The long and winding road of the SEC’s extractive resource payment disclosure rule took another turn last month with the emergence of yet another proposed rule. The SEC had to walk a tightrope between duplicating the rule requirements that Congress invalidated in 2017 while still complying with the Dodd-Frank Act mandate to act in this area. The resulting proposal may successfully respect the congressional disapproval resolution, but it does little to implement the spirit of the Dodd-Frank disclosure mandate.
This is the third iteration of the rule to emerge from the statutory mandate enacted in 2010 in Section 1504 of the Dodd-Frank Act. The current version of the proposed rules would require companies engaged in resource extraction (such as mining and drilling) to disclose payments made by the issuers to foreign governments or the U.S. federal government for the purpose of the commercial development of oil, natural gas or minerals. Issuers would also be required to disclose payments made by a subsidiary or any entity controlled by the issuer.
Section 1504 represented an attempt by Congress to mitigate the “resource curse,” under which resource-rich nations often suffer significant costs associated with the extraction of those resources. Many of these countries are poor, and the population often does not benefit from the economic rewards of extraction.
Previous attempts at complying with the Section 1504 mandate have not ended well. Rules covering resource extraction payments first surfaced in 2012. As adopted, these rules required resource extraction issuers to annually file a new form with the SEC, Form SD (the form is also used for conflict mineral disclosures).
The U.S. District Court for the District of Columbia vacated the rules on July 2, 2013. The court found that the Commission misread Section 1504, now codified as Exchange Act Section 13(q), to compel the public disclosure of the issuers’ reports, and found that the SEC’s explanation for not granting an exemption for when disclosure is prohibited by foreign governments was arbitrary and capricious.
In June 2016, the SEC adopted a revised version of the rules and amendments to Form SD that addressed the concerns raised in the prior litigation. On February 14, 2017, Congress disapproved the rules by a joint resolution pursuant to the Congressional Review Act (CRA).
The CRA disapproval places the SEC in an interesting statutory box. The CRA joint resolution had no impact on the Section 1504 mandate. That provision still directs the SEC to adopt rules requiring “each resource extraction issuer to include in an annual report of the resource extraction issuer information relating to any payment made by the resource extraction issuer, a subsidiary of the resource extraction issuer, or an entity under the control of the resource extraction issuer to a foreign government or the Federal Government for the purpose of the commercial development of oil, natural gas, or minerals.” The CRA provides, however, that a rule disallowed by Congress “may not be reissued in substantially the same form, and a new rule that is substantially the same as such a rule may not be issued.” The rule proposals also had to deal with the issues that caused the district court to vacate the 2012 rule.
The December 2019 Proposal
The SEC, by a 3 to 2 vote, attempted to resolve the conundrum by significantly changing some of the terms of the 2016 rules. The proposed rule changes would:
—revise the definition of the term “project” to require disclosure at the national and major subnational political jurisdiction, as opposed to the contract level;
—revise the definition of “not de minimis” to include both a project threshold and an individual payment threshold so that disclosure with respect to payments to governments that equal or exceed $150,000 would be required when the total of the individual payments related to a project equal or exceed $750,000;
—add two new conditional exemptions for situations in which a foreign law or a pre-existing contract prohibits the required disclosure;
—add an exemption for smaller reporting companies and emerging growth companies;
—revise the definition of “control” to exclude entities or operations in which an issuer has a proportionate interest; and
—limit the liability for the required disclosure by deeming the payment information to be “furnished” to, but not “filed” with, the Commission;
As proposed, the rules would require disclosure of the following kinds of payments:
—royalties, fees, and bonuses;
—community and social responsibility payments; and
The rule as proposed does require that the Form SD disclosures be made publicly available on EDGAR. However, the public disclosure requirement is significantly watered down from the 2012 version. The higher de minimus threshold would shield many payments from disclosure, and the submission deadline would be significantly extended. As proposed, for issuers with fiscal years ending on or before June 30, the disclosure must be furnished no later than March 31 in the following calendar year, and for issuers with fiscal years ending after June 30, companies must provide the information no later than March 31 in the second calendar year following their most recent fiscal year.
The disclosures would also be treated as “furnished” rather than filed. Such treatment precludes liability under Exchange Act Section 18 (but not Section 10), and disclosures that are “furnished” rather than “filed” are not automatically incorporated by reference into Securities Act registration statements.
Do the Changes Avoid the CRA “Substantially the Same” Prohibition?
Are the changes sufficient to avoid the “substantially the same” CRA restriction? The act itself provides little guidance, either on its face or in the legislative history, on what “substantially the same” actually means, and the courts have not weighed in to date.
The differences between the 2016 rules and the 2019 proposal do appear to be significant, however. The proposed increase in the de minimis threshold from $100,000 to $150,000 is notable, and even these payments must be disclosed only when the total of the individual payments related to a project equal or exceed $750,000. The shift from disclosure based on a per contract basis to the national and major subnational political jurisdiction level is also significant. Issuers would also be allowed to aggregate payments by payment type made at a level below the major subnational government level. In addition, the proposal adds an exemption for smaller reporting companies and emerging growth companies and includes relief for issuers that have recently completed their U.S. initial public offerings.
The Dissenters and the Section 1504 Question
The 2019 proposals may have avoided the CRA prohibition, but do the measures satisfy the SEC’s obligation to act under Dodd-Frank Act Section 1504? The answer from the commissioners in the minority is a resounding no.
According to Commissioner Robert J. Jackson Jr., the proposed rulemaking fails to “give investors nearly enough information about how their money is used to pay for the right to extract certain natural resources.” He stated that the heightened de minimis threshold would keep many payments in the dark, and indicated that the SEC would frustrate the purpose of the rulemaking mandate by “allowing issuers to file confidential disclosures rather than providing the public accountability that Congress intended when enacting Section 1504.”
Commissioner Allison Herren Lee stated that the proposal would not further the role of the U.S. in leading international anti-corruption efforts. According to Commissioner Lee, the proposals would “deviate widely from existing international disclosure regimes and severely limit the utility of the required disclosure.”
She recognized the dilemma inherent in balancing compliance with both Section 1504 and the CRA. She rejected the notion, however, that “the CRA disapproval requires us to promulgate a rule that essentially reverses the 2016 final rule in almost every significant respect.” She commented that the majority did not identify any legal authority or precedent that would compel this result, and concluded that “I cannot agree that we must stray so far from the policy determinations the Commission made in 2016" to comply with the CRA.
She also was very critical of the $750,000 aggregate de minimis threshold. The commissioner stated that the $750,000 figure was “a number without support anywhere in the release,” and added that “it stretches credulity to call three quarters of a million dollars ‘de minimis’ in this context.”
A federal court and conflicting congressional directives combined to put the SEC in a rather untenable position. The Commission must act under Section 1504, but the CRA draws a rather narrow, if poorly defined, circle around what that action may look like.
Even the commissioners who voted for the proposal noted the awkwardness of the situation. Commissioner Hester Peirce stated that under the Dodd-Frank Act, disclosure requirements have become “the vehicle of choice for achieving laudable objections that are outside the SEC’s normal remit.” Similarly, Commissioner Elad L. Roisman stated that the rulemaking “has no pretense of furthering the SEC’s tripartite mission: protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation,” and added that “not one of us can pretend that it does so.” As Commissioner Lee points out however, even if “some may disagree with Section 1504 or that the Commission should be in the business of promulgating anti-corruption rules,” that is the law.
The disclosures that would be generated under the proposed rules will be of little decision-making use to investors. Too many payments may be shielded under the proposed de minimis standard, and the information would not be available to investors in a timely fashion. Commissioner Lee described the challenge of crafting a delicate balance between Congress’ intent under Section 1504 and the concerns expressed in the CRA disapproval resolution. The resulting rulemaking proposal, however, has largely abandoned that balance and swung dramatically away from the intent of Congress in enacting Section 1504.