Dodd-Frank Financial Reform Legislation Requires Extractive Industry Participants to Disclose Payments to GovernmentsJuly 21, 2010
Earlier today, July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Legislation”). While much of the legislation is focused on financial regulatory reform to address the financial crisis, the bill also imposes several lesser-known but equally significant new requirements on publicly-traded companies outside the financial sector. One of these is a new requirement for extractive resource issuers to disclose payments made to “governments”. This requirement, which was inserted into the legislation during conference negotiations, is based upon earlier proposals by Senator Richard Lugar, Senator Benjamin Cardin, and others seeking to mandate disclosures by extractive industry participants which are currently voluntary under initiatives such as the Extractive Industry Transparency Initiative (“EITI”) and “Publish What You Pay”.
Scope of legislation. The extractive industry disclosure provisions require certain companies engaged in “commercial development of oil, natural gas, or minerals” to disclose in their annual reports data concerning all “payments” made by the company (including subsidiaries or entities under its control) to the U.S. Federal Government or a “foreign government” for the purpose of commercial development of oil, natural gas, or minerals. A company engaged in such extractive industry activities will be subject to this new requirement if it is an “issuer” of securities that is required by to file an annual report with the U.S. Securities and Exchange Commission (“SEC”). The legislation provides no exemption for foreign issuers. As such, the SEC implementing rules are likely to cover issuers of ADRs, except those who are not required to file annual reports, such as issuers of so-called “level 1 ADRs” that trade over-the counter.
Key terms in the legislation are defined as follows:
- “Commercial development of oil, natural gas, or minerals” is defined to include “exploration, extraction, processing, export, and other significant actions relating to oil, natural gas, or minerals, or the acquisition of a license for any such activity, as determined by the” SEC. 15 U.S.C. § 78m(q)(1)(D), (A).
- “Foreign government” is defined to include the foreign government itself, as well as its departments, agencies, or instrumentalities, and companies it owns, as determined by the SEC. Unlike earlier proposals, which blurred the line between government bodies and individual officials potentially pushing disclosure far beyond EITI, the final provisions do not include officials or agents in the definition of “foreign government.”
- “Payment” means a “payment that is made to further the commercial development of oil, natural gas, or minerals, that is not de minimis, and that “includes taxes, royalties, fees (including license fees), production entitlements, bonuses, and other material benefits, that the Commission, consistent with the guidelines of the Extractive Industries Transparency Initiative (to the extent practicable), determines are part of the commonly recognized revenue stream for the commercial development of oil, natural gas, or minerals.” Id. § 78m(q)(1)(C).
As discussed below, while the U.S. legislation appears in most respects to align with the EITI, how it is implemented by the SEC will ultimately determine the scope of the disclosure requirements.
SEC rulemaking and unresolved issues. The SEC has 270 days from enactment to issue the final rules for reporting. The final rules would apply to annual reports for the fiscal year ending “not earlier than one year” after the final rule. Thus, assuming the final rules are issued in mid-April 2011, they will apply to reports for fiscal years ending after mid-April 2012. Several non-governmental organizations acting in the human rights and anti-corruption arena who are longtime proponents of this legislation have announced their intention to advocate for the SEC to adopt the “strongest possible” rules. The SEC rules likely will address several key issues:
- Which extractive industry participants are covered. The legislation grants the SEC authority to determine with greater precision which types of extractive industry participants are covered by the new disclosure requirements. In particular, the SEC has discretion to determine what type of activities qualify as "significant actions" relating to commercial development of oil, natural gas, or minerals. The SEC rules therefore may provide further guidance on the extent to which contractors, service providers, and other participants are covered by or excluded from the scope of the disclosure requirement.
- Definition of a controlled entity whose payments must be disclosed. The legislation requires disclosure of payments to governments by any entity “under the control of” the issuer. It will be important for the SEC to adopt a clear guideline for the term “control”, such as ownership of voting shares in excess of 50%, or an entity whose results are consolidated for reporting purposes. If implemented too broadly or ambiguously, the legislation could create significant problems for companies, including disclosure obligations relating to payments by joint ventures or partnerships from which companies may not be able to compel information.
- Definition of state enterprise and other public bodies whose receipt of payments must be disclosed. Unlike the EITI, the legislation does not define state enterprises as being only those engaged in upstream extractive activities. See U.K. Dept. of Int’l Dev., EITI Source Book 47 (2005). Rather, the legislation leaves it to the SEC to determine what types of state enterprises are covered as recipients of payments. It would be helpful for the SEC's implementing regulations to align this definition more closely with the definition used in the EITI.
- Scope of the definition of “payments.” The legislation’s broad definition of payments excludes only those that are “de minimis,” without defining this concept. By contrast, the EITI only applies to payments that are “material”. See U.K. Dept. of Int’l Dev., EITI Validation Guide 17 (2006). The new requirement under U.S. law thus may cover payments that are smaller in amount than those covered by the EITI. Beyond this difference, it is likely that this aspect of the disclosure requirement will be largely consistent with the EITI. Although the legislation grants the SEC authority to define further the scope of payments that must be disclosed, it must do so consistent with the EITI “to the extent practicable”.
- Extent to which payment data must be disaggregated. The amendment originally proposed by Senator Cardin called for data on “each payment” to be disclosed in interactive data format. The final provisions call for disclosure of “any payments.” Although, the final provisions suggest that data need not be disaggregated down to the individual payment level, they do call for payment data to be disaggregated by financial period, currency, business segment, government recipient, country recipient, project affected, and pursuant to other criteria the SEC may establish. The absence of any limiting language in the bill’s delegation to the SEC leaves the door open for the SEC to require anything from the minimum required by EITI to considerably more extensive disaggregation, but reaching at least to the project level. How the SEC approaches disaggregation could have significant implications for the burden of reporting and the impact of reports. The final rules could require disclosure of information regarding the type and total amount of such payments for each project of the issuer and to each foreign government. In addition, the SEC conceivably could seek to require that payments be disaggregated by payee. The SEC also could define terms such as “project” or “business segment” narrowly (increasing disaggregation), or broadly (decreasing disaggregation). The more the SEC minimizes disaggregation requirements, the lower risk issuers may face under confidentiality provisions in foreign contracts or host government regulations.
- Form of disclosure required. The legislation states that the required disclosures must be made in “an annual report”, without specifying a particular type of report. The SEC rules could mandate disclosure in glossy annual reports, as an integral part of Form 10-K (or Form 20-F for foreign issuers) filed with the SEC, in either form, or in some other form.
- Nature of penalties and applicable liability standards. The new provisions do not establish penalties for their violation, leaving it unclear whether all of the traditional SEC liability rules and regulations may apply to these newly-required disclosures. The rules also may establish whether the disclosures will be covered by the executive certifications filed with periodic reports which are subject to significant penalties set forth in the Sarbanes-Oxley requirements. In any event, absent a provision to the contrary in the SEC rules, the anti-fraud provisions of Rule 10b-5 and other books and records rules would apply. That may not make much sense, in light of the burden and uncertainties inherent in this new form of payment tracking and disclosure, and given that decisions to invest are unlikely to be affected by the disclosure in the same manner as earnings and other financial results. Thus, companies affected may want to try to seek provisions during the rulemaking process that exempt the required disclosures from the scope of the anti-fraud provisions of the securities laws (as well as possibly other provisions of the securities laws relating to books and records, control person liability, or otherwise). That could be accomplished through differing approaches, such as a presumption against materiality of the required disclosures or a blanket exemption.
Extractive industry companies were split on the bills that preceded this legislation, while several NGOs strongly supported it. Companies that have supported EITI and companies that have not will now be faced with compliance with this disclosure requirement. As with many other aspects of the financial reform legislation, the SEC implementing regulations will be critical to ensuring that this provision is implemented in a way that is consistent with EITI and minimizes the burdens on reporting companies.