“Resource Payments” Disclosure: SEC Adopts Final Rules on Disclosure of Payments to Governments for Commercial Development of Oil, Natural Gas or Minerals

New York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Tokyo Hong Kong Beijing Melbourne Sydney www.sullcrom.com July 7, 2016 “Resource Payments” Disclosure SEC Adopts Final Rules on Disclosure of Payments to Governments for Commercial Development of Oil, Natural Gas or Minerals SUMMARY The Securities and Exchange Commission has adopted final rules that implement the “resource payments” disclosure provisions of Section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The rules require reporting companies engaged in the commercial development of oil, natural gas or minerals to make detailed disclosure, in an annual report on Form SD, of payments to foreign governments or the U.S. Federal Government related to the commercial development of oil, natural gas or minerals. The SEC re-proposed resource extraction payment disclosure rules in December 2015 following a 2013 court ruling vacating the rules adopted by the SEC in 2012. The final rules largely track the December 2015 proposal, and are designed to harmonize the SEC’s approach with those taken by the European Union and Canada on such disclosure. In addition, pursuant to a separate order issued on the same day as the final rules, issuers may use reports prepared pursuant to reporting requirements of the EU, Canada and, to some extent, the U.S. Extractive Industries Transparency Initiative (USEITI) to comply with the SEC disclosure requirements. Resource extraction issuers are required to comply with the final rules with respect to fiscal years ending on or after September 30, 2018. BACKGROUND The SEC is adopting Rule 13q-1 and a related amendment to Form SD in order to implement Section 1504 of the Dodd-Frank Act, which added Section 13(q) to the Securities Exchange Act of -2- “Resource Payments” Disclosure July 7, 2016 1934 (Exchange Act) and required the SEC to promulgate rules requiring resource extraction issuers to include in annual reports information relating to any payment made by the issuer, a subsidiary of the issuer or an entity under the control of the issuer to a foreign government or the Federal Government, for the purpose of the commercial development of oil, natural gas or minerals.1 Section 13(q) reflects the U.S. foreign policy interest in supporting global efforts to improve the transparency of payments made in the extractive industries in order to help combat global corruption and promote accountability. In response to the court ruling vacating the 2012 rules, the SEC re-proposed rules implementing Section 1504 on December 11, 2015.2 The re-proposed rules sought to address issues identified by the District Court decision vacating the 2012 rules and made other modifications designed to harmonize the SEC’s approach with those taken by the European Union and Canada with respect to similar disclosure as well as the guidelines of the Extractive Industries Transparency Initiative (EITI). DESCRIPTION OF THE FINAL RULES The final rules are largely similar to the proposed rules. Some of the more significant differences are as follows:  The final rules include two targeted exemptions to the reporting requirements, which:  allow for a one-year delay in reporting payments related to exploratory activities; and  provide a longer transition period for recently acquired companies that were not previously subject to reporting under the final rules;  The final rules revise the definition of “payments” to include community and social responsibility payments (CSR payments) that are required by law or contract; and 1 The SEC originally adopted Rule 13q-1 on August 22, 2012. Soon after adoption, the 2012 rules were challenged by various parties, including the U.S. Chamber of Commerce and the American Petroleum Institute. On July 2, 2013, the U.S. District Court for the District of Columbia vacated the rules on the grounds that: (1) the SEC misread Section 13(q) as compelling the public disclosure of the issuers’ reports; and (2) the SEC’s explanation for not granting an exemption for when disclosure is prohibited by foreign governments was “arbitrary and capricious.” Following the District Court’s decision, the SEC did not act immediately to re-propose or otherwise modify the resource extraction disclosure rules. On September 18, 2014, Oxfam filed suit in the U.S. District Court for the District of Massachusetts to compel the SEC to promulgate a final rule implementing Dodd-Frank Section 1504, and on September 2, 2015 that court issued an order holding that the SEC unlawfully withheld agency action by not promulgating a new rule. See our memoranda, dated August 31, 2012, titled “SEC Adopts Final Rules to Implement the ‘Resource Payments’ Disclosure Requirements of the Dodd-Frank Act” (see https://www.sullcrom.com /siteFiles/Publications/SC_Publication_SEC_Adopts_Final_Rules_to_Implement_the_Resource_Pay ments_Disclosure_Requirements.pdf) and dated July 2, 2013, titled “Court Vacates SEC Resource Payment Disclosure Rule.” (see https://www.sullcrom.com/siteFiles/Publications/ SC_Publication_Court_Vacates_SEC_Resource_Payments_Disclosure_Rule.pdf). 2 See our memorandum, dated December 22, 2015, titled “SEC Re-Proposed Resource Payments Disclosure Rules.” See https://www.sullcrom.com/siteFiles/Publications/SC_Publication_SEC_ Re_Proposes_Resource_Payments_Disclosure_Rules.pdf. -3- “Resource Payments” Disclosure July 7, 2016  The final rules provide additional guidance on various provisions and definitions, including with regard to in-kind payments and terms included in the definition of “commercial development of oil, natural gas, or minerals,” as discussed in more detail below. RESOURCE EXTRACTION ISSUER The final rules define “resource extraction issuer” as an issuer that is required to file an annual report on Form 10-K, 20-F or 40-F and that “engages in the commercial development of oil, natural gas or minerals.” The definition excludes companies registered under the Investment Company Act and issuers subject to Tier 2 reporting requirements under Regulation A or to Regulation Crowdfunding’s reporting requirements. The SEC explicitly declined to exclude foreign private issuers from the definition. However, foreign private issuers that are exempt from Exchange Act registration and reporting requirements under Rule 12g3-2(b) are not subject to the final rules as they are not required to file an annual report with the SEC. COMMERCIAL DEVELOPMENT OF OIL, NATURAL GAS OR MINERALS Consistent with the definition provided in Section 13(q) and the proposed rules, the final rules define “commercial development of oil, natural gas, or minerals” as exploration, extraction, processing and export of oil, natural gas or minerals, or the acquisition of a license for any such activity. Responding to comments on the proposed rules, the final rules also provide additional guidance on certain key terms included in this definition. “Extraction” is defined as the production of oil and natural gas as well as the extraction of minerals. “Processing” includes, but is not limited to, midstream activities such as the processing of gas to remove liquid hydrocarbons, the removal of impurities from natural gas prior to its transport through a pipeline, and the upgrading of bitumen and heavy oil, through the earlier of the point at which oil, gas or gas liquids (natural or synthetic) are either sold to an unrelated third party or delivered to a main pipeline, a common carrier or a marine terminal. It also includes the crushing and processing of raw ore prior to the smelting phase. “Processing” does not, however, include downstream activities, such as refining or smelting. The final rules define “export” as the transportation of a resource from its country of origin to another country by an issuer with an ownership interest in the resource, with certain exceptions that are intended to limit the rule to activities related to exploration and extraction and the categories of payments to governments identified in the statute. The definition specifically excludes payments related to transportation on a fee-for-service basis across an international border by a service provider with no ownership interest in the resource. The SEC also intends the term “export” to avoid capturing activities with little relationship to upstream or midstream activities, such as commodity trading-related activities. Accordingly, the definition of “export” also excludes the movement of a resource across an international border by a company that (a) is not engaged in the exploration, extraction, or processing of oil, natural gas or minerals and (b) acquired its ownership interest in the resource directly or indirectly from a foreign government or the Federal Government. However, the definition does cover the purchase of such -4- “Resource Payments” Disclosure July 7, 2016 government-owned resources by a company otherwise engaged in resource extraction. Furthermore, the definition does not intend to capture activities that are ancillary or preparatory to commercial development, such as providing products or services that support such covered activities. Nevertheless, an issuer must disclose payments made by a service provider on the issuer’s behalf when it meets the definition of “payment” under the final rules. COVERED PAYMENTS Types of Payments The final rules define “payment” to mean a payment that:  is made to further the commercial development of oil, natural gas or minerals;  is “not de minimis”; and  is one or more of the following: taxes, royalties, fees (including license fees), production entitlements, bonuses, dividends, payments for infrastructure improvements and CSR payments that are required by law or contract. Only payments that fall within this specified list are required to be disclosed. In a departure from the proposed rules and consistent with the EITI guidelines, the final rules include CSR payments that are required by law or contract because the SEC believes such payments are now generally considered part of the commonly recognized revenue stream for the commercial development of oil, natural gas or minerals. The final rules also require issuers to disclose in-kind payments at cost or, if cost is not determinable, at fair market value, and to provide a brief description of how the monetary value is calculated. The final rules provide additional guidance regarding how to report payments made to a foreign government or the Federal Government to purchase resources associated with production entitlements that are reported inkind. Issuers are not required to report the volume of in-kind payments (but only their monetary value as described above). The final rules also revise Form SD to state expressly that the payment information need not be audited and must be made on a cash basis. The definition of “not de minimis” in the final rules is consistent with the proposed rules, as “one that equals or exceeds $100,000, or its equivalent in the issuer’s reporting currency, whether made as a single payment or series of related payments.” The final rules also adopt the anti-evasion provision as proposed, requiring disclosure with respect to any activity (or payment) that, although not within the categories included in Form SD, “is part of a plan or scheme to evade the disclosure required” under Section 13(q). This is intended to cover, for example, payments that were substituted for otherwise reportable payments in an attempt to evade the disclosure rules, as well as activities and payments that were structured, split or aggregated in an attempt to avoid -5- “Resource Payments” Disclosure July 7, 2016 application of the rules. Similarly, the SEC noted that a resource extraction issuer could not avoid disclosure by re-characterizing as transportation an activity that would otherwise be covered under the rules, or by making a payment to the government via a third party in order to avoid disclosure under the rules. Payments by a Subsidiary or an Entity Under the Control of the Resource Extraction Issuer Using the language from Section 13(q) and consistent with the proposed rules, the final rules require a resource extraction issuer to disclose covered payments made by a subsidiary or an entity under the control of the issuer. Issuers have “control” of another entity if the issuer is required to consolidate that entity or proportionately consolidate an interest in the entity or operation under the accounting principles applicable to its filed financial statements (if U.S. GAAP or IFRS) or under U.S. GAAP (in other cases). In the case of proportionately consolidated entities or operations, the issuer is required to disclose the issuers’ proportionate amount of that entity’s or operation’s payments, indicating the issuer’s proportionate interest. Payment Information to Be Disclosed The final rules follow the proposed rules and require resource extraction issuers to disclose:  The type and total amount of payments made for each project relating to the commercial development of oil, natural gas or minerals;  The type and total amount of such payments for all projects made to each government;  The total amounts of the payments by category;  The currency used to make the payments;  The fiscal year in which the payments were made;  The business segment of the resource extraction issuer that made the payments;  The governments that received the payments and the country in which each such government is located;  The project to which the payments relate;  The particular resource that is the subject of commercial development; and  The subnational geographic location of the project. The final rules, in line with the proposed rules, call for a high degree of granular transparency despite the strong disagreement expressed by many industry commenters. The SEC remained persuaded that disaggregation is necessary and appropriate to further the goals of promoting transparency and accountability and combating corruption. Payment Information with Respect to Each “Project” The final rules define “project” as operational activities that are governed by a single contract, license, lease, concession or similar legal agreement, which form the basis for payment liabilities with a government. -6- “Resource Payments” Disclosure July 7, 2016 Multiple agreements that are both operationally and geographically interconnected may be treated by the resource extraction issuer as a single project. The final rules also provide a non-exclusive list of factors to help issuers determine whether agreements are so interconnected. Those factors include whether the agreements relate to the same resource and the same or contiguous part of a field, mineral district or other geographic area; whether they were performed by shared key personnel or with shared equipment; and whether they were part of the same operating budget. Issuers are not required to disaggregate payments that are made for obligations levied on the issuer at the entity level rather than the project level. Therefore, if a government levies a payment obligation, such as a tax or a requirement to pay a dividend, at the entity level rather than on a particular project, an issuer may disclose that payment at the entity level. Foreign Government and Federal Government The final rules require disclosure with respect to any payment to a “foreign government” or the Federal Government. A “foreign government” is defined to include a foreign government, a department, agency or instrumentality of a foreign government, or a company at least majority-owned by a foreign government. Consistent with Section 13(q) and with the EU Accounting Directive and the EU Transparency Directive (EU Directives), Canada’s Extractive Sector Transparency Measures Act (ESTMA) and EITI, foreign government 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. “Federal Government” means the U.S. Federal Government and does not include subnational governments within the United States. Issuers must also identify the administrative or political level of subnational government that is entitled to a payment under the relevant contract or foreign law and must include any payments made by third parties to such government on the issuer’s behalf. PUBLIC DISCLOSURE One of the grounds cited by the District Court in vacating the 2012 rules was that the SEC misread Section 13(q) to “compel” public disclosure of resource extraction issuers’ reports. Nevertheless, in the proposed rules, the SEC stated that it would require public filing of the resource payment disclosure based on the discretion provided to the SEC by the statute and because it believed such publicity is necessary to further the objectives of the statute. Many commenters concerned about the competitive harm that could be caused by public disclosure suggested permitting confidential filings, with the SEC providing a public compilation aggregating and anonymizing that information. Other commenters expressed concern about instances in which the required payment disclosure would be prohibited under the host country’s laws. -7- “Resource Payments” Disclosure July 7, 2016 In line with the proposed rules, the final rules mandate public filing, including disclosure of the identity of the issuer, and reiterate the SEC’s ability to provide exemptive relief on a case-by-case basis using its existing authority under Rule 0-12 of the Exchange Act, which will allow the SEC to tailor such relief to the particular circumstances, such as where payment disclosure is prohibited under the host country’s laws. The SEC declined to provide a blanket exemption in countries where the law may prohibit the disclosure and stated its belief that a case-by-case exemptive approach would be significantly less likely than a blanket approach to encourage foreign governments to enact laws prohibiting the disclosures required by Section 13(q). The SEC also declined to provide an exemption for contracts that may prohibit the disclosure. The SEC suggested that many contracts allow for disclosure of information when it is required by law and also that the two-year period before the disclosure obligations take effect should allow most issuers to amend existing contracts if required to permit the disclosure. EXEMPTIONS In a significant departure from the proposed rules, the final rules include two targeted exemptions. Exploratory Activities Exemption The first exemption responds to several commenters’ concerns regarding the disclosure of commercially sensitive information. Pursuant to the final rules, issuers will not be required to report payments related to exploratory activities for the fiscal year in which the payments are made but can instead delay reporting such payments until the following fiscal year. As noted in the adopting release, the exemption is limited to one year because the SEC believes the likelihood of competitive harm from disclosing payment information related to a new discovery diminishes over time once exploratory activities on the property have begun. For purposes of this exemption, payments are related to exploratory activities if they are made as part of the process of identifying areas that may warrant examination or examining specific areas that are considered to have prospects of containing oil and gas reserves, or as part of a mineral exploration program. This exemption is limited to activities conducted prior to the development or extraction of the oil and gas or minerals that are the subject of the exploratory activities and is not permitted for payments related to exploratory activities if the issuer has commenced development or extraction activities anywhere on the property in question, an adjacent property or a property that is part of the same project. Acquired Company Exemption The second targeted exemption provides a transition period for recently acquired companies that were not previously subject to reporting under the final rules. This exemption allows issuers that have acquired or otherwise obtained control over a company whose resource extraction payments are required to be disclosed under the final rules, and that has not previously been obligated to provide such disclosure, to delay reporting payment information for the acquired company until the fiscal year following the date of -8- “Resource Payments” Disclosure July 7, 2016 the acquisition. The final rules do not provide similar transitional relief for newly acquired companies that were already required to report such payments or for companies conducting initial public offerings, on the basis that such companies would already be familiar with the reporting requirements or would have sufficient notice of them. ALTERNATIVE REPORTING Under the final rules, issuers will be able to meet the requirements of Section 13(q) by providing disclosure that complies with a foreign jurisdiction’s or the USEITI’s resource extraction payment disclosure requirements if they are deemed “substantially similar” by the SEC. The issuer may only use an alternative report for an approved foreign jurisdiction or regime if the issuer is subject to the resource extraction payment disclosure requirements in that jurisdiction and has made the report prepared in accordance with that jurisdiction’s requirements publicly available prior to filing it with the SEC. An issuer choosing to avail itself of this accommodation must submit as an exhibit to Form SD the same report it made publicly available in accordance with the approved alternative jurisdiction’s requirements and include a statement in the body of the Form SD that it is relying on this accommodation and identifying the relevant alternative reporting regime. The issuer must also tag the alternative report using XBRL and provide an English translation if the alternative report is prepared in a foreign language. In contrast to the proposed rules, under the final rules an issuer filing an alternative report may also follow the reporting deadline in the alternative jurisdiction, but must submit a notice on Form SD-N on or before the due date of its Form SD indicating its intent to submit by the alternative deadline. In conjunction with the adoption of the final rules, the SEC issued an order recognizing the EU Directives, ESTMA and the USEITI in their current forms as substantially similar regimes for purposes of alternative reporting under the final rules, subject to certain conditions. However, because USEITI does not cover payments to foreign governments and uses calendar year instead of fiscal year reporting, USEITI reports will only satisfy the disclosure requirements for payments made by an issuer to the Federal Government, and an issuer would have to supplement its USEITI report with disclosure regarding any payments to foreign governments and to provide the required payment information on a fiscal year basis (which would affect only issuers that do not have a December 31 fiscal year end). Issuers, governments, industry groups and trade associations may submit applications to the SEC to request recognition of other jurisdictions’ payments transparency rules as substantially similar to the rules adopted under Section 13(q) for purposes of alternative reporting. FORM, LOCATION AND TIMING OF DISCLOSURE The final rules provide for disclosures in a separate, stand-alone annual report, to be made on the amended Form SD within 150 days of the end of the applicable fiscal year. The Form SD will be filed -9- “Resource Payments” Disclosure July 7, 2016 rather than furnished and will therefore be subject to liability under Section 18 of the Exchange Act.3 The detailed payments data must be provided in an exhibit to Form SD, which must be in XBRL format and include the electronic tags identified in Form SD, which include those specified in Section 13(q), as well as tags for (a) the type and total amount of payments made for each project, (b) the type and total amount of payments made to each government, (c) the particular resource that is the subject of commercial development and (d) the subnational geographic location of the project. Additional guidance is also provided in the final rules with regard to types of tags, including with regard to tags for the subnational geographic location of the project that use ISO codes. The final rules do not require Inline XBRL. Form SD, including exhibits, will be submitted via the SEC’s Edgar system and made publicly available. A separate public compilation of the payment information submitted in the Form SD filings will be made available online by the SEC. Resource extraction issuers are required to file annual reports on Form SD for fiscal years ending on or after September 30, 2018 and filing will not be due until 150 days later. Therefore, for issuers whose fiscal year ends on December 31, the first filing deadline will be May 30, 2019. * * * 3 Section 18 of the Exchange Act imposes liability for false and misleading statements relating to a material fact included in a filing under the Exchange Act unless the defendant can establish that he or she acted in good faith and had no knowledge that the statement was false or misleading. Copyright © Sullivan & Cromwell LLP 2016 -10- “Resource Payments” Disclosure July 7, 2016 ABOUT SULLIVAN & CROMWELL LLP Sullivan & Cromwell LLP is a global law firm that advises on major domestic and cross-border M&A, finance, corporate and real estate transactions, significant litigation and corporate investigations, and complex restructuring, regulatory, tax and estate planning matters. Founded in 1879, Sullivan & Cromwell LLP has more than 800 lawyers on four continents, with four offices in the United States, including its headquarters in New York, three offices in Europe, two in Australia and three in Asia. CONTACTING SULLIVAN & CROMWELL LLP This publication is provided by Sullivan & Cromwell LLP as a service to clients and colleagues. The information contained in this publication should not be construed as legal advice. Questions regarding the matters discussed in this publication may be directed to any of our lawyers listed below, or to any other Sullivan & Cromwell LLP lawyer with whom you have consulted in the past on similar matters. If you have not received this publication directly from us, you may obtain a copy of any past or future related publications from Stefanie S. Trilling (+1-212-558-4752; [email protected]) in our New York office. CONTACTS New York Robert E. Buckholz +1-212-558-3876 [email protected] Catherine M. 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