At an open meeting yesterday, the SEC adopted, by the usual three to two, final Rule 13q-1 and an amendment to Form SD to implement Section 1504 of Dodd-Frank, which relates to disclosure of payments by resource extraction issuers. These rules, last proposed almost exactly a year ago (see this PubCo post), have had a long and troubled history. This effort at new resource extraction disclosure rules represents the SEC’s third attempt at these rules—making their consideration a holiday tradition, according to SEC Commissioner Hester Peirce—and today is almost on target as the tenth anniversary of the original proposal. Will the third time be the charm? Even if you’re not remotely drawn to the subject matter of these rules, you might nevertheless find worthwhile the debate at the meeting about whether this rulemaking was appropriately within the remit of the SEC: was the mandate about informing and protecting investors, maintaining orderly markets or facilitating capital formation or was it rather about social policy unrelated—or at most distantly related—to the SEC’s core mission? Will the majority view on that question have any influence on future legislation?
The SEC also voted (also three to two) to issue an Order recognizing the resource extraction payment disclosure requirements of the European Union, the United Kingdom, Norway, and Canada as alternative reporting regimes for purposes of alternative reporting under Rule 13q-1 under the Exchange Act.
First, a little background
Originally adopted in 2012 under Section 1504 of Dodd-Frank at the same time as the conflict minerals rules, the resource extraction rules faced an immediate challenge in litigation brought by the American Petroleum Institute and the Chamber of Commerce. They had contended that the rule compelled U.S. resource extraction companies to engage in speech in violation of their First Amendment rights. (Sound familiar? See this PubCo post and this PubCo post .) They also maintained that the SEC had misinterpreted the mandate of the statute which, they argued, required only a compilation of aggregate information, not a separate report for every foreign project. As a result of this misinterpretation, they contended, the rule required U.S.-based companies to disclose sensitive commercial information that competitors could use to their benefit. (See this Cooley news brief.)
The U.S. District Court, in a fairly scathing opinion, vacated the SEC’s rule, contending, among other things, that the SEC fundamentally “misread” the requirements of the statute by mandating public disclosure of each report (rather than a compilation of reports) and that, in rejecting companies’ request for an exemption from disclosing payments to countries that prohibited disclosure of payment information, the SEC was “arbitrary and capricious.” (See this Cooley news brief. ) The SEC declined to appeal the ruling, evidently accepting the conclusion that it would need to rewrite the rule. (See this Cooley news brief.) However, the timetable for a new rule proposal was delayed several times, and, finally, Oxfam America sued the SEC to compel it to complete the rulemaking.
Oxfam succeeded. (See this PubCo post.) Final rules were adopted in June 2016, and resource extraction issuers would have been required to comply with the final rule and form for fiscal years ended on or after September 30, 2018. (See this PubCo post.) However, relying on the rarely used Congressional Review Act, Congressional Republicans took the ax to the new rules. According to the Washington Post, the first piece of legislation signed into law by then-new (now outgoing) administration was the bill tossing out the resource extraction payment disclosure rules. However, in the absence of repeal of the Dodd-Frank mandate, the SEC was still required to issue a new rule on the same topic because the regulation was mandated by a Congressional statute. (See this PubCo post.)
Because the rules were disapproved under the CRA, the SEC was obligated to comply with the CRA requirement to propose rules that were not “substantially the same” as the rules that were disapproved. Unfortunately, however, there is no case law or guidance as to the meaning of that term. That left the SEC having to thread the needle—to craft rules that were not “substantially the same” as the 2016 rules—whatever that means—but still satisfy the statutory mandate. In developing the latest rulemaking, the staff took into account the concerns expressed by Congress in disapproving the 2016 rules under the CRA, which related principally to the high cost of compliance and potential anti-competitive effect. The most significant change in the final rules was the revision of the term “project” to require disclosure at the level of the national and major subnational political jurisdiction, as opposed to the contract-level disclosure that was required by the 2016 rule. The change meant that, when disclosing payments made, issuers would be able to aggregate payments, by payment type, at a level below the major subnational government level, but would still be required to disclose the “aggregated amount for each subnational government payee and identify each subnational government payee.” Interestingly, the SEC justified the change by making clear that
“we do not believe that the purpose of the required disclosures is to provide material information to investors. First, we believe that the Commission’s existing rules should elicit all material risk-related disclosure. For example, issuers are required to disclose the most significant risks affecting an issuer or the securities being offered as well as any known trends or uncertainties that have had or are reasonably likely to have a material impact on the registrant’s liquidity, capital resources, or results of operations. Moreover, we continue to believe that the direct incremental benefit to investors from the payment information may be limited because investors would typically require additional information to calculate cash flows and other indices of risk, which may be lacking. Further, it is likely that the vast majority of the individual contract-level project payment amounts would not be material to the financial condition of the issuers that are subject to the Section 13(q) reporting requirements. As such, we do not believe that such information is likely to be material to an investment decision.”
According to this article in the WSJ, even though the most recent iteration of the rule is more industry friendly than the original, “[o]pponents of the new proposal have indicated they might launch a new legal challenge against the rule, if passed…. But the agency’s efforts to ease the compliance burden on companies has drawn criticism from anticorruption advocates who have accused it of rushing a vote in the final weeks” of the current administration. As noted above, the final rules allow disclosures about payments to be aggregated in most cases, instead of provided on a contract-by-contract basis. According to the article, that change “has caused a split between some large U.S. oil and gas companies, represented by the [American Petroleum Institute], and rivals in Europe and Canada, which are subject to transparency rules that were modeled after the Dodd-Frank provision.” Some of the rival companies, the WSJ reports, have “voiced support in comments to the SEC for disclosing payments on a contract-by-contract basis. The API, meanwhile, has voiced support for key aspects of the latest proposal. But it has also requested several changes, including to a proposal that would require companies to directly disclose payments made to foreign governments.” According to the WSJ, the API advocated that that information be collected confidentially and published in “an aggregated, anonymized compilation.”
At the open meeting
The frustration was nearly audible in SEC Chair Jay Clayton’s voice as he read his statement. Observing that this will be the third time that the SEC has considered adoption of final rules to implement this Dodd-Frank provision, Clayton observed that, in developing these rules in the context of the Dodd-Frank mandate and the CRA, the SEC “strived to finalize final rules for a final time. This has required substantial staff resources and has been the focus of extensive engagement with a variety of market participants and—somewhat unusually for the Commission—interested parties who are not market participants.”
Clayton identified two key challenges to the rulemaking. The first challenge was the difficulty of crafting rules that provided a “reasonable implementation” of the Dodd-Frank Section 13(q) mandate, while also meeting the CRA’s not “substantially the same” test. Referring to a table in the adopting release (pp.20-22), Clayton contended that it was clear that the change in the definition of “project” to require disclosure “at the national and major subnational political jurisdiction level, as opposed to the contract level,” along with several other changes, would satisfy the CRA criteria. In addition, he believed that the new definition, along with the rest of the rulemaking, provided “a reasonable implementation of Section 13(q) and promotes the statute’s goal of transparency into resource extraction payments to governments.” In his view, the new rules fell “squarely in the center of Venn diagram intersection” created by these potentially conflicting requirements.
Perhaps anticipating the criticism that the changes in the final rules would render them less effective, Clayton then argued that the SEC was second to none in taking on international corruption—the problem was rather in asymmetric jurisdictional efforts:
“Let me note here that I and many members of the Commission and the staff are passionate about combatting international corruption in this space. We have brought 77 cases under the Foreign Corrupt Practices Act (FCPA) in the past four years with financial remedies totaling over $5.5 billion. The United States still stands largely alone in this area. The numbers never tell the whole story, but in this space they are stark. One of the factors that undermines the effectiveness of these efforts is the decades-long lack of effective effort by many of our international counterparts in this area—to be clear—not just enacting and talking anti-corruption laws but enforcing them. As I have noted, anti-corruption laws without vigorous enforcement are just words. In fact, assuming that corruption slows to where it is most profitable—a safe assumption—those types of jurisdictional asymmetries can increase corruption rather than decrease it.”
The second challenge proved to be the most contentious among the commissioners. “Why has this rulemaking taken this much time and this many iterations?” he asked, and yet, “why will the final rules be unsatisfactory to many interested parties?” In part, he contends, while the purpose of Section 13(q) is laudable and one that he supports, it is “not one that the Commission is well-positioned to pursue. It is outside of our area of expertise—note that of our 4,500 personnel, none are stationed outside of the United States. In many cases, using the information generated by the rule to further its purposes will be outside of our jurisdictional authority. Said another way, we are promulgating a disclosure rule that we are counting on others—others not at the table, others who have demonstrated little effectiveness in pursuing anti-corruption efforts—to use as an information tool.”
More significantly, perhaps, in Clayton’s view—and the view of two other commissioners—the mandate was essentially aimed at social policy, not investor protection. Was it appropriately assigned to the SEC? According to Clayton, the rulemaking employed the SEC’s “world-leading, highly effective, investor-oriented, rigorous disclosure regime to address the interests of non-investors or parties for whom investing is not their primary interest. This posture runs the risk of our disclosure framework subordinating the interests of investors to other interests. That is a risk of which we should all be wary regardless of the nature of the non-investment oriented issue. Due to the focus of the women and men of the SEC on investors and investment decisions, we are the world’s most effective securities regulators. We should maintain that focus and be wary of using our effectiveness for purposes beyond our remit.”
Commissioner Peirce supported the proposal for one reason only—because the SEC was required by Congress to adopt rules and these rules reflected a reasonable approach (although she would have preferred an “anonymized, aggregated disclosure approach”). But she was not surprised that the undertaking was so arduous. Much like Clayton, she believed that the reason was that
“the subject matter is unrelated to our tripartite mission. We maintain a corporate disclosure framework rooted in the concept of materiality. It elicits information that a reasonable investor would consider important in deciding how to vote or to make an investment decision. Yet today’s release unequivocally states, ‘we do not believe that the purpose of the required disclosures is to provide material information to investors.’ These are chilling words to read in a rulemaking issued by the Commission. New Rule 13q-1 will lead to the publication of payment information of interest to individuals and organizations focused on holding governments accountable in connection with the commercial development of oil, natural gas, and minerals. As important as that job is, most of those people are not investors.”
In the end she hoped that the SEC’s struggle with these rules would “serve as a cautionary tale for those that would lead us down similar paths to regulate issues of societal, but not investor, import in the years to come. An issue that is important to society is not necessarily material from a securities law perspective.”
Commissioner Elad Roisman had a similar view. The SEC’s rulemaking did “not advance our mission. As we all well know, the SEC has a tripartite mission: to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. The rule we are adopting today has none of these goals….While some investors may choose to invest based on certain idiosyncratic interests and values, our mandate has never been understood to include requiring disclosures of all information that any investor might want to know, particularly for making an investment decision.” Although he personally had strong views about foreign government corruption, that did not equip him, as an SEC commissioner, “to make rules to act on these views. Global anticorruption policy, like many policy issues, is complex. It touches on foreign relations, trade policy, and international human rights, among other areas. There are many people, both within our government and outside it, who have focused on mastering the nuances of these issues. But as an SEC Commissioner, I am not one of them. This rulemaking task is simply not within my expertise nor does it further our mission.”
Not surprisingly, Commissioner Allison Lee, who dissented, strongly disagreed with these views. In her view, the statutory mandate was designed to enhance transparency, with the goal of promoting accountability and fighting corruption. That goal, she argued, is consistent with the U.S.’s history as “a leader in international efforts to combat corruption” and the SEC’s role in enforcing the Foreign Corrupt Practices Act. It was also intended to “promote good governance” and empower investors through information. Accordingly, to Lee, the rulemaking was well within the SEC’s ambit. Indeed, although the adopting release largely “dismisses the idea that we should even consider the potential materiality of these disclosures to investors,” it ignores the specific findings made by Congress “about the reputational and operating risks to companies that flow from ‘opaque and unaccountable management of natural resource revenues by foreign governments’ [and which] concluded that the ‘effects of these risks are material to investors.’”
However, Lee dissented because the final rules permitted “payment information to be aggregated to such a degree that the resulting disclosures will obscure information crucial to anti-corruption efforts and material to investment analysis. As a result, today’s rule, by the Commission’s own determination, will severely restrict the transparency and anti-corruption benefits that the disclosures might provide, and thus fails to advance the statute’s goals.” Although the release indicated that it was addressing Congressional concerns regarding compliance costs and potential anti-competitive effects, commenters that have complied with disclosures under foreign regimes have shown “that significant compliance costs and anti-competitive effects simply have not arisen.” By changing the definition of “project” to more payment aggregation, the SEC has limited the “type of granular disclosure” that the SEC itself determined in 2016 was “necessary to advance in a meaningful way the statute’s anti-corruption and accountability objectives.”
In addition, she contended, the changes also reduce “the utility of these disclosures for investment analysis.” In contrast to the position of the three other commissioners, Lee argues that investors have consistently
“explained that the contract-level disclosures do yield material information. The release largely brushes aside these arguments, in part based on the idea that, if the information is material, it’s already being disclosed under existing principles-based requirements. This response to investors’ views regarding materiality wrongly assumes that the principle of materiality is applied in a manner both sweeping and precise, such that the general principle elicits from all companies disclosures with the specific granularity—no more and no less—required of each individual company. In fact, general principles-based obligations do not invariably yield the specific information material to investors.”
Commissioner Caroline Crenshaw also dissented. In her view, the final rules did not require “sufficiently granular disclosure to meet the objectives of Section 1504 of Dodd-Frank and, notably, [depart] from the Commission’s previous findings on this subject without an adequate and reasoned basis. Section 1504 instructs the Commission to issue disclosure rules that, to the extent practicable, ‘support the commitment of the Federal Government to international transparency promotion efforts’….Without contract-level disclosure, it is difficult, if not impossible to identify the source of corruption.” In addition, she argued, “we should be moving toward a more uniform global disclosure approach that will allow for comparability across issuers operating in the same country.” A number of countries have imposed disclosure requirements that “largely mirror” the SEC’s 2016 rules, and most issuers that will be subject to this new rule are “already complying with these international requirements.” Yet the SEC did not receive comments from individual issuers alleging competitive harm as a result of a contract-level project definition. Rather, she maintains, multiple issuers advocated that the SEC rules be consistent with the international disclosure regimes to promote comparability and help “identify government payees and hold them accountable.”
In response to her plea for consistency, Clayton observed that, with response to international standards, under the Order to be issued in conjunction with the adoption of the new rules, issuers will be able to comply with those other disclosure regimes as alternative reporting under Rule 13q-1.
The final rules
Under the final rules, resource extraction issuers (defined as oil, natural gas and mining companies that are Exchange Act reporting companies) will be required to file a Form SD on an annual basis providing “information about payments related to the commercial development of oil, natural gas, or minerals that are made to a foreign government or the Federal Government.”
The highlights of the final rules as set forth in the press release are as follows:
- “require public disclosure of company-specific, project-level payment information;
- define the term ‘project’ to require disclosure at the national and major subnational political jurisdiction, as opposed to the contract, level, recognizing that more granular contract-level disclosure could be used to satisfy the rule;
- add two new conditional exemptions for situations in which a foreign law or a pre-existing contract prohibits the required disclosure;
- add a conditional exemption for smaller reporting companies and emerging growth companies;
- define ‘control’ to exclude entities or operations in which an issuer has a proportionate interest;
- limit the liability for the required disclosure by deeming the payment information to be furnished to, but not filed with, the Commission;
- add relief for issuers that have recently completed their U.S. initial public offerings; and
- extend the deadline for furnishing the payment disclosures”
Rule 13(q)(1) will become effective March 16, 2021. Following a two-year transition period, an issuer will be required annually to submit Form SD no later than 270 days following the end of its most recently completed fiscal year.