Acting New York State Attorney General Barbara Underwood has sued ExxonMobil for fraud, alleging the company misled investors about how its current and future profitability was—and will be—shaped by climate change. The Attorney General’s case tests legal compliance. ExxonMobil shareholders face a different test.
The lawsuit charges that ExxonMobil, in effect, kept at least two sets of books. The hidden internal set detailed how the company’s profitability is imperiled by current market forces and inevitable policy changes prompted by climate change. The external set for investors suggested the company was growing, its reserves sufficiently abundant and varied to withstand whatever negative market consequences were brought on by climate events or carbon-related policy changes.
Shareholders should act to improve management now.
The complaint is a tale of high-level corporate deceit that targets ExxonMobil’s highest officials as the purveyors of toxic accounting. The issue for shareholders is what to do about the corporate management that created the conditions that led to this round of litigation. Win, lose, or draw, ExxonMobil must be held to account.
One clear message to shareholders is that the suit raises questions about the internal valuation of reserves, accounting treatments of various oil and gas basins, handling of oil price and cost assumptions, and how various carbon scenarios will affect the reserve portfolio. In sum, the complaint suggests that the company’s current reserves are only marginally capable of producing profits.
So the days of gangbuster returns, $40+ billion dividend payouts, and stock appreciation are over. Adding in carbon costs, the rosiest scenario is that ExxonMobil – and most of the oil and gas industry – have a diminished long-term outlook. Put another way, these companies are floating in a sea of red ink.
In effect, the suit tells us why oil and gas stocks have declined for most of the last decade. The complaint explains how ExxonMobil continues to lag the market during a time of dramatic increases in oil prices. The stock dropped more than two points on the day the suit was announced, hitting $77.62 per share, a number not seen since August, during a period of rising oil prices.
THE COMPANY’S RESPONSE TO THE SUIT SHOULD MAKE SHAREHOLDERS WARY. The company did not offer a financial response. Instead it launched an extraordinarily partisan—and completely off-base—attack on Ms. Underwood, a caretaker until a new A.G. takes office in January, who has no partisan incentive to carry out this suit and a sterling reputation as a public servant. If this suit, started under her predecessor, was, indeed, a legal action motivated by partisan concerns, Ms. Underwood would not have filed it.
TO UNDERSTAND THE SUIT, EXXONMOBIL AND ITS SHAREHOLDERS SHOULD ACQUAINT THEMSELVES WITH NEW YORK’S MARTIN ACT, which gives the state’s Attorney General a unique authority to pursue securities fraud. It recognizes the centrality of the securities industry to New York’s economy and assumes that an honest, level playing field is the best market environment. Fraud in the stock market gives dishonest companies a leg up over honest ones. New York taxpayers expect the Attorney General to pursue securities cases that taint the market. ExxonMobil is in the top ten of the Standard and Poor’s 500, with approximately 4.3 billion outstanding shares and a market capitalization of $428 billion. A taint on ExxonMobil’s books is a taint on the whole market. From the point of view of New York State law and its role in the securities industry, this suit could not be more on point.
The direction for the suit is clear; it will wind its way through the justice system. For ExxonMobil shareholders, there is also a clear direction. If they do not act, they will likely lose a lot of money. Rather than wait for the outcome of this litigation, they can divest. Shareholders who still do not see the value in divesting their stock have various tools to improve management now. They can demand clear public answers to the questions raised by this lawsuit and sue if Exxon Mobil maintains its imperious stance. They can hold senior managers accountable through shareholder resolutions, demand resignations and vote against current board members. They can demand a halt to political attacks on law enforcement and an end to wasteful use of shareholder dollars to fight constructive solutions to climate change. They can plan for what will be inevitable class action suits as the stock value drops. Or they can continue to hide.
Tom Sanzillo is IEEFA’s director of finance. Kathy Hipple is an IEEFA financial analyst.