A high-stakes legal battle between ExxonMobil and the New York attorney general's office is roiling around documents held by the company's auditors. Those documents, usually dry disclosures that hold little public interest, could afford a candid—and perhaps damaging—glimpse into Exxon's private calculations of the business risks posed by climate change.
As part of a financial fraud investigation, state Attorney General Eric Schneiderman subpoenaed Exxon auditor PricewaterhouseCoopers last August for climate risk assessments by Exxon.
Investors and the public rely on those disclosures to assess the impact climate change could have on the company's profitability. If they are incomplete or misleading, the public could be misled about investment decisions.
Schneiderman could unearth anything from a smoking-gun email to revealing discussions related to Exxon's posture on climate change. They could show a conflict between the company and PwC over whether Exxon was adequately calculating its financial risks.
The documents have the potential to be some of the most unvarnished records exposing Exxon's assessment—and perhaps reluctance to fully gauge—the risk that climate change posed to its business.
Exxon says the records it provided PwC for review are privileged—much like the communications between lawyers and their clients—and should be kept from the eyes of investigators.
A Manhattan judge ruled in Schneiderman's favor last year, saying the Texas accountant-client privilege law Exxon is invoking to block the subpoena carries no weight in New York. The judge ordered PwC to hand over the records.
Exxon disagreed and rushed to appeal that ruling. A hearing is scheduled for March 21.
Schneiderman opened his financial fraud investigation of Exxon in November 2015 with a subpoena to the energy giant for decades of records related to its history of climate change understanding.
Exxon turned over more than 1.2 million pages of records, then refused to cooperate. At the same time, the company went to court in Texas to block the investigation.
Nine months later, the attorney general followed with a subpoena to PwC seeking documents related to the auditors' work for Exxon. Records sought include documents about accounting and reporting of oil and gas reserves, evaluation of assets for potential impairment charges or write-downs, energy price projections and the cost-benefit analyses of complying fully with regulations aimed at reducing greenhouse gas emissions.
N.Y. Prosecutors: Moral Obligation to Comply
Attorneys for Exxon argue that forcing PwC to surrender documents "eviscerates" the accountant-client privilege afforded by the laws of Texas, where Exxon is headquartered. "While the lower court may disagree with Texas's enumerated exceptions, it may not ignore them," according to a brief filed in the appellate division of the New York Supreme Court.
New York prosecutors argue that New York State law extends no such privilege. Further, they argue, PwC should feel a moral obligation to cooperate. "As a certified public accountant, PwC 'owes ultimate allegiance to [a] corporation's creditors and stockholders, as well as to the investing public,'" according to the attorney general's response.
The accounting firm, which has expertise in climate risks faced by fossil fuel companies, has remained neutral in the legal fight but has honored Exxon's request to withhold the documents, pending the outcome of the litigation.
Caroline Nolan, a PwC spokeswoman, said the company had no comment.
David Shapiro, an assistant professor of public management at New York's John Jay College of Criminal Justice, said state investigators likely will be seeking records documenting internal discussions that may expose conflicts; they will be seeking paper trails leading to unpublished appraisals, and for any incriminating smoking-gun emails and documents Exxon thought would never come to light.
Through documents obtained from the company by a separate subpoena, "the attorney general has Exxon's story," he said. "Now they want to see how PricewaterhouseCoopers viewed that story and if there were any conflicts."
'They Could Go Consultant-Shopping'
Investigators will be particularly interested in whether PwC engaged different independent consultants to double-check Exxon's books, estimates and assumptions. That's a common approach used by auditing firms to ensure records are scrutinized from various angles.
It's not unusual for an independent auditor to solicit two or three external analyses of a client's records. It then picks the one most in line with its client estimates and assumptions, said Shapiro, a forensic accountant and former FBI agent who specialized in financial crimes.
"If Exxon was looking for a specific valuation of oil reserves or a certain risk assessment conclusion, for example, they [PwC] could go consultant-shopping," Shapiro said. "In the final audit, everything might look clean."
"But you might never hear of other opinions."
Even if an outside specialist's opinion is not adopted, there still will be a contract for the work and a record of payment, a clue investigators will be looking to uncover.
"Finding that record will give investigators the opportunity to follow up with the outside consultant whose analysis was not adopted and ask the question, 'What did you find?'" Shapiro said.
Determining How Exxon Calculated Climate Risk
The auditor's job is to determine how accurately Exxon calculated risks posed by climate change.
But to do that, Exxon would have to be forthright in telling PwC what it knew about climate change, the potential for shifting oil demand, and how it took those factors into account when determining risk, said Kathy Enget, an assistant professor of forensic accounting and data analytics at the State University of New York at Albany.
Exxon performs its own risk calculations and asks its auditors to double-check its conclusions, including financial estimates that reflect how the company's worth could be impacted by various climate change scenarios. It is those work papers—records that never become part of a company's public disclosure—that investigators would want to review, she said.
"The auditor's records will show what information was used by the company in addressing whether there was risk associated with climate change," Enget said. "PwC would then have tested those conclusions, checking to see if they were reasonable."
PwC's records would reflect any questions it had regarding Exxon's assessment, and any recommendations for revising risks associated with climate change.
"There could be conflicts," she said. "The records would show the basis for those conflicts and how they got resolved."
Exxon ultimately decides—and is responsible for—what public disclosures it makes through the U.S. Securities and Exchange Commission. Among the world's largest oil companies, Exxon has been one of the most resistant to factoring climate change, and possible responses to it, in financial projections.
In a surprise announcement last year, the company revealed that it might cut estimates of its Canadian tar sands reserves, though the company cited no link to climate change. When it later did drop 3.5 billion barrels from its reserves, it attributed the move to dropping oil prices. While Exxon was contemplating that, word was circulating on Capitol Hill that the SEC had opened a probe into whether Exxon had been forthcoming with investors about climate change.
Building a Financial Fraud Case
Critical to New York's review of PwC records will be the depth of information Exxon provided, said Joel D. Schwartz, a former federal prosecutor.
"It's theoretically possible that by hiding what the company knew about climate change from auditors, it meant the company would not have to identify it as a financial threat," said Schwartz, who served as an assistant director of the Public Accounting Oversight Board. The non-profit organization was established by Congress to oversee the audits of public companies.
With a forthright assessment of climate change, however, it's conceivable PwC would have urged the company to write down—or devalue—its assets, Schwartz said.
If Exxon knew the extent of the risk posed by climate change and withheld that information, that could form the foundation of a fraud case, Schwartz explained, because investors would have relied on Exxon's climate risk accounting in making investment decisions.
"So what you're looking for is what did Exxon tell PwC, what kind of questions did PwC ask Exxon relative to climate change risks, and how was it ultimately resolved," Schwartz said.