The US Securities and Exchange Commission (the "SEC") has adopted rules to implement Section 13(q) of the US Securities Exchange Act of 1934 (the "Exchange Act"), which was added by Section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the "Dodd-Frank Act").
The new rules require resource extraction issuers to disclose annually payments such issuers (or their subsidiaries or entities under their control) make to a foreign government or the US federal government for the purpose of the commercial development of oil, natural gas or minerals. The rules require the disclosure about the type and total amount of payments a company makes to each government for each project.
Companies Covered by the Rules
The new disclosure requirements apply to all US and foreign companies that qualify as "resource extraction issuers", i.e., companies that are (i) required to file annual reports with the SEC under the Exchange Act and (ii) engaged in the commercial development of oil, natural gas or minerals.
The new rules define commercial development of oil, natural gas or minerals to include (a) exploration, (b) extraction, (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 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, 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 will apply to all covered issuers 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 issuers. There are also no exemptions from the rules for smaller reporting companies or non-US companies which qualify as "foreign private issuers" or for covered issuers subject to similar reporting requirements under home country laws, listing rules or Extractive Industries Transparency Initiative (EITI) programs. The rules also do not provide an exemption for situations where the required disclosure pertains to commercially sensitive information or where the disclosure is prohibited by a contract or host country law.
Types of Payments to Be Disclosed
The disclosure obligations will apply to any payment:
- that is made to the US federal government or a foreign government (including a foreign national government or a subnational government (a state, province, county, district, municipality or territory) or a company that is at least majority owned by a foreign government);
- that is made in cash or in kind;
- that is made to further the commercial development of oil, natural gas, or minerals;
- that is not de minimis (defined in the final rules, in a change from the proposed rules, as any payment, whether a single payment or a series of related payments, that equals or exceeds US$100,000 during the most recent fiscal year); and
that includes the following payments that are part of 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 other considerations for licenses and concessions),
- production entitlements,
- bonuses (including, without limitation, signature, discovery and production bonuses),
- 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 other shareholders and
- payments for infrastructure improvements, such as building a road or railway.
In contrast to the proposed rules, the final rules do not include in the types of covered payments a broad category of "other material benefits." Also, the final rules do not require the disclosure of social or community payments, such as payments to build a hospital or schools, because it is not clear that these types of payments are part of the commonly recognized revenue stream.
The final rules capture payments not only by a resource extraction issuer but also by its subsidiaries and entities under its control. An issuer that engages in joint ventures or contractual arrangements will need to consider whether it has control. Whether an issuer has "control" should be based on a consideration of all relevant facts and circumstances (the definition of "control" being consistent with the Exchange Act's definition of such term). At a minimum, an issuer will be deemed to control any entity that it is required to consolidate in the financial statements included in the issuer's Exchange Act reports. Depending on whether "control" is present, an issuer may also be required to provide disclosure for entities in respect of which it provides proportionately consolidated financial information.
Method and Content of Disclosure Required
Covered issuers must disclose the required payment information annually on a new form (Form SD), separate from their Exchange Act annual reports on Forms 10-K, 20-F or 40-F, as the case may be. Such information must be presented in one exhibit (Exhibit 2.01 to Form SD) rather than in two exhibits, as was proposed. The required exhibit must be formatted using 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, a resource extraction issuer must provide the type and total amount of payments made for each project and the type and total amount of payments made to each government.
The term "project" was left undefined in the final rules to give issuers flexibility in applying the term to different business contexts depending on factors such as the particular industry or business in which the issuer operates. The SEC noted, however, that "project" is a commonly used term whose meaning resource extraction issuers and investors generally understand. The SEC also noted that "project" should not be defined with reference to a materiality threshold or at either the country, reporting unit, or geological resource level. The SEC indicated that it believes that an issuer's government contract for the commercial development of oil, natural gas or minerals generally provides a basis for determining the payments, and the required payment disclosure, that would be associated with a particular "project".
Issuers may disclose payments at the entity level if the payment is made for obligations levied on the issuer at the entity level rather than the project level. Thus, if an issuer has multiple projects in a host country, and that country's government taxes the issuer on its income in the country as a whole, and not with respect to a particular project or operation within such country, the issuer is permitted to disclose the resulting income tax payments without specifying a particular project associated with the payments.
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 final 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 of one of the categories specified under the final rules, is part of a plan or scheme to evade the disclosure required under the rules.
Disclosure to Be Filed not Furnished
The payment disclosure on Form SD will be considered "filed" with the SEC, and therefore subject to liability under Section 18 of the Exchange Act for material misstatements or omissions. This characterization is a significant change from the proposal, which originally provided that the required disclosure only would be deemed "furnished" to the SEC and therefore not subject to heightened liability under Section 18. However, consistent with the proposed rules, the payment disclosure will not be deemed to be incorporated by reference into SEC filings unless the issuer does so affirmatively. The payment disclosure is also not subject to the annual officer certifications required under the Exchange Act.
A covered issuer must file its Form SD electronically with the SEC on EDGAR no later than 150 days after the end of its fiscal year. The issuer will be required to comply with the new rules for fiscal years ending after September 30, 2013. For the first report filed for fiscal years ending after September 30, 2013, the issuer may provide a partial year report if the issuer's fiscal year began before September 30, 2013.