On July 2, 2013, the United States District Court for the District of Columbia vacated Rule 13q-1 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which was adopted on August 22, 2012 by the Securities and Exchange Commission (the “SEC”) pursuant to Section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”).1 Rule 13q-1 would have required resource extraction issuers2 to publicly file on EDGAR an annual report on new Form SD – beginning with fiscal years ending after September 30, 2013 – disclosing information relating to any payment made by the issuer, or by a subsidiary or another entity controlled by the issuer, to a foreign government or the U.S. federal government for the purpose of the commercial development of oil, natural gas or minerals, including details regarding the total amount of payments, the governments that received the payments and the projects to which the payments related. Notably, the rule did not provide any exemptions from the disclosure requirements, even if foreign law prohibited the required disclosure or where the issuer was subject to a confidentiality provision in an existing or future contract.3
Findings of the Court
The plaintiffs, which included the American Petroleum Institute, the U.S. Chamber of Commerce, the Independent Petroleum Association of America and the National Foreign Trade Council and who represent the interests of issuers that would be directly affected by these rules, challenged the validity of the rules on multiple grounds.4 In an opinion critical of the SEC‟s interpretation of this statute added by Dodd-Frank and the implementation of the rule, the court vacated Rule 13q-1 on the following two grounds – grounds the court characterized as “substantial errors”:
- Misreading the statute to require the public filing of annual reports. The court found that the SEC misread the statute as requiring resource extraction issuers to file the annual reports on new Form SD publicly on the SEC‟s EDGAR filing system. Among its findings, the court noted that the language in Section 13(q)(2)(A) neither made any reference to, nor included any implication of, a requirement to “publicly” file the annual reports, and found the language in Section 13(q)(3)(A) that the SEC “shall make available online, to the public, a compilation of the information required to be submitted” in the annual reports supportive of the contrary interpretation taken by the court that public disclosure of a subset of the information from the annual reports, and not the annual reports themselves, was intended.
- Denying exemption where foreign law prohibits disclosure of payments. Although the SEC acknowledged concerns raised by commentators that certain countries prohibit disclosure of payments covered by the rule, which creates the potential for significant economic losses and competitive burdens for resource extraction issuers, the SEC included no exemption to alleviate these concerns. In particular, the plaintiffs argued that these rules “„could add billions of dollars of [additional] costs‟ through the loss of trade secrets and business opportunities,” which would be after the initial and ongoing cost of compliance estimated by the SEC to be approximately $1 billion and between $200 and $400 million, respectively. Noting this potential and that the SEC conducted no further analysis on the potential adverse economic effects of the rule and overly relied on the purpose of the statute, the court found that the SEC acted arbitrarily and capriciously by not providing an exemption for foreign countries that prohibit disclosure of these payments. The court characterized the omission of any exemption in the face of these arguments as a “serious error that independently invalidates” Rule 13q-1.
As resource extraction issuers are not currently required to comply with Rule 13q-1, the court viewed vacating the new rule and remanding to the SEC for further proceedings as the most appropriate decision, particularly given that the alternative would be “requiring compliance with an invalid Rule whose substance might change significantly” in light of the decision.
This decision will delay the implementation of Section 1504 of Dodd-Frank, which still requires the SEC to adopt rules implementing the statute. Until the SEC adopts a revised version of the rule or successfully appeals the decision, resource extraction issuers will not have to comply with Rule 13q-1, which would have become effective beginning with fiscal years ending after September 30, 2013. The SEC has not commented on this decision or indicated how it will respond. In the meantime, resource extraction issuers should benefit from efforts already taken to comply with Rule 13q-1, such as implementing appropriate internal procedures and tracking mechanisms and taking other steps towards compliance, given the rulemaking requirement imposed by Dodd-Frank.
Furthermore, the National Association of Manufacturing, the U.S. Chamber of Commerce and the Business Roundtable have raised similar challenges in the same federal court against rules adopted by the SEC implementing the “conflict minerals” disclosure requirements in Section 1502 of Dodd-Frank, which require an issuer to disclose certain information about conflict minerals used in its business if the materials are necessary to the functionality or production of a product manufactured, or contracted to be manufactured, by the issuer.5 A decision by the court, which heard oral arguments in early July, is expected in the near future.