Oil, Gas, and Mining Disclosure Proposal Raises Questions

A controversial Dodd-Frank Act disclosure mandate aims to promote transparency in government payments by oil, gas, and mining companies, but it's far from clear how the rules will operate.

The Securities and Exchange Commission issued a proposal in December that would require public companies that engage in the commercial development of oil, natural gas, or minerals—known as “resource extraction issuers”—to disclose details about certain payments they make to U.S. or foreign governments. However, critics say the proposed rules are unclear and fraught with unintended questions. Comment letters to the SEC also indicate that the proposal raises far more questions than it answers.

“There are a lot of big issues that are left open under the proposed regulations,” says Lucinda Low, a partner in the law firm Steptoe & Johnson. She says the release didn't define a number of important terms, but instead sought comment on how they might be implemented. How the terms are ultimately defined in the final rules will determine how burdensome the disclosure requirements are.

Specifically, the proposal calls for extraction companies to disclose the following: the type and total amount of payments made for each project; the type and total payments made to each government; the amounts of the payments by category; the financial period in which they were made; and the name and country location of government that received the payments.

The proposed rules would require the disclosure of payments including taxes, royalties, fees, production entitlements, and bonuses that aren't considered nominal or “de minimis,” but don't include a standard for what amounts would be considered de minimis. That means companies may end up reporting very small payments, which is burdensome, and does not necessarily serve the bill's purpose, says Amy Lehr, an associate in Foley Hoag's corporate social responsibility practice.

Another factor is how the term “project” is defined. The language in the Act specifies that issuers should disclose payment information at the project level, but the term isn't defined in a statute or the proposed rule. “That's a big open question that has a lot of implications,” says Low. For instance, she says it's unclear how companies would report payments such as taxes, which aren't made on a project basis, but are typically paid on an entity or consolidated entity basis.

Some have called for the SEC to give a limited reporting allowance for issuers to report those specific types of payments at an entity level, rather than at the project level. That idea was floated in a letter submitted by Publish What You Pay, a coalition of non-profit groups aimed at promoting transparency in payments to governments, which urged the SEC to define “project” in relation to each lease, license, or other concession-level arrangement entered into by a resource extraction issuer.

“The disclosure doesn't touch the community that's perceived as the least compliant—the national oil companies in countries that are notorious for using bribes as a business strategy.”

—Alexandra Wrage,

President,

Trace International

Unintended Consequences

Another worry raised in comment letters is that the disclosure will put some companies at a competitive disadvantage since it only applies to resource extraction issuers that file with the SEC. Competitors that don't list on U.S. exchanges would have access to confidential, proprietary information they can use against U.S.­-listed companies in competing for energy resources, the American Petroleum Institute said in a Dec. 16 statement.

Others are concerned that the disclosure would violate foreign laws or contracts with host governments that require confidentiality or limit the disclosure of government. Royal Dutch Shell, API, and a group of eight law firms suggest the SEC add an exemption if a company has a confidentiality agreement or the law in the country in which they operate prohibits such reporting, and that it limit disclosure only to material projects.

That idea does not sit well with some lawmakers. “There should be no exemptions for confidentiality or for host-country restrictions,” Sen. Benjamin Cardin (D-Md.) wrote in a Dec. 1 letter to SEC Chairman Mary Schapiro. “It would be too easy for countries that want to avoid disclosures to simply pass their own law against disclosure.”

Karin Lissakers, executive director of Revenue Watch Institute, pointed out that such exemptions aren't required. “Confidentiality clauses contained in extractive contracts generally do not prohibit disclosure of information included in contracts, or of the contracts themselves, where such disclosure is required by law, and many confidentiality provisions specifically include exceptions for disclosure pursuant to home country laws or securities listing requirements,” she wrote in a Dec. 17 letter. Much of the information that would be required under Section 1504 would already be in the public domain or would be of such minimal competitive value that disclosure wouldn't be likely to cause substantial harm to an issuer's competitive position, she added.

SEN. CARDIN COMMENTS

The following excerpt is from Sen. Benjamin Cardin's letter to SEC Chairman Mary Schapiro regarding the SEC rule proposal for “Disclosure of Payments by Resource Extraction Issuers”:

The language of Sec. 1504 is clear. However, during the rulemaking comment process, there are three areas that I believe deserve comment.

Scope of coverage

The intent of Sec. 1504 is to provide the broadest possible meaning to the term “resource extraction issuer.” Specifically, the intent was to include all issuers, including foreign issuers, which have a reporting requirement to the SEC. For example, we would expect to see payment information included in reports such as Forms 10-K, 20-F, 40-F, or an Annual Report to Security Holders (ARS).

Exemptions for Confidentiality of contracts

Some industry comments have cited the need for broad reporting exemptions if a company has a confidentiality agreement or the law in the country in which they operate prohibits this reporting. The language of Sec. 1504 is very clear: There should be no exemptions for confidentiality or for host-country restrictions. It would be too easy for countries who want to avoid disclosures to simply pass their own law against disclosure. The purpose of Sec. 1504 is to not allow for exemptions for confidentiality or other reasons that undermine the principle of transparency and full disclosure.

Project level Reporting Standard and Relationship to EITI

Reporting under Sec. 1504 is designed to complement reporting done under the Extractive Industries Transparency Initiative (EITI), but does not mimic it, and purposefully requires reporting at the project level, disaggregated by payment stream. This is because ElTI is a minimum reporting standard, and the intent of Sec. 1504 was to go beyond these requirements. Indeed, the EITI encourages implementing countries to innovate, and current practice within EITI-implementing countries clearly demonstrates that countries willingly go beyond these requirements. For example, half of EITI implementing countries have decided to report on a disaggregated basis, by company and payment type. Many have expanded reporting to the sub-national level, as well as to other sectors, and many are considering reporting on social payments. Where possible, the SEC rules should align with EITI disclosure practices, but Sec. 1504 is clear that reporting should go beyond the EITI's minimum reporting standards.

Source

Sen. Cardin Letter to Mary Schapiro (Dec. 1, 2010).

Some issuers already provide some form of payment disclosure in other markets. For instance, the Hong Kong Stock Exchange and the London Stock Exchange AIM market have adopted limited country level disclosure requirements, and the European Union and International Accounting Standards Board are considering similar disclosure requirements. Martin ten Brink, executive vice president and controller at Royal Dutch Shell, urged the SEC to consider a limited foreign private issuer exemption to allow those issuers to follow home country rules and disclose it in their Form 20-F.

The rule could also unintentionally hamper the progress of the Extractive Industries Transparency Initiative, a voluntary initiative that's implemented at the country level, rather than by individual companies. That effort could be derailed if issuers focus their efforts on complying with the mandate, says Alexandra Wrage, president of Trace International. “More transparency is good, but this only gets at part of the problem and it may create more issues than it resolves,” she says. “The disclosure doesn't touch the community that's perceived as the least compliant—the national oil companies in countries that are notorious for using bribes as a business strategy.”

“Gathering and reporting this information will be a significant exercise for many companies,” says Low. Of course, the actual compliance challenge associated with the rule will ultimately depend how all of those details get sorted out in the final rule, as well as the size and complexity of the company.

Comments on the proposals are due by Jan. 31, and final SEC rules are due by April 15, 2011.