Politicized law enforcement and the ExxonMobil white whale

The latest lawsuit against ExxonMobil (EM), filed by Acting New York State Attorney General Barbara Underwood, is straightforward:

• EM uses one general “proxy cost” for the costs of prospective greenhouse gas (GHG) policies averaged over the entire firm’s worldwide operations.
• EM uses different GHG proxy costs for specific projects in particular locales.
• Therefore, EM is misleading investors by maintaining, figuratively, two (or perhaps multiple) sets of books.

{mosads}Got that? Underwood actually is arguing that EM should not concern itself — or its investors — with (1) the aggregate effect of GHG policies on prospective worldwide demand conditions for its energy products, and (2) the costs of the specific GHG policies applicable in given locations as it evaluates the business-case analytics of projects in particular nations. And by doing both, EM is engaged in “fraud.” This literally is like saying that a delivery company is engaged in fraud if it uses an average fuel cost for evaluation of its worldwide operations but a specific fuel price for evaluation of its costs in a specific nation with, say, high taxes on motor fuels.

Underwood has made this “fraud” allegation in the context of New York’s Martin
Act, which is aimed at material misrepresentations. Nowhere in her complaint does she point to an actual purported misrepresentation. Instead, the complaint continually offers arguments about appropriate accounting standards, without claiming that EM violated the actual accounting standards that now govern corporate bookkeeping.

Even if we assume solely for discussion purposes that those existing standards are inadequate or in need of reform: Is litigation the proper vehicle for that? Or would it not be better if a board charged with establishing such standards were to undertake that task in the context of public testimony by experts?

In a larger context, Underwood’s “fraud” stance is irrelevant in the context of investor behavior. Does she believe that investors as a class are stupid? The cost of GHG policies, whether as an international average or as estimated for given projects in specific locales, are useful for planning and for decisions on specific investments, but they are likely to be largely irrelevant for investors because there is no reason that marginal investors cannot see beyond them. Suppose that EM assumed a future GHG policy cost of $1 million per ton; would the market believe that?  That is why EM’s choices among a high figure, a low figure, a single figure, or multiple ones in different contexts are irrelevant. No one is being “defrauded.”

Let us take a step back: Virtually every state attorney general sees in the mirror a future governor or senator or — even a president. Accordingly, Underwood is hardly the first state attorney general to perceive political benefits from pursuing EM. Before Underwood there was then-New York state Attorney General Eric Schneiderman, who for almost three years pursued EM, the great white whale of political pole climbing.

First, there was his argument that the firm had misled investors by downplaying the risks of anthropogenic climate change in order to prop up the value of its shares. In a nutshell, Schneiderman asserted that EM knew back in the 1970s that anthropogenic climate change was destined to create a future crisis. (That was unknown then and remains unknown today.)

Accordingly, Schneiderman argued, EM knew that the world will turn away from fossil fuels (nope) and therefore that it knowingly was overestimating the value of its fossil-fuel reserves. Schneiderman’s argument actually was worse than just summarized: Under clear regulations from the Securities and Exchange Commission, the value of reserves must be estimated using average oil prices for the previous year. 

Schneiderman then tried to make the opposite argument. EM in its planning analyses used two different figures for the future cost of climate regulations: a public figure of $60 per ton of GHG for projects in the advanced economies, but only $40 in its internal analyses. In other words, EM, instead of trying to prop up its share value as asserted earlier, tried this time to put downward pressure on it. Well, which was it?

Note also that EM, like other private entities with large capital investments, is a long-lived entity with powerful incentives to protect its credibility. Underwood has not explained how EM benefits over the longer term by publishing false or multiple estimates of hypothetical future GHG costs. Even in the extreme case in which EM “knows” what future GHG policies will be, but has misled others, it would not be long before market participants understood that reality. Because those observers’ beliefs about future GHG policies would vary, there would be a statistical distribution of such beliefs. Market participants would know that EM might not be telling the truth, so the effect would be to shift the entire distribution of beliefs about EM’s value to the left. The market in effect would hedge against the possibility of being misled. 

Future GHG policies and their costs are far less obvious than Underwood pretends. What is obvious is that she, like Schneiderman before, has decided to attack a firm that is not popular politically. That is not the way law enforcement is supposed to work in a constitutional republic governed by the rule of law. Instead of picking an unpopular target and then trying to find a way to convict it of something, prosecutors are supposed to wait until evidence emerges of an actual crime, after which sufficient evidence to demonstrate probable cause must be marshalled against a specific suspect, who then is afforded a legal presumption of innocence until convicted in a court of law governed by the rules of due process. That is how freedom is preserved, however unpopular the target. Down Underwood’s path lies a land called autocracy.

Benjamin Zycher is a resident scholar at the American Enterprise Institute