbers to privately plan how to invest the company’s own funds.
The suit, which was filed last year, is the culmination of a lengthy investigation of Exxon’s actions and communications about climate change that began under Eric Schneiderman. The suit was filed by Barbara Underwood, who was appointed when Schneiderman resigned in 2018, and is being prosecuted by James, who was elected AG last year.
If proven true, the fraud could cost the company dearly.
The AG’s office has asked the court to hold the company liable for between $476 million and $1.6 billion in shareholder losses, and that’s only a preliminary estimate. The suit also asks the court to order an examination of Exxon’s past and future accounting methods and to appoint an independent monitor to supervise the process. Exxon has also been forced to turn over years of internal documents, which could also be used by others to bring more civil suits.
James alleges “this fraud reached the highest levels of the company” to include former chief executive Rex Tillerson, who left the company in 2017 to become President Trump’s first Secretary of State, and current chief executive Darren Woods.
The Strictest Anti-Fraud Law in the Nation
Enacted in 1921, New York’s Martin Act is the strictest anti-fraud law in the nation. It gives the New York attorney general broad powers to investigate and prosecute securities fraud against publicly traded firms. Former AG Eliot Spitzer used the law to investigate some of New York’s biggest investment firms in the early 2000s, eventually fining them more than $1.4 billion.
“The Martin Act was essentially enacted to protect investors from unscrupulous brokers and dealers and those individuals who were selling securities of some sort with big promises and typically poor returns,” said former New York attorney general Dennis C. Vacco.
“What made the statute so broad was the pre-filing subpoena power of the attorney general’s office and that power exists to this date,” said Vacco, who said he initially was critical of Schneiderman’s use of the act to investigation Exxon, which Schneiderman frequently compared to suits against the tobacco industry. But, as the Exxon investigation ran its course, Vacco said it more closely aligned with cases typically pursued under the Martin Act.
Exxon is charged with civil violations, but the law allows for criminal charges to be filed against any business or person involved in fraudulent transactions within the state.
Although the AG’s office alleges Exxon’s deception was intentional, all that needs to be proven is that the deception took place.
“Unlike most statutes in the United States that require some mental intent, the Martin Act does not in any way shape or form require there be specific intent to engage in wrong-doing,” Vacco said. “Those two taken together, make the Martin Act a very powerful and broad tool.”
While other fraud statutes usually require the court to use a legal standard known as reasonable reliance—determining whether a prudent person would believe and act on the alleged deception—the Martin Act doesn’t require that determination.
“Reasonable reliance doesn’t apply here, specific intent doesn’t apply here, and you have the pre-filing ability to do unlimited discovery, but yet at the end of the day, the statute is grounded in fraud,” he said, adding that while the goal is to eliminate fraud, some say it goes too far.
“The targets of that fraud investigation aren’t afforded the same rights and prerogatives
that defendants in other fraud cases might otherwise be entitled to. So it gives very broad authority and investigative authority to the state attorney general,” he said.
Over the years, as the catastrophic effects of climate change became better understood, investors have grown concerned about how regulation and other climate policies might affect their investments. Increasingly, shareholders have pressed Exxon and other fossil fuel companies to divulge how they calculate those risks.
Like other companies, Exxon uses a proxy cost of carbon, or number to represent its best estimate, to determine what those costs could be in the future. In order to be useful, the proxy cost of carbon, or greenhouse gas (GHG) proxy, must be consistently applied and communicated to shareholders, something James’ office alleges Exxon failed to do.
The suit claims Exxon deceived investors by using one GHG proxy cost internally to make those projections, while it used a separate GHG proxy cost to communicate those projections to shareholders.
Exxon doesn’t deny the allegation that it used different numbers, but says it used a proxy cost of carbon assumption to determine future energy demand and a separate greenhouse gas cost to evaluate investments.
“ExxonMobil did not mislead investors into believing that the proxy cost of carbon and GHG costs were set at the same levels. None of ExxonMobil’s disclosures said that, and none of its disclosures suggested as much,” Exxon wrote in its pre-trial memorandum, adding that investors should have been able to determine that from its disclosures.
The attorney general contends that Exxon used deceptive language, leaving the public with no way to know proxy costs were not being applied evenly across its many reports.
“ExxonMobil’s public representations interchangeably used a number of terms to describe the costs it applied, including ‘proxy cost,’ ‘GHG cost,’ ‘cost of carbon,’ ‘price of carbon,’ and ‘GHG proxy cost,’” the AG’s office wrote in its pre-trial memorandum.
Shareholders had pressed the company for more information in 2014 and Exxon responded by issuing two reports—titled Energy and Carbon-Managing the Risks and Energy and Climate. Both were reviewed and approved by top management, including Tillerson.
Both contained additional disclosures that the AG says were later determined to be fraudulent.
The AG’s office maintains that the reports led investors, who were initially pleased with the disclosures, to withdraw requests for enhanced reporting after Exxon also promised to provide further disclosures in the future. The AG claims the company also “falsely represented that it was applying a GHG proxy cost approaching $80 per ton to its investment decisions.”
The discrepancy was intended to purposefully paint a rosy picture of Exxon’s financial future for investors, the AG claims. It points to an internal Exxon guide directing employees to apply a GHG proxy of less than $40 per ton—and in some circumstances to apply none at all.
“For many years, ExxonMobil’s undisclosed internal guidance directed its employees to apply a far lower cost of carbon than the company purported to use. When ExxonMobil employees later tried to use the publicly disclosed figures, the company realized that doing so would lead to ‘large write-downs’ and ‘massive GHG costs’ and therefore instructed its employees not to apply those costs,” the AG’s office wrote.
“Sophisticated investors considered ExxonMobil’s climate-related risk to be low because ExxonMobil purportedly applied a GHG proxy cost, which seemed to signify that it was already accounting for future climate change regulations,” wrote the AG. “Investors reasonably assumed, based on the company’s misrepresentations, that ExxonMobil was applying an escalating GHG proxy cost approaching $80 per ton to assess the costs the company would face from its projected GHG emissions. They were deceived.”
The AG’s office says when its investigation uncovered the deception, Exxon’s stock price fell, “injuring investors who must now be made whole.”
What to Expect
New York Supreme Court Judge Barry Ostrager has set aside three weeks for the trial. He’s expected to hear from nearly three dozen witnesses, including Exxon employees and securities experts and will also review dozens of depositions and examine hundreds of documents.
Ostrager, who was appointed in 2017 by Gov. Andrew Cuomo and is assigned to the Commercial Division, has said he intends to render a decision no more than 30 days after the trial wraps up.