"If Exxon's disclosure is deficient, what of the failure of renewable energy companies to list climate change as a risk?...If climate change is perceived to be slowing or becoming less of a risk, many 'clean energy' companies may become less valuable and some may be altogether worthless. Therefore, any fraud theory requiring more disclosure of Exxon would surely require more disclosure by 'clean energy' companies."
So wrote thirteen Republican state attorneys general in an open letter to the coalition of their Democrat peers that categorized climate change skepticism as possible securities fraud earlier this year. While the Republican group claims that, unlike the Democratic coalition, they have no desire to launch legal investigations into renewable energy companies and their backers, the letter outlines just how ugly the debate surrounding the so-called climate change fraud investigations could become.
Climate change and the truth
The investigation into Exxon Mobil (NYSE:XOM) was launched last November by New York State attorney general Eric T. Schneiderman. The investigation, which was launched alongside a subpoena, is focused on whether or not the company lied to its investors about the threat posed to its earnings by climate change. Specifically, the investigation focuses on research conducted by the company's own employees in the 1970s and 1980s about the contribution of fossil fuel greenhouse gas emissions to climate change. The implication here is that the company knew that its business was contributing to climate change, and by extension, should have warned investors of a potential backlash against fossil fuel investments by the broader public.
The immediate cause of the Democratic coalition's investigation was the discovery that the management at Exxon Mobil failed to take seriously its own researchers' warnings in the 1970s about the contribution of anthropogenic greenhouse gas emissions to climate change. In other words, Exxon Mobil's management allegedly committed fraud by failing to acknowledge the risks to its earnings posed by climate change in official securities filings (management did permit the publication of the findings in the refereed literature, however, making it difficult to argue that a cover-up took place).
The investigation has grown in scope and scale since last November, first as additional Democratic state attorneys general launched their own investigations in March. This move has triggered additional investigations into the Democratic investigations by Republican members of Congress. What was initially presented as a mere (albeit unprecedented) securities fraud investigation has morphed into a broader partisan debate about free speech, climate science, and corporate duties.
This is a debate that strikes very close to home for me. I routinely write about energy companies, both fossil and renewable, here on Seeking Alpha. Frequently, I take a stab at calculating an energy company's valuation. On occasion, I own shares in the company that I am valuing (always with the proper disclosures at the end of the article, of course). Due to my backgrounds in the law and energy policy, I also consider the earnings of these companies in the context of energy policy programs such as the Clean Power Plan, revised Renewable Fuel Standard, renewable energy tax credits, and so on.
What I don't do is consider their earnings in the context of climate change within a vacuum, however. Yes, it is possible that a broad voter backlash against climate change would result in the implementation of new laws restricting greenhouse gas emissions - notwithstanding past failed efforts to do so here in the U.S. But I don't have the gift of clairvoyance, let alone any idea as to what those future policies would look like after surviving the meat-grinder that is Congress, or even if they would be implemented.
Indeed, I lost money on an investment in nuclear power utility Exelon (NYSE:EXC) that was made in part on the expectation that 2008 truly was the "moment when the rise of the oceans began to slow." Armies of political pundits were unable to predict the failure of the American Clean Energy and Security Act of 2009. If analysts can't even assume that legislation supported by the political party with the White House, a majority in the House of Representatives, and supermajority in the Senate will be implemented, how can the timing and shape of legislation that hasn't even been introduced yet be predicted? How can the impacts on corporate earnings be known in advance with any accuracy?
Fraud, denial, and alarmism
Nonetheless, here's what the Democratic coalition of state attorneys general had to say on the matter last March:
"If there are companies-whether utilities or fossil fuel companies-committing fraud in an effort to maximize their short-term profit at the expense of the people we represent, we want to find out about it and want to expose it and we want to pursue them to the fullest extent of the law, prosecute them to the fullest extent of the law."
The Democratic coalition has limited its crosshairs to fossil fuel companies and utilities for the time being. As their Republican counterparts point out, however, it is a small step to expand the investigation to include individuals. Approaching the debate from the other side of the political spectrum, the Wall Street Journal was quick to find what it terms "arguably mislead[ing]" statements made by former senator and vice president Al Gore regarding the value of clean energy companies, including those that his venture capital fund have invested in such as SolarCity (NASDAQ:SCTY), in the context of climate change "alarmism." Even those of us who write about energy firms could conceivably be covered by the Democratic coalition's definition of fraud were it to be applied to individuals, especially if we make investments in those firms on the basis of our opinions regarding the magnitude (or lack thereof) of climate change.
This is why the precedent that the Democratic coalition of attorneys general is intent on establishing is so concerning: It essentially requires energy companies, their investors, and potentially the analysts who cover them to have a level of scientific and political knowledge if they are to avoid fraud allegations that is well beyond that required in the past. Securities fraud in the energy sector has historically taken the form of companies falsely inflating the value of past capital inflows or failing to report actual losses.
The Exxon Mobil investigation takes what has been a backward-looking requirement and expands it to include the future. Statements of past returns are being replaced by computer model forecasts of future conditions as the cause of action. Exxon Mobil was supposed to have known not just that its 1970s computer models were capable of accurately modeling an incredibly complex global weather system, but that they were capable of modeling it at the high-granularity level necessary to predict the policy consequences of the modeled climate shift.
That isn't the only requirement posed by this new version of fraud, however. In addition to being forward-looking, it also requires corporate management to know when the scientists are correct. It is often said that the scientific consensus supports the contention that humans are causing global climate change, and this is correct. Even now, however, one in six climate and earth scientists still hold the opinion that the human role in climate change is "little or none." A minority, to be certain, but minority opinions in science often become the consensus with time.
As an example, at one point, the majority of physicists, Albert Einstein among them, believed that black holes were incompatible with reality. We now know that not only are black holes abundant in the observable universe, but that complex life only exists because of them. It is a tall order to require companies to be able to distinguish between minority opinions that will forever remain in the minority, such as the now-discredited link between childhood vaccines and autism, and those that will eventually become the consensus, such as the existence of black holes and anthropogenic climate change.
Climate science is incredibly complex due to the chaotic nature of the planet's weather systems. Climate change magnitude and timing estimates are quite uncertain as a result. The 21st century has witnessed a "pause" or "slowdown" (researchers cannot agree as to which) in global warming that wasn't predicted by climate models. This unexpected development led to numerous Congressional hearings and gave rise to the "global warming is a hoax" sentiment that is common in some circles. (There is a growing consensus among climate scientists that the pause only occurred, in as much as it did, because the oceans have been absorbing a great deal of heat that would have otherwise shown up in the atmosphere. Any pause is therefore temporary, and in any case, it is causing major damage to the world's ocean ecosystems.)
Imagine that Exxon Mobil had listened to its researchers in the 1970s and warned its investors of the long-term threat to its earnings in the name of full risk disclosure. Now imagine that Republican attorneys general in office in the 2000s had utilized the new definition of fraud just as evidence of a global warming pause was coming to the forefront. Would all of those attorneys general have been willing to overlook the fact that shareholders had apparently been harmed by the company's reliance on relatively rudimentary climate models? Or would they, in the interest of attacking corporate fraud, have investigated Exxon Mobil for hurting shareholder value by relying on early computer models that were not supported by the evidence at the time?
This is not as absurd a thought exercise as it may appear at first glance. Imagine that another unpredicted pause occurs at some point in the near future. The Democratic coalition's new fraud definition has become precedent. Republican attorneys general will have the grounds and quite possibly the will to investigate clean energy firms and their backers for committing fraud in the form of "climate change alarmism." By changing the definition of securities fraud in this way, the Democratic coalition is potentially setting the stage for the vagaries of climate change to become the basis of legal attacks against opposing ideologies rather than just of political attacks.
Fraud in the future
In the interest of full disclosure, I should point out that I am in the camp that believes that climate change is occurring, and that it will ultimately impose tremendous costs on the global financial system as its impacts increase in magnitude. I have also spent several years advocating for the implementation of a revenue-neutral carbon tax in the U.S. Climate change is a major risk that is currently underappreciated by investors. I can certainly empathize with the Democratic attorneys general coalition's ultimate goal. It probably isn't a coincidence that Total (NYSE:TOT) cancelled plans to exploit Arctic hydrocarbons and tar sands after the Exxon Mobil investigation was first announced.
That said, the Democratic coalition is pursuing a dangerous means of achieving its goal of reducing greenhouse gas emissions. Its unprecedented definition of fraud threatens to impose an undue and possibly unachievable regulatory burden on energy firms and their investors. New York's attorney general position has a great deal of sway over corporate law given its jurisdiction over some of the world's most important financial markets. A successful fraud conviction against Exxon Mobil in the state would quickly lead to the adoption of the expanded fraud definition by plaintiffs' attorneys and prosecutors in New York and other states.
Most concerning, however, is that the expanded definition's scope might not just be limited to fossil energy firms. The Democratic coalition's Republican counterpart has already raised the prospect of individuals being investigated for climate change fraud, albeit of a very different type than the form that Exxon Mobil is alleged to have engaged in, in addition to clean energy firms. Bringing the weight of the law to bear against politically-unpopular firms for failing to heed the results of computer models that we only know to have been correct with the benefit of three decades of hindsight is the wrong way to combat climate change, and it could end up doing as much harm as good.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.