SEC Proposes Revised Rule on Disclosure of Payments by Resource Extraction Issuers

To Our Clients and Friends Memorandum friedfrank.com Copyright © 2015 Fried, Frank, Harris, Shriver & Jacobson LLP 12/21/2015 A Delaware Limited Liability Partnership 1 SEC Proposes Revised Rule on Disclosure of Payments by Resource Extraction Issuers On December 11, 2015, the Securities and Exchange Commission (the “SEC”) released a revised proposed rule implementing disclosure requirements relating to payments by issuers to foreign governments or the US federal government for the purpose of the commercial development of oil, natural gas or minerals required by Section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). 1 The SEC also proposed an amended Form SD for use by covered issuers in disclosing the information required by the proposed rule. The proposed rule reflects US foreign policy interests in supporting global efforts to improve the transparency of payments made in the resource extraction industry. The goal is that citizens in resource rich countries – which are too often plagued by high levels of governmental corruption – will be able to use the required disclosures to hold their own government officials accountable for how they use these payments at home. The proposed rule is the most recent example of the US government’s efforts seeking to stem the tide of international corruption through use of public company disclosure requirements. The SEC initially adopted rules implementing Section 1504 of the Dodd-Frank Act in 2012 (the “2012 Rules”) but a federal district court vacated those rules in 2013.2 While the new proposed rule is largely similar to the 2012 Rules since it implements a statutory mandate, it also seeks to address the concerns of the court and reflects international standards developed through disclosure requirements in Canada and the European Union. 3 The SEC will accept initial comments on the proposed rule through January 25, 2016, and reply comments responsive to comments raised in the initial comment period by February 16, 2016. The vote on the final rules is scheduled to take place by June 2016. This memorandum reviews the proposed disclosure requirements and provides practical recommendations for preparing to comply with the proposed rule. 1 Release No. 34-76620 can be accessed on the SEC’s website at http://www.sec.gov/rules/proposed/2015/34- 76620.pdf. 2 For additional information, see SEC Adopts Rules Implementing Disclosure Requirements Related to Payments by Resource Extraction Issuers: Practical Steps for Complying with These Requirements, Fried Frank Client Memorandum (Oct. 18, 2012) and US District Court Vacates Rule Relating to Payments by Resource Extraction Issuers, Fired Frank Client Memorandum (July 10, 2013). 3 Section 1504 of Dodd-Frank was meant to “complement multilateral transparency efforts such as the Extractive Industries Transparency Initiative–the EITI–under which some countries are beginning to require all extractive companies operating in their territories to publicly report their payments.” 156 C. R. S3816 (daily ed. May 17, 2010) (Statement of Senator Lugar). Fried Frank Client Memorandum 2 Overview of the Proposed Rule The proposed rule would require resource extraction issuers to include in its annual report information relating to any payment made by the issuer, or by a subsidiary or another entity controlled by the issuer, to a foreign government4 or the US federal government for the purpose of the commercial development of oil, natural gas or minerals. The disclosure will require details regarding:  the type and total amount of payments;  the governments that received the payments; and  the projects to which the payments relate. The information would be presented in a new Form SD which will be filed with the SEC and, therefore, is subject to liability under Section 18 of the Securities Exchange Act of 1934 (the “Exchange Act”).5 The proposed rule would require issuers to disclose full payment information publicly, including the identity of the issuer, though the SEC will address, on a case by case basis, any situations where confidential treatment may be warranted based upon the specific facts and circumstances. Relevant Definitions The proposed rule would apply to all “resource extraction issuers,” defined as an issuer, including a foreign private issuer, that is required to file an annual report with the SEC pursuant to Section 13 or 15(d) of the Exchange Act and engages in the commercial development of oil, natural gas or minerals, regardless of the size of the issuer or the extent of business operations constituting commercial development of oil, natural gas or minerals, and each subsidiary or other entity controlled by the issuer. Issuers subject to Tier 2 reporting obligations under Regulation A and investment companies registered under the Investment Company Act of 1940 would not be subject to the proposed rule. In a change from the 2012 Rules, the proposed rule would define the terms “subsidiary” and “control” based on accounting principles rather than using the definitions of those terms provided in Rule 12b-2. Specifically, a resource extraction issuer would have “control” of another entity when the issuer consolidates that entity or proportionately consolidates an interest in an entity or operation under the accounting principles applicable to its financial statements filed pursuant to Section 13(a) or 15(d) of the Exchange Act. For purposes of determining control, the resource extraction issuer would follow the consolidation requirements under generally accepted accounting principles in the United States or under the International Financial Reporting Standards as issued by the International Accounting Standards 4 “Foreign government” is defined as a foreign government, a department, agency or instrumentality of a foreign government, or a company owned by a foreign government, and includes 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. Notably, the proposed rule on its face does not appear to require disclosure of any payments made to individuals who are closely associated with foreign governments. 5 See Securities and Exchange Of Act of 1934, Section 18 (“Any person who shall make or cause to be made any statement in any application, report, or document filed pursuant to this title or any rule or regulation thereunder or any undertaking contained in a registration statement . . . shall be liable to any person . . . who, in reliance upon such statement shall have purchased or sold a security at a price which was affected by such statement, for damages caused by such reliance, unless the person sued shall prove that he acted in good faith and had no knowledge that such statement was false or misleading.”) (emphasis added). Fried Frank Client Memorandum 3 Board, as applicable. The extent to which the controlled entity is consolidated would determine the extent to which payments made by that entity would need to be disclosed.6 The term “commercial development of oil, natural gas or minerals” includes exploration, extraction, 7 processing and export8 of oil, natural gas or minerals, or the acquisition of a license for any such activity. The definition is intended to capture only activities that are directly related to the commercial development of oil, natural gas or minerals, as opposed to activities that are ancillary or preparatory to such commercial development. A manufacturer of drill bits or other machinery used in the extraction of oil would not fall within the definition of commercial development, nor would an issuer engaged by an operator to provide hydraulic fracturing or drilling services. However, if a service provider makes a “payment” to a government on behalf of a resource extraction issuer, the resource extraction issuer would be required to disclose the payments. Further, the SEC indicated that whether an issuer is a resource extraction issuer will depend on the specific facts and circumstances. Under the proposed rule, “processing” would include field processing activities, such as the processing of gas to extract liquid hydrocarbons, the removal of impurities from natural gas after extraction and prior to its transport through the pipeline and the upgrading of bitumen and heavy oil and also includes the crushing and processing of raw ore prior to the smelting phase. The SEC does not believe “processing” was intended to include refining or smelting. A “payment” under the rule would mean an amount paid that:  is made to further the commercial development of oil, natural gas or minerals;  is not de minimis; 9 and  includes taxes, royalties, fees (including license fees), production entitlements, bonuses, dividends and payments for infrastructure improvements. The proposed rule and instructions also make the following clarifications:  The SEC would not automatically exempt disclosures that are prohibited under foreign law. However, the SEC may address, on a case by case basis, any situations where confidential treatment may be warranted based upon the specific facts and circumstances. In certain circumstances, issuers may provide disclosures that comply with a foreign jurisdiction’s rules or that meet the United States EITI reporting requirements, if the SEC has determined that those rules or requirements are substantially similar to the rule adopted under Section 13(q). 6 A resource extraction issuer’s determination of control would be subject to the audit process as well as to the internal accounting controls that issuers are required to have in place with respect to reporting audited financial statements filed with the SEC. 7 The SEC notes that “extraction” includes the production of oil and natural gas as well as the extraction of minerals. 8 The SEC believes that “export” includes the export of oil, natural gas or minerals from the country of origin. 9 “Not de minimis” is defined as any payment, whether a single payment or a series of related payments, that equals or exceeds $100,000 during the most recent fiscal year. Fried Frank Client Memorandum 4  Issuers would not have to disclose payments related to transportation on a fee-for-service basis by a service provider with no ownership interest in the resource. However, the proposed rule would require disclosure with respect to an activity (or payment) that, although not within the categories included in the proposed rule, is part of a plan or scheme to evade the disclosure required under Section 13(q).  Issuers would have to disclose payments for taxes levied on corporate profits, corporate income and production, but not for consumption taxes, such as value-added taxes, personal income taxes or sales taxes.  The proposed rule would include rental fees, entry fees and concession fees. And bonuses would include signature, discovery and production bonuses.  Issuers would generally not need to disclose dividends paid to a government under the same terms as other shareholders. However, the issuers will be required to disclose any dividends paid to a government in lieu of production entitlements or royalties.  Issuers need not disclose social or community payments, such as payments to build a hospital.  Issuers would be required to disclose in-kind payments, reportable at cost, or if cost is not determinable, fair market value. Form SD Under the proposed rule, the resource extraction issuer is required to file Form SD not later than 150 days after the end of the issuer’s most recent fiscal year.10 Form SD will require issuers to include a brief statement in the body of the form in an item entitled, “Disclosure of Payments By Resource Extraction Issuers,” directing readers to detailed payment information provided in an exhibit to the form. The required exhibit must provide the information using the XBRL interactive data standard. Practical Considerations and Convergence with Preexisting FCPA Requirements In anticipation of the adoption of the proposed rule, resource extraction issuers should begin to consider how best to incorporate compliance procedures dedicated to the proposed disclosure requirements into their currently existing compliance program framework. Pursuant to the Foreign Corrupt Practices Act (the “FCPA”), issuers are already under an obligation to maintain accurate books and records and internal controls and to prevent bribery of foreign government officials. Given the nature of the company information that must be tracked and monitored in order to comply with the proposed resource extraction disclosure requirement, resource extraction issuers should begin to integrate the new disclosure compliance procedures with existing protocols designed to identify and prevent those activities proscribed by the FCPA. Similar to the FCPA, resource extraction issuers must also consider compliance protocols for disclosures required for subsidiaries and controlled entities. While the proposed rule and the FCPA are meant to serve similar interests, issuers need to continue to scrutinize payments to foreign government entities (and individuals closely associated with foreign government entities) for FCPA compliance regardless of whether such payments are being disclosed pursuant to the proposed rule. 10 Generally, resource extraction issuers would be required to comply with the rules starting with their fiscal year ending no earlier than one year after the effective date of the adopted rules. Fried Frank Client Memorandum 5 In general, issuers should consider implementing the following procedures in order to initiate a formal practice of compliance with the proposed extraction resource disclosure requirements:  Direct the existing compliance team to conduct a thorough analysis to determine whether the issuer (including its subsidiaries and controlled entities) comes within the definition of “resource extraction issuer” and is thus subject to the disclosure requirements;  Determine with the accounting staff which controlled entities are covered by the rule;  Task the appropriate compliance personnel to coordinate with affected business units in order to adopt tracking mechanisms to collect the data required to appropriately comply with the disclosure requirements (e.g., payment amounts, receiving foreign government, projects to which the payments relate) and a timeline for implementation;  Train compliance and operations personnel on the new disclosure requirements and internal compliance procedures;  Coordinate internal monitoring protocols and system checks for resource extraction disclosure requirements with the existing FCPA compliance framework to avoid potential compliance blind spots; and  Regularly update these procedures and notify new relevant personnel of the disclosure requirements. If you have any questions regarding the proposed rule and how it might affect your business, or are interested in submitting comments to the SEC, please reach out to one of the contacts listed below. * * * Authors: Joshua T. Coleman Stuart H. Gelfond Michael Gershberg Steven M. Witzel Joshua D. Roth Jocelyn P. Ryan This memorandum is not intended to provide legal advice, and no legal or business decision should be based on its contents. If you have any questions about the contents of this memorandum, please call your regular Fried Frank contact or an attorney listed below: Fried Frank Client Memorandum New York Washington, DC London Paris Frankfurt Hong Kong Shanghai friedfrank.com 6 Contacts: New York Joshua T. Coleman +1.212.859.8633 [email protected] Stuart H. Gelfond +1.212.859.8272 [email protected] Steven M. Witzel +1.212.859.8592 [email protected] Washington, D.C. Michael Gershberg +1.202.639.7085 [email protected]