The Securities and Exchange Commission has once again proposed a rule requiring oil, gas, and mining companies to disclose payments made to governments for extraction rights. And, once again, legal teams are sharpening their pencils as covered companies sweat the details.
An earlier rule, back in 2012, lingered for years before it was squashed by an industry lawsuit. The re-written rule addresses those earlier concerns—sort of—but leaves plenty of gray areas and room for interpretation, which doesn’t sit well with compliance teams.
The proposed rule, like its predecessor, would implement Section 1504 of the Dodd-Frank Act. It requires public companies involved in the extraction of natural resources to annually report payments made by themselves—as well as by their subsidiaries and entities they control—to governments for the commercial development of oil, natural gas, or minerals.
The SEC adopted rules to implement the mandate back in 2012, but they were subsequently vacated after a successful lawsuit by the American Petroleum Institute. Fast forward to September 2015 and Oxfam America prevailed with a lawsuit of its own, demanding that the SEC make good on its promise to redraft the rules.
The new proposal, released on Dec. 11, would require domestic and foreign issuers to disclose government payments at the project level. These public disclosures will be filed annually with the Commission on Form SD and electronically tagged using the eXtensible Business Reporting Language (XBRL) format. Companies would be required to file Form SD no later than 150 days after the end of their fiscal year.
Payments that must be disclosed include those made to further the commercial development (defined as exploration, extraction, processing, and export, or the acquisition of a license for any such activity) of oil, natural gas, or minerals and are “not de minimis,” defined as any payment, whether one-time or a series of related payments, which exceeds $100,000 during the same fiscal year.
The proposing release notes that the Commission could provide exemptive relief from these requirements on a case-by-case basis.
The proposal, despite efforts to resolve issues raised by the court decision that vacated initial reporting demands, is still not currying much favor with API. “Our industry has been working hard to increase transparency for more than a decade, but this rule could interfere with ongoing efforts by making U.S. firms less competitive against state-owned firms not covered by this rule,” says Stephen Comstock, API’s director of tax and accounting policy.
Comstock says the industry has been working globally since 2003 to implement the Extractive Industries Transparency Initiative, a program that has now been implemented in 49 countries. New rules could interfere with those efforts, he claims, a concern that was echoed by the U.S. District Court when it vacated the initial rule.
“Our industry has been working hard to increase transparency for more than a decade, but this rule could interfere with ongoing efforts by making U.S. firms less competitive against state-owned firms not covered by this rule.”
Stephen Comstock, Director of Tax and Accounting Policy, API
“The SEC rule would only apply to U.S. firms, placing them at a competitive disadvantage against government-owned oil giants not subject to the rule,” Comstock added. Firms would need to reveal extensive data about how much they pay in licenses, taxes, royalties, and other fees, “potentially giving their competitors an upper hand when bidding for future energy contracts.”
Will API file yet another lawsuit? Comstock didn’t say, and a spokesman for the organization declined to comment on that prospect.
Also unhappy with the redrafted rule is SEC Commissioner Michael Piwowar. He also took issue with requirements that could put publicly-traded companies at a competitive disadvantage to private companies and foreign companies that are not subject to Commission reporting requirements. The disclosure of project-level payment information could also “be used by third-party actors, including non-profit and non-governmental organizations, as a means to extract their own payments in return for not opposing various projects throughout the world.”
Questions now facing oil, gas, and mining companies include whether litigation will once again delay and shape a final rule. More importantly, how should they begin to approach compliance?
The District Court took issue with the SEC’s demand for public disclosures of each report instead of a periodic compilation. The court also deemed it “arbitrary and capricious” that the SEC would offer no exemptive relief for companies that wanted to withhold disclosures because the laws of the country hosting a project would prohibit it (whether any such laws are currently enforced remains an argumentative debate).
PROPOSED RULE HIGHLIGHTS
The following is from a fact sheet the Securities and Exchange Commission issued regarding a proposed rule on the disclosure of payments by resource extraction issuers.
Who Must Disclose:
The proposed rules would require a domestic or foreign issuer to disclose payments made to governments if:
The issuer is required to file an annual report with the Commission under the Securities Exchange Act (Exchange Act); and
The issuer engages in the commercial development of oil, natural gas, or minerals.
In addition, a resource extraction issuer would be required to disclose payments made by a subsidiary or another entity controlled by the issuer. For purposes of the rule, control would be determined by reference to financial consolidation principles that the issuer applies to the audited financial statements in its Exchange Act annual reports.
What Must Be Disclosed:
Under the proposed rules, a resource extraction issuer would be required to disclose certain payments made to a foreign government, including foreign subnational governments, or the U.S. federal government.
Resource extraction issuers would need to disclose payments that are: made to further the commercial development of oil, natural gas, or minerals; “not de minimis”; and within the types of payments specified in the rules.
The proposed rules would define commercial development of oil, natural gas, or minerals to include exploration, extraction, processing, and export, or the acquisition of a license for any such activity. The proposed rules would define “not de minimis” as any payment, whether a single payment or a series of related payments, which equals or exceeds $100,000 during the same fiscal year.
The types of payments related to commercial development activities that would need to be disclosed include: taxes; royalties; fees (including license fees); production entitlements; bonuses; dividends; and payments for infrastructure improvements.
The proposed rules would clarify the types of taxes, fees, bonuses, and dividends that are required to be disclosed and how they should be disclosed. This list of payment types would be consistent with the requirements of the European Union, Canada, and the Extractive Industries Transparency Initiative.
The proposed rules would define “project” using an approach that is focused on the legal agreement that forms the basis for payment liabilities with a government. This definition could also include operational activities governed by multiple legal agreements.
The proposing release notes that the Commission could provide exemptive relief from the requirements of the proposed rules on a case-by-case basis using its existing authority under the Exchange Act. Also, in light of international developments, as well as the progress made by the U.S. Extractive Industries Transparency Initiative (USEITI), the proposed rules would allow issuers to use a report prepared for foreign regulatory purposes or for the USEITI to comply with the proposed rules if the Commission determines the requirements are substantially similar to the proposed rules.
When It Must Be Disclosed:
A resource extraction issuer would be required to file the Form SD with the Commission no later than 150 days after the end of its fiscal year.
If approved for publication by the Commission, the proposed rules will be published on the Commission’s website and in the Federal Register. Initial comments will be due on Jan. 25, 2016. Reply comments, which may respond only to issues raised in the initial comment period, will be due on Feb. 16, 2016.
The SEC did somewhat satisfy both concerns, but nevertheless hedged its bets. Criteria for exemptive relief was left to its discretion, not defined, and lacks mention of conflicts with foreign laws as a factor.
“That is one of the things that will concern industry,” says Dynda Thomas, a partner with Squire Patton Boggs. “It would be difficult to get an exemption at an early enough time to make a difference. If a company is working on a finance project and is concerned about what is going to be disclosed because there may be a competitive disadvantage, they won’t know whether they are going to have an exemption for what could be another year. Companies will be required to either request an exemption and go through that potentially lengthy process without any certainty before they engage in the transaction, or just wait and hope for the best.”
The past ruling steered clear of two of the most popular challenges to Dodd-Frank rulemaking: an inadequate economic analysis of a rule’s impact, as demanded by the Administrative Procedures Act; and whether certain mandatory disclosures violate a company’s First Amendment rights (the basis to a challenge to the SEC’s similar conflict minerals rule that may be headed to the Supreme Court). Either could be fodder for future litigation.
Litigation may not be as important as having better guidance for companies that may struggle with the rule as currently written. Among the gray areas is the definition of a “project.”
“There is no specific definition that companies are going to be able to put a box around,” Thomas says. “They focused on the phrase ‘operationally and geographically interconnected,’ which the SEC hopes that will give guidance for what should be seen as a project. It does allow some aggregation between, perhaps, one hole in the ground here and another hole in the ground there being seen as a project and put together, but it is definitely different from the more geographic aggregation some in the industry were proposing.”
The lack of specificity means that companies will need to initially reach their own conclusions, a problem because “industry always wants to have as much certainty as possible,” Thomas says.
While setting the de minimus level at $100,000 is likely higher than activists might have wanted, it was an industry concession. “If you are a [large oil company], $100,000 is not even a blip and it is very difficult to keep track of what may be thousands and thousands of payments, especially when you consider the types of payments that are included,” Thomas says. In earlier comment letters, for example, ExxonMobil estimated its cost of compliance as north of $50 million.
What’s next, beyond the threat of more legal delays? Expect a final rule to set a ground floor for socially responsible investor groups who can then supplement those disclosure demands with more of their own through shareholder proposals. “It’s the start of a name and shame campaign that puts the next steps into the hands of those audiences,” Thomas says. Those efforts will be expedited by the requirement that Form SD filings be made in the XBRL interactive data format, allowing the disclosures to be presented in a more searchable and malleable form.
Most challenging of all is that companies may have to go it alone when it comes to compliance. “They will want to be very careful about sharing that information with others,” Thomas says.