As I recently predicted, New York Attorney General Letitia James lost the case against ExxonMobil alleging fraud under New York’s Martin Act over the company’s reporting about the cost of carbon. The judge case made clear he wasn’t going to let politics infect his interpretation of the narrow claim at issue in the case when he wrote, “This is a securities fraud case, not a climate change case.”
The political gamesmanship that a small set of conflicted liberal shareholders have long played with shareholder votes to engage companies on climate change and other pet social issues is just now beginning to affect the securities fraud litigation world, but thankfully, this judge was having none of it.
It is further revealing that the Securities Exchange Commission dropped its investigation into this exact issue in 2018 after it found that no accounting fraud had taken place. It is also telling that the New York Attorney General dropped a number of her fraud claims at the eleventh hour because she knew those claims were on shaky ground.
Securities fraud and financial litigation is supposed to be about protecting investors from the risk of fraudsters stealing by overvaluing their investment. The federal securities laws and New York’s Martin Act exist to go after the Bernie Madoffs of the world. These laws are not there to provide the New York Attorney General with a megaphone to gain public attention as a leader in the fight for climate change regulation.
Thankfully, the court understood that in what was an embarrassing loss for the New York Attorney General. One of the claims made by James’s office was that ExxonMobil engaged in fraudulent reporting about estimates of climate change’s cost. That allegation shows such a lack of understanding of modern accounting practices for public companies that any other litigant might face judicial sanction and malpractice liability.
The judge found that while ExxonMobil did use different estimates for the cost of carbon internally and externally, those differing estimates were entirely consistent with widespread management practices — much like a global company making widgets might have different estimates for the cost to produce widgets in Canada versus the United States or Asia, taking into account the different manufacturing, labor, and regulatory costs in those regions.
ExxonMobil had different estimates of the cost of carbon for different projects. Apple’s internal cost estimates for iPhone production no doubt differ from the numbers it uses externally to report expenses because internal cost accounting incorporates overhead costs in a different manner than external GAAP accounting.
Furthermore, ExxonMobil provided appropriate risk warnings in the risk factor section of their financial statements that reminded investors of the difficulty of estimating a global price of carbon in any event, particularly multiple decades into the future as investors were asking the company to do.
A ruling in any other way would have muzzled the hundreds of scientists, geologists, and environmental experts at ExxonMobil and other companies around the world from engaging in scientific discussions about climate change. A less judicious ruling on this question would have changed the tenor of the discussion from one led by scientists to one in which every scientific document would need to be culled over by securities lawyers to ensure that the risk of potential liability is eliminated.
The result would be that company discussions about climate change would become as dull and boilerplate as legal notices in consumer contracts. That would not have enhanced investor understanding of the effect of climate change on companies.
The materiality standard used in federal securities cases has been adopted by New York and strengthened in this case. That standard can serve as a bulwark against abusive litigation by ensuring liability only for those items that are important to the reasonable investor. The materiality standard focuses on information having an impact on stock prices and financial information that represents a sizable change in important accounting estimates. The materiality standard does not consider the political projects of politicians and progressive shareholder groups to be material.
This case is a victory not only for ExxonMobil but for the rule of law and the protection of investors.
J.W. Verret (@JWVerret) is an associate professor at the George Mason University Antonin Scalia Law School.
