As I noted when it was filed in 2016, the securities class action lawsuit investors filed against ExxonMobil and certain of its executives represented something of a milestone as it was the first securities class action lawsuit of which I am aware based on climate change-related allegations. In an August 14, 2018 opinion, Northern District of Texas Judge Ed Kinkeade largely denied the defendants motion to dismiss. The opinion contains a number of interesting features, including in particular in its discussion of the plaintiff’s climate change related allegations. Judge Kindeade’s opinion can be found here.
Background
In November 2016, investors filed a securities class action lawsuit in the Northern District of Texas against Exxon alleging that the company the company had failed to adjust or delayed the adjustment of the “proved reserves” the company carried on its balance sheets. The plaintiff alleged that the proved reserves should have been adjusted or adjusted earlier because at the relevant times it was no longer economically feasible to realize the value of the assets.
The plaintiff allege that the company avoided making these needed adjustments by failing to recognize the impact of and costs associated with climate change, and failing to adjust for falling declining global oil prices. In making the climate change allegations, the plaintiff specifically alleged that the “carbon proxy” the company used (intended to reflect the anticipated future costs associated with climate change regulation) in its public statements and disclosures was different and lower than the one the company was using internally. The plaintiff alleged that the failure to adjust its proved reserves and its statements about its assessment of its reserves were materially misleading. The defendants filed a motion to dismiss.
The August 14, 2018 Opinion
In his August 14, 2018 opinion, Judge Kinkaide denied the motion to dismiss as to all but one of the defendants; he granted the motion to dismiss the Rule 10b-5 action against one of the individual defendants.
In granting the motion, Judge Kinkaide specifically ruled that the plaintiff had sufficiently pled that the defendants had made material misrepresentations about the company’s use of carbon proxy costs and in the company’s failure to adjust or delay in adjusting of specific assets the company previously had considered proved reserves.
With respect to the carbon proxy costs statements, Judge Kinkaide found that the plaintiff has sufficiently alleged that Exxon “stated a different proxy cost value in public statements than was actually applied in internal calculations.” He added that “a reasonable investor would likely find it significant that ExxonMobil allegedly applied a lower proxy cost of carbon than it publicly disclosed.”
In connection with the company’s alleged failure to recognize or delay in recognizing the impairment of one specific energy asset, the Rocky Dry Gas Operation, the plaintiff had alleged among other things that the company had failed to conduct impairment determinations according to GAAP because the company failed to include its proxy cost of carbon in the impairment analysis. Judge Kinkaide concluded that the alleged failure to include the proxy cost in the impairment determination necessarily omitted facts going to the basis of the company’s impairment opinion, making the opinion materially misleading.
Judge Kinkaide also concluded that the plaintiff has sufficiently pled scienter as to the company and all but one of the individual defendants, despite the absence of any insider trading allegations. In reaching this conclusion, Judge Kinkaide relied on the plaintiff’s allegations that Exxon CEO Rex Tillerson and the other individual defendants received in-depth briefings on and actively engaged in discussions of the company’s financial position and the risks of climate change. The company and individual defendants had a motive to maintain the company’s AAA credit rating by using a lower, internal proxy cost and not recognizing asset impairment so as to complete a planned $12 billion public debt offering (the largest in the company’s history) in order for the company to continue to be able to pay shareholder dividends.
Finally, Judge Kinkaide concluded that the plaintiff had sufficiently pled loss causation, notwithstanding the defendants’ argument that there was not any actual corrective disclosures and resulting drop in stock price. The plaintiff alleged that rather than a single corrective disclosure there was a series of several partial disclosures resulting in the company’s share price dropping gradually. Judge Kinkaide concluded that the plaintiff had sufficiently alleged loss causation, reasoning that “it is plausible that over the course of the alleged partial disclosures, the market became aware of ExxonMobil’s alleged fraud and reacted each time with ExxonMobil’s common stock falling.”
Discussion
The court’s conclusion that the plaintiff has adequately alleged that the defendants misled investors with respect to the company’s own assessment of its future costs associated with climate change represents something of a milestone. I have long been predicting the possibility of climate change disclosure-related D&O litigation. The initiation of this lawsuit confirmed that this type of D&O litigation could arise. The fact that the allegations based on climate change-related disclosure proved sufficient to survive a motion to dismiss suggests that the potential D&O exposure related to climate change disclosures could be substantial. At a minimum, this lawsuit’s survival of the dismissal motion could be enough to encourage plaintiffs’ lawyers to file additional climate change related lawsuits.
To be sure, one lawsuit doesn’t make a trend. But the fact is, this lawsuit does show that these kinds of claims are indeed possible. The outcome of the dismissal motion highlights the fact that these kind of claims represent a potentially serious risk.
The climate change related angle is not the only thing that makes Judge Kinkaide’s opinion interesting. His finding that the plaintiff has sufficiently alleged scienter despite the absence of insider trading allegations is particularly interesting, especially his finding that the plaintiff had adequately alleged that the individual defendants received in-depth briefings about climate change issues and were fully aware of the company’s climate change related risks. Judge Kindaide’s conclusion that the plaintiff had adequately alleged loss causation, despite the absence of a single identifiable corrective statement and resulting stock drop, is also interesting. His willingness to recognize the adequacy of plaintiff’s allegations of a series of corrective disclosure and resulting stock drops represents a significant and interesting variation in loss causation analysis.