Late last week, the New York Attorney General ("NYAG") filed a law suit in the Supreme Court of the State of New York1 against Exxon Mobil Corporation ("Exxon") alleging that Exxon violated, among other things, the securities fraud provisions of a 1921 New York statute called the Martin Act2 in connection with Exxon's public disclosures of the future costs of complying with climate change regulation, as well as the potential for impairment of certain of the company's existing carbon-intensive energy assets. The lawsuit does not specify any quantum of damages, but makes a claim for "all appropriate monetary relief".
In the law suit, the NYAG has alleged that Exxon misrepresented to its investors and the public the risks that were posed by climate change by failing to use its publically disclosed estimates of climate change costs, instead using different (and lower) internal estimates, when evaluating the risks of its business projects. The NYAG has asserted this dual method of evaluating the commercial risk of climate change, and the failure to disclose the assumptions and estimates that were actually used internally, rendered Exxon's disclosure to investors false and misleading, making Exxon a riskier investment than the company let investors believe, and ultimately causing its securities to be overvalued in public markets.
A focal point of the NYAG's claim is Exxon's public disclosures. The importance of crafting accurate disclosure that is not misleading on a go-forward and continuous basis is necessary for a corporation to fulfill its obligations to its investors. This may compel publicly-traded corporations to take into consideration the potential impact on their businesses and financial positions of pending or anticipated regulatory changes when preparing their public disclosures. Forecasting the effect of pending or prospective regulatory changes can be exceedingly challenging for corporate managers, but relying solely on current legislative requirements may not be enough for a corporation to satisfy its disclosure obligations towards investors.
Climate change risks are particularly important for investors in the oil and gas industry, the NYAG argues, as the corporations who conduct business in this sector must evaluate projects for the long term, including the possibility that their assets could become "stranded" (meaning assets that become too costly and therefore uneconomic to operate or develop).
In support of its claim on the importance of climate change in public disclosure, the NYAG refers, among others, to the United Nations Framework Convention on Climate Change and the 2015 Paris Agreement (Canada is a party to both), the carbon tax schemes in Alberta and British Columbia, and Alberta's Specified Gas Emitters Regulation which was replaced in January 2018 by the Carbon Competitive Incentive Regulation. These are among the legislative instruments that national and sub-national governments have so far adopted in response climate change, creating an increasingly complex legislative framework which creates incremental regulatory risk and financial burdens for corporations.
The NYAG's claim against Exxon has been brought under a legislative framework which has no equivalent in Canada. However, the initiation of climate change litigation in the United States creates a real prospect of similar litigation in Canada. It has been reported in Canadian news media coverage of the NYAG's claim against Exxon that cases founded on similar principles to those engaged by the NYAG are currently being prepared against Canadian energy companies.3 In addition, any large damages award in a climate change litigation could invite similar lawsuits outside of the oil and gas industry, extending to other types of businesses that are especially vulnerable to significant, complex regulatory change.
In Canada, there are a number of existing continuous disclosure requirements that may pertain to climate change information, to the extent such information is material to an issuer. For example, under National Instrument 51-102 Continuous Disclosure Requirements, an issuer is required to discuss in its MD&A any commitments, events, risks or uncertainties that it reasonably believes will materially affect its future performance. Materiality is assessed from the perspective of a reasonable investor. CSA Staff Notice 51-333 Environmental Reporting Guidance provides the following guidance, which is intended to assist reporting issuers in assessing materiality of environmental matters:
- there is no bright-line test for materiality;
- materiality must be considered in light of all the facts available;
- the determination of materiality is a dynamic process that depends on the prevailing market conditions at the time of reporting;
- the time horizon of a known trend, demand, commitment, event or uncertainty may be relevant to an assessment of materiality; and
- where doubt exists as to materiality, issuers are encouraged to disclose.
In addition, in April 2018, the Canadian Securities Regulators published CSA Staff Notice 51-354 – Report on Climate Change-related Disclosure Project (the "Climate Change Notice"). The Climate Change Notice was the product of a year-long public consultative process that involved a review of selected reporting issuers' mandatory disclosures and solicitation of input from a number of stakeholders, including representatives of the reporting issuer and investor communities. In general, issuers expressed concerns with the prospect of any regulatory requirements that would impose mandatory disclosure requirements relating to climate change, which investors expressed concerns about the adequacy of existing continuous disclosure requirements as they apply to climate change. In the result, the CSA indicated that it will be considering the introduction of new disclosure requirements relating to climate change-related risks and financial impacts.
In Canada, any climate change disclosure law suit would most likely be framed as a class action proceeding pursuant to the provisions of provincial securities legislation, which creates a civil liability regime for secondary market disclosure. Specifically, Canadian provincial securities laws were amended more than a decade ago to create a civil liability regime for misrepresentations in a reporting issuer's continuous disclosure filings, as well as in public oral misrepresentations made by specified senior officers on behalf of a reporting issuer.
Our civil liability regime in Canada provides investors in the secondary market with a limited right of action to seek damages resulting from a reporting issuer's misstatement or omission of a material fact, or a failure to disclose a material change. Importantly, it is not necessary for an investor to show reliance on a misrepresentation or failure to make a disclosure. This deemed reliance aspect has made our regime attractive to class action plaintiffs.
Damages are generally calculated with reference to the change in market value of the reporting issuer's securities acquired by an investor which can be attributable to the misrepresentation or omission of a material fact (typically determined by the change in price following a public correction of the misrepresentation or omission). The scope of potential defendants includes the issuer, its directors and officers, and its controlling shareholders, among others. For each category of defendant, the legislation specifies an upper limit on liability, which is 5% of market capitalization in the case of the reporting issuer.
In addition, our legislation specifies several defences, including a due diligence defence, and treats most forward-looking information differently from historical information pursuant to what are commonly referred to as "safe harbour provisions". Specifically, forward-looking information is not actionable if accompanied by reasonable cautionary language and if the person or corporation making the forward-looking statement had a reasonable basis for concluding that the statement did not contain a misrepresentation.
In addition to possible exposure to statutory damages, the scope of disclosure and volume of documents required to be produced during documentary discovery in a case such as the claim against Exxon would be onerous in terms of time, resources, and expense for a corporation.
In conclusion, the Exxon lawsuit illustrates the potential dangers that lurk at the intersection of sound risk management, changing regulations, and the application of complex accounting principles.
Best practice would suggest that issuers may need to reasonably assess possible changes to the evolving Canadian legislative framework surrounding climate change and incorporate them in their accounting practices, and ensure any such assessments are accurately described in any public disclosure, to minimize their regulatory risk and fulfill their disclosure obligations to investors. In addition, when assessing the application of existing and anticipated regulatory requirements on an issuer's business and future prospects, the issuer's management should be mindful of the due diligence defence that is afforded by Canada's civil liability regime for secondary market disclosures. Creating and following well-articulated internal policies and robust, carefully-documented procedures for assessing materiality and preparing public disclosures should assist issuers in meeting their disclosure obligations and establishing a due diligence defence. Likewise, investors, M&A acquirers, securities underwriters and lenders should consider the impact of climate change legislation and follow any related litigation developments.
2 The Martin Act is the same statute that was used by former NYAG Eliot Spitzer to extract a US$1.4 billion settlement in September 2001 from ten US-based investment banks concerning their equity research practices.
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