Fraudulent Environmental Liability Estimates

Occidental Petroleum’s Failure to Disclose Environmental Liability

A landmark investigation into Occidental Petroleum’s environmental disclosures revealed that major incidents of environmental damage can also help regulators identify equally significant financial fraud in liability disclosures.

When corporate coverups of environmental damage are revealed, media coverage and independent investigations typically focus on how the company obscured environmental damage by misrepresenting scientific evidence, by hiding legal violations from regulators, or by funding misinformation campaigns. However, there is another significant form of deception that can enable industries to obscure the consequences of their environmental impacts: securities fraud.

This includes disclosures about the impacts of the costs of compliance with environmental laws on capital expenditures and earnings. It also includes the risk of potential liability resulting from violations of environmental laws.

To prevent false or misleading statements to investors, the U.S. Securities and Exchange Commission (SEC) regulates financial statements by all publicly traded companies with shares sold in the U.S. To identify companies who may be misleading investors about their environmental disclosures, the Dodd-Frank SEC Whistleblower program allows whistleblowers to make confidential reports about misleading disclosures. Whistleblowers who provide original information that leads to successful SEC prosecution can receive between 10% and 30% of monetary sanctions.

If a company omits the potential financial impacts of their environmental violations or the costs of future compliance in their financial statements, they can mislead investors about the company’s environmental record or the feasibility of its future plans. In addition to misleading investors, companies who misrepresent their liabilities can also gain an unfair advantage over companies with stronger compliance records or industries with less harmful environmental impacts.

After recent investigations revealed how oil and gas companies misled the public about the science of global warming for decades, there have been increasingly questions about whether oil and gas companies have enabled this deception by misleading investors about the extent of their environmental liabilities. While this may seem like a novel theory, a famous investigation into Occidental Petroleum’s failure to disclose environmental liabilities at the height of the anti-toxics movement in the 1970s demonstrates that this connection would not be a first for the oil and gas industry.

Occidental Petroleum’s Love Canal Liabilities

In the late 1970s, an infamous environmental tragedy that came to be known as “Love Canal” began when residents of a small community near Niagara Falls discovered that industrial waste dumped into a nearby, abandoned canal was leaching into their homes. The waste had been disposed of in the unlined canal and three other sites by Hooker Chemical, who was bought by Occidental Petroleum in 1968. Resident concerns soon prompted studies that linked the chemicals to a string of unusual cancers, birth defects, and other serious illnesses that had plagued the community.

A series of provocative protests by desperate residents captured media attention, making the story a symbol of growing national concern over toxic waste. The media attention also put significant pressure on the state and federal government to evacuate residents and remediate the site. In 1979, the Environmental Protection Agency and the Department of Justice sued Hooker Chemical and Occidental Petroleum for USD$124.5 million dollars for clean-up costs and reimbursement for relocating the affected residents. In 1980, the state of New York also sued for USD$635 million in damages.

While Love Canal became a symbol of the dangers of toxic waste and how companies can deceive the public about those dangers, it also crucially revealed how companies could obscure the impacts of those dangers by misleading investors. By 1977, Occidental Petroleum, through its wholly owned subsidiary, Hooker Chemical, was exposed to significant potential liabilities, estimated at $680 million dollars, due to Hooker Chemical’s previous ownership of the Love Canal site and the three adjacent hazardous waste sites. Yet, in Occidental’s 1977 Annual Report, there was no mention of the specific nature or scale of these liabilities. Instead, the Report ambiguously stated that “[i]n light of the expansion of corporate liability in the environmental area in recent years…, there can be no assurance that Occidental will not incur material liabilities in the future as a consequence of the impact of its operations upon the environment.”

Omissions related to the Love Canal scandal drew attention to the company’s disclosures, but a subsequent SEC investigation also discovered a much larger pattern of obscuring environmental liabilities. While Occidental Petroleum’s 1977 Annual Report acknowledged the possibility of environmental liabilities, it failed to provide estimates of substantial potential liabilities the company had acquired as a result of its subsidiaries’ frequent failures to comply with environmental regulations. The investigation found that, between 1974 and 1976, the company had failed to disclose a total of 90 administrative and judicial proceedings, the majority of them related to similar acts of improperly disposing of waste or excessive emissions.

The company had failed to disclose, for example, that another wholly owned subsidiary, Island Creek Coal Company, faced criminal misdemeanor actions for polluting streams in West Virginia. The company had also failed to disclose that federal authorities were contemplating criminal litigation in relation to falsified Air Pollution Emissions forms at a chemical plant in Florida. In descriptions of capital expenditures and earnings, the company’s annual report omitted information about how the costs of future environmental compliance, particularly related to consent orders, would impact capital expenditure and earnings.

The investigation also drew attention to a number of other non-environmental omissions. Occidental had delayed disclosing to investors negative developments at a refinery near London that had reduced the value of the refinery by $90 million. The company had also omitted information about risks, including the significant risks posed by a deal with the Libyan government.

In 1980, the SEC ordered Occidental Petroleum to disclose the hundreds of millions to dollars related to potential liabilities. To settle the allegation that it had failed to properly disclose the liabilities, the company agreed to appoint an Environmental Director who would prepare a report for the Board of Directors on environmental liabilities.

Key Takeaways from the Case

As concern about hazardous waste reached a peak, an investigation into Occidental’s environmental disclosures revealed an important connection between a company’s record of environmental violations and its ability to obscure that record from investors. The outcome also set a significant precedent for the level of specificity required in environmental liability disclosures.

Since then, enforcements based on environmental liabilities have been rare but significant. For example, in 2012 BP paid $525 million to settle SEC allegations that it misled investors about environmental liabilities resulting from the Deepwater Horizon spill in the Gulf of Mexico. In 2014, Anadarko Petroleum (now owned by Occidental Petroleum) paid $5.15 billion to settle a fraudulent conveyance case in which its subsidiary Kerr McGee had been accused of understating environmental liabilities in order to spin off the liabilities into a new company destined for bankruptcy.

As the world increasingly moves to reduce carbon emissions, even more attention will be focused on the environmental liabilities that fossil fuel companies disclose. A series of investigations into the disclosures made by coal companies and a recent securities fraud case against Exxon suggest that a focus on fossil fuel disclosures will increasingly probe a potential connection between the industry’s deception over environmental harm and potential financial fraud. As the Occidental case demonstrates, the impact of such a case on the industry could be substantial.

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