For the past 23 years, my “partners” and I have defrauded each and every one of you…
At least, that’s how the state of New York saw it.
Until just last month, New York was working hard to extract a huge fine from us. It didn’t work out that way. In fact, the story recently made headlines. I’ve escaped justice… And I won’t have to pay a dime.
Granted, if New York had its way, I would have essentially paid restitution to myself. So it’s hard to say if I’ve won or lost.
Today, I want to explain all the details about how I found myself in this ridiculous situation… how the chances are good that you’ll find yourself in a similar quandary at some point, if you haven’t already… and what you should do if it happens.
Let’s start in the 1980s, when I was growing up in Virginia…
My mom’s mom, Granny, lived with us. She was a creature of habit. Every morning, as I walked into the kitchen for breakfast, she’d rattle off the latest on ExxonMobil’s (XOM) stock…
“Up six cents, heavy volumes.”
If it was baseball season, Granny gave me an equally brief morning update on the Atlanta Braves, which usually involved complaining about the bullpen. I was more interested in that. But looking back, maybe the seed for a stock-picking passion was being planted…
Granny had worked for years through the 1950s and 1960s at “Esso” – as it was still called back then. She wrote memos and letters for executives – on a typewriter – and socked away a few dollars from every paycheck into Esso stock.
Those shares became the basis of her retirement… which is why she was constantly watching the stock price.
In the mid-1990s, long after the company became ExxonMobil, Granny gave me 20 of her shares as a birthday gift. At the time, they were probably worth about $1,200 total.
I remember getting my first dividend check… for $14. As Granny pointed out, “There’s not much you can do with $14, is there?”
Then, she explained the power of dividend reinvestment plans (“DRIPs”)…
Instead of receiving dividends in cash, you use the payout to automatically buy more shares. It’s a great way to compound your holdings over time. And it’s how Granny had socked away enough shares to retire.
I liked the idea. So Granny pulled down her old Smith-Corona typewriter and, just like old days, dashed off a corporate letter to enroll my shares in a DRIP.
After two share splits and roughly $3,500 worth of reinvested dividends, I own 147 shares of ExxonMobil’s stock. As of last August, my total stake is worth about $11,000. That isn’t life-changing money for most of us… And the returns have been only slightly better than the broad market over the past two-plus decades.
But because I’ve held onto these shares through the years – because I own ExxonMobil stock at all – I ended up in the crosshairs of New York regulators, along with the oil company itself.
I’ll explain exactly why in a moment. But first, you need to understand that what happened with ExxonMobil is a symptom of a much larger regulatory epidemic.
You see, lawsuits can be hard work – and a massive waste of time – for everyone involved…
Years of evidence discovery. Dozens of witnesses to interview. Proving intent. Navigating gray areas. Not to mention the docket jockeying and inevitable appeals process. It’s all so… exhausting. If only there were an easier way to punish companies who do bad stuff.
As it turns out, clever regulators and lawyers believe they’ve discovered a solution…
In recent years, they’ve started exploiting a convenient “loophole” in securities law – the rules that govern publicly traded entities.
In short, regulators can punish companies for all kinds of naughtiness by charging them with securities fraud… but probably not for the traditional spirit-of-the-law reasons that come to mind like old-fashioned insider trading and stock price manipulation.
Essentially, the loophole is stated in the law as “a material misrepresentation or omission to shareholders.”
We’ll simply characterize it as “lying to shareholders.”
And recently, regulators like the U.S. Securities and Exchange Commission (“SEC”) and the New York attorney general’s office have been stretching the definition of what constitutes misrepresentation.
What’s more, scores of law firms are engaging in an opportunistic form of “ambulance chasing” involving securities… by exploiting this law designed to protect shareholders.
This loophole really centers around what constitutes “adequate disclosure”…
Any time a company does a “bad thing,” the company needs to explicitly disclose the bad thing to the public. Otherwise, that can be considered securities fraud.
For example, in late July 2018, various women alleged sexual harassment against CBS Chairman Les Moonves. The stock immediately fell 11% after the news broke. Moonves ultimately lost his job and forfeited $35 million in compensation in the fallout.
But that isn’t where the story ended…
Various firms still brought a class-action lawsuit against CBS for failing to disclose the apparent widespread sexual harassment at the company. An amendment later alleged other insiders sold shares knowing the misconduct would come to light – falling under insider trading. But the sinking stock price combined with the “lack of disclosure” was all these firms needed to allege securities fraud.
And the truth is, shareholders will likely end up footing a bill of around $50 million to defend the company against the charges.
As you can see, this loophole leaves a lot of room for interpretation…
The act of lying usually isn’t against the law. When you catch a friend, a co-worker, or a politician in a lie, you can’t press charges. The part of the First Amendment about freedom of speech generally protects our right to lie to each other.
One of the notable exceptions is that publicly traded companies can’t lie to their shareholders… That actually is illegal. And it makes sense because you don’t want folks investing based on lies. Clearly, protections are necessary.
Consider what happened with theme-park operator SeaWorld Entertainment (SEAS)…
In 2013, the documentary Blackfish suggested that cruel practices and questionable conditions led an orca whale held at SeaWorld in Orlando to pull its trainer into the water, ultimately killing her. The backlash against the theme-park chain was strong…
The documentary led to months of news articles about the captivity of killer whales. Angry musicians even refused to perform at SeaWorld parks.
While traditional media and social media skewered the company in the court of public opinion, SeaWorld attendance remained surprisingly stable… falling only 1%-2% in the quarters following the Blackfish controversy.
SeaWorld told investors the dip was due to the timing of the Easter holiday and other factors. That explanation, as it turns out, was a mistake.
An investigation revealed that SeaWorld executives actually believed that Blackfish had been the cause of the tepid attendance numbers, not the Easter holiday.
The SEC and various securities law firms ended up going after SeaWorld… not for treating animals badly, but for lying to investors about the source of the attendance decline.
Rather than dealing with a difficult legal gray area, the regulators and lawyers exploited the “don’t lie to shareholders” loophole.
In the backlash of the orca tragedy, SeaWorld paid more than $5 million in fines. The crime? Well, technically… securities fraud.
Bloomberg’s Matt Levine is the ultimate authority on these types of cases. “Every! Thing! Is! Securities! Fraud!” is a running theme in his columns. Every week, he has new material to cover.
Why? Because when a company does something bad, the easiest road to punishment for regulators has become to contort the facts into a convoluted “securities fraud” narrative.
That brings us back to ExxonMobil and my role in its saga…
In 2015, Eric Schneiderman, New York’s attorney general, opened an investigation to determine if ExxonMobil had “lied to the public about the risks of climate change.” By 2016, other attorneys general had joined in.
At a March 2016 press conference, Massachusetts Attorney General Maura Healey piled on, noting that companies like ExxonMobil:
Have deceived investors about the risks climate change poses to the planet and to their bottom lines [and]… must be held accountable.
Did you catch that? The focus of the investigation had shifted. This was no longer an accusation about ExxonMobil destroying the planet. This was now an accusation of deceiving investors by not disclosing its supposed role in climate change.
It became clear at that grandiose March 2016 press conference that the weapon these states would use to destroy ExxonMobil on climate change would be… securities fraud.
And, as with all securities fraud cases, the regulators and lawyers making the allegations had to position themselves as protecting the shareholders. (As a shareholder, I have no way of objecting to this “legal help.”)
Specifically, the attorneys general accused ExxonMobil of not reserving enough money to cover the true cost of its climate change liabilities.
Had the true liabilities been disclosed, the accusers assert, investors would have valued the business at a lower amount. Therefore, securities fraud!
Now look… I want to be very clear. Companies that do bad things should be punished and held accountable for their actions.
Mistreating animals is bad. Sexual harassment is inexcusable.
But the problem with these enforcement loopholes used by regulators and lawyers is that they ignore the actual victims of these transgressions.
When attorneys general came after ExxonMobil, they did so under the guise of protecting Bryan Beach, the shareholder.
But the public – the smog-choking victim of ExxonMobil’s alleged climate-destroying malfeasance – gets nothing but a couple of headlines to read.
If you find this whole arrangement incredibly stupid, you’re not alone…
Here was Levine’s take:
For one thing, if you actually think that ExxonMobil is engaged in a diabolical conspiracy to suppress climate science to wring extra profits out of an earth-destroying business, the last people you should be worried about are Exxon’s shareholders. They’re the ones profiting from all that destruction!
For another thing, if you are concerned about those shareholders, the last thing you should do is fine Exxon a lot of money. They’re the ones who will ultimately have to pay that money!
According to Schneiderman and his band of grandstanding attorneys general, in an odd way, I defrauded myself.
I was therefore entitled to compensatory damages which, unfortunately, I would have had to pay myself. This “payment,” to be clear, would come in the form of lower earnings and dividends from ExxonMobil stock… so I wouldn’t literally be writing myself a check.
This happens with all these cases…
That $5 million SeaWorld settlement isn’t going to some animal health organization… Around 30% went to the SeaWorld shareholders and 70% went straight to the SEC’s coffers.
And remember those law firms attacking CBS… They aren’t representing the women that Moonves allegedly groped – those firms are representing shareholders.
Any penalty extracted will be paid by the company (i.e., the shareholders) in the form of thousands of checks written to those same shareholders. The law firms, of course, keep a large cut for themselves.
At the core of this situation lies the precarious relationship between a company’s shareholders and its management team…
In this, Granny was a noteworthy exemplar. She took her role as an ExxonMobil “business owner” very seriously. She was a stickler for corporate expenses as much as an effective bullpen.
One time, through some kind of clerical mistake, the company calculated Granny’s dividend incorrectly. It was off maybe a few hundredths of a cent per share. The company mailed her a check for $0.04 to correct the error.
Out came the old Smith-Corona typewriter…
Granny dashed off a missive chastising management for “wasting $0.25 in postage to mail me a check for $0.04.” I explained to Granny that the whole thing was probably automated… and that there was nobody down in Texas making a conscious decision to mail out $0.04 checks.
“Well then, computers are stupid,” Granny groused as she lined up the typewriter page. “I’ll be sure to tell them that, too.”
I can’t imagine how Granny would feel about ExxonMobil paying lawyers tens of millions of dollars to defend itself against lawsuits that might require one set of shareholders to write a check to another set of shareholders.
The whole situation seemed so outrageous, I reached out to a securities lawyer to make sure I wasn’t missing something…
Unfortunately, I wasn’t.
It may seem odd to extract a penalty from shareholders like me for the sins of company management. But the lawyer explained the daisy chain of command…
If ExxonMobil’s management purposely defrauds mankind, the malfeasance drifts up to the board of directors… and ultimately up to the shareholders (i.e. business owners) who elected that board of directors.
The buck stops with the shareholders. This seems silly. But it does, in a way, make sense. I mean, who else would pay the penalty, if not the owners?
A New York state judge ruled in favor of ExxonMobil last month…
He said the attorneys general “failed to establish by a preponderance of the evidence” that Exxon had misled its shareholders.
But the company still faces a similar fraud case filed by the Massachusetts Attorney General. And the New York Times reports that several other cities and counties are going after the oil industry, seeking compensation for costs associated with climate change.
Moreover, as we’ve seen today, folks will attack companies in all kinds of industries. You’re going to see a lot more of this regulatory strategy in the years to come.
So what do you do if you find yourself in my position? It depends.
Shareholder lawsuits and SEC fines and settlements can be big, market-moving news…
Once SeaWorld’s management admitted that the Blackfish movie had hurt attendance, shares fell 35% from $28 to $18 in just three trading sessions. More than five years later, the market has forgotten all about Blackfish. SeaWorld shares trade at about $35 today.
These situations are complicated. As is often the case, SeaWorld had legitimate price pressure other than the drama that attracted the regulators and lawyers.
But bad headlines and avoidable drama generally can’t turn an otherwise good business into a lousy one…
Over the long term, the market has a way of forgetting about this stuff.
So keep your eye on the news, but don’t dwell on headlines. If you’re committed to a business for the long term, you don’t necessarily need to bail on it because of some noise related to regulators and opportunistic lawyers.
Look, I don’t love ExxonMobil’s business. I never really have. But I’m not ashamed to be associated with my shares, whether the state of New York considers me part of a fraudulent scheme or not.
It may be sentimental, but I doubt I’ll ever sell. I own ExxonMobil for the same reason I listen to the Atlanta Braves broadcasts every night. Granny’s stock. Granny’s team.
Speaking of that: If you do have a long-term holding, and you also have grandkids… why don’t you throw them a few shares for their birthday? They may end up writing about it 30 years later.
Good investing,
Bryan Beach
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Source: Daily Wealth