New rule 13q-1 requires all SEC-reporting resource extraction companies, including non-US companies, to make annual public disclosure of their payments to host country governments for the commercial development of oil, natural gas and minerals. The reports will be required for financial years ending on or after 30 September 2018.

The rule took effect on 26 September 2016 after a long and troubled rulemaking history that saw an earlier version of the rule invalidated by a US court in July 2013. Since then, the EU and Canada have implemented similar disclosure requirements and the new US rule takes account of these developments as well as the issues raised by the court. The new rule is significantly more user-friendly than its invalidated predecessor particularly because it allows for alternative reporting using reports required under existing non-US disclosure regimes found to be substantially similar to the new US regime. The SEC has found that both the Canadian disclosure requirements and the EU requirements as implemented in an EU or EEA member country are substantially similar. The new rule also defines ‘control’ in a way that provides more certainty than the earlier version of the rule and offers two specific delayed reporting exemptions and the ability to request individual exemptions. The first reports are due in 2019.

Rule 13q-1 was mandated by section 13(q) of the Securities Exchange Act of 1934 (the Exchange Act), part of the Dodd-Frank Act of 2010. The policy objective is to support global efforts to improve transparency in the extractive industries. The purpose of such transparency is to help fight global corruption and to empower citizens of resource-rich countries to hold their governments accountable for the wealth generated by these resources. The SEC’s Adopting Release explains the new rule and contains the text of the rule together with the Form SD on which the disclosure is made.

In this briefing we look at some of the practical implications of the new rule, including its relationship with the comparable EU and Canadian disclosure regimes, and at its key features.

Practical advice

Companies already subject to the EU or Canadian disclosure regime

Those SEC-reporting companies who are already subject to the EU or Canadian reporting regime and complying with those regimes can use the reports prepared under those regimes to meet their rule 13q-1 reporting obligation in full provided they meet the procedural requirements explained below. SEC-reporting companies already subject to any reporting regime other than the EU or Canada may wish to consider whether they can apply to the SEC for recognition of that other regime for alternative reporting purposes while also preparing to comply with the US rule.

Companies not subject to the EU or Canadian regime

Those SEC-reporting companies who are not subject to the EU or Canadian regimes will want to use the two-year period before first reports are due to ensure that their internal controls over financial reporting and Foreign Corrupt Practices procedures are adequate for gathering the data required and if not, develop and implement new internal controls and procedures that monitor payments subject to the new rule. Companies should also allow time for identifying what constitute ‘projects’ under the rule and for arranging to obtain sufficiently detailed information for proportionately consolidated entities where they are not the operator. They may also wish to consider whether they may want to apply for an individual exemption for any payments.

Because the rule applies to covered companies without regard to the materiality of the extractive business or the materiality of the payments, some larger companies may find it difficult to identify all reportable payments within their existing compliance and monitoring thresholds.

Companies only subject to the US rules may want to consider whether to withdraw from insignificant businesses that trigger a reporting requirement where the compliance burden outweighs the benefit of continuing in the minor business. This approach was seen among companies subject to the SEC’s other specialised disclosure rule relating to conflict minerals.

Key features

How are payments disclosed? By filing a Form SD (Specialised Disclosure Report) with the SEC no later than 150 days after the end of the company’s most recent financial year with first reports due for financial years ending on or after 30 September 2018. So calendar year-end companies’ first reports would be due on 30 May 2019. The filing will be publicly available on EDGAR, the SEC’s searchable online system. The Form SD refers the reader to an exhibit which contains the required payment data that must be electronically tagged using the eXtensible Business Reporting Language format. Form SD is also used for the specialised disclosure on conflict minerals where applicable.
What about companies already subject to the EU or Canadian disclosure requirements? Good news. Such companies, whether US companies or incorporated outside the US, can comply with the US rule using so-called alternative reporting by providing the disclosure report required by the EU or Canada as the exhibit to their Form SD. To be eligible for alternative reporting, the issuer must be subject to the EU or Canadian reporting requirement and must have made the report public as required by the EU or Canada before filing it with the SEC. Such companies can also follow the EU or Canadian filing deadline as long as they indicate that they intend to do so by filing a notice (Form SD-N) with the SEC on or before the due date for their Form SD. However, if a company fails to file the notice on Form SD-N or files the notice then fails to file the alternative report with the SEC within two business days of its home country filing date, the company will be unable to rely on alternative reporting for its Form SD for its next fiscal year. Issuers relying on alternative reporting must provide ‘a fair and accurate English translation’ where the original report to the non-US jurisdiction is not in English. The new rule allows alternative reporting where the SEC has found that another jurisdiction’s disclosure requirements are ‘substantially similar’ to the new US rule. Resource extraction companies, governments and industry groups can apply for to the SEC for recognition of a disclosure regime as substantially similar for alternative reporting purposes.
Who must file a report? All resource extraction companies that report to the SEC including companies incorporated outside the US (foreign private issuers or FPIs). An FPI that is exempt from Exchange Act registration and reporting requirements under Rule 12g3-2 (b) is not caught by the new rule. A resource extraction company is one that engages in the commercial development of oil, natural gas or minerals. This includes exploration, extraction, processing and export of oil, natural gas or minerals or obtaining a licence for such activities. Export means movement of a resource across an international border by a company with an ownership interest in the resource. It does not include export of resources by a company that is not engaged in such development activities but acquired an ownership interest in the resource from the government concerned.
Are there any exemptions? Yes. Companies may apply to the SEC for an individual exemption from the disclosure requirement on a case-by-case basis. Possible bases for seeking exemptive relief include where an issuer can establish that it would suffer substantial commercial or financial harm from the required disclosure or where disclosure would conflict with the terms of a material pre-existing contract, reveal commercially sensitive information not otherwise publicly available or be substantially likely to jeopardise the safety of the issuer’s personnel (See the Adopting Release page 116 footnote 399). In addition, there are two specific delayed reporting exemptions:
  • a one-year delay for reporting payments related to exploratory activities;
  • and a longer transition period for recently acquired companies not previously subject to any disclosure requirement, including one under an alternative regime.

The SEC also has exemptive authority to add to the specific exemptions in future where warranted.

What must be included in the report? All payments (whether made individually or as a series of related payments) of $100,000 or more (not de minimis) made by the company, its subsidiaries and other entities under its control in a financial year to further the commercial development of oil, natural gas or minerals. The new rule gives a clear test for determining control: there must be disclosure of payments made by entities that are consolidated in the company’s consolidated financial statements as determined by applicable accounting principles and of proportionate amounts of payments made by entities or operations that are proportionately consolidated. Issuers expressed concern during the comment process that it would be difficult to obtain sufficiently detailed information on proportionately consolidated entities and operations where the company filing the Form SD was not the operator of the venture. In the Adopting Release (page 71), the SEC explains that it expects non-operator issuers to make a reasonable effort to resolve this issue with existing joint venture operators during the initial two-year compliance period and to negotiate for access to the information for future joint ventures. Where issuers cannot get access to information on existing ventures after making reasonable effort, they can rely on Exchange Act Rule 12b-21 to leave out the information provided they meet the conditions of that rule (see footnote 251 of the Adopting Release). An FPI that prepares financial statements using accounting principles other than IFRS as issued by the IASB or US GAAP and files a reconciliation to US GAAP with its annual report to the SEC must determine control using US GAAP. Broadly, disclosure must be made of the type and total amount of payments for:
  • each project; and
  • all projects made to each government.

Government includes a company at least majority owned by a non-US government. Non-US government includes both a foreign national government and its departments, agencies or instrumentalities and a foreign subnational government such as that for a state, province, county, district, municipality or territory under a foreign national government. Government also includes US Federal government but not state or local governments. Project means ‘operational activities governed by a single contract, licence, lease, concession or similar legal agreement, which form the basis for payment liabilities with a government’. Contracts that are both operationally and geographically interconnected may be treated as a single project by the company and there is a non-exclusive list of factors to consider including whether the agreements are part of the same operating budget.

What counts as a payment? There is a finite list, namely: 1) taxes; 2) royalties; 3) fees (including licence fees); 4) production entitlements; 5) bonuses; 6) community and social responsibility (CSR) payments that are required by law or by contract; 7) dividends; and 8) infrastructure payments. Under the rule, issuers are required only to disclose the payments that fall within this specified list of payment types. However, there is an anti-evasion provision that catches any activity or payment not on the list where the activity or payment is part of a plan to evade disclosure. The Adopting Release discusses the treatment of in-kind payments concluding that they should generally be reported at cost. It also notes that while the EU and Canadian regimes do not include CSR payments as a specific payment type, their payment in kind disclosure requirements could include building a road or a school, refurbishing a government building or many other activities that do not result in a payment of money to the host country government as well as the commonest form of payment in kind which is the production entitlement. Form SD has an instruction which gives a non-exclusive list of what is included in:
  • royalties: unit-based, value-based and profit-based;
  • fees: rental fees, entry fees, concession fees; and
  • bonuses: signature, discovery and production bonuses.

Only dividends paid in lieu of production entitlements or royalties are caught – not dividends paid to a government as an ordinary shareholder in common with other such shareholders. The Form also indicates that payment information need not be audited and must be provided on a cash basis.

Is the reporting company liable for defective disclosure on Form SD? Yes, the Form SD is filed with the SEC and the company will have liability under section 18 of the Exchange Act for any false and misleading statements in the Form unless it can establish that it acted in good faith and had no knowledge that the disclosure was materially defective.
More on alternative reporting The Canadian Extractive Sector Transparency Measures Act came into force on 1 June 2015 and the EU regime is being implemented across Europe with the UK being among the first in December 2014 via its Reports on Payments Regulations and (for UK listed companies) DTR 4.3A of the Financial Conduct Authority Disclosure and Transparency Rules. First reports for companies subject to the UK rules were due in 2016. The SEC order finding the Canadian and EU regimes substantially similar also found that the US Extractive Industries Transparency Initiative (US EITI) disclosure requirements are substantially similar for purposes of payments to the US Federal Government (but not for payments to non-US governments due to the more limited scope of the US EITI requirements for these payments). The EU regime also allows for alternative reporting whereby reports prepared under a non-EU regime may be deemed to be equivalent under specific criteria. To date no equivalence determinations have been made.