In a February 8, 2014 article entitled “A Shrunken Giant” (here), the Economist magazine examined BP’s efforts to regain its footing after the disastrous April 2010 Deepwater Horizon explosion and oil spill. The article concludes by stating that “Repairing the balance sheet and books is one thing. Repairing BP’s reputation for management excellence will take longer.” While the article tracks the need for BP’s management to rehabilitate its reputation only back as far as the 2010 Gulf oil spill, a recent Ninth Circuit decision is a reminder that BP’s environmental challenges and management woes go back even further, to the company’s prior environmental disaster – the company’s 2006 Prudhoe Bay oil spills.
In a February 13, 2014 opinion (here), the Ninth Circuit reversed in part the district court’s dismissal with prejudice of the securities class action lawsuit brought by holders of BP ADRs alleging that the company and certain of its directors and officers had made misleading statements about the condition and maintenance of the company’s Prudhoe Bay pipelines and about the company’s environmental compliance practices.
Rejecting the district court’s suggestion that the plaintiffs’ complaint alleged at most “simple mismanagement, but not securities fraud,” the Ninth Circuit said that “while we agree that BP’s actions exemplify corporate mismanagement, the pleadings also charge that BP is a company that has publicly shirked responsibility for its role in causing the Prudhoe Bay spills at every step of the way,” adding that while mismanagement “would be a plausible explanation” for the company’s misinformation, the alleged facts “support the inference that BP was, at the very least, deliberately reckless as to the false and misleading nature of their public statements.”
In March 2006, BP sustained the first of two significant oil spills from pipelines in its Prudhoe Bay operation in Alaska. The spill, which was widely publicized, triggered a government investigation. According to the Ninth Circuit, it quickly came to light that the pipeline that leaked had not had an important corrosion test since 1998. The U.S. Department of Transportation order correction actions in a Corrective Action Order, which were to be completed by June 2006. However, BP failed to complete the action until a month after the deadline. The diagnostic tests, completed in July 2006, showed significant pipeline corrosion. Shortly after that, on August 5 and 6, 2006, the company discovered leaks at a second Prudhoe Bay pipeline. BP was forced to temporarily shut down its Prudhoe Bay operations.
In October 2007, BP’s Alaska unit pled guilty to a misdemeanor violation of the Clean Water Act. In its plea agreement, BP admitted that it was aware of corrosion in the pipeline where the first spill occurred in 2005. In 2011, BP resolved separate civil suits that had been brought by the Department of Justice and the State of Alaska. The company entered consent decrees that required it to take certain remedial and prophylactic measures.
In d addition, certain BP security holders filed complaints alleging that BP and certain of its directors and officers had made misleading statements in violation of the securities laws. The plaintiffs alleged that four specific sets of statements were misleading.
Following the first spill, Margaret Johnson, a senior VP and the head of BP’s Prudhoe Bay operations, made public statements that BP’s most recent inspection data prior to the spill showed that the pipeline where the spill occurred had a “low and manageable corrosion rate.” In a later statement, Johnson said the spill was “anomalous” and that the conditions contributing to the spill were not present at BP’s other Prudhoe Bay pipelines. The company’s CEO stated at an April 2006 news conference that the March spill had occurred “in spite of the fact that BP had world class corrosion monitoring and lead detection systems.” In addition, the company’s 2005 Annual Report (issued on June 30, 2006) stated that management believes that BP was in compliance in all material respects with applicable environmental laws and regulations.
On March 14, 2012, Western District of Washington Judge Marsh Pechman dismissed the plaintiffs’ securities suit with prejudice, finding that while a number of the statements on which the plaintiffs relied were actionably false, the plaintiffs did not plead facts giving rise to a strong inference of scienter. A copy of Judge Pechman’s opinion can be found here.
The Ninth Circuit’s Opinion
In a February 13, 2014 opinion written by Eastern District of New York Senior Judge Raymond J. Dearie (sitting by designation) for a three-judge panel of the Ninth Circuit, the appellate court reversed in part and affirmed in part the district court’s dismissal of the plaintiffs’ complaint.
The appellate court found that the plaintiffs had adequately alleged both falsity and scienter as to Margaret Johnson’s assurances about the low and manageable corrosion rate at the pipeline where the first spill occurred, and as to Johnson’s statements that the conditions at BP’s other Prudhoe Bay pipelines were different from the conditions at the pipeline where the spill occurred. The court also found that the plaintiffs had sufficiently alleged falsity and scienter as to the statement in the 2005 Annual Report that management believes that the company is in compliance with environmental laws and regulations. However, the appellate court agreed with the district court that the plaintiff’s had not sufficiently alleged scienter with regard to the CEO’s statements that the company had a “world class” leak detection system and corrosion monitoring program.
In finding contrary to the district court that the plaintiffs had sufficiently alleged that Johnson made the allegedly misleading statements with scienter, the Ninth Circuit relied heavily on Johnson’s education, position and responsibilities, as well as her alleged incentive to misrepresent the facts, based upon which the appellate court concluded that “not only would Johnson be aware of corrosion problems, but she would be among the first to know. A strong inference of scienter is therefore found in the pled facts.”
In reaching its conclusion that Johnson had made the statements with scienter, the appellate court also relied on the “core operations” inference, noting that because Johnson was the person overseeing operations in the area where the spill took place, “we find it absurd to believe that she did not have knowledge of information contradicting her statements.”
The Ninth Circuit also applied the “core operations” inference in concluding that the statements in the 2005 Annual Report about the company’s environmental compliance were made with scienter. The Court said that “in light of the magnitude of the violations, the immense public attention on BP in the wake of the spills, and the contemporaneous documents demonstrating management’s awareness of the company’s non-compliance with the Corrective Action Order [entered after the first spill], we find it ‘absurd’ that management was not aware of BP’s significant, existing compliance issues that rendered the statement misleading.”
Even though the Ninth Circuit had concluded that the plaintiffs had sufficiently alleged that Johnson’s statements and the statement in the 2005 Annual Report had been made with scienter, the appellate court separately undertook a “holistic” review of the allegations to determine whether the allegations create a strong inference of scienter. The district court had undertaken the same exercise and had concluded that the allegedly misleading statements “more closely resemble simple corporate mismanagement than actionable securities fraud.” The Ninth Circuit said
To some extent, corporate mismanagement would be a plausible explanation for how misinformation travels to the corporate suite. But in this case, facts alleged in the complaint support the conclusion that BP had been aware of the corrosive conditions for over a decade, and yet chose not to address them…. And it suggests that BP had every reason to know, at the very least, that they did not have accurate information regarding the conditions of the Prudhoe Bay pipelines. When we consider the allegations holistically and accept them to be true, as we must, the inference that BP was, at the very least, deliberately reckless as to the false or misleading nature of their public statements is at least as compelling as any opposing inference.
The appellate court concluded by saying that “in the end, we conclude that after six years of preliminary litigation, the allegations should now be tested on the merits.” The case will now go back to the district court for further proceedings.
There are no references in the Ninth Circuit’s opinion to the 2010 Deepwater Horizon disaster. However, it felt to me as if the shadow of the subsequent Gulf oil spill overhung the appellate court’s consideration of the Prudhoe Bay spill securities suit. Just as the Deepwater Horizon disaster looks even worse in light of the company’s involvement in the prior spills at Prudhoe Bay, the company’s reassuring statements after the first Prudhoe Bay spill take on an even more disturbing quality in light of the subsequent incident in the Gulf of Mexico. I think that as a result there is a tone of barely restrained outrage in the appellate court’s opinion. In some ways, the court arguably got carried away with its indignation – for example, the court’s statement that BP has “publicly shirked its responsibility” for the Prudhoe Bay spill “every step of the way” cannot be squared with the guilty plea the company entered in the environmental enforcement proceeding or the consent decrees (which included numerous admissions) the company had entered with the DoJ and the State of Alaska.
The extent to which the Court relies on circumstantial support for its conclusions on the issue of scienter may be less than satisfying to some readers of the court’s opinion. The Court’s conclusion that Johnson must have know or should have known the information contradicting her statements – as well as the Court’s “core operations” inference that it is “absurd” to suggest that she didn’t know of the contradictory information – is different from direct support for the conclusion that she actually knew the contradictory information or that she intended to mislead.
If nothing else, this decision shows how critically important a company’s statements after it has disclosed bad news can be. The three statements the appellate court concluded were actionable all took place after the first spill. The problem with Johnson’s statements, as the Ninth Circuit viewed them, is that in her effort to sound reassuring, she allegedly understated the extent to which the company was aware of the pipeline conditions that contributed to the spill, as well as the extent to which the conditions might exist in the company’s other pipelines. This case is a reminder that the way the company responds to bad news – and in particular how it manages its communications after bad news – can significantly affect the company’ s potential liability exposures under the federal securities laws.
Those responsible for companies’ disclosure documents will also want to consider the court’s conclusion that the statements about the company’s environmental compliance were actionable. The statement itself seemingly was carefully couched. The statement said only that “management believes” that the company was in compliance, and was further qualified by adding “in all material respects.” The statement also followed a much longer statement referencing the unpredictability of future developments and the environmental risks inherent in the company’s operations.
Nevertheless, the Ninth Circuit concluded that the statement was actionable, basically because of the magnitude of the environmental violations the company subsequently acknowledged. The lawyers whose responsibility it is to draft disclosure document statements of this type will want to consider whether there are ways to craft statements about regulatory compliance that will not be found to be misleading if regulatory issues later arise.
The Economist article cited above suggests that BP still has further to go to rehabilitate the reputation of its management in the wake of the Deepwater Horizon disaster. The Ninth Circuit’s recent opinion is a reminder that BP’s management’s reputational deficit runs further back than the Gulf oil spill. The Ninth Circuit’s revival of the Prudhoe Bay securities suit also means that the company’s costs of extricating itself from the consequences of the past sins will be even greater than the company might have been assuming.
Veritas: This week’s issue of the Economist also has an article about efforts to try to invigorate trade in Ningxia, an autonomous region in China’s northwest. The article reports that “Ningxia is hoping to sell nutritious goji berries to people worried about their bodies, certified Halal foods to Muslims worried about their souls, and fine red wines to people relaxed about both.”
And Finally: In his essay about growing old, entitled “This Old Man,” in the February 17, 2014 issue of the New Yorker (here), Roger Angell (after he admits that he told a friend following his wife’s death that he didn’t know how he was going to get through it): “I am a world-class complainer but find palable joy arriving with my evening Dewar’s, from Robinson Cano between pitches, from the first pages once again of ‘Appointment in Samarra’ or the last lines of the Elizabeth Bishop poem called ‘Poem.’ From the briefest strains of Handel or Roy Orbison, or Dennis Brain playing the early bars of his stunning Mozart concertos. (This Angel recording may have been one of the first things Carol and I acquired just after our marriage, and I hear it playing on a sunny Saturday morning in our Ninety-fourth Street walkup.)”