The new SEC rules on disclosure by “resource extraction issuers” became effective on November 13. Rule 13q-1 under the Exchange Act requires those issuers to disclose annually on Form SD payments of $100,000 or more to a foreign government or the U.S. federal government in connection with the “commercial development of oil, natural gas, or minerals.” A resource extraction issuer must provide information about payments for each project and to each government made by it, its subsidiaries or any entity it controls. Rule 13q-1 implements Section 13(q) of the Exchange Act, which was added by Section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) to increase the transparency of payments made to governments by issuers engaged in extraction activities in the oil, natural gas, and minerals industry. When it issued Rule 13q-1, the SEC amended Form SD (Specialized Disclosure Report), which it had adopted as part of its “conflict minerals” rules, to require the resource extraction disclosure.

Resource extraction issuers must comply with the new rules for fiscal years ending after September 30, 2013. The disclosure on Form SD must be filed within 150 days after the end of the issuer’s fiscal year. For issuers whose fiscal year corresponds with the calendar year, the initial Form SD filing deadline is May 30, 2014 and the period of payments required to be disclosed is the partial period from October 1, 2013 through December 31, 2013.

This SEC Update summarizes, in a question-and-answer format, the principal provisions of the new rules. The SEC’s release adopting the rules (No. 34-67717) is available here.  

Where can issuers find the new requirements?

The requirements for resource extraction disclosure are contained in the instructions to the amended “Form SD, Specialized Disclosure Report,” which is set forth beginning on page 223 of the SEC’s rule release. Rule 13q-1 does not prescribe any requirements other than the filing of Form SD. The SEC’s release is an important source of guidance on the new requirements.

What is the purpose of the Dodd-Frank provision requiring resource extraction disclosure?

The congressional intent in enacting Section 1504 of the Dodd-Frank Act was to increase the transparency of payments to governmental entities by issuers engaged in the extraction of oil, natural gas, or minerals. In sponsoring Section 1504, Senator Richard Lugar expressed the view that the provision will “….help empower citizens to hold their governments to account for the decisions made by their governments in the management of valuable oil, gas and mineral resources and revenues.”

What is the Extractive Industries Transparency Initiative (EITI) referred to in the Dodd-Frank Act and discussed in the SEC’s rule release?

The EITI is an independent initiative supported by various non-governmental organizations and certain countries (including the United States) that provides a framework for oil and gas and mining companies to report payments they make to governmental authorities. The SEC noted that its new rules generally are consistent with the EITI guidelines, except where the language or approach of Exchange Act Section 13(q) clearly differs from that of the EITI.

What types of companies are subject to the rules?

The rules apply to all U.S. and foreign companies that meet the definition of “resource extraction issuer,” as described below, regardless of the size of the company or the extent of its business operations that constitute commercial development of oil, natural gas, or minerals.

What is a “resource extraction issuer”?

The rules define a “resource extraction issuer” to mean any U.S. or foreign company that engages in the commercial development of oil, natural gas, or minerals and that is required to file with the SEC an annual report on Form 10-K, Form 20-F or Form 40-F. This broad definition encompasses government-owned and government-controlled issuers.

Do the rules exempt certain types of issuers?

No. Despite the urging of some commenters on the rule proposal, the SEC decided not to exempt from the disclosure requirement any categories of resource extraction issuers. Accordingly, the rules apply to registrants such as foreign private issuers and smaller reporting companies that receive accommodations under other disclosure requirements. The rules do not extend to foreign private issuers that are exempt from Exchange Act registration under Rule 12g3-2(b), since those issuers do not have to file annual reports with the SEC and therefore fall outside the definition of resource extraction issuer.

Do the rules accommodate issuers subject to inconsistent requirements?

No. The SEC’s rules do not provide exceptions for resource extraction issuers subject to a foreign law that prohibits resource extraction disclosure or that prescribes disclosure similar to that under the rules, or for issuers bound by confidentiality provisions in contracts that prohibit or restrict the required disclosure.

Whose payments must be disclosed?

A resource extraction issuer must disclose payments made directly by it or by any subsidiary or entity under the issuer’s control where the subsidiary or entity is consolidated in the issuer’s financial statements. The issuer also must report payments by other entities it controls within the meaning of Exchange Act Rule 12b-2. In applying the control test of Rule 12b-2, the resource extraction issuer will be required to consider all relevant facts and circumstances.

How do the rules define the “commercial development of oil, natural gas, or minerals”?

The “commercial development of oil, natural gas, or minerals” is defined to include the “exploration, extraction, processing, and export of oil, natural gas, or minerals, or the acquisition of a license for any such activity.” Despite industry requests, the SEC did not limit commercial development to “upstream” oil and gas activities, such as the exploration and extraction of resources. The SEC also declined to adopt the definition of “oil and gas producing activities” in Rule 4-10 of Regulation S-X, which would have narrowed the coverage of the new rules. Companies involved in the extractive industry will have to evaluate the scope of their activities and those of entities they control to determine which of their operations may constitute commercial development.

Did the SEC specify any limitations to the scope of “commercial development of oil, natural gas, or minerals”?

The rule release identifies some limitations to the broad reach of the commercial development concept. The SEC said it intends the rules “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” to commercial development. In the rule release, the SEC clarified that, under this test, the manufacture of products (such as drill bits) used in extraction activities does not constitute "extraction," refining and smelting activities do not constitute "processing," and the removal of oil, natural gas, or minerals from the place of extraction to the refinery, smelter or first marketable location (as opposed to the export of the resources from the host country) does not constitute "export." The SEC also noted that transportation of minerals does not fall within the scope of commercial development, unless the transportation is undertaken for purposes of export.

What must an issuer disclose under the rules?

A resource extraction issuer must disclose covered payments made by it directly or by any subsidiary or entity under the issuer’s control to a foreign government or the U.S. federal government during the fiscal year covered by the issuer’s annual report. The new rules define “foreign government” to include “a foreign national government as well as a foreign subnational government, such as the government of a state, province, county, district, municipality, or territory under a foreign national government.” The rules do not require issuers to disclose payments to state, local or other subnational governments in the United States.

What types of payments do the rules cover?

A resource extraction issuer must disclose any payment that (1) is made to further the commercial development of oil, natural gas, or minerals, (2) is “not de minimis” and (3) is one of the types of payments listed below. The rules define as “not de minimis” any payment, whether made as a single payment or a series of related payments, that equals or exceeds $100,000 during the issuer’s most recent fiscal year. The covered payments include the following:

  • Taxes, including taxes levied on corporate profits, corporate income and production (but not on consumption, such as value added taxes, personal income taxes or sales taxes);
  • Royalties;
  • Fees, including license, rental and entry fees and other consideration for licenses or concessions;
  • Production entitlements;
  • Bonuses, including signature, discovery and production bonuses;
  • Dividends (other than dividends paid to the government on the same terms as to other shareholders); and
  • Payments for infrastructure improvement related to project operations (but not for social or community projects).

Is disclosure required for “in-kind” payments?

Yes, the rules require the issuer to disclose in-kind payments and to explain how the issuer determined the monetary value of the payments, which may be at cost or, if not determinable, the fair market value of the payments.

What payment information must issuers disclose?

Resource extraction issuers must disclose the following:

  • Type and total amount of payments for “each project”;
  • Type and total amount of payments to each government;
  • Total amounts of payments, by category;
  • Currency in which the payments were made (converted to U.S. dollars or the issuer’s reporting currency based on exchange rates (1) at time of the payment, (2) weighted over the reporting period or (3) at the issuer’s fiscal year end);
  • Financial reporting period during which the payments were made;
  • Business segment of the resource extraction issuer that made the payments;
  • Government that received the payments (and the country in which it is located); and
  • Project to which the payments relate.

Payments (such as dividends) made at the entity level rather than the project level may be disclosed at the entity level if (a) the issuer has more than one payment in a country and (b) taxes (such as an income tax) apply to its activities. The issuer also must report payments made by a third party on the issuer’s behalf pursuant to a contractual obligation.

How do the rules define “project”?

The SEC declined to adopt a specific definition of the term “project,” indicating instead that the term has the meaning generally understood by resource extraction issuers and investors. The SEC, however, did provide in the rule release some guidance concerning the meaning of the term, which it noted is used in a variety of contexts within the industry.

How must issuers present the disclosure?

Resource extraction issuers must present the required payment information in the XBRL interactive data format in an exhibit to the Form SD. Electronic tags must identify, for any payments, the information listed above. A brief statement in the body of Form SD under Item 2.01 will refer readers to the exhibit. Form SD does not require an audit of the disclosed payment information.

Will the report on Form SD be deemed “filed” under the Exchange Act?

Yes, the Form SD report will be considered “filed” rather than “furnished” for purposes of Section 18 of the Exchange Act, thereby subjecting the issuer to potential liability under that provision for misleading statements. The instructions to Form SD, however, state that the information and documents filed on the report will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act unless the issuer specifically incorporates the report into such a filing. The Form SD disclosure is not subject to the CEO and CFO certifications required by Rules 13a-14 and 13d-14 under the Exchange Act.

What steps should issuers consider to evaluate their potential compliance obligations under the new rules?

Issuers will need to consider whether any business conducted by them and their controlled entities qualifies as commercial development and, if so, whether they have made payments covered by the rules. For many issuers, this will be a significant undertaking requiring a review of the operations of numerous subsidiaries and joint ventures. If an issuer determines that it is subject to the rules, it likely will have to implement significant new financial reporting procedures to capture the information necessary for disclosure, as well as to expand the scope of its disclosure controls and procedures to include the new reporting obligation.

Issuers subject to the rules also will need to review their existing contracts, concessions and licenses to determine if their compliance with the rules could violate confidentiality provisions. Covered issuers should consider seeking amendments or waivers of any existing contractual restrictions and should ensure that future agreements permit compliance with the new disclosure requirements. If an issuer conducts resource extraction operations in a country that prohibits the required disclosure, the issuer will have to consider the nature of the penalties to which it might be exposed if it provides disclosure inconsistent with the foreign law and the broader effects of compliance on its business relations with the host country.

What is the nature of the litigation challenging the new rules?

On October 10, 2012, the U.S. Chamber of Commerce, joined by associations representing the oil industry, filed a complaint with the U.S. District Court for the District of Columbia and a petition for review with the U.S. Court of Appeals for the D.C. Circuit, claiming that the new rules violate the First Amendment, the Administrative Procedure Act and the Exchange Act. The lawsuit alleges, among other claims, that the rules are “incompatible with the First Amendment,” and “arbitrary and capricious” and that the SEC failed to conduct an adequate cost-benefit analysis, as required by law. The claimants allege in particular that the new rules will require covered issuers to disclose information on how they bid for projects and compete at a time when their international competitors are not required to provide the same type of information. In light of the success of recent litigation challenging other SEC rulemaking, this latest lawsuit injects a degree of uncertainty regarding the ultimate fate of resource extraction disclosure under the new rules.