iThe Securities and Exchange Commission (SEC) recently published for public comment proposed rules that would require each resource extraction issuer to disclose in its annual report 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. The proposed rules would implement the disclosure provisions of Section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Based on the volume of SEC comment requests contained throughout the proposing release, which can be found here, the final rules may vary significantly from the proposed rules. Comments on the proposed rules must be submitted to the SEC by January 31, 2011.
This client alert briefly summarizes the proposed rules and provides a list of action items for issuers to consider in response to the proposed rules.
Proposed Payment Disclosure Rules
What Issuers Would be Subject to the Proposed Rules? Any domestic or foreign private issuer (including any smaller reporting company or issuer owned or controlled by a government) 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 as a resource extraction issuer).
What Activities Constitute the “Commercial Development of Oil, Natural Gas, or Minerals?” The SEC proposed to define the phrase to include:
- exploration;
- extraction (which the SEC believes includes the production of oil and natural gas and the extraction of minerals);
- processing;
- export;
- other significant actions relating to oil, natural gas or minerals; and
- the acquisition of a license for any of these activities.
The SEC indicated that the proposed definition is intended to capture only activities that directly relate to the commercial development of oil, natural gas or minerals. The proposed definition would not capture activities that are “ancillary or preparatory” to commercial development. For example, the SEC noted that manufacturing drill bits or other machinery used in oil extraction would not be considered commercial development. Commercial development also would not generally include transportation activities to the extent the transportation is for purposes other than export. However, the proposed definition would cover an issuer involved in impurity removal (for example, sulfur, carbon dioxide and water) from natural gas after extraction and prior to transport through the pipeline. The rationale was that impurity removal is generally considered to be a necessary part of natural gas processing to prevent pipeline corrosion.
The SEC did not provide any additional guidance regarding what activities would constitute a “significant action” under the proposed definition. However, the SEC solicited comment regarding whether it should provide further guidance regarding activities not specifically listed in the proposed definition but that could constitute a “significant action” and, if so, what activities should be covered.
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
-
includes:
- taxes;
- royalties;
- fees (including license fees);
- production entitlements; and
- bonuses.
The SEC did not propose a definition for the phrase “not de minimis.” However, the SEC indicated its belief that the phrase is not the same as a materiality standard.
The SEC noted that the proposed list of payments is generally consistent with the payment types that the Extractive Industries Transparency Initiative suggests should be disclosed. An instruction to the proposed rules provides that issuers would be required to disclose taxes on corporate income, corporate profits and production, but not taxes on consumption (for example, value added taxes), personal income or sales. The SEC also noted that issuers would be required to disclose concession, entry and leasing and rental fees and signature, discovery and production bonuses. The proposed definition does not include “social or community” payments (for example, school or hospital improvement payments) or infrastructure improvements.
The SEC believes that the proposed definition would cover payments made in cash or in kind.
What Payments Require Disclosure? Payments made (1) during the fiscal year covered by the annual report (2) by a resource extraction issuer, its subsidiaries or any entities it controls (3) to a foreign government or the U.S. Federal Government (4) for the purpose of the commercial development of oil, natural gas or minerals. The proposed definition of “foreign government” includes foreign national and subnational governments, departments, agencies and instrumentalities of foreign national and subnational governments and companies owned (meaning at least majority-owned) by foreign national and subnational governments.
When Must Payments by Subsidiaries and Other Entities be Disclosed? A resource extraction issuer must provide disclosure not only for payments it made but also for those made by its subsidiaries and controlled entities. Whether a resource extraction issuer controls an entity would require the issuer to make a factual determination based on all relevant facts and circumstances. The SEC noted that, at a minimum, subsidiary and controlled entity payments would be subject to disclosure if the resource extraction issuer must consolidate that entity’s financial information in the financial statements included in reports filed under the Securities Exchange Act of 1934 (Exchange Act). Depending on the circumstances, a resource extraction issuer that is the operator of a joint venture may be deemed to control the joint venture and would be required to provide payment disclosure for the joint venture.
What Payment Information Would be Disclosed? The payment information that would be disclosed includes:
- 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 when the payments were made;
- the business segment of the issuer that made the payments;
- the government that received the payments and the country where the government is located; and
- the project of the issuer related to the payments.
The proposed rules do not define the term “project.” The SEC noted that it did not propose a specific definition in order to provide flexibility in the application of the term to different business contexts.
Where Would the Payment Disclosure be Made? In two exhibits to a resource extraction issuer’s annual report on Form 10-K, Form 20-F or Form 40-F, as applicable. One exhibit would be filed in HTML or ASCII format and the other would be filed in XBRL format. A resource extraction issuer would also be required to disclose in the body of the annual report that the payment disclosure is included in specified exhibits to the annual report. The payment disclosure would not be required in registration statements.
Are There any Exceptions to the Disclosure Rules? There are no exceptions to the proposed rules. The SEC, however, solicited comment regarding whether it should provide exceptions under certain circumstances, including when a host country’s laws prohibit disclosure or for confidentiality clauses in existing or future agreements.
Would the Payment Disclosure Need to be Audited? The payment disclosure would not be required to be audited or provided on an accrual basis, although the SEC solicited comment regarding whether it should impose these requirements.
Would the Payment Disclosure be Deemed “Filed” with the SEC? The payment disclosure would not be deemed “filed” with the SEC, subject to liability under Section 18 of the Exchange Act or incorporated by reference into any filing under the Securities Act of 1933 (Securities Act) or the Exchange Act, unless a resource extraction issuer specifically incorporates the information by reference into a Securities Act or Exchange Act filing.
When Would the Payment Disclosure be Required? Section 1504 requires the SEC to issue final payment disclosure rules by April 15, 2011. Assuming that the SEC adopts final rules on April 15, 2011, the rules would likely apply to the annual report for the first fiscal year ending on or after April 15, 2012. Accordingly, for a calendar-year issuer the rules would apply to the annual report for the year ending December 31, 2012.
Action Items
While the final rules may vary significantly from the proposed rules outlined above, issuers engaged in the commercial development of oil, natural gas or minerals should consider taking the following actions in advance of the adoption of final rules:
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Determine whether they are a resource extraction issuer that would be subject to the rules. If so, evaluate how they will be impacted if the rules are adopted as proposed, including:
- whether any countries where they operate prohibit disclosure of the payment information;
- 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;
- how they will determine whether or not a payment is “not de minimis;”
- whether they have any subsidiaries or controlled entities (including joint ventures) whose payments would require disclosure; and
- how they would define “project” for data tracking and disclosure purposes.
- Determine whether to comment (either individually or as part of a trade or industry group) on the proposed rules by responding to the SEC’s numerous general and specific questions contained in the proposing release.
- If they are a resource extraction issuer, determine whether existing data gathering systems would need to be modified to track and collect information about different types of payments across projects, governments, countries, subsidiaries and other controlled entities and, if so, how and the timeline for implementing the modifications.
- If they are a resource extraction issuer, determine whether existing disclosure controls and procedures would need to be modified in order to record, process, summarize and report the required payment information and, if so, how and the timeline for implementing the modifications.
