On December 16, 2020, the Securities and Exchange Commission (the “SEC") adopted final rules (available here) requiring certain disclosure by public companies that engage in the commercial development of oil, natural gas or minerals. Under the final rules, domestic or foreign “resource extraction issuers" (the definition of which is discussed below) will have to file a Form SD on an annual basis that includes information about payments related to the commercial development of oil, natural gas or minerals that are made to a foreign government or the U.S. federal government.
What's the History Here?
The SEC's release sets forth the tortured, more-than-eight-year history of this rulemaking process (see previous Gibson Dunn posts regarding this topic in 2019, 2015, 2013 and 2010). The SEC adopted these rules by mandate pursuant to Section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act") after having earlier-adopted versions of the rules vacated in 2012 by the U.S. District Court for the District of Columbia (a ruling which the SEC declined to appeal) and disapproved in 2016 by Congress pursuant to its authority under the Congressional Review Act (the “CRA"). While Congress disapproved of the rules adopted in 2016, it did not repeal Section 1504 of the Dodd-Frank Act, so the SEC's rulemaking mandate remained in place. Revised rules cannot be substantially similar to the ones disapproved by Congress under the CRA. As such, the SEC proposed new rules in 2019 that differed from the 2016 rules (see this earlier blog post for a breakdown of the differences between the 2016 rules and the 2019 proposed rules). Today's newly adopted rules follow the proposed 2019 rules with a few minor differences (which are discussed in more detail below).
What Does This Entail?
The final rules implement Section 13(q) of the Securities Exchange Act of 1934, as amended, and will require disclosure of the following company-specific, project-level information in an amended version of Form SD (available on page 212 of the adopting release):
• the type and total amount of payments, by payment type, made for each project of the resource extraction issuer relating to the commercial development of oil, natural gas or minerals;
• type and total amount of such payments, by payment type, for all projects made to each government;
• the currency used to make the payments;
• the fiscal year in which the payments were made;
• the business segment of the issuer that made the payments;
• the governments that received the payments and the country in which each such government is located;
• the specific projects to which such payments relate;
• the resources that are being developed;
• the method of extraction used in the project and the major subnational political jurisdiction of each project; and
• the payments made by a subsidiary or entity controlled by the issuer.
The final rules define “project" using a three-pronged definition: (1) the type of resource being commercially developed; (2) the method of extraction; and (3) the major subnational political jurisdiction where the commercial development of the resource is taking place. This definition will allow an issuer to make the payment disclosure at a higher level of aggregation than under the 2016 rules' contract-based definition.
The final rules define “payment" to mean a payment that 1) is made to further the commercial development of oil, natural gas or minerals, 2) is not de minimis (which is discussed in more detail below) and 3) includes taxes, royalties, fees, production entitlements, bonuses or other material benefits that the SEC determines to be part of the commonly recognized revenue stream for oil, natural gas or minerals.
What Kinds of Activities Does It Apply To?
Commercial development of oil, natural gas or minerals means exploration, extraction, processing and export of oil, natural gas or minerals, or the acquisition of a license for any such activity. The final rules define “extraction" to mean the production of oil or natural gas or the extraction of minerals. “Processing" includes some midstream activities such as the crushing or preparing of raw ore prior to smelting. Processing also includes midstream activities such as removing liquid hydrocarbons from gas and upgrading bitumen or heavy oil, through the earlier of the point of being sold to an unrelated third party or delivered to a main pipeline, a common carrier or a marine terminal. Processing does not include downstream activities such as refining or smelting. “Export" means a resource's movement across an international border from the host country to another country by an issuer with an ownership interest in the resource.
This definition of commercial development will capture only “those activities that are directly related to the commercial development of oil, natural gas, or minerals, and not activities ancillary or preparatory to such commercial development." Therefore, this definition will exclude, for example, drill bit manufacturers, hardware providers and operators that provide hydraulic fracturing or drilling services.
Who Does This Apply To?
The adopted rules apply to any resource extraction issuer, which is defined as an issuer that is required to file an annual report with the SEC and that engages in the commercial development of oil, natural gas or minerals. For joint ventures or arrangements where no one party has control, the operator of the venture or arrangement must report all of the payments. Non-operator members are only required to report payments that, as resource extraction issuers, they make directly to governments. All companies with activities related to the development of oil, natural gas or minerals, even if only tangentially, should be aware of this definition and the guidance provided in order to determine whether or not they will be subject to further disclosure requirements.
Who Is Exempt?
The final rules include several important exemptions, although as discussed in the next section, there are limitations on the exemptions for smaller reporting companies and emerging growth companies. There are exemptions for:
• an issuer who is unable to comply with the final rules without violating the laws of the jurisdiction where the project is located;
• an issuer who is unable to comply with the final rules without violating the expressly written terms that were included (before the final rules were adopted) in a contract that became effective before the final rules were adopted;
• smaller reporting companies, meaning issuers with a public float of less than $250 million and issuers with annual revenues of less than $100 million for previous year and public float of less than $700 million; and
• emerging growth companies, meaning issuers with total annual gross revenues of less than $1,070,000,000 during their most recently completed fiscal year.
The final rules include transitional relief for recently acquired companies and for issuers that completed their IPO within their last full fiscal year.
When Are the Final Rules Effective?
The new rules will become effective 60 days after publication in the Federal Register. Once the rules are effective, there will be a two-year transition period during which no issuer will be required to disclose any new information. Following the transition period, the submission deadline for an issuer's Form SD will be 270 days following the end of the issuer's most recently completed fiscal year, beginning with the first completion of a fiscal year after the two-year transition period. In the SEC's own example, if the rules become effective on March 1, 2021, an issuer with a fiscal year end of December 31 will be required to submit its Form SD no later than September 30, 2024 (270 days after December 31, 2023).
The SEC makes clear that disclosures under the final rules are deemed to be “furnished" rather than “filed", therefore limiting the liability an issuer may incur for violations of the final rules.
How Are the Final Rules Different from the 2019 Proposed Rules?
The adopted rules differ from the 2019 proposed rules in a few respects:
• an issuer may aggregate payments by payment type, but must disclose the aggregated amount for each subnational government payee and identify each subnational government payee (Note that under the 2019 proposed rules, the issuer could have aggregated all of its payments of a particular payment type without having to identify the particular subnational government payee. The change in the adopted rules will provide for more transparency than the 2019 proposal. The SEC provided the following example of this type of payment aggregation in the adopted rules: “[A]n issuer with extractive operations in the three oil sands regions of Alberta, Canada (the Regional Municipality of Wood Buffalo, Northern Sunrise County, and the Municipality of Cold Lake), would be required to identify each such subnational government entity, as well as aggregate and report all of its fees paid for environmental and other permits to each such entity.");
• “not de minimis" is defined as a payment that equals or exceeds $100,000, whether made as a single payment or series of related payments (Note that this is the same as the “not de minimis" definition in the 2016 rules. The 2019 proposed rules defined “not de minimis" as any payment made to a government that equals or exceeds $150,000, subject to the condition that disclosure for a project is only required if the total payments for a project equal or exceed $750,000, which the SEC decided not to adopt after receiving several negative comments.);
• the exemption for smaller reporting companies and emerging growth companies is limited to companies not subject to an alternative reporting regime that has been deemed by the SEC to require disclosure that satisfies the transparency objectives of Section 13(q); and
• an extension of the transition period and a longer period during which to file the required Form SD.
What Did the Commissioners Have To Say?
The SEC Commissioners approved the new rules by a 3-2 vote, with Commissioners Caroline A. Crenshaw and Allison Herren Lee dissenting. As befitting rules that are now on their third iteration and are outside the SEC's traditional purview, the Commissioners have provided commentary on the adopted rules.
Commissioner Crenshaw recognized the difficulty of striking a balance between, on the one hand, the mandate in Section 1504 of the Dodd-Frank Act and, on the other hand, the CRA's requirement that the SEC's new rules not be “substantially the same" as the rejected 2016 rules. Commissioner Crenshaw argued that the new rules strike the wrong balance for two reasons. First, because the rules define “project" at the national and subnational levels rather than at the contract level, they “do not require sufficiently granular disclosure to meet the objectives of Section 1504." The rules also depart from the SEC's 2016 findings regarding the correct level of disclosure without providing an adequate basis for the departure. Second, Commissioner Crenshaw argues that the rules do not match the more rigorous requirements that have been implemented by several foreign regulatory regimes (which are similar to the 2016 rules), and this disparity will hinder comparability without saving most issuers any costs, because they have to comply with the foreign regulatory regimes anyway.
Commissioner Lee expressed concern in her statement that, as revised, the adopted rules do not achieve the objective of Section 1504, which is to fight against global corruption by increasing transparency. In particular, Commissioner Lee noted that the new definition of “project" allows for too high a level of payment aggregation, which excessively limits the benefits of disclosure and fails to provide the level of transparency that the SEC previously determined was necessary to advance Dodd-Frank's anticorruption objectives. She also argues that the aggregation of data makes the disclosures less useful for investment analysis.
Unlike Commissioner Lee, Commissioner Hester M. Pierce felt that the adopted rules “satisfy [the SEC's] Congressional mandate in a measured, reasonable manner." The bulk of her statement, however, focused on her concern that the primary beneficiaries of the new rules are not investors and that the SEC should not be involved in such reforms, regardless of however important the issue is to society at large. Similarly, Commissioner Elad L. Roisman noted in his statement that the new rules do not advance the SEC's “tripartite mission: to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation." Both Commissioner Pierce and Commissioner Roisman pleaded with Congress to stop mandating that the SEC regulate matters it is not properly equipped to handle.
Finally, Chairman Jay Clayton observed that, due to the change of the definition of “project," the adopted rules “provide for a reasonable implementation of Section 13(q) and promote the statute's goal of transparency into resource extraction payments to governments," while simultaneously conforming to the CRA's requirement of not being substantially the same as the 2016 rules. The Chairman also stated concerns similar to those of Commissioners Pierce and Roisman, namely (1) that the SEC is not well-positioned to handle anti-corruption regulations and (2) that the primary beneficiaries of the rules are not investors, or at least not individuals whose primary interest is investing.
Companies involved in the commercial development of oil, natural gas or minerals should closely examine these newly adopted rules to determine whether and to what extent the new reporting burden will apply to them. Remember also that there is a two-year transition period during which no Form SD is due.
We would like to thank Harrison Tucker and Benjamin Lefler in our Houston office for their work on this article.