Final Rule Implementing Dodd-Frank Extractive Resource Issuer Disclosure Requirements Applies to Government Payments Starting in October 2013; European Parliament May Consider an Even Broader Government Payment Disclosure Regime for All Industry Sectors

On August 22, 2012, by a 2-1 vote[1], the U.S. Securities and Exchange Commission (the “Commission”) adopted new Rule 13q-1 implementing the extractive resource issuer disclosure provisions in Section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”).[2]  Section 1504 amended the Securities Exchange Act of 1934 to require extractive resource issuers to make annual disclosures, in interactive data format, of payments made by the issuer, its subsidiaries, and entities under its control to a foreign government or the U.S. Federal Government for the commercial development of oil, natural gas, or minerals.[3]  Section 1504 further required that these disclosures provide information about the type and total amount of such payments by project and by government, and that the disclosure requirements align as much as possible with the Extractive Industry Transparency Initiative (“EITI”), a voluntary disclosure regime under which governments and extractive firms disclose public payment flows associated with extractive activities.

The Final Rule will take effect for payments made to governments starting on October 1, 2013.  For most issuers, this will result in a partial year’s disclosure for the first fiscal year, as discussed below.  According to the Final Rule, the disclosure requirements are expected to affect over 1,100 issuers (companies that file annual reports with the Commission). 

Significant Developments in the Final Rule

The clarifications provided in the Final Rule are summarized below.  The most significant developments in the Final Rule include that it:

  1. adopts a bright-line US$100,000 threshold to define what type of payment (or series of related payments) are “not de minimis” and therefore must be disclosed;
  2. requires disclosure of payments beyond those associated with “upstream” activity that are covered by EITI;
  3. does not allow the required disaggregation of payment data by “project” to be done at the country level or the level of the reporting unit;
  4. requires disclosure of payments by controlled entities even if they are not consolidated in the issuer’s financial statements (e.g., joint ventures, contractual arrangements, and other entities otherwise determined to be controlled under the broad definition of “control” in Rule 12b-2);
  5. does not allow exemptions by type of issuer or based upon foreign laws, confidentiality restrictions, or participation in parallel reporting or disclosure regimes; and
  6. imposes an “anti-evasion” provision and requires that reports be filed and thereby subject to stricter liability standards than reports that are furnished.

As such, the Final Rule embraces an expansive view of transparency, calling for disclosure of significantly more information, on more payments, by more issuers, relating to more associated entities, in a greater level of detail, and subject to greater liability risks than was clearly envisioned in the Proposed Rule.  In particular, the Final Rule’s use of a US$100,000 absolute threshold to determine what is “not de minimis” is expected to place a greater-than-expected burden on larger reporting companies, whose materiality thresholds are considerably higher.  In addition, the entity-specific control tests may create thorny issues for companies that hold significant interests in or influence over non-consolidated or proportionately consolidated entities.  Finally, a broader range of securities fraud liability risks – whether via SEC enforcement or private shareholder litigation – can arise from required disclosures.

The expansive approach taken in the Final Rule may augur of an even more expansive approach being considered by the European Parliament this fall.  As discussed below, the European Parliament may consider a new regulation that would call for E.U. member states to require government payment disclosures by companies in all sectors, and not just the extractive sector.

Overview of the Final Rule

Issuers that are subject to the disclosure requirement.  Under Section 1504 of the Act, an issuer of securities on a U.S. exchange is subject to the annual disclosure requirement if:  (1) it is required to file an annual report with the SEC[4]; and (2) it engages in the commercial development of oil, natural gas, or minerals.  The Final Rule does not make any exceptions or exemptions to these criteria, whether for issuers who are foreign private issuers (even if they are subject to similar reporting requirements under home country laws, listing rules, or an EITI program), state-owned or controlled, smaller reporting companies, companies that are only engaged in a limited amount of such commercial development activities, or otherwise.

Types of payments that must be disclosed Issuers will be required to disclose all payments that meet the following four criteria:

  1. Payment is made by the issuer and entities that it “controls”.  The Commission did not explicitly adopt a definition of “control”.  It did, however, reject the view that only entities whose results are consolidated in the issuer’s financial statements need be considered.  Instead, the Final Rule requires that issuers make a control determination based upon all relevant facts and circumstances, applying the broad control test found in Rule 12b-2:  “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 shares, by contract, or otherwise.”  This expansive view of “control” may present challenges for companies that lack access to certain accounting data.
  2. Recipient is a foreign government (including subnational units) or the U.S. Federal Government.  Section 1504 defines a “foreign government” to include a foreign government, department, agency, or instrumentality, as well as a company owned by a foreign government.  As with the Proposed Rule, the Final Rule clarifies that the term “foreign government” includes subnational governments (whether at the state, province, county, district, municipality, or territory level); the Final Rule also clarifies that a state must have at least a majority stake for an entity to be considered state owned.
  3. Purpose is to further commercial development of oil, natural gas, or minerals.
  • What constitutes commercial development of oil, natural gas, or minerals.  As defined in Section 1504 of the Act, the “commercial development of oil, natural gas, or minerals” includes the following activities:  exploration, extraction, processing, and export, or the acquisition of associated licenses.  The Final Rule expressly declined to limit this definition to “upstream” activities as many extractive sector companies had urged to ensure consistency with EITI.  The Final Rule did clarify that activities that are “ancillary” or “preparatory” are not covered.  Examples of non-covered activities include marketing, transportation for purposes other than export, and manufacture of products or equipment used in commercial development of oil, natural gas, or minerals.  In addition, refining and smelting are not covered.
  • Examples of payments furthering commercial development of oil, natural gas, or minerals.  Under Section 1504, payments made to further these activities include the following:  taxes, royalties, fees (including license fees), production entitlements, bonuses, and other “material benefits” the Commission finds, consistent with EITI guidelines, to be part of the commonly recognized revenue stream for commercial development of oil, natural gas, or minerals.  (The EITI Guidelines are focused on revenue streams enjoyed by governments.)
    • The Final Rule clarifies several of these terms as follows:  (1) “taxes” include taxes on “corporate profits, corporate income, and production” but not on “consumption” such as “value added taxes, personal income taxes, or sales taxes”; (2)“fees” include “rental fees, entry fees, and concession fees”; and (3) “bonuses” include “signature, discovery, and production bonuses”.  In addition, “in-kind” payments are covered, with reporting at cost, or fair market value if cost is not determinable.
    • In the Final Rule, the Commission adds two additional categories to the statutory list of payments requiring disclosure:  (1) dividends (other than those paid to the government as a common ordinary shareholder); and (2) payments for infrastructure improvements.  As a basis for adding the latter category, the Final Rule pointed to revised EITI Requirement 9(f) requiring participants to develop a process to disclose infrastructure payments.
    • Relying upon EITI Requirement 9(g), however, the Final Rule clarifies that social or community payments are not covered.  Notably, the Final Rule characterizes a payment to “build a hospital or school” in this group of non-covered payments, rather than infrastructure payments.
  • Anti-evasion provision.  In a move not contemplated in the Proposed Rule, the Commission added an “anti-evasion provision” to the Final Rule.  This provision seeks to deter companies from avoiding disclosure by exploiting the use of non-covered categories of payments.  Under this provision, payments that are part of a “plan or scheme to evade disclosure” must be disclosed.  See Instruction 9 to Item 2.09 of Form SD.  As an example that may raise evasion issues, the Final Rule pointed to activity whose categorization is changed after the issuance of the Final Rule in order to avoid disclosure.
  1. Amount is not de minimis.  In a departure from the Proposed Rule, the definition of what is “not de minimis” is based upon an absolute dollar amount: “any payment (whether a single payment or a series of related payments) that equals or exceeds $100,000 in the most recent fiscal year”.  The Commission did not view the “not de minimis” concept as equivalent to “material” (whether to the issuer or the government).

Content of disclosures.  The Final Rule requires the following information be included about payments that must be disclosed:

  • Project-level reporting.  Section 1504 requires the disclosure to include electronic tags identifying the type and total amount of payments for each “project” to which payments relate.  Consistent with the Proposed Rule, the Final Rule does not define the term “project”.  The Final Rule does, however, provide some limited guidance, suggesting that concessions based upon a contract document would be “projects”.  The Final Rule expressly rejects limiting the disclosures to projects that are “material”, and also rejects equating the term “project” with either a “reporting unit” or a “country”.  Certain payments levied at the entity level, such as corporate taxes, can be disclosed at the entity-level, however.
  • Other electronic tags required for classifying payment data.  Under Section 1504, payment data in the disclosure also must include electronic tags indicating the type and total amount of payments made to each government, the government and the country in which it is located[5],  the total amounts of payments by category, the currency used, the financial period in which the payments were made, and the business segment of the resource extraction issuer that made the payments.
  • No exemptions for confidentiality restrictions in foreign law or contracts. The official commentary in the Final Rule indicated that the Commission had decided not to include any exemption from disclosure for payments whose disclosure is prohibited by a foreign law or a confidentiality restriction in a contract (whether now existing or adopted in the future).
  • Auditing not required.  While the disclosures are subject to antifraud liability standards in the securities laws (as discussed below), issuers are not required to audit the data disclosed on Form SD.

Form of disclosure and associated liability risks.  The Proposed Rule had called for the disclosure to be furnished as an exhibit to the annual Exchange Act disclosures issuers file on Form 10-K or Form 20-F (for foreign issuers).  The Final Rule reversed course on both fronts.

  • Use of new Form SD.  Under the Final Rule, the disclosure must be made on a separate specialized disclosure form, called Form SD, no later than 150 days after the end of the issuer’s fiscal year.  This form is not part of the issuer’s annual report filed on Form 10-K or Form 20-F (for foreign issuers).  In response to comments, the Commission also set the filing deadline for Form SD later than the deadline for such annual reports on Forms 10-K or 20-F.  The payment data must be included in an exhibit and electronically filed in an interactive data (XBRL) format.  The taxonomy for the payment disclosures will be the subject of further guidance to be issued.
  • Disclosures must be “filed”.  Notably, in contrast with the Proposed Rule, the Commission elected to require that the disclosure be “filed”, rather than “furnished”.  This decision subjects the disclosures to a broader range anti-fraud liability standards under the securities laws – namely, including Section 18 of the Exchange Act.  Under Section 18, a person making or causing a materially false or misleading statement can be held liable by investors who relied on the statement to their detriment (unless the person can prove it acted in good faith and with no knowledge that the statement was false or misleading).  The disclosures are not, however, subject to certifications by executives (CEO and CFO) for the annual reports.

Effective date.  Issuers will be required to file annual reports starting with fiscal years ending after September 30, 2013.  For fiscal years ending between September 30, 2013, and September 30, 2014, only data relating to payments made after September 30, 2013, will be required to be disclosed.

European Parliament May Consider Government Payment Disclosure Regime for All Sectors

In 2011, the European Commission issued a proposal that also would require disclosure of payments to governments by all extractive and logging companies who are listed on an exchange in an E.U. member state or who are incorporated in an E.U. member state and are “large”.  Like the Dodd-Frank Act Section 1504, one of the stated objectives of the E.U. proposal is to support EITI.  When it meets this fall, the Legal Affairs Committee of the European Parliament is expected to take up the proposal to amend the E.U. Transparency Directive 2004/109/EC (which applies to exchange listed companies) and the Accounting Directives 78/660/EEC and 83/349/EEC (which applies to public and private companies incorporated in the European Union), and amendments to the original proposal.  

While the E.U. proposal mirrors the Dodd-Frank Act in calling for project-level reporting, the E.U. proposal differs in other significant respects from Dodd-Frank Act in the Final Rule.  For example, in some respects, the E.U. proposal calls for a narrower set of payments to be disclosed – using a significantly higher threshold for reporting (payments that are “material” to the recipient government), and allowing for exceptions for disclosures prohibited by local criminal laws.  On the other hand, however, the E.U. proposal would apply to a broader range of companies, including not companies in the extractive sector, but also companies in the logging sector, and not only E.U.-listed companies, but also “large” non-listed companies that are incorporated in an E.U. member state (defined as having two or more of the following:  an annual net turnover over EUR 40 million, balance sheet total assets over EUR 20 million, or average number of employees in the financial year over 250).[6]

In fact, the Committee on Legal Affairs of the European Parliament issued a draft report in March 2012 (PR\896951EN.doc) that called for broadening even further the scope of companies that would be subject to the disclosure requirement.  Under the proposed amendments in its draft report, the government payment disclosure requirement would apply to all sectors of economic activity (and not only to extractive or logging sectors).  This development suggests a need for any companies with E.U. listings to monitor the developments with respect to a possible E.U. government payment disclosure regime.  The European Council also has analyzed the E.U. proposal, and has not recommended amending the proposal to expand the disclosure requirement to all sectors.  As a result, negotiations between the European Parliament and the European Council over the proposal would take a significant period of time.  Both bodies would need to adopt any final laws.