On June 27, 2016, the SEC adopted final rules requiring issuers to disclose information relating to payments made to a foreign government or to the U.S. federal government for the purpose of commercial development of oil, natural gas or minerals. The rules were mandated by Section 13(q) of the Securities Exchange Act of 1934 (the “Exchange Act”), adopted as part of the Dodd Frank Act and Consumer Protection Act. The goal of the rules is to bring accountability by making public information about issuers’ payments to governments in relation to resource extraction. At the same time, the rules seek to consider the impact on issuers, and include exceptions in the interest of competition. As we’ve discussed previously, the resource extraction rules first adopted by the SEC in 2012 were vacated in 2013.
Who must disclose?
“Resource extraction issuers” are required to disclose under the new rules. The new rules provide that resource extraction issuers are U.S. and foreign companies required to file an annual report with the SEC on Forms 10-K, 20-F or 40-F that engage “in the commercial development of oil, natural gas, or minerals." No statutory exemptions are given based on size, ownership, foreign private issuer status or the extent of business operations constituting commercial development of oil, natural gas or minerals. Issuers subject to Tier 2 reporting requirements under Regulation A or Regulation Crowdfunding’s reporting requirements, as well as investment companies registered under the Investment Company Act of 1940, are intentionally excluded from the reporting requirements. See also “Does the Rule Provide any Exemptions to the Reporting Obligations?” below.
Which payments must issuers disclose?
The new rules require resource extraction issuers to disclose all payments that (i) are made to further commercial development of oil, natural gas or minerals, (ii) equal or exceed $100,000 and (iii) are the types of payments listed in the new rules.
Commercial development of oil, natural gas or minerals
Commercial development of oil, natural gas or minerals means exploration, extraction, processing and export of these resources, as well as the acquisition of a license for any of these activities.
The new rules focus on payments in connection with upstream activities (ex. exploration and extraction) and midstream activities (ex. processing resources to remove certain impurities or elements or change the composition of the resource), as opposed to downstream activities (ex. refining or smelting).
In addition to the extraction of minerals, “extraction” includes the production of oil and natural gas.
“Export” requires movement of a resource across an international border. The meaning of “export” in this context is limited to explicitly exclude movement of resources by a company that (i) is only a service provider with no ownership interest in the resource or (ii) if it has an ownership interest, acquired it from the government (directly or indirectly) and doesn't also conduct exploration, extraction or processing of the resource.
- $100,000 threshold per fiscal year
A series of related payments should be aggregated for purposes of the $100,000 annual threshold.
- Types of payments specified in the new rules
The types of payments specified in the new rules are: taxes, royalties, fees (including licensing fees), production entitlements, bonuses, dividends, payments for infrastructure improvements, and, if required by law or contract, community and social responsibility payments.
What information is required to be disclosed?
Type and total amount of payments must be disclosed on a per project and per government basis. Totals must also be given for each payment type. Disclosure must also include the currency and fiscal year in which the payments were made, the business segment that made the payments, governments that received the payments, the project related to the payments, the resource being developed and the subnational geographic location of the project. “Project” means the operational activities that are governed by a single contract, license, lease, concession or similar legal agreement, on which payment liabilities to a government are based. However, agreements that are both operationally and geographically interconnected may be treated by the resource extraction issuer as a single project. In-kind payments (including production entitlements, building a road or school, refurbishing a government building, etc.) are to be reported at cost, not fair market value. Disclosure must be made on a cash basis.
Which payeess and payors are generally relevant for a resource extraction issuer?
Payments (of the type described in the new rules) to a foreign government (including subnational governments or agencies and companies majority owned by a foreign government) or to the U.S. federal government (excluding domestic subnational governments) require disclosure under the new rules. A resource extraction issuer must also disclose these types of payments if made by a subsidiary or an entity under the issuer’s control (each defined using accounting principles). Entities the issuer consolidates for purposes of its financial statements are deemed to be controlled. Payments by entities that are proportionately consolidated must be proportionately disclosed. A resource extraction issuer must also disclose any payment made by a service provider to a government, within the meaning of the new rules, on behalf of the resource extraction issuer.
How does the rule address evasion?
The new rules require disclosure with respect to an activity or payment that is part of a plan or scheme to evade the disclosure required under Section 13(q) of the Exchange Act (See Rule 13q-1(b)). This applies even where an activity or payment is not included in the listed categories, such as in the cases of payments substituted for otherwise reportable payments, activities and payments that were structured (including split or aggregated), recharacterization of an activity that falls within a category enumerated in the new rules as a post-extraction activity (such as transportation) or paying a government via a third party, in each case, in an attempt to avoid disclosure.
Does the rule provide any exemptions to the reporting obligations?
The new rules include 3 exemptions to reporting obligations to avoid competitive harm to issuers.
- When a resource extraction issuer acquires a company not previously subject to the new rules, that issuer does not need to report payment information for that acquired company until the filing of a Form SD for the first fiscal year following the acquisition.
- Reporting of payments related to exploratory activities may be delayed for 1 year.
- The SEC may grant exemptive relief on a case-by-case basis. For instance, issuers may seek exemptive relief when foreign laws may prohibit the required disclosures.
How must the disclosure be filed?
The resource extraction disclosure must be filed as an exhibit to Form SD and be XBRL tagged. In addition, the SEC will periodically make a separate compilation of the payment information submitted in the Form SD filings available online.
Resource extraction issuers subject to alternative reporting requirements may use an English language copy of their alternative report as an exhibit to Form SD to comply with the new rules if the SEC determines that the requirements applicable to the alternative reports are substantially similar to the SEC’s requirements (see Item 2.01(c) of Form SD). Examples of substantially similar requirements include those of the EU Directives, Canada’s ESTMA and the U.S. Extractive Industries Transparency Initiative. Issuers, governments, industry groups and trade associations may submit additional applications for alternatives. Even alternative reports must be provided in XBRL format.
By when must issuers comply with the new rules?
Resource extraction issuers are required to comply with the final rule for fiscal years ending on or after September 30, 2018. The disclosure must be filed no later than 150 days after the end of the most recent fiscal year. Therefore, resource extraction issuers with a December 31 fiscal year end are required to include their first resource extraction disclosure in their Form SD to be filed no later than May 30, 2019. Note that this deadline is one day before the May 31, 2019 due date for Forms SD. Additionally, for issuers with a fiscal year other than the calendar year, the deadline of 150 days from the fiscal year end will not be aligned with the current Form SD deadline of May 31 following the end of a fiscal year. Extensions are not available.
What should issuers do now?
Issuers should assess whether they are resource extraction issuers and whether they, or any of the entities for which the issuer would be required to make disclosure, have made any relevant payments to covered government entities. Because the first disclosure will be due in respect of fiscal years ending after September 30, 2018, issuers have an opportunity to review their current practices and assess whether adjustments to those practices are warranted. Issuers should also be aware that the new rules may be challenged in court.
Nonetheless, issuers should begin to prepare for potential future disclosure obligations.
Thanks to summer associate Eugene Lim for his assistance in writing this alert.