The D & O Diary : Directors and Officers Liability and Insurance : The D & O Diary : Kevin LaCroix : Securities Laws, Corporate Fraud, D & O Litigation

On February 2, 2010, the SEC published its interpretive release providing guidance to public companies on the SEC’s existing disclosure requirements as they apply to climate change. The release can be found here. A February 4, 2010 memo from the Gibson Dunn law firm analyzing the SEC’s release can be found here.

While the interpretive release take pains to emphasize that it only clarifies existing obligations, the release nevertheless represents the Commission’s clearest statement about expectations for public company’s climate change disclosures. The release’s specificity and its reliance on requirements that have themselves previously been cited in suits pertaining to more traditional environmental disclosures raise the question whether suits pertaining to climate change-related disclosure may be next.

The release cites several existing disclosure rules that it says required public companies to provide disclosures regarding climate change, including Items 101, 103 and 303 (among others) in Regulation S-K.

The release also identifies four topics that could require climate change-related disclosures, including: the impact of climate change legislation and regulation; the impact of international climate change accords; indirect consequences of climate change regulation or business trends; and the physical impacts of climate change.

Public companies will now have to accommodate their disclosure practices to the SEC’s guidance. While the SEC claimed only to be clarifying existing requirements, the practical reality is that many companies will now have to reconsider their disclosure process and practices, and, in many cases, alter the content of their disclosures.

With the SEC’s clarification of the disclosure requirements comes the opportunity for claimants or even for the SEC itself to later allege that a company’s climate change disclosures fell short of requirements. By way of illustration of how these claims might arise, it is worth considering that the very disclosure provisions with respect to which the SEC provided its climate change guidance have previously served as reference points in claims alleging misrepresentations or omissions of more traditional environmental liabilities and exposures.

For example, as I noted in a prior post (here), the SEC has in the recent past brought disclosure-related enforcement actions against reporting companies for alleged failures to observe existing environmental reporting requirements.

Nor are these types of claims limited solely to regulatory enforcement actions; investors have also brought damages actions relating to alleged misrepresentations or omissions regarding environmental issues. For example, as I noted in a recent post here, shareholders of Tronox Corporations recently filed a securities class action lawsuit against the company and certain of its directors and offices, as well as the company’s corporate predecessors in interest, based upon the company’s alleged failure to disclose the true nature of its environmental and tort liabilities.

There may be a temptation to view climate change related considerations as remote and distant future concerns, but as I noted in a recent post here, climate change related issues are already a practical component of current business conduct, for example, in the M&A context.

Just as disclosure obligations regarding traditional environmental concerns have given rise to disclosure-related enforcement actions and even shareholder litigation, the newly clarified expectations regarding climate change disclosures seem likely to create a context out of which similar actions may arise in the future.

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With the United Nations Climate Change Conference set to begin December 7, 2009 in Copenhagen, activists and observers are dialing up the volume both with calls for reform and with updated reports of the projected risks that global warming threatens. Among the long-standing initiatives advocates are now seeking to advance is the petition before the SEC calling for the adoption of climate change disclosure requirements.

These renewed calls for disclosure reform, as well as the release of additional data regarding insurance industry exposure to climate change, are clearly intended to coincide with the upcoming UN conference. One question, however, is how much recent email revelations of climate change researchers’ practices will affect the current dialog.

First, with respect to climate change disclosures, on November 23, 2009, a coalition of twenty public pension funds, public officials and environmental groups filed a "Supplemental Petition on Interpretive Guidance" (here) renewing their call for the SEC to "act promptly to clarify that existing disclosure requirements apply to climate change." Background regarding the group’s initial September 2007 petition can be found here.

As described in their November 23, 2009 press release (here), the group has renewed its call for climate change disclosure reform because of the "spate of recent regulatory, legislative and scientific developments – including the Environmental Protection Agency’s new mandatory greenhouse gas reporting rule – and the new economic opportunities that dramatically change the landscape of corporate climate change disclosure."

In a separate development, a November 23, 2009 report issued jointly by Allianz and the World Wildlife Fund entitled "Major Tipping Point in the Earth’s Climate System and Consequences for the Insurance Sector" (here) asserts that rising sea levels due to global warming could put trillion of dollars of U.S. assets at risk. Among other things, the report states that the planet’s atmosphere is close to dangerous atmospheric thresholds or "tipping points" that could cause dire environmental and economic consequences. The World Wildlife Fund’s November 23, 2009 press release regarding the report can be found here.

In addition to rising sea levels, the report also cites three additional "tipping points" that likely to have an impact: an increasingly arid climate in California; disturbances in the summer monsoon in India and Nepal; and reduction to the Amazon rainforest due to drought.

At the same time, the upcoming Copenhagen conference is clearly creating pressure for governmental action, as suggested by the announcements last week that both Chinese and U.S. officials will arrive at the conference with various country-level carbon emissions goals (as discussed here).

This same pressure could increase the likelihood of implementation of reforms such as the proposed climate change disclosure requirements, as these types of initiatives afford governmental officials the opportunity to show they are taking actions without at the same time requiring theme to address proposals that could directly affect economic activity or that could prove politically more controversial.

However, one wild card that has been played in the midst of all of these developments is the recent revelation of email communications amongst climate change researchers. These emails have been portrayed as suggesting that the researchers manipulated data to support their findings of climate change and that they suppressed contrary points of view. The question arises of how much these disclosures will undermine the perception of trustworthiness of the scientific conclusions on which so much of the current dialog is premised.

One example of the way in which the email revelations can affect perceptions is the joint Allianz/WWF report described above. Two of the three individual authors of the report are affiliated with the Tyndall Centre for Climate Change at the University of East Anglia, which is the institution form which the hacked emails were obtained. While the report’s authors’ affiliations would hardly have occasioned comment previously, now these institutional associations will inevitably raise the question whether the report and its conclusions reflect trustworthy and objective scientific analysis, or something else.

Climate change skeptics and reform opponents are already attempting to seize on the email disclosures to try to suggest that, due to the damage to the perception of trustworthiness of the climate change science, reform initiatives are doomed.

There is no doubt that the email disclosures have affected the dialog. At the same time, events such as the upcoming Copenhagen conference carry their own inertial dynamic. President Obama’s commitment to address the conference certainly will reinforce this dynamic. In this context, reform initiatives, such as the proposed climate change disclosure application, could acquire a certain inevitability. That is certainly the hope of the initiative’s proponents.

The prospect for increased climate change-related disclosure requirements, and the continuing agitation of climate change activists, will put increased pressure on public companies to address climate change issues in their public filings. As I recently noted (here), investor interest in climate change-related disclosures, along with the effects of voluntary initiatives (such as the NAIC’s climate change disclosure project, about which refer here), may separately create their own independent pressures for corporate climate change disclosures.

As these disclosure expectations become more generalized, the possibility of investor litigation relating to climate change disclosure also increases. As I recently noted (here), litigation developments in other areas of the law have moved the possibility of climate change-related disclosure litigation one step closer.

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While I have long predicted (refer here) the possibility of litigation against directors and officers of public companies concerning global climate change-related disclosures, to date the lawsuits have not materialized. Which is not to say that there have not been relevant developments – to the contrary, there have been many, as discussed below. There just haven’t been any disclosure lawsuits.

However, recent case law developments in the Second and Fifth Circuits, though relating to an entirely different area of the law, suggest that there may be a new environment for climate change-related lawsuits, as a result of which climate change disclosure lawsuits have moved one step closer.

The Recent Decisions

As summarized in an October 29, 2009 memorandum entitled “Judicial Climate for ‘Global Warming’ Claims Getting Worse?” (here) by Theodore Howard and Jeremiah Galus of the Wiley Rein law firm, the two recent case law developments are the Second Circuit’s September 21, 2009 decision in Connecticut v. American Electric Power Co. (here) and the Fifth Circuit’s October 16, 2009 decision in Comer v. Murphy Oil USA (here).

In each of these cases, a variety of claimants asserted claims based on nuisance and other tort theories against a variety of utilities and energy related companies, claiming that the defendants’ carbon emissions had caused (or increased) the plaintiffs’ claimed harm. The claimants in the Comer case are victims of Hurricane Katrina, who basically claim the defendants’ activities exacerbated the hurricane damage. In each case, the district court held the plaintiffs’ claims could not surmount initial justiciability and standing hurdles.

However, in both cases, the appellate courts determined that the plaintiffs did have standing to assert their claims and held that their claims do not present non-justiciable political questions.

As the law firm memo notes, these rulings “may have removed significant hurdles from the paths of plaintiffs seeking to hold corporate emitters of greenhouse gases liable for harms allegedly caused by global warming.” But though the decisions “may signal a shift in the way courts view tort-based global warming claims,” it is “still too early to project the decisions’ significance.”

Among other considerations the memo notes as suggesting that the decisions’ significance ultimately may be reduced is the fact that at least one district court case already has expressly declined to follow the Second Circuit’s analysis in the American Electric Power case. The memo also notes that the “plaintiffs undoubtedly still face the potentially insurmountable task of proving how and to what extent a particular corporation’s contribution to global warming proximately caused a particular plaintiffs’ injuries.”

For these reasons, the memo notes, it “remains to be seen” whether the cases “pose a serious risk of liability exposure for corporate defendants,” but the corporations – and their insurers – “should be paying close attention to further developments in these cases.”

Discussion

On at least one level – and arguably on all levels – these developments have little to do with the possibility of claims against corporate directors and officers for climate change-related disclosures. These lawsuits raise claims only on tort and nuisance theories. Moreover, it does, as the law firm memo notes “remain to be seen” whether these cases will result in any liability even on those claims.

Nevertheless, I believe these cases represent potentially significant developments with respect to the possibility of climate change disclosure litigation. First, as the memo notes, these cases “may signal a shift in the way in which the federal courts view tort-related global warming claims.” The extent to which judicial perspectives have been changed and to which hurdles have been removed may not be limited just to the context of tort-related cases.

The context within which all climate change related cases are considered may have changed, particularly to the extent these courts “newfound willingness” to consider these cases is, as the memo suggests, “derived from a perceived failure on the part of the legislative and executive branches to address the issue.” If prospective plaintiffs believe that climate change-related claims may be more likely to receive a receptive hearing, they may be encouraged to bring further claims, whether based on tort or based on other theories.

Some readers may regard my generalization of these tort case developments to the world of D&O claims as analytically unwarranted, and they may be right. However, I think this recent case decisions are most properly viewed as the just the latest in a series of developments that have brought the climate change debate ever closer to the courts.

The first development in this chain was the U.S. Supreme Court’s 2007 decision in Massachusetts v. EPA (about which refer here). The chain continued with New York AG Andrew Cuomo’s climate change disclosure subpoenas to several utilities, which resulted in several of the utilities agreeing to certain disclosure principles (refer here). There have been several other extensions of the chain, including the National Association of Insurance Commissioners’ promulgation of climate change disclosure principles for insurance companies, as well as the EPA’s April 2009 endangerment finding (about which refer here). Similarly, there have been a variety of Congressional and other initiatives toward mandating climate change related disclosures (refer here).

These appellate decisions are just the latest event in this continuing chain of developments. In addition,  there are other reasons why I think we can expect to see disclosure related litigation. Among other things, the pattern for the kind of disclosure related case that may yet arise is already established. As I noted in a recent post (here), there is already a pattern for disclosure-related cases based on alleged misrepresentations or omissions related to environmental liabilities and contingent litigation exposures.

Moreover, there is an extensive network of activists who are politically motivated to bring these kinds of claims. Andrew Cuomo was attempting to appeal directly to this network when he filed the disclosure-related subpoenas against the utilities, and there are countless others whose political agenda would be served by similar initiative, including litigation. As the chain of developments outlined above continues to lengthen, these motivated actors, who already have demonstrated their willingness to pursue litigation to advance their goals, may well target concerned players concerning their climate change-related disclosure.

I know from prior communications with readers that there is some significant skepticism about the prospect for climate change-related disclosure litigation any time soon. These skeptics could well be right, since there that kind of litigation is unlikely to arise in the absence of a significant share price decline from a company’s disclosure of some climate change or greenhouse gas emission related issue. But I still think the possibility of these kinds of claims arising is merely a question of when, not if. (Some people I am sure assume I am afflicted with some unbreakable curse that compels me to make these predictions at least once every quarter.)

A Couple of Securities Class Action Settlement Notes: The long-running securities class action lawsuit involving Adams Golf and certain of its directors and officers has finally settled. The case, which was went all the way through discovery and which suffered from delays owing to judicial vacancies,  was first filed in June 1999 and related to the company's July 1998 IPO. More details about the case can be found here.

According to the company's November 3, 2009 press release (here), the settlement provides for a payment to the plaintiff class of $16.5 million, of which Adams Golf itself has agreed to contribute $5 million.

Readers of this blog may be interested in the statement in the press release that Adams was "forced" to contribute the $5 million "because one of its former insurers refused to contribute to teh settlement based on the alleged late notice of the claim." The press release states that Adams has commenced coverage litigation against the former insurer and against its former insurance broker. The settlement requires Adams to pay the class action plaintiffs the first $1.25 million of any recovery, net of fees and expenses, that Adams recovers in the ongoing litigation with the former insurer and former broker. Further details about the settlement and the coverage litigation can be found on Adams Golf's November 3, 2009 filing on Form 8-K (here).

In a separate development, in a November 3, 2009 press release (here), Quest Software announced that it has settled the options backdating related  securities class action lawsuit that had been filed against the company and certain of its directors and officers. The case settled for $29.4 million. Background regarding the case can be found here. I have added the Quest Software settlement to my running tally of options backdating related settlements, which can be found here.

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for providing the information about the Quest settlement.

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 On June 26, 2009, when the U.S. House of Representatives passed the American Clean Energy and Security Act of 2009, it set the stage for changes that could have a direct effect on corporate financial results. The Act has now moved to the Senate, where it could face significant hurdles. But strong White House support for the initiative and pressures from looming regulatory changes suggest that some form of climate related requirements will ultimately be enacted, with significant implications for companies’ carbon-related risk disclosures.

As reflected in a July 8, 2009 CFO.com article entitled "Clearing the Air on Carbon Disclosures" (here), the cap and trade system currently under Congressional consideration "contains the makings of a new asset class for affected companies" in the form of carbon emissions allowances. The likely corporate trading in these allowances could have a material effect on reported financial results – the CFO.com article cites analyses suggesting that carbon costs "could depress earnings before interest, taxes, depreciation and amortization by 5.5% for the S&P 500."

These potential financial impacts will, as the article comments, "likely cause investors to demand more information about carbon-related risk."

According to a June 2009 report from PricewaterhouseCoopers Transaction Services Division entitled "Capitalizing on a Climate of Change" (here), as the financial impacts of climate change issues rise, "investors, stakeholders and regulators will demand greater transparency and comparability of companies’ financial information."

As reflected in M&A examples cited in the PwC report, this process is already well underway. The report refers to Porsche’s recent bid to acquire a majority stake in Volkswagen, which, the report claims, was motivated in part by Porsche’s desire to "offset its fleet’s high emissions with the more efficient and low emissions VW line."

The PwC report suggests that "climate change considerations will likely be a key consideration in M&A activity" and that in more and more deals, "the potential impacts of climate change on earnings, cash flow, and target valuation, as well as any opportunities for cost reduction through synergies, will have to be thoroughly evaluated."

The likelihood that these kinds of considerations will become increasingly critical does not depend alone on whether or not Congress ultimately enacts a climate change bill; regulatory developments at the EPA and elsewhere could drive climate change related mandates, as disclosed at greater length in a prior post, here. Indeed, the likelihood that regulators will act if Congress does not is one of the strongest motivations for Congress to find a way to put something together rather than to cede field to regulators.

According to the PwC report, in light of these considerations, "companies should begin planning today for the elevated status this issue now commands." Climate change issues are likely to become increasingly material, and companies that fail to adapt could risk "penalties, less profitability and damaged reputations." as well as "missed opportunities for growth."

The disclosure-centered nature of many of these potential risks creates a context within which litigation could well arise. To cite one example from the PwC report, investors may become increasingly attentive to M&A-related climate change exposures, the presence or absence of which could significantly affect deal valuations. Whenever there is an opportunity for investors to later contend they were misled or not fully informed, there is a danger of possible litigation.

The current predominance of issues relating to the global financial crisis may make these climate change related issues seem relatively remote and unimportant. But the possibility of claims based on carbon-related disclosures is only a matter of when, not if.

For that reason, in my view, the constituencies that will be scrutinizing carbon-related disclosures includes not only investors and regulators, but will also include D&O underwriters. As best practices in this area develop, D&O underwriters will necessarily develop their own sense of what disclosure practices suffice. Just as there are risks for companies that fail to adapt to the climate change related issues, there will be risks for D&O underwriters as well.

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The recent Environmental Protection Agency (EPA) proposal to find that greenhouse gases "contribute to air pollution that may endanger public health or welfare" is just the latest in a series of actions and events suggesting that climate change related issues could affect a large number of companies, in a variety of ways, including most specifically with respect to at least some companies’ disclosure obligations. These trends could have important implications for potential liability exposures of directors and officers of public companies.

On April 17, 2009, the EPA released a proposed "endangerment finding" with respect to six greenhouse gases (including carbon dioxide). The EPA’s April 17 press release can be found here and a summary of the proposal can be found here. Under the EPA’s proposed finding (which can be found here), the EPA is proposing that the six gases "threaten the public health and welfare of current and future generations." The EPA also proposes to find that motor vehicle emission of these gases "contribute to concentrations of these key greenhouse gases and hence to the threat of climate change."

The proposed endangerment finding was promulgated in response to the 2007 U.S. Supreme Court decision in Massachusetts v. EPA (discussed at length here). The EPA’s proposed finding, which is now in its public comment period, does not itself include any specific regulatory action or requirements. However, if the proposed finding is adopted, regulatory and even legislative action seems probable, especially given the politics and inclinations of the current President and Congress. Indeed, the adoption of the proposed finding could motivate legislators to act preemptively, to try to avert regulatory provisions they might find unacceptable.

The potential scope of any future regulatory or legislative action can be gauged by the specific observations in the EPA’s proposed endangerment finding. That is, the proposed finding not only concludes that climate change "impacts human health in several ways" (such as increased threat of catastrophic weather activity or harm to water and other natural resources), but also that the effects of climate change will have a "disproportionate impact" on certain vulnerable segments of the populations, such as the very poor, the elderly and those already in poor health.

The EPA’s report also includes the suggestion that climate change has "serious natural security concerns" based on the instability that could follow in the wake of "increasing scarcity of resources."

With these kinds of concerns as a starting point, the potential for any ensuing regulatory or legislative activity to have a disruptive impact on many industries and companies seems high. Indeed, if the risk assessments in the EPA’s findings are anywhere near accurate, the climate change itself, independent of any governmental action, could have a disruptive impact on many industries and companies.

Many of the industries and companies likeliest to be affected already are under pressure to anticipate these changes and assess their possible future impact.

The most recent effort to mandate these kinds of assessments is the disclosure requirement adopted on March 17, 2009 by the National Association of Insurance Examiners (NAIC). The NAIC’s March 17 press release can be found here and further background regarding the NAIC’s disclosure initiative can be found here.

The NAIC’s new disclosure requirements specify that no later than May 1, 2010, all insurance companies with annual premiums over $500 million must complete a Insurer Climate Risk Disclosure Survey. The Survey is designed to require the insurers to disclose "the financial risks they face from climate change, as well as the actions the companies are taking to respond to those risks."

Under the NAIC’s mandate, insurers will be required to report on "how they are altering their risk-management and catastrophe-risk modeling in light of the challenges posed by climate change." Insurers must also report on "steps they are taking to engage and educate policymakers and policyholders on the risk of climate change," as well as "whether and how they are changing their investment strategies." As discussed below, the requirement for insurers to disclose how they are "engaging and educating" policymakers and policyholders could be the bridge that extends the NAIC’s initiative to many other industries.

Another industry under pressure to analyze and assess climate change impacts is the utilities industry. As discussed (here), in August 2008, New York Attorney General Andrew Cuomo reached the first of several regulatory settlements with utilities companies, in which the settling companies agreed "to disclose financial risks that climate change poses to investors."

Among other things, the settling utilities have undertaken to disclose risks associated with probable future climate change regulation; climate change related litigation; and the physical impacts of climate change. In his press release relating to the first of these settlements, Cuomo expressly stated that he expected these companies’ disclosure undertakings to "establish a standard."

The insurance and utilities industries may be the most likely industries but they are far from the only industries that potentially will be affected by climate change regulation and the physical impacts of climate change. Other obvious possibilities include auto manufacturing; oil and gas extraction, production and distribution; transportation and shipping; mining; agriculture; tourism; and forestry.

But the comprehensive nature of climate change suggests that the potential impacts will not be restricted just to these more obvious industries; the regulatory and the physical impacts of climate change are likely to extend to any business that is engaged in manufacturing; owns or operates vehicles; owns or operates buildings or other physical facilities; or has any other process or activity that has carbon outputs.

In other works, the impacts could well reach every company and enterprise. This assessment may seem overly dramatic, but at a minimum it seems likely that the kinds of disclosure requirements now facing insurance companies and the utilities industry could come to be expected of many other companies. As Cuomo said in connection with the settlement described above, he expects that the disclosure requirements will "establish a standard."

Whether these changes will actually take place remains to be seen. But whether or not they ultimately happen, the prudent course would seem to be to anticipate that they will. Which leads to the point referenced above, about the prospect that insurers could wind up driving change for many other companies.

That is, with insurers themselves obliged to start reporting next May among other things on what steps they are taking to engage and educate policymakers and policyholders on climate change, one possibility is that insurers could take the lead in communicating the message that prudent companies should assume that these changes are coming. Insures could wind up spurring their policyholders to undertake the same kind of risk assessment and disclosure that Cuomo is requiring in the regulatory settlements with the utilities.

Specifically, it seems possible that D&O insurers, in order to fulfill their own disclosure obligations under the NAIC’s mandate (and to look proactive while doing so) could undertake to "educate" their policyholders about the need to assess both the possible regulatory and physical impacts of climate change on their operations and financial condition, and to disclose those assessments to investors, as a way to manage a variety of climate change related risks.

In any event, whether or not insurers actually take that step, well-advised companies may independently conclude on their own that given the possible regulatory and physical impacts of climate change, risk assessment and disclosure is simply prudent.

One of the lurking dangers when a single issue predominates, as the global financial crisis recently has, is that all other concerns may seem trivial and unimportant by comparison. For many companies, especially those outside the insurance and utilities industries, climate change issues may now seem subordinate and remote to the point of irrelevance. But when we finally emerge from the current crisis, we may find that the climate change risks loom larger than ever and are more important than anyone now imagines.

This is not the first time I have raised these climate change related issues (refer for example here). I know there are those who think I am alarmist about this issue, and I suppose the skeptics could be right. However, even the most hardened cynic will have to acknowledge that, given the EPA’s recent pronouncement and given the current political environment in Washington, regulatory and even legislative activity seems likely, which is clearly a risk, trend or uncertainly that prudent companies will be assessing and disclosing.

And allow yourself for a moment to consider the possibility that the risk assessments in the EPA report could actually come to pass. At a minimum, if these things are possible, shouldn’t companies also be assessing the possible impact of climate change on their operations and financial condition?

Many companies today might conclude that there will be time enough tomorrow to deal with tomorrow’s problems. That was exactly the logic that led Detroit to keep grinding out SUVs and Hummers for the last twenty years, when more forward-looking competitors were already capturing market share by making hybrid vehicles. Just as Detroit’s past leaders are now criticized for their lack of vision, so too may other corporate leaders who now defer on these issues find themselves later under siege for failing to look ahead and anticipate the changes and problems just ahead.

Somehow, on Earth Day, these issues seemed particularly important for me. And for my kids.

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In order to assign responsibility in connection with the enforcement of public welfare objectives, courts have developed the "responsible corporate officer doctrine," which in recent years has been applied with increasing frequency in environmental enforcement. A California appellate court recently applied the doctrine to enforce civil liability on the officers of a family run business. The case, and indeed the doctrine itself, raise important concerns about the potential liability of directors and officers.

Background

John and Ned Roscoe were officers, directors and shareholders of a family company that had a underground storage tank. The tank leaked 3,000 gallons of gasoline. A company employee notified the county and hired a consultant to clean up the leak. However, as the appellate court later put it, cleanup "did not proceed timely and adequately," and though regulators sent multiple notices to the company, no one from the company "attempted to make sure the problems were addressed."

The county filed a civil lawsuit against the Roscoes and their family company for failure to remediate and to file certain reports as required by law. Following a bench trial, the court found the Roscoes and their company jointly and severally liable for $2.4 million in "civil penalties."

The trial court specifically found that the Roscoes had "overall authority" for the company, could have remediated the problems, but did not "exercise their responsibilities and power to use all objectively possible means" to remedy the problem. The Roscoes appealed.

The Appellate Ruling

In a December 26, 2008 opinion (here), the California Court of Appeal for the Third Appellate District applied the "responsible corporate officer doctrine" and affirmed the trial court.

As the appellate court noted, the responsible corporate officer doctrine was developed by the U.S. Supreme Court in the 1943 case of United States v. Dotterweich, to hold corporate officers in responsible positions of authority personally (and in that case, criminally) liable for violating strict liability statutes protecting the public welfare.

Though the Dotterweich case involved a criminal proceeding, the California court in Roscoe applied the doctrine to uphold the imposition of civil liability. The Roscoe court described the doctrine as "a common law theory of liability separate from piercing the corporate veil or imposing personal liability of direct participation in tortious conduct."

The appellate court in the Roscoe case held that the trial court properly applied the doctrine to the Roscoes because they had "overall authority," they "could have prevented or remedied promptly the problem," and because they did not "exercise their responsibilities and power to use all objectively possible means" to remedy the problem.

Discussion

Typically, the corporate veil doctrine would shield corporate officers or shareholders from direct personal liability for legal violations of the corporation, consistent with long-developed notions of the distinct and separate legal identity involved with the corporate form.

But the "responsible corporate officer doctrine" expands the power of government to impose liability on individuals, seemingly in disregard of the corporate form, and apparently without requirement of participation in the wrongful conduct or even the requirement of a culpable state of mind, in the name of protecting public health and welfare.

I understand from reviewing a variety of articles online (refer for example here) that there arguably may be nothing new about the California court’s invocation of the responsible corporate officer doctrine. It apparently has been applied in any number of states (refer for example here) and seems to be most frequently used in connection with environmental enforcement actions.

Indeed, the doctrine is embodied in the statutory wording of several fundamental federal environmental statues and has now found its way into the environmental statutes of many states that modeled the statutory scheme on the federal laws. I understand from conversations with an environmental attorney (I happen to be married to one) that this is a recognized and well-established doctrine in environmental law.

That the doctrine may have a lengthy pedigree behind it does not make it any less troubling to me. The idea that liability could be imposed on an individual for corporate misconduct, in apparent disregard of the corporate form and without even a requirement for a culpable state of mind, seems inconsistent with my (perhaps not fully informed) assumptions about the way the law ought to work.

To my mind, this doctrine seems to impose liability for nothing more than a person’s status. The word "responsible" in the responsible corporate officer doctrine’s name does not mean that the individual was responsible for the misconduct, but only that the individual was responsible for the corporation.

The California court did specify prerequisites that could circumscribe the doctrine’s application; that is, the court indicated that "there must be a nexus between the individual’s position and the violation in question such that the individual could have influenced the corporate actions" and that "the individual’s actions or inactions facilitated the violations." But while these requirements could constrain the doctrine’s application, they also seem to relate more to an individual’s position or status, rather than the individual’s actual state of mind or even direct culpability.

It appears that other courts have considered knowledge of the violation a prerequisite to the imposition of liability based on the responsible corporate officer doctrine, which to me seems like a minimal requirement for the doctrine’s application to be consistent with traditional notions of justice and fair play.

In any event, the typical directors and officers liability insurance policy would not likely respond to provide indemnification for these kinds of awards, for at least two reasons. The first is that most policies contain a broad form pollution exclusion. The second is that most policies will not cover fines and penalties.

While the typical D&O policy would not cover these kinds of penalties, I can imagine an argument that there should be insurance for these kinds of exposures. The fines are imposed on individuals essentially because they occupied a corporate office – that is, by reason of their status, seemingly without regard to actual fault. (It may well be that there are separate environmental liability insurance policies available in the marketplace that are designed to respond to these very exposures, an issue on which I invite readers’ comments and observations.)

A public policy advocate might well argue that individuals should have to pay these amounts out of their own resources, in order that the liability threat will deter future violations and motivate compliance. These kinds of arguments seem most compelling to someone who is secure in the knowledge that they will never have to worry about having liability imposed on them for conduct of which they might have been completely unaware.

A January 14, 2009 memorandum from Foley & Lardner law firm discussing the Roscoe case can be found here.

Special thanks to Damien Brew for providing a copy of the Roscoe opinion. I hasten to add that the views expressed in this post are exclusively my own.

Climate Change Disclosure: In prior posts, I have noted a variety of developments that are increasing pressure on publicly traded companies to increase their disclosure on climate change related issues. For example, I noted here the Petition for Interpretive Guidance on Climate Risk Disclosure filed with the SEC on September 18, 2007 by the Coalition for Environmentally Responsible Economies (CERES) and others. In another post (here), I discussed the settlements that Xcel Energy and others reached with the New York Attorney General regarding climate change risk disclosure.

These developments raise the question whether these and other circumstances have changed public companies' disclosure practices regarding climate change issues. In a January 15, 2009 memorandum (here), the McGuire Woods law firm reports the results of its survey of the of the 2008 10-K filings of approximately 350 companies in order to determine the state of SEC disclosure practices regarding climate change.

What the law firm found was that "very few companies made any type of 10-K disclosure regarding [greenhouse gas, or GHG] emissions or climate change." Only 42 of 350 companies reviewed, about 12.2% made any disclosure whatsoever regarding GHG emissions or climate change. Unsurprisingly, the largest concentration of companies making some disclosure on these issues was among utility companies, particularly large utilities. Of the 26 non-utility companies making some disclosures, the next largest concentrations were in the energy and industrial sectors.

The memorandum observes that "very few companies outside the energy and utilities industries made any type of GHG emissions or climate change-related disclosures" in 2008. The memo goes on to predict, however, that "this state of affairs is likely to change in 2009," as a result of the change in administration and the changing political climate, as well as changing regulator and investor expectations.

The report concludes that "each company that does not currently provided GHG or climate change disclosures will need to carefully evaluate whether that is a reasonable approach given the kinds of risks, and opportunities, that GHG and climate change issues present." The report ends by noting that "we expect the number of public companies that make GHG and climate change disclosures in their SEC reports will increase in 2009."

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In a development of potentially great significance for climate change disclosure and reporting issues, on August 27, 2008, New York Attorney General Andrew Cuomo announced (here) that Xcel Energy had entered a “binding and enforceable agreement” requiring the company “to disclose the financial risks that climate change poses to investors.” Xcel's announcement regarding the agreement can be found here.

The agreement follows Cuomo’s September 2007 subpoenas to Xcel and four other utilities companies. As I discussed in a post at the time (here), the subpoenas were directed to the companies’ disclosures to shareholders of the financial risks regarding global warming and climate change. In his August 27 press release, Cuomo stated that his investigations of the other four companies (AES Corporation, Dominion Resources, Dynegy and Peabody Energy) are “ongoing.”

In its agreement, Xcel has undertaken to “provide detailed disclosure of climate change and associated risks” in its annual SEC filing on Form 10-K. Specifically, Xcel will provide “an analysis of financial risks from climate chance,” focused among other things on: 1. “present and probably future climate change regulation”; 2. “climate-change related litigation”; and 3. “physical impacts of climate change.”

In addition, Xcel also committed to a “broad array of climate change disclosures” including current and projected future increases in carbon emissions (particularly from planned coal-fired plants); company strategies for reducing or managing its global warming and climate change emissions; and corporate governance actions related to climate change, “including whether environmental performance is incorporated into officer compensation.”

Although Xcel is the only company that is party to the agreement, Cuomo was very explicit in his press release that his believes that the Xcel agreement has managed to “establish a standard,” and third parties are quoted in his press release as saying that the agreement may have created “an enforceable model for climate change disclosure.”

Perhaps one might imagine that developments involving only Xcel are irrelevant for other companies. However, one could imagine that only by disregarding overwhelming contemporaneous evidence to the contrary. Among other things, Cuomo’s recent auction rate securities settlement, similarly announced to great fanfare, quickly became a model for regulatory settlements with other auction rate securities targets. For that reason, it must be anticipated that the other four companies Cuomo targeted with subpoenas will face enormous pressure to enter similar agreements.

The more interesting question is whether the Xcel agreement will have a broader impact, and influence disclosures at other companies – and not just in the utilities industry, but in manufacturing, transport, mining and energy production and distribution, agriculture, and even insurance. As I noted in my prior post, virtually contemporaneous with Cuomo’s subpoenas to these utilities, several public interest organizations had petitioned the SEC to adopt specific climate change reporting guidelines. It is entirely possible that the Xcel settlement will increase the pressure, from shareholders as well as from regulators, to disclose their own financial risks from global climate change.

As I have previously noted, the danger to publicly traded companies is not just that they may face greater disclosure obligations; the danger arises from the fact that companies undertaking greater disclosure commitments, whether voluntarily or as result of compulsion, may be exposed to later allegations that they engaged in “selective disclosure” or “omission” of unfavorable information. It may only be a matter of time before allegations of this type make their way into civil complaints.

To be sure, a lawsuit must not only allege misrepresentations or omissions, it must also allege causally related damages. In the absence of shareholder losses related to climate change disclosures, plaintiffs’ lawyers would have little incentive to pursue a climate change disclosure lawsuit. But as scrutiny of these issues increases, and as disclosure pressures mount, the opportunity for market moving announcements also increases. To put it another way, as disclosure expectations increase, so do disclosure risks.

I have previously asserted that directors and officers of public companies face growing climate change-related exposure. Though these views have been greeted with some interest, there has also been skepticism. Indeed, there have, in fact, as yet been no climate change disclosure related D&O claims.

However, there are too many politicians who see this topic as a way to enhance their stature. There are too many interest groups that are willing to use all means, including litigation, to advance their agenda. And, indeed, there may even be too many financial risks and uncertainties from the underlying issues. Sooner or later, these forces inevitably will come together in a lawsuit (or perhaps many lawsuits) seeking to hold companies and their directors and officers responsible.

As today’s announcement from the New York Attorney General’s office demonstrates, climate change already is an important governance and disclosure issue. A myriad of forces ensure that its importance will only increase.

An August 27, 2008 New York Times article discussing the Xcel agreement can be found here.

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