On August 22, 2012, the SEC adopted final rules under the Securities Exchange Act of 1934 that implement the “resource payments” disclosure provisions of Section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The final rules require an issuer that files an annual report on Form 10-K, Form 20-F or Form 40-F to file separately a new Form SD to be filed annually that discloses detailed information relating to payments made during the covered fiscal year by the issuer or any entity controlled by it to a foreign government (including subnational governments and government-owned companies) or the U.S. federal government for purposes of the commercial development of oil, natural gas or minerals.
The final rules are largely similar to the rules proposed in December 2010. Some of the more significant differences between the proposed rules and the final rules are as follows:
- Rather than being included in the issuer‟s Form 10-K, 20-F or 40-F, the disclosure will be included in a separate Form SD, to be filed within 150 days of fiscal year-end. This is the same form that will be used for conflict mineral disclosure, under rules adopted by the SEC on the same day (see our separate publication on those rules).
- Form SD will be “filed with,” not “furnished to,” the SEC, and will be subject to liability under Section 18 of the Exchange Act. Form SD will not, however, be incorporated by reference into Securities Act offering documents, and will not be covered by the Sarbanes-Oxley CEO and CFO certifications.
- The final rules include a $100,000 bright-line standard for determining whether a payment is “not de minimis.”
- The final rules add dividends and payments for infrastructure improvements to the exclusive list of payment types that require disclosure.
- The adopting release provides a number of examples of activities covered by the terms “extraction,” “processing” and “export.”
- The final rules include a new anti-evasion provision to prevent re-characterization of activities or payments to evade disclosure.
The final rules will become effective 60 days after their publication in the Federal Register. Resource extraction issuers must file Form SD for fiscal years ending after September 30, 2013. With respect to fiscal years beginning before and ending after September 30, 2013 (e.g., calendar year 2013), resource extraction issuers may file a partial-year report covering the period from October 1, 2013 through the end of the issuer‟s fiscal year. Resource extraction issuers must file a full-year report for any fiscal year beginning after September 30, 2013.
Section 1504 of the Dodd-Frank Act added a new Section 13(q) to the Exchange Act and directed the SEC to adopt regulations requiring disclosure of certain payments related to natural resource extraction activities. After soliciting and receiving pre-rulemaking comments, the SEC issued proposed rules on December 15, 20101 and subsequently extended the comment period for the proposal from January 31, 2011 to March 2, 2011. The SEC adopted final rules on August 22, 2012 by a 2-1 vote (with Chairman Schapiro and Commissioner Paredes recusing themselves).2
Section 13(q) specifies that “[t]o the extent practicable, the rules . . . shall support the commitment of the Federal Government to international transparency promotion efforts relating to the commercial development of oil, natural gas, or minerals.” The SEC states that Congress intended for Section 13(q) to “increase the accountability of governments to their citizens in resource-rich countries for the wealth generated by those resources.” The SEC notes that Section 13(q)‟s primary purpose is to achieve a social benefit, which differs from investor protection, the typical policy goal of SEC rulemaking.
In its economic analysis, the SEC states that the express statutory mandate drives many of the final rules‟ economic effects.3 The final rules generally track the language of Section 13(q), and the adopting release makes clear that the close relationship between the final rules and the underlying statutory provisions reflects the SEC‟s sensitivity to imposing costs on issuers to achieve benefits that “are inherently difficult to quantify.”
The statute explicitly refers to the Extractive Industries Transparency Initiative (“EITI”) and provides that the SEC rules must, to the extent practicable, be consistent with the EITI in defining “payment.” The SEC discusses the EITI in explaining many aspects of the final rules (not just those relating to the definition of payment). Where the SEC exercises its express discretionary authority to expand the scope of the final rules beyond the statutory language (and correspondingly increase the costs borne by issuers beyond those necessary to achieve the express statutory mandate), the SEC cites consistency with the EITI as a justification. The SEC emphasizes that where the final rules differ from the language of Section 13(q), the differences are rooted in principles expressly set forth in the underlying statutory provisions.
DESCRIPTION OF THE FINAL RULES
“RESOURCE EXTRACTION ISSUER”
Under the final rules, a “resource extraction issuer” is defined as an issuer that is required to file an annual report on Form 10-K, Form 20-F or Form 40-F4 with the SEC and that “[e]ngages in the commercial development of oil, natural gas or minerals.” The final rules apply to every reporting company that is a resource extraction issuer, regardless of the size of the company or the extent of its business operations constituting the commercial development of oil, natural gas or minerals, whether a U.S. or non-U.S. company and whether or not it is owned or controlled by any government. The SEC states that requiring disclosure by all reporting companies that are resource extraction issuers best serves Section 13(q)‟s transparency objectives. The SEC explains that exemptions for smaller reporting companies or foreign private issuers could place larger companies or U.S. companies at a competitive disadvantage, and exempting issuers owned or controlled by governments (or subjecting them to modified disclosure requirements) would frustrate the transparency goals of Section 13(q) and could similarly raise competitiveness concerns.
The SEC requested comment on whether to allow a foreign private issuer to comply with other resource payment disclosure requirements (such as home or host country requirements, listing rules or an EITI program) but decided not to permit substituted compliance. The SEC notes that Section 13(q) requires greater disclosure than other transparency regimes and that permitting compliance with other rules, to the extent they are less extensive, would be inconsistent with the purposes of Section 13(q). The SEC describes such an exemption as “premature,” which suggests that it may later permit compliance with other regimes if standards converge.
The SEC also confirms that foreign private issuers that are exempt from Exchange Act registration and reporting requirements under Rule 12g3-2(b) are not subject to the final rules because they are not required to file an annual report with the SEC.
“COMMERCIAL DEVELOPMENT OF OIL, NATURAL GAS OR MINERALS”
The final rules define “commercial development of oil, natural gas or minerals” to include the activities of “exploration, extraction, processing, and export of oil, natural gas, or minerals, or the acquisition of a license for any such activity.” Section 13(q) provides the SEC with discretionary authority to include “other significant activities” relating to oil, natural gas or minerals in the definition of commercial development. The SEC declined to exercise this authority. The SEC cites consistency with EITI, which focuses on the “upstream activities” of exploration and production, as among the reasons it did not extend the final rules to activities beyond those expressly listed in the statute. The final rules include an anti-evasion provision that prevents resource extraction issuers from avoiding disclosure by re-characterizing an activity or payment that would otherwise be covered by the final rules. The SEC considered defining “commercial development” more broadly to cover a wider range of activities but determined that an anti-evasion provision would promote the goals of Section 13(q) with lower compliance costs.
In response to requests for additional guidance on the activities covered by the final rules, the SEC provides examples of activities that constitute “extraction,” “processing” and “export.” The SEC explains that “extraction” includes the production of oil and gas in addition to the extraction of minerals; “processing” includes activities prior to transporting, refining or smelting but does not include transporting (unless directly related to exporting), refining or smelting; and “exporting” includes the export of natural resources from the host country and is not limited to the removal of natural resources from the place of extraction to the first marketable location, such as a refinery or smelter. The SEC further clarifies that issuers engaged only in exporting natural resources, and not in exploring for, extracting or processing them, could be subject to the rules.
The final rules require disclosure with respect to any payment to a “foreign government” or the U.S. federal government. The final rules define “foreign government” to include a foreign national government; foreign subnational governments, such as the government of a foreign state, province, county, district, municipality or territory; a department, agency or instrumentality of a foreign national or subnational government; and any company owned by any of the foregoing. Payments to U.S. state or other subnational governments in the United States (such as cities or municipalities) are not, however, covered by the final rules. In addition, the final rules clarify that a company owned by a foreign government is one that is at least majority-owned by a foreign government. The SEC declined to specify the types of payments to a foreign government-owned company that will be required to be disclosed, leaving it to issuers to consider whether the payments made fall within the categories of payments specified in the final rules.
Types of Payments
The final rules define “payment” to mean a payment that:
- is made to further the commercial development of oil, natural gas or minerals;
- is not de minimis; and
- includes taxes, royalties, fees, production entitlements, bonuses, dividends5 and payments for infrastructure improvements, such as building a road or a railway.
The final rules added dividends and payments for infrastructure improvements, which do not appear in Section 13(q) or the proposed rules. Section 13(q) lists taxes, royalties, fees, production entitlements and bonuses and allows the SEC to include “other material benefits” that the SEC, consistent with the EITI‟s guidelines, determines are part of the commonly recognized revenue stream for the commercial development of oil, natural gas or minerals. The SEC believes that including dividends and infrastructure improvement payments, which broadens the scope of the final rules and correspondingly increases compliances costs, is justified because it makes the final rules more consistent with the EITI, which Section 13(q) expressly requires with regard to the definition of payment, and such payments are part of the commonly recognized revenue stream for this purpose, as evidenced by the EITI and certain comments. The final rules require disclosure of payments for infrastructure improvements (for example, building a road or railway) to further the commercial development of oil, natural gas, or minerals, whether the issuer pays the host country government or is “obligated” to make the infrastructure improvements itself instead of paying the host government.
Like the proposed rules, the final rules include an instruction to the definition of “payment” requiring resource extraction issuers to disclose taxes on corporate profits, corporate income and production, but not taxes levied on consumption, such as value added taxes, personal income taxes and sales taxes. The final rules do not expressly cover social or community payments (such as payments to improve a host country‟s schools or hospitals), but the SEC notes that, consistent with the EITI, they may be voluntarily disclosed.
The final rules add an anti-evasion provision to prevent issuers from avoiding disclosure by re-characterizing an activity or payment that would otherwise be covered by the rules.
“Not De Minimis”
The SEC reiterates its position set forth in the proposing release that “not de minimis” does not equal “material.” In response to comments, the SEC has adopted an absolute threshold of $100,000 for any payment or series of related payments. The SEC believes that an absolute threshold will ease compliance burdens by providing clear guidance regarding the payments issuers need to track and will increase comparability of disclosures.
As under the proposed rules, a resource extraction issuer must disclose payments by it to its own national government, even when the issuer is owned or controlled by that government.
Payments by a “Subsidiary” or an “Entity under the Control” of the Resource Extraction Issuer
Using the language from Section 13(q), the final rules require a resource extraction issuer to disclose resource payments made by a subsidiary or an entity under its control, in addition to its own payments.6
A resource extraction issuer must make a factual determination as to whether it has control of an entity based on a consideration of all relevant facts and circumstances. “Control” for these purposes is defined by reference to Exchange Act Rule 12b-2, and thus means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract or otherwise. The adopting release expressly rejected comments to limit the definition to consolidated subsidiaries, and notes that this may require disclosure of payments made by an unconsolidated joint venture or equity investee if a facts-and-circumstances analysis indicates that the resource extraction issuer “controls” the entity.
Payment Information to be Disclosed
The final rules require resource extraction issuers to disclose:
- the type and total amount of payments made for each project relating to the commercial development of oil, natural gas or minerals;
- the type and total amount of payments made to each government;
- the total amounts 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.
The final rules require a resource extraction issuer to provide payment information on a cash basis for its fiscal year. The information need not be audited. The SEC notes that using a fiscal year, instead of a calendar year, reporting period may result in lower compliance costs, as resource extraction issuers may be able to use their existing tracking and reporting systems.
The final rules also require disclosure of in-kind payments. Resource extraction issuers must determine the monetary value of in-kind payments, which must be reported at cost or, if cost is not determinable, fair market value. If a resource extraction issuer discloses the fair market value, it must include a brief description of how it calculated the monetary value.
Payment Information with Respect to Each “Project”
As noted above, the final rules require that payments be disclosed on a project-by-project basis. Like the proposed rules and the EITI, the final rules do not define “project.” In response to requests from commentators, the SEC provides guidance on the meaning of the term, which emphasizes that contractual arrangements between resource extraction issuers and governments should serve as the basis for determining what constitutes a “project.” The underlying principle is that contracts define the relationships and payment flows between resource extraction issuers and governments. The SEC also notes that not adopting a definition will provide resource extraction issuers with some flexibility to apply the term to varying business contexts and consider factors such as the issuer‟s industry, business or size.
A number of commentators suggested that “project” be defined with reference to a given country, an issuer‟s reporting segments or a geologic resource (such as a geologic basin or mineral district, which may span multiple countries). The SEC believes that these approaches would not achieve Section 13(q)‟s transparency objective or provide for the disclosure expressly contemplated by Section 13(q), which requires a resource extraction issuer to separately identify the country, business segment and project to which a payment relates. The SEC also declined to define “project” by reference to a materiality standard, as the SEC believes that would be inconsistent with Congress‟s intent.
FOREIGN LAW AND CONTRACTUAL PROHIBITIONS ON DISCLOSURE
The final rules do not include any exception to the disclosure requirements under Section 13(q) in the event that host country laws or regulations or a contract between a government and a resource extraction issuer prohibit disclosure of the information to be included on Form SD. The SEC requested comment on whether compliance with the disclosure requirement could potentially cause a resource extraction issuer to violate host country laws or contractual provisions and whether an exception would be appropriate for the disclosure requirements under Section 13(q). Commentators disagreed on whether disclosure may be prohibited by applicable law. The SEC believes that an exception would be inconsistent with the purposes and language of the statute and could undermine the statute by encouraging governments to adopt laws prohibiting disclosure required by the final rules. With respect to contractual provisions, the SEC believes that an exemption would similarly be inconsistent with the purposes of Section 13(q), and notes that contracts typically permit disclosure to the extent required by law.
FORM AND LOCATION OF DISCLOSURE
Unlike the proposed rules, which would have required a resource extraction issuer to include disclosure on resource payments in their annual reports, the final rules provide for disclosures in a separate, stand-alone annual report, to be made on the newly adopted Form SD.7 The SEC decided to require resource extraction issuers to provide resource payment disclosures in Form SD to address commentators‟ concerns about providing the disclosures in annual reports on existing Exchange Act forms, such as annual reports on Form 10-K, Form 20-F or Form 40-F, and reduce compliance costs. The SEC notes that Form SD, unlike Exchange Act annual reports, does not include audited financial statements, and that auditors need not consider whether the resource payment disclosures are materially inconsistent with the issuer‟s financial statements, which certain commentators had thought may be required.
Resource extraction issuers must file Form SD within 150 days of the end of the applicable fiscal year. The detailed data must be provided in an exhibit to Form SD. The exhibit must be submitted in XBRL format. Form SD, including exhibits, will be submitted via the SEC‟s Edgar system and made publicly available. The final rules, unlike the proposal, do not require issuers to submit a separate exhibit with the same data in HTML format, since the XBRL data is viewable through tools included on the SEC website. The SEC notes that the staff is currently working to develop the taxonomy for the payment information.
Liability for Resource Payment Disclosures
In contrast to the proposed rules, which would have allowed disclosure to be “furnished to” rather than “filed with” the SEC, resource payment disclosures on Form SD will be filed with the SEC and, therefore, subject to liability under Section 18 of the Exchange Act.8 The SEC states that the language of Section 13(q) contemplates that an annual report would include the resource payment disclosure (which suggests that the information should be “filed” and not “furnished”). Additionally, a number of commentators believed that disclosure would be better and investors would benefit if resource payment information were “filed” and subject to Section 18 liability.
Because resource payment disclosure is made on Form SD (which does not contain financial statements) and not on Form 10-K, Form 20-F or Form 40-F (which do contain financial statements), the disclosure is not subject to the CEO and CFO certification requirements imposed by the Sarbanes-Oxley Act of 2002.
Disclosure on Form SD will not be incorporated by reference into any filing under the Securities Act or the Exchange Act, including registration statements, except to the extent that the resource extraction issuer specifically incorporates it by reference.