The U.S. Securities and Exchange Commission (the “SEC”) has adopted new rules which require “resource extraction issuers” to disclose annually the type and amount of payments that they (or their subsidiaries or entities under their control) make to a foreign government or the U.S. federal government for the purpose of the commercial development of oil, natural gas or minerals. New Rule 13q-1 and corresponding amendments to Form SD implement Section 13(q) of the U.S. Securities Exchange Act of 1934 (the “Exchange Act”), which Section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) added to the Exchange Act. The SEC believes that these rules will increase the transparency of payments that resource extraction companies make to foreign governments and will hold those governments accountable for their natural resource wealth.
Background of the payment disclosure rules
In December 2015, the SEC re-proposed these payment disclosure rules to replace rules that it initially adopted in August 2012 (the “2012 Rules”). In 2013, the U.S. District Court for the District of Columbia (the “District Court”) invalidated the 2012 Rules in a rare use of judicial oversight over the SEC’s rulemaking. The District Court found that two aspects of the 2012 Rules were improper. It found that the SEC erred by stating that the Dodd-Frank Act required public disclosure and did not allow confidential disclosure, when, in fact, the statute gave the SEC discretion to decide whether to require public disclosure or permit confidential disclosure. The court also found that the SEC acted arbitrarily and capriciously by failing to provide any exemption for resource extraction companies when disclosure would violate a foreign law. The SEC chose not to appeal the District Court’s decision and instead decided to rewrite and re-propose the resource extraction payment disclosure rules, and it has now adopted them substantially in the form re-proposed in 2015.
Overview of the new payment disclosure rules
The new rules are substantially similar to the 2012 Rules except that the SEC changed the rules to comply with the District Court’s order. Nonetheless, even those changes are minor. Consistent with the 2012 Rules, the SEC used its discretion to require public, not confidential, disclosure, and there is still no blanket exemption for disclosure prohibited by foreign law. Instead, the new rules allow companies to apply for exemptive relief on a case-by-case basis, as discussed in greater detail below.
The SEC added exemptions for payments by recently acquired companies and for payments related to exploratory activities as well as alternative reporting methods for companies that meet the requirements of other jurisdictions or disclosure regimes. The SEC noted in its adopting release that both Canada and the European Union have recently adopted resource extraction disclosure laws (“ESTMA” and the “EU Directives,” respectively) that are similar to these rules. Further, in 2014, the United States became a “candidate country” for the Extractive Industries Transparency Initiative (the “EITI”), which is a voluntary coalition of oil, natural gas and mining companies, foreign governments and other organizations that are dedicated to improving transparency and accountability in countries rich with resources. Concurrent with adopting Rule 13q-1, the SEC determined that disclosure requirements of Canada’s ESTMA, the EU Directives and the U.S. EITI are “substantially similar” to the requirements of Rule 13q-1, and, subject to certain conditions described below, public filings pursuant to those laws also would satisfy the new SEC requirements.
Companies covered by the rules
The disclosure requirements apply to all U.S. and non-U.S. companies that (i) are required to file annual reports with the SEC pursuant to Section 13 or 15(d) of the Exchange Act on Forms 10-K, 20-F or 40-F and (ii) engage in the commercial development of oil, natural gas or minerals.
The rules define commercial development of oil, natural gas or minerals to include: (a) exploration, (b) extraction (meaning the production of oil and natural gas as well as the extraction of minerals), (c) processing (including, without limitation, such activities as the processing of gas to extract liquid hydrocarbons, the removal of impurities from gas after extraction and prior to its transport through the pipeline, and the upgrading of bitumen and heavy oil, or the crushing and processing of raw ore prior to the smelting phase, but not refining or smelting), (d) export of oil, natural gas or minerals from the host country by a company with an ownership interest in the resource or (e) the acquisition of a license for any of the activities listed in items (a) through (d) above.
Although the SEC did not limit the definition of commercial development to upstream activities, the final rules carve out certain downstream activities. According to the SEC, the definition is intended to capture only activities that are directly related to the commercial development of oil, natural gas or minerals, but not activities that are ancillary or preparatory, such as transportation activities (unless for export purposes), marketing activities or manufacture of a product (e.g., drill bits) used in the commercial development of oil, gas or minerals.
The rules apply to all covered companies regardless of the size of the company or the extent of business operations constituting commercial development of oil, natural gas or minerals and regardless of whether or not a government owns or controls such companies. There are also no exemptions from the rules for smaller reporting companies or non-US companies that qualify as “foreign private issuers.”
Types of payments to be disclosed
The disclosure obligations will apply to any payment that:
- a company makes to the U.S. federal government or a foreign government (including a foreign national government or a foreign subnational government (a state, province, county, district, municipality or territory) or a company that is at least majority-owned by a foreign government);
- a company makes in cash or in kind;
- a company makes to further the commercial development of oil, natural gas or minerals;
- is not de minimis (defined as any payment, whether a single payment or a series of related payments, that equals or exceeds U.S.$100,000 during the most recent fiscal year); and
- is one of the following types of payments in the commonly recognized revenue stream for the commercial development of oil, natural gas or minerals:
- taxes levied on corporate profits, corporate income and production, but not taxes levied on consumption, such as value added taxes, personal income taxes or sales taxes;
- fees (including, without limitation, license fees, rental fees, entry fees and concession fees);
- production entitlements;
- bonuses (including, without limitation, signature, discovery and production bonuses);
- community and social responsibility (or “CSR”) payments, such as payments to build hospitals or schools, that are required by law or contract;
- dividends that are paid to a government in lieu of production entitlements or royalties, but not dividends paid to a government as a shareholder of the issuer as long as dividends are paid to the government on the same terms as to other shareholders; and
- payments for infrastructure improvements, such as building a road or railway.
The requirements capture payments not only by a resource extraction company but also by its subsidiaries and other entities under its control. Therefore, a company that engages in joint ventures or enters into contractual arrangements will need to consider whether it has control over its counterparties. Whether a company has “control” is based on accounting principles under GAAP or IFRS, which is a change from the 2012 Rules. The 2012 Rules had defined “control” based on Exchange Act Rule 12b-2. Under the new rules, a company has “control” of another entity if it consolidates that entity in the financial statements included in the company’s Exchange Act reports. If the company proportionately consolidates an entity, it has to report that entity’s payments on a proportionate basis.
Method and content of required disclosure
Covered companies must disclose the required payment information annually on Form SD, which is used for specialized disclosure outside a company’s periodic or current reports, such as disclosure regarding conflict minerals under Rule 13p-1. Thus, this disclosure is separate from a company’s Exchange Act annual reports on Forms 10-K, 20-F or 40-F, as the case may be. The requisite information must be disclosed in new Exhibit 2.01 to Form SD. The required exhibit must be formatted using the XBRL (eXtensible business reporting language) interactive data standard. Disclosure in the exhibit must include the following information regarding payments:
- the total amount of the payments, by category;
- the currency used to make 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 country in which the government is located; and
- the “project” of the resource extraction issuer to which the payments relate.
In addition, under the rules, a resource extraction issuer must provide and electronically tag the type and total amount of payments made for each project and the type and total amount of payments made to each government. The rules also require that companies tag the particular resource that is the subject of commercial development as well as the subnational geographic location of the project.
The term “project” (which was not defined in the 2012 Rules) is defined in the new rules as “operational activities that are governed by a single contract, license, lease, concession, or similar legal agreement, which form the basis for payment liabilities with a government.” Companies may treat as a single project multiple agreements that are “operationally and geographically interconnected” even if the terms of the agreements are not substantially similar. In addition, the SEC has provided a non-exclusive list of factors to determine whether agreements are operationally and geographically interconnected. These factors include: “(a) whether the agreements relate to the same resource and the same or contiguous part of a field, mineral district, or other geographic area; (b) whether the agreements will be performed by shared key personnel or with shared equipment; and (c) whether they are part of the same operating budget.”
Companies may disclose payments at the entity level if the payment is made for obligations levied on the company at the entity level rather than at the project level. If a company has multiple projects in a host country, and that country’s government taxes the company on its income in the country as a whole and not with respect to a particular project or operation within that country, the company is permitted to disclose the resulting income tax payments without specifying a particular project associated with the payments. Thus, companies are not required to disaggregate payments for obligations that are levied at the entity level.
The rules do not require the disclosures to be audited or provided on an accrual basis.
In an effort to emphasize substance over form or characterization and to reduce the risk of evasion, the rules also include an anti-evasion provision. The provision requires disclosure with respect to an activity or payment that, although not in form or characterization in one of the categories specified under the final rules, is part of a plan or scheme to evade the disclosure required under the rules.
As with the 2012 Rules, the SEC’s new rules require resource extraction companies to disclose their payments under the rule publicly rather than confidentially. The District Court stated that Section 13(q) gives the SEC discretion to require public disclosure or to permit confidential disclosure. However, the SEC noted that it chose to require public disclosure because public disclosure furthers the statutory goal of promoting international transparency. In addition, the SEC determined that the text, structure and legislative history of Section 13(q) support requiring public disclosure. As a result, companies that file under Rule 13q-1 cannot simply file confidentially with the SEC but must make public disclosure unless they seek exemptive relief from the disclosure obligation from the SEC, which the SEC may grant on a case-by-case basis.
Exemptions from compliance
The final rules include two exemptions. One exemption provides a longer transition period for recently acquired companies that were not previously subject to reporting under these rules. Specifically, the first fiscal year for which resource extraction activities of the acquired entity are required to be reported is the fiscal year immediately following the year of the acquisition. The second exemption allows a one-year delay in reporting payments related to exploratory activities. The SEC believes that such payments are likely to relate to commercially sensitive information, and the one-year delay in reporting should diminish any potential competitive harm that otherwise might result from earlier public disclosure under the new rules.
Some commenters had sought an additional exemption in situations in which host country law may prohibit the required disclosure. The SEC declined to provide such a blanket exemption, however. Instead, the SEC stated that when host country law may prohibit the required disclosure it will consider granting an exemption from the disclosure obligations on a case-by-case basis upon request from a resource extraction company. To file such a request, the company must make a written request to the SEC that describes both the payment disclosure that it wants to keep confidential and the specific reasons why it merits an exemption. The SEC will consider various factors in deciding whether to grant the request, including an opinion of counsel regarding a foreign law’s prohibition of the disclosure, whether the information is already publicly available and whether other companies have disclosed similar information under similar circumstances.
The new rules also allow companies to fulfill their disclosure obligations by complying with another country’s reporting rules or with the EITI requirements in instances in which the SEC first determines that those other rules or requirements are “substantially similar” to the SEC’s requirements. This dispensation allows a resource extraction company that has already prepared and submitted a report pursuant to “substantially similar” requirements to avoid the costs of having to prepare a separate report for the SEC.
In order for the SEC to determine whether another country’s rules or disclosure requirements are “substantially similar” to the new rules, it will consider several factors, including: (1) the types of activities that trigger disclosure; (2) the types of payments that must be disclosed; (3) whether the project-level disclosure is required and, if so, the definition of “project”; (4) whether the disclosure must be publicly filed and include the identity of the issuer; and (5) whether there are any exemptions allowed. If a company has already publicly filed a report for such a substantially similar reporting regime, that company would need to file that report only as an exhibit to Form SD, include a statement in Form SD that it is relying on this accommodation to satisfy its disclosure obligation and identify the alternative reporting regime on which it is relying.
Concurrently with adopting Rule 13q-1, the SEC issued an order recognizing the disclosure requirements of each of Canada’s ESTMA, the EU Directives and the U.S. EITI as “substantially similar” to Rule 13q-1 under the foregoing standards. Therefore, public filings pursuant to those standards will satisfy the new SEC rules. In addition, under the new rules, if the SEC decides in the future that other disclosure rules are “substantially similar” to the SEC’s rules, companies could opt to comply with their SEC reporting obligations in accordance with those reporting obligations as well, rather than prepare separate disclosure under the SEC’s rules.
Disclosure to be filed not furnished
The payment disclosure on Form SD will be considered “filed” with the SEC and therefore subject to heightened liability under Section 18 of the Exchange Act for material misstatements in or omissions from SEC filings. However, the payment disclosure will not be deemed to be incorporated by reference into other SEC filings unless the reporting company does so affirmatively. The payment disclosure is also not subject to the annual officer certifications required for annual reports under the Exchange Act.
Effective date and timing
A covered company must file its Form SD with the SEC on EDGAR online using XBRL electronic format no later than 150 days after the end of its fiscal year, and it will first be required to comply with the new rules for resource extraction activities in its first fiscal year that ends on or after September 2018. Therefore, most calendar-year companies will not be required to provide resource extraction disclosure until they file Form SD in 2019.