On August 22, 2012, the Securities and Exchange Commission ("SEC") issued its final rule regarding disclosure of payments made to governments for the commercial development of oil, natural gas, or minerals. The rule implements Section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act"), which was designed to improve transparency and empower citizens of resource-rich countries to hold their governments accountable for the management of revenues derived from natural resources.2 The disclosure requirements under Section 1504 are in addition to another final rule adopted on the same day, which implemented Section 1502 of the Dodd-Frank Act. As discussed in our August 2012 Business Fraud Advisor, that rule imposed reporting requirements on issuers in connection with their use of certain "conflict minerals."3
Rule Scope and Reporting Requirements
Covered Entities, Activities and Payments
The SEC's new resource extraction rule applies to U.S. and foreign companies that 1) are engaged in the commercial development of oil, natural gas, or minerals, and 2) are required to file annual reports with the SEC. The rule applies to all such companies, regardless of their size or the extent of their activities constituting the commercial development of oil, natural gas, or minerals.4
The SEC broadened the scope of the rule through adoption of an expansive definition of the term "commercial development." Under the rule, payments related to exploration, extraction, processing, and export, as well as the acquisition of a license for such activities, would all be covered. Thus, the rule encompasses not only the types of mining and drilling operations that are at the core of the natural resources industry, but also related activities such as surveying, refining, processing and shipping.5
Issuers that meet these requirements must complete a new annual report reflecting all payments (or series of related payments) of $100,000 or more. This threshold reflects the SEC's interpretation of the Dodd-Frank Act's requirement that the rule cover payments that are "not de minimis." In adopting this definition, the SEC rejected suggestions that it implement a more flexible, and potentially higher, "materiality" threshold, arguing that "'not de minimis' was not intended to equate to a materiality standard." However, the SEC also rejected proposals from commentators that sought a much lower threshold (down to $10,000 in at least one case), finding that the $100,000 requirement would avoid the increased compliance burden associated with a lower cut-off.6
In addition, the rule applies not only to payments made by the issuer itself, but also to payments made by a subsidiary of the issuer or an entity under the issuer's control. With respect to joint ventures and equity investments, the SEC commented that the rule is not limited to entities for which the issuer provides consolidated financial information. Rather, issuers must determine whether they have control over the entity "based on a consideration of all facts and circumstances."7
Payments to any foreign government are covered by the rule, as are payments to the U.S. government. And while payments to U.S. state or local governments are exempted, the term "foreign government" also comprises state, provincial, municipal and other subnational governments, as well as any company majority-owned by a foreign government.8
Finally, "payment" is defined to include the following payment types: taxes, royalties, fees, production entitlements, bonuses, dividends, and payments for infrastructure improvements. With the addition of "dividends" and "payments for infrastructure improvements," this list represents a modest expansion of the types of payments enumerated in the statutory language of the Dodd-Frank Act.9 The SEC declined to adopt a broader, non-exhaustive list of payment types, and also omitted a catch-all category for "other material benefits." Therefore, the rule requires companies to disclose only those payments that are covered by the above-mentioned list of payment types. However, the rule also includes an anti-evasion provision designed to prevent companies from concealing or mischaracterizing the true nature of payments that would otherwise require disclosure.10
During the rulemaking process, a number of exemptions to the rule were considered but ultimately rejected. For example, there is no exemption for issuers that are subject to similar reporting requirements under home country laws or other mandates. Conversely, the rule does not provide an exemption for instances in which a foreign law prohibits a required disclosure. Accordingly, issuers cannot use the law of a resource-producing state as a shield against disclosure to the U.S. government. Rather, the SEC has, in effect, mandated that issuers disregard such foreign laws. Finally, the SEC's rule does not provide an exemption for confidentiality provisions in existing or future contracts that would otherwise prevent disclosure of commercially sensitive information.11
Form SD Requirements
Specific information required by the new report, designated "Form SD",12 includes:
The total amount of payments, by category;
The currency used for the payments;
The financial period in which the payments were made;
The business segment of the resource extraction issuer that made the payments;
The government that received the payments and the relevant country;
The projects to which the payments relate;
The type and total amount of payments for each project; and
The type and total amount of payments to each government.13
Companies covered by the rule will be required to file their first report for the period beginning October 1, 2013 through the end of the company's fiscal year, and annually thereafter.14 The Form SD must be filed within 150 days after the end of the issuer's fiscal year.15
Liability and Next Steps
Significantly, during the rulemaking process the SEC considered whether to require that resource extraction payments be "filed" or instead merely "furnished." The distinction amounts to more than mere semantics, as liability under Section 18 of the Exchange Act attaches only to false or misleading material statements and omissions that are filed in a report, application, or other document under the Exchange Act. Thus, by requiring payment information to be filed via Form SD, the SEC opened the door to lawsuits from persons who purchased or sold securities in reliance on any material misstatements or omissions contained in the new report. In addition, issuers could also face civil liability and significant penalties under Section 10(b)(5) of the Exchange Act for any misstatements or omissions of material fact.16
Furthermore, companies could face penalties and other repercussions overseas, as the European Union is expected to follow the U.S. government's lead and enact its own regulations. In fact, on September 18, 2012, the Legal Affairs Committee of the European Parliament approved draft legislation that requires the disclosure of resource extraction payments. In its current form, the draft law contains provisions similar to those of the SEC's final rule. For example, companies would be required to disclose payments of more than €80,000 (approximately $104,000), and would also have to disclose country and project-level information.17
In light of the potential consequences of non-compliance with resource extraction payment reporting requirements, companies should act quickly to update and implement necessary policies and procedures. In particular, companies should ensure that they are able to identify relevant government payments, as well as associated currency, country, project and other information. Companies should also stress the importance of compliance with the new rule to employees, and ensure that any efforts to circumvent the rule's reporting requirements are treated seriously. By the SEC's own measure, compliance with the new rule initially will cost the industry as a whole $1 billion, with additional ongoing costs of $200 to $400 million per year. 18 The costs of non-compliance, however, can be expected to be even more onerous, as alleged violators could face government investigations, penalties, and possible private litigation.
1 The Editors would like to thank James Treanor for his contribution to this Business Fraud Advisor.
2 Disclosure of Payments by Resource Extraction Issuers, Release No. 34-67717; File No. S7-42-10 (August 22, 2012) ("Final Rule Release") at 5-6, www.sec.gov/rules/final/2012/34-67717.pdf
3 Cadwalader, Wickersham & Taft LLP, SEC Issues Conflict Minerals Rule, Business Fraud Advisor (August 29, 2012), www.cadwalader.com/PDFs/newsletters/201208295326_BusinessFraudAdvisor_August_2012.pdf
4 Final Rule Release at 13.
5 The rule does not, however, cover ancillary or preparatory activities, such as the manufacturing of equipment and other products used in the commercial development of oil, natural gas, or minerals. Id. at 35.
6 Id. at 73-75.
7 Id. at 94.
8 Id. at 14-15.
9 Interestingly, the Commission appears to have rejected a requirement that bribes paid to foreign government officials in connection with resource extraction contracts be disclosed. As noted in the final rule, "[a]lthough one commentator submitted data regarding payments made by some oil companies for tuition, rent, and living expenses for the students [sic] and relatives of officials in Equatorial Guinea, those payments are not within the list of payments types specified by Section 13(q)." Final Rule Release at 75, fn 257 (emphasis added). This comment originated in a letter submitted by Senator Carl Levin, United States Senate Committee on Homeland Security and Government Affairs, to Elizabeth M. Murphy, Secretary, SEC, (February 1, 2011)
10 Final Rule Release at 58-66.
11 Id. at 13.
12 Form SD is also the reporting mechanism for information provided under the SEC's "Conflict Minerals" rule, issued under Section1502 of the Dodd-Frank Act.
13 Final Rule Release at 16-17.
14 Id. at 17.
15 Id. at 109-110.
16 Id. at 130, fn 477.
17 See Samuel Rubenfeld, European Parliament Panel Approves Extractive Transparency Legislation, Wall St. J. (September 18, 2012), http://blogs.wsj.com/corruption-currents/2012/09/18/european-parliament-panel-approves-extractive-transparency-legislation/?mod=google_news_blog
18 Final Rule Release at 140.