On August 22, 2012, the Securities and Exchange Commission (SEC) adopted long-awaited and highly debated rules that require each “resource extraction issuer” to disclose in a new report on Form SD information relating to any “payment” made by the issuer, its subsidiaries or entities it controls to a “foreign government” or the U.S. Federal government for the purpose of the “commercial development of oil, natural gas or minerals.”1 The final rules are substantially similar to the proposed rules.2 The rules implement the provisions of Section 13(q) of the Securities Exchange Act of 1934 (Exchange Act), which was added by Section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
While the rules will become effective on November 13, 2012, a resource extraction issuer will not be required to comply with the rules and file the new report on Form SD until its first fiscal year ending after September 30, 2013. The report on Form SD must be publicly filed on EDGAR within 150 days after the end of such fiscal year. Thus, for a calendar-year issuer, its first report on Form SD for fiscal 2013 would not be due until May 30, 2014. A resource extraction issuer with a fiscal year beginning before September 30, 2013 need only disclose payments for the period from October 1, 2013 through the end of its fiscal year in its initial report on Form SD. A resource extraction issuer with a fiscal year beginning on or after September 30, 2013 must file a report on Form SD disclosing payments for the full fiscal year.
This client alert discusses key aspects of the rules and provides practical considerations for issuers to consider.
Payment Disclosure Rules
Who is subject to the rules? Any domestic or foreign private issuer, including any smaller reporting company or government-owned issuer, that (1) is required to file an annual report with the SEC and (2) engages in the “commercial development of oil, natural gas or minerals” (referred to throughout this alert as a resource extraction issuer). If an issuer satisfies the resource extraction issuer definition, it will be subject to the rules regardless of its size or the extent of its business operations constituting the commercial development of oil, natural gas or minerals.
While the rules apply to foreign private issuers, they do not apply to foreign private issuers that are exempt from Exchange Act registration pursuant to Exchange Act Rule 12g3-2(b) as they are not required to file annual reports with the SEC. The rules do not apply to investment companies required to file reports pursuant to Rule 30d-1 under the Investment Company Act of 1940.
What activities constitute the “commercial development of oil, natural gas or minerals”? The phrase is broadly defined to include the following activities:
- extraction, including the production of oil and natural gas and the extraction of minerals;
- processing, including 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, the upgrading of bitumen and heavy oil and the crushing and processing of raw ore prior to the smelting phase, but excluding refining or smelting;
- exporting, including exporting oil, natural gas or minerals from the host country, but excluding removing resources from the extraction site to the refinery, smelter or first marketable location; or
- acquiring a license for any of the foregoing activities.
Transportation activities do not generally constitute commercial development, unless the activities are directly related to the export of oil, natural gas or minerals. For example, transporting a resource to a refinery or smelter or to underground storage prior to exporting it would not be considered commercial development. Moreover, marketing activities and security support activities are not included in the commercial development definition.
Whether an issuer is engaged in commercial development will depend on its specific facts and circumstances. The SEC noted that the commercial development definition is intended to capture only activities that are directly related to the commercial development of oil, natural gas or minerals, and not activities that are ancillary or preparatory to commercial development. Thus, the SEC noted that it would not consider a manufacturer of a product used in the commercial development of oil, natural gas or minerals to be engaged in the commercial development of the resource. For example, in contrast to the process of extraction, manufacturing drill bits or other machinery used in oil extraction would not be considered commercial development.
The rules add an anti-evasion provision that requires disclosure of an activity that, although not in form or characterization of one of the specified categories of commercial development activities, is part of a plan or scheme to evade the disclosure requirements. For example, an issuer could not avoid disclosure by re-characterizing an activity that would otherwise constitute commercial development as transportation.
What must resource extraction issuers disclose? “Payments” made (1) during the fiscal year covered by the report (2) by a resource extraction issuer, any of its subsidiaries or any entity it controls3 (3) to a “foreign government”4 or the U.S. Federal government (4) for the purpose of the commercial development of oil, natural gas or minerals. Unlike payments made to governments outside the United States, disclosure is not required for payments made to subnational governments (for example, state and local governments) in the United States.
Whether a resource extraction issuer controls an entity will require the issuer to make a determination based on all relevant facts and circumstances. At a minimum, subsidiary and controlled entity payments are subject to disclosure if the entity’s financial information must be consolidated in the issuer’s financial statements included in its Exchange Act reports. Moreover, an issuer may be required to provide disclosure for entities in which it provides proportionately consolidated information. Depending on the circumstances, a resource extraction issuer engaged in the commercial development of oil, natural gas or minerals through a joint venture, as the operator of a joint venture, or through an equity investment may be deemed to control the joint venture or equity investee.
What is a “payment”? An amount paid that:
- is made to further the commercial development of oil, natural gas or minerals;
- is “not de minimis;” and
- taxes, including taxes levied on corporate profits, corporate income and production, but not taxes levied on consumption, including value added taxes, personal income taxes or sales taxes;
- fees, including license fees, rental fees, entry fees and other considerations for licenses or concessions;5
- production entitlements;
- bonuses, including signature, discovery and production bonuses;6
- dividends; and
- payments for infrastructure improvements, such as building a road or railway, whether the payments are required by contract or undertaken voluntarily.7
Unlike the proposed rules, which did not define the phrase “not de minimis,” the final rules define the phrase to mean any single payment or series of related payments that equals or exceeds $100,000 during the most recent fiscal year. However, the SEC reiterated its belief that the phrase is not the same as a materiality standard. In the case of any arrangement providing for periodic payments or installments, a resource extraction issuer must consider the aggregate amount of the related periodic payments or installments when determining whether the payment threshold has been met.
While dividends are required to be disclosed, dividends paid to a government as a common or ordinary shareholder of the resource extraction issuer are generally not required to be disclosed as long as the dividend is paid to the government under the same terms as other shareholders. However, dividends paid to a government in lieu of production entitlements or royalties must be disclosed.
The rules do not require disclosure of social or community payments, including payments to build a hospital or school.
The rules add an anti-evasion provision that will require disclosure of a payment that, although not in form or characterization of one of the specified payment categories, is part of a plan or scheme to evade the disclosure requirements.
Must in-kind “payments” be disclosed? The monetary value of in-kind “payments” must be disclosed along with how the monetary value was calculated. In-kind payments may be reported at cost or, if cost is not determinable, fair market value.
What payment information must be disclosed? A resource extraction issuer must disclose the following information in the XBRL interactive data standard for any payment required to be disclosed:
- the type and total amount of payments made for each project of the issuer relating to the commercial development of oil, natural gas or minerals;
- the type and total amount of payments made to each government;
- the total payment amounts (by category);
- the currency used to make the payments;
- the financial period (i.e., the fiscal year) when the payments were made;
- the business segment of the issuer that made the payments;8
- the government that received the payments and the country where the government is located; and
- the project of the issuer to which the payments relate.
The rules do not define the term “project” and the SEC explicitly rejected defining the term by reference to a materiality standard, as a geologic basin or as a reporting unit. Furthermore, the SEC believes that the term requires more granular disclosure than country-level reporting. The SEC did not provide a specific definition in order to provide flexibility in applying the term to different business contexts depending on factors including the issuer’s industry, business or size. However, the SEC did note that a contract for the commercial development of oil, natural gas or minerals defines the relationship and payment flows between a resource extraction issuer and a government and, therefore, the SEC believes that such contract could provide a basis for determining the payments, and required payment disclosure, that would be associated with a particular “project.”
Payments made for governmental obligations levied at the entity, rather than project, level may be disclosed at the entity level. For example, if an issuer has more than one payment in a country and the country levies corporate income taxes on all of the issuer’s income in the country and not for particular projects or operations, the issuer may disclose the resulting income tax payments without specifying a particular project or business segment associated with the payment.
What currency should be used to report the payment information? The total payment amounts required by the rules must be reported in either U.S. dollars or the issuer’s reporting currency. Issuers making payments in other currencies must convert those payments into either U.S. dollars or the issuer’s reporting currency, as applicable, and disclose which of the following methods was used to calculate the currency conversion:
- translation of expenses at the exchange rate existing at the time the payment is made;
- use of a weighted average of the exchange rates during the period; or
- the exchange rate as of the issuer’s fiscal year end.
Where must the payment disclosure be made? In a change from the proposed rules, a resource extraction issuer must provide the payment information in an XBRL exhibit to a newly created report on Form SD9 rather than in two separate exhibits to its annual report on Form 10-K, 20-F or 40-F. A resource extraction issuer must disclose in the body of the report on Form SD that the payment disclosure is provided in an exhibit to the report. As the SEC expects to have the XBRL taxonomy for the payment disclosure ready by the time Form SD is required to be filed to report payments,10 it did not provide a delay for the interactive data tagging requirement.
Unlike annual reports on Form 10-K, 20-F and 40-F, reports on Form SD do not require chief executive officer and chief financial officer certifications. However, reports on Form SD must be signed by an executive officer, but not by an issuer’s directors.
Payments made by a resource extraction issuer that is an Exchange Act reporting issuer and a wholly-owned subsidiary of an Exchange Act reporting parent that is a resource extraction issuer are not required to be separately disclosed in the subsidiary’s report on Form SD provided that the parent has included the payments in the parent’s report on Form SD. However, the parent must indicate that it is filing the payment disclosure for the wholly-owned subsidiary and identify the subsidiary and the subsidiary must file its own report on Form SD indicating that the payment disclosure was provided in the parent’s report on Form SD.
Must the payment disclosure be audited? The payment disclosure is not required to be audited or provided on an accrual basis.
Is the payment disclosure deemed “filed” with the SEC? In a significant change from the proposed rules, the payment disclosure will be deemed “filed” with the SEC and thus subject to liability under Section 18 of the Exchange Act for false or misleading material statements. Section 18 does not impose strict liability, as an issuer would have the standard defense to Section 18 claims if the issuer can prove it acted in good faith and had no knowledge that the statement complained of was false or misleading.
Is the payment disclosure incorporated by reference into other issuer filings? The payment disclosure will not be deemed incorporated by reference into any filing under the Securities Act of 1933 (e.g., a registration statement) or the Exchange Act, unless a resource extraction issuer specifically incorporates the information by reference.
Are there any exemptions from the rules? The rules do not provide any exemptions from the disclosure requirements, including exemptions sought by certain commentators for:
- issuers subject to similar reporting requirements under home country laws, stock exchange listing rules or a program pursuant to the Extractive Industries Transparency Initiative;
- situations where foreign law may prohibit the required disclosure;11
- situations where an issuer has a confidentiality provision in a relevant contract;
- commercially or competitively sensitive information, regardless of the existence of a contractual confidentiality provision;12 or
- situations where disclosure would jeopardize the safety and security of an issuer’s operations or employees.
While the first report on Form SD for most issuers (i.e., calendar-year issuers) will not be due until 2014, issuers engaged in the commercial development of oil, natural gas or minerals should consider taking the following actions as soon as possible.
- Determine whether they are a resource extraction issuer that would be subject to the rules by examining whether based on their facts and circumstances they are involved in any activities that constitute the “commercial development of oil, natural gas or minerals.” If so, evaluate how they will be impacted by the rules, including:
- whether any countries where they operate prohibit disclosure of the payment information and, if so, whether those laws would require them to cease operations in the impacted countries or incur penalties to comply with the rules;
- whether any existing commercial agreements prohibit disclosure of the payment information and how future commercial agreements may be impacted as a result of the rules;
- whether they expect to have any “payments” to disclose;
- whether they have any subsidiaries or controlled entities (including joint ventures, equity investees or other contractual arrangements) whose payments would require disclosure, including how to collect the payment information from such entities; and
- how they will define “project” for data tracking and disclosure purposes.
- Determine whether data gathering systems need to be modified to track and collect information about the different types of payments across projects, governments, countries, subsidiaries and other controlled entities.
- Determine whether disclosure controls and procedures need to be modified in order to record, process, summarize and report the required payment information.
- Review the SEC’s draft taxonomy for Form SD and consider whether to provide comments.