Industry NewsfeedCourtesy of Stikeman Elliott. View original article here.
In a December 2019 ruling, the New York Supreme Court dismissed an important action by the state’s Attorney General alleging that, between 2013 and 2016, Exxon Mobil Corporation had made material misrepresentations to the effect that it had fully considered the risks of climate change regulation. This ruling may have implications for future attempts to use secondary market civil liability or securities law claims in actions related to climate change against oil and gas industry participants.
Executive Summary
What you need to know about the ruling:
- The New York Attorney General (“NYAG”) originally cited four causes of action, including:
- Breach of Martin Act[1] prohibition against the use of any “deception, misrepresentation, concealment, suppression” in connection with the “issuance, exchange, purchase, sale, promotion” of securities (the “Martin Cause”);
- Breach of Executive Law § 63(12)[2] prohibiting “repeated fraudulent or illegal acts” in the “carrying on, conducting or transaction of business” (the “Executive Cause”);
- Equitable fraud; and
- Common law fraud.
- The NYAG ultimately withdrew its actions for equitable and common law fraud following the completion of Exxon Mobil’s closing submissions and at the commencement of the NYAG’s closing.
- The NYAG alleged a longstanding scheme to defraud investors that was sanctioned at the highest levels of Exxon Mobil by misleading investors that it had fully considered the risks of climate change regulation and factored those into its business operations when Exxon Mobil allegedly knew that its representations were unsupported by fact.
- The Court found that Exxon Mobil’s disclosures were neither misleading nor material to investors and by implication that the NYAG’s accusations of a longstanding fraudulent scheme were also unsubstantiated.
On December 10, 2019, following “three and one-half years of investigation and pre-trial discovery”, the production of “millions of pages of documents and dozens of witnesses”, and a trial that made public “reams of proprietary information”, New York Supreme Court Justice Ostrager closed what might turn out to be the final chapter in the NYAG’s pursuit of Exxon Mobil.[3]
The Complaint
In the Complaint filed on October 24, 2018, the NYAG alleged Exxon Mobil had engaged in a “longstanding fraudulent scheme … to deceive investors and the investment community” through public disclosure of “materially false and misleading [representations]” concerning Exxon Mobil’s consideration and disclosure of the risks and projected costs posed by future climate change regulations.[4] The crux of the allegations asserted that Exxon Mobil fraudulently misled investors by implying, in various voluntary publications and investor presentations, that it used a public-facing “proxy cost of carbon”[5] in assessing future demand for fossil fuels and making all of its investment decisions while at the same time using a different and inconsistent set of internal-facing valuations, “GHG costs”, in making internal investment decisions. Simply put, Exxon Mobil purportedly downplayed its knowledge of the heightened long-term GHG regulatory risks to shareholders of the company.
Causes of action
Notwithstanding the accusation of a longstanding fraudulent scheme, the NYAG opted to rely exclusively on the two asserted causes of action that do not require proof of scienter (knowledge) and reliance; specifically that Exxon Mobil had made materially false and material disclosures to the public in violation of (i) the Martin Act and (ii) Executive Law § 63(12). The Court noted that in order to succeed under the Martin Cause, the NYAG must prove a misrepresentation of material facts or an omission of material facts such that there is
“a substantial likelihood that the [misrepresentation or the] disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available”.[6]
The standard of materiality, in other words, is that:
“[a] statement or omission is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to act.”[7]
While an assessment of the Executive Cause turns on “repeated fraudulent or illegal acts”, the definitions of fraud under the two pieces of legislation are virtually identical. As a consequence, the Court’s analysis of the Martin Act breach issue ultimately served as the stepping stone to its assessment of possible Executive Law § 63(12) violations.
The Court’s Analysis
Exxon Mobil’s public disclosure: not misleading
In addressing whether Exxon Mobil’s public disclosures were misleading, Justice Ostrager considered the language used in characterizing proxy costs and GHG costs as distinct metrics, the contextual differences for which these metrics were applied, and whether inconsistent application of metrics in internal financial models would mislead a reasonable investor in consideration of the “total mix” of publicly available information.
Based on witness testimony, the Court accepted that the proxy cost of carbon was an assumption used by Exxon Mobil in assessing future trends in energy supply and demand – the proxy cost attempted to reflect and capture all possible regulations and climate-policies that may be enacted which may impact energy demand. On the other hand, GHG costs were a separate metric intended to capture a subset of climate regulatory costs that might relate to future potential projects in specific jurisdictions. Understandably, the Court noted that it would be
“manifestly inappropriate for [the] Court to rule either that ExxonMobil’s default GHG assumptions for future projects … should have been applied uniformly, or that they should have had the same values assigned to the proxy cost of carbon which were used for an entirely different purpose and which were not disclosed with any specificity, other than to indicate variation by time in the distant future and by region”.[8]
While the Court systematically dismantled each alleged instance of misstatement or omission, it was critical to the Court that the distinction between the two metrics and the utilization of GHG costs, amongst other factors, in undisclosed proprietary valuation models were made clear in the subject public disclosure.
Alleged misrepresentations by Exxon Mobil: not material
Although the finding that the alleged misstatements or omissions by Exxon Mobil failed to meet the required materiality threshold was largely predicated on the absence of credible expert witnesses or any testimony to the contrary, the Court took the opportunity to restate key materiality assessment factors in the specific context of climate change-related risk disclosure.
An alleged misstatement is material to a reasonable investor only if it is “sufficiently specific” to “guarantee some concrete fact or outcome”[9]. In this case, Exxon Mobil investors were not privy to how the company internally determined when it would apply variable GHG costs regarding specific projects or investment opportunities. Furthermore, not only does the company not publish proprietary valuations of GHG costs, it explicitly highlights that the GHG cost metric was disclosed on a conceptual level to alert investors as to a more refined calculation of carbon cost. The Court noted that tentative and generic statements that emphasize the complex, evolving regulatory environment faced by a corporation, like proxy costs, cannot be material,[10] and then concluded, succinctly, that
“no reasonable investor … would make investment decisions based on speculative assumptions of costs that may be incurred 20+ or 30+ years in the future with respect to unidentified future projects”.[11]
Climate Change Liability Considerations in Canada: What Now?
The Court’s decision in favour of Exxon Mobil was unsurprising. Furthermore, the strong criticisms that Justice Ostrager levelled at the NYAG’s tactics, evidence and witnesses will inform any future efforts to sanction oil and gas companies for their contributions to climate change through securities fraud provisions. Nevertheless, given the many initiatives to secure financial and other reparations from oil and gas companies, it would be reasonable to assume that attorneys general and private litigants alike will continue to seek out mechanisms to hold such companies to account.
Continued claims against oil and gas companies
Exxon Mobil itself remains the subject of a similar case in Massachusetts and claims against oil and gas companies generally by city, state and provincial governments under existing legislation and common law are on the rise. In this regard, many Canadians will have heard of the letter writing campaigns of a significant number of Canadian municipalities seeking compensation for the impacts of climate change, as well as the City of Victoria’s support for a class action lawsuit seeking to have oil and gas companies pay a portion of the costs associated with climate change. In the end, these claims raise the age-old legal and philosophical question of causality and fair contribution among those who may have contributed to costs, in this instance as among oil and gas companies, societies at large, or subsets thereof.
Growing attention from securities regulators
Outside the courtroom, these pressures have and will continue to manifest themselves in the securities regulatory arena through guidance and policy for issuers in respect of the disclosure of climate change related risks and the management of them. Central to the disclosure model is the assessment by management of the materiality of the full spectrum of risks associated with climate change, which necessitates thoughtful deliberation based on the circumstances of a particular issuer, the uncertainties associated with longer term forecasting and the potential for adaptation. In addition, and where practicable, issuers would be expected to quantify and disclose the potential financial and other operational impacts arising as a result of the manifestation of such risks.
It is in this regard, however, that the risk of civil litigation in relation to climate change also arises, as such risk disclosures are typically found in an issuer’s annual information form (AIF) and management’s discussion and analysis (MD&A) and the securities legislation in many Canadian jurisdictions provides for statutory civil liability for misrepresentations found in such documents. To the extent issuers undertake incremental voluntary disclosures in the climate change arena, as Exxon Mobil did in this case, the potential also exists for civil liability in relation to such disclosures. As a result, issuers need to be deliberate and thorough in their assessment of materiality in respect of climate change risks and the potential impacts thereof, both qualitatively and quantitatively where appropriate, and provide sufficient disclosure to ensure that all such documents do not contain a misrepresentation.
Conclusion
The Supreme Court of New York’s dismissal of the NYAG’s claims against Exxon Mobil should give comfort to issuers who are rigorous and thoughtful in their consideration of climate change, the regulatory and other implications thereof and their public disclosure. It is also a reminder that a cavalier approach to the consideration and disclosure of material climate change risks may come with a heavy price.
[1] New York General Business Law Article 23-A (“Fraudulent Practices In Respect to Stocks, Bonds and Other Securities”, known as the “Martin Act”).
[2] Executive Law, Consolidated Laws of New York, ss. 63(12).
[3] People of the State of New York v. Exxon Mobil Corporation, NYSCEF Doc. No. 567, page 1.
[4] NYSCEF Doc. No. 1, Complaint 1.
[5] A proxy cost of carbon is a stand-in metric used in economic modelling to account for and reflect potential policies governments may employ related to exploration, development, production, transportation or use of carbon-based fuels, such as carbon emission standards and renewable portfolio standards.
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