© 2016 The Texas Lawbook.
By Ben Morgan and Garrett DeVries of Akin Gump
(Aug. 1) – On June 27, 2016, the Securities and Exchange Commission (SEC) adopted new rules requiring certain producers of oil, natural gas and minerals to publicly disclose information regarding payments to the U.S. federal government, as well as to foreign governments, to further the commercial development of such resources.
The new rules, which are effective for fiscal years ending on or after September 30, 2018, will require significant new disclosure by affected issuers, including many Texas oil and gas companies. This article begins with a summary of the new rules, and concludes with a description of the steps Texas issuers should be taking to prepare for the new rules. A more complete summary of the new rules can be found here.
Which Issuers Are Affected?
The new rules apply to any “resource extraction issuer,” which is defined as any U.S. or foreign company required to file annual reports with the SEC pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended (the Exchange Act), and engaged in the commercial development of oil, natural gas or minerals. A resource extraction issuer must disclose any covered payments to governmental entities made by it, its subsidiaries and other entities it controls.
Which Payments Require Disclosure?
Payments requiring disclosure are those made to the U.S. federal government or a foreign government to further the “commercial development of oil, natural gas and other minerals” (i.e., the exploration, extraction, processing or exporting of such resources, or the acquisition of a license to perform such activities). The rules provide a de minimis exception, for a single payment or a series of related payments, of less than $100,000 during a fiscal year.
The types of payments covered by the rules are:
- taxes (including taxes on corporate profits, corporate income and production taxes),
- royalties (including unit-based, value-based and profit-based royalties),
- license and other fees,
- production entitlements,
- bonuses (including signature, discovery and production bonuses),
- community and social responsibility (or CSR) payments (to the extent required by contract or law),
- dividends and
- infrastructure improvement payments.
In addition to cash payments, the new rules cover certain in-kind payments, which are to be valued at cost or, if cost is not determinable, fair market value. Payments of fines and penalties to a government are outside of the scope of the new rules.
The rules generally require disclosure on a per-project basis, with a “project” defined as operational activities that are governed by a single contract, license, lease, concession or other similar legal agreement, which form the basis of payment for liabilities with a government. Issuers are permitted to treat multiple agreements that are both operationally and geographically interconnected as a single project, even if the terms of the two agreements are not the same.
During the comment process and in its adopting release, the SEC clarified that the new rules are not intended to cover downstream activities, such as refining or smelting, or payments related to transportation on a fee-for-service basis by a service provider with no ownership interest in the resource.
In addition, the new rules are not intended to capture activities that are ancillary or preparatory to the commercial development of oil, natural gas or minerals. As a result, many service providers, such as drill bit manufacturers, hardware providers, and hydraulic fracturing and drilling service providers, would not be “resource extraction issuers” under the new rules.
How and When Must the Disclosure Be Done?
The required disclosure must be reported on Form SD, which is currently used to file Conflict Minerals reports pursuant to Rule 13p-1 under the Exchange Act. Issuers must present the payment disclosure in an eXtensible Business Reporting Language (“XBRL”) exhibit to Form SD with all required tags, including tags for:
- the type and total amount of payments made for each project,
- the type and total amount of payments made to each government,
- the total amounts of payments by category (e.g., bonuses, taxes, fees),
- the particular resource that is the subject of development and
- the subnational geographic location of each project.
Issuers are not required to have the payment disclosure audited or reported on an accrual basis. Rather, information is required to be reported only on a cash basis.
The report is due within 150 days of the end of the issuer’s fiscal year. The new rules are effective for fiscal years ending on or after September 30, 2018, meaning that, for issuers with a December 31 fiscal year-end, their first Form SD with resource extraction payment disclosure will be due on May 30, 2019. The rules do not provide for any phase-in period or other accommodation for smaller reporting companies, emerging growth companies or other types of issuers subject to the rules.
What About Delayed Reporting and Exemptions from Reporting?
The new rules allow for delayed reporting in two specified situations. First, if an issuer acquires a company that was not subject to the reporting requirements under the new rules during its last full fiscal year, then the issuer would not be required to commence reporting payment information for the acquired company until the second Form SD filing after the effective date of the acquisition. Second, the rules permit an issuer to delay the reporting of payments related to “exploratory activities” until the filing of the Form SD for the fiscal year following the fiscal year in which the payments are made.
This delayed reporting accommodation is intended to alleviate issuers’ concerns regarding the competitive harm that could result from the disclosure of commercially sensitive information about a new development target. Specifically, among other concerns, industry participants argued that disclosure of payments under the contract-based definition of “project” would allow competitors to derive important information about new areas under exploration for potential resource development, the value that the issuer places on such resources and the costs associated with acquiring the right to develop such resources.
The SEC will consider exemptive relief from reporting for other situations on a case-by-case basis.
What if an Issuer Has Alternative ‘Substantially Similar’ Reporting Requirements?
In an effort to decrease compliance costs for issuers that are cross-listed or incorporated in foreign jurisdictions, the SEC will permit certain issuers to comply with the new rules by filing alternative reports if the requirements of such reports are “substantially similar” to those under the new rules, as determined by the SEC.
In a companion order issued on June 27, 2016, the SEC recognized the EU Accounting Directive and the EU Transparency Directive (collectively, the EU Directives) adopted by the European Parliament and Council of the European Union, Canada’s Extractive Sector Transparency Measures Act (ESTMA) and the U.S. Extractive Industries Transparency Initiative (USEITI) as “substantially similar” disclosure regimes for purposes of alternative reporting under the final rules, subject to certain conditions. USEITI, in its current form, will only satisfy the disclosure requirements under the new rules for payments made to the U.S. federal government, and not with respect to payments to foreign governments.
What Steps Should Texas Companies Be Taking?
Although the new rules do not go into effect for over two years, the rules could necessitate the implementation of new financial reporting and information technology systems, training and other measures, so affected issuers need to begin preparing now. The following is an overview of the steps Texas companies, particularly those with foreign and offshore operations, should be taking to prepare for the new rules:
• Determine Applicability. First, every Texas company whose business relates to the extraction of oil, natural gas and minerals will need to determine whether it is a “resource extraction issuer.” For many issuers, including E&P companies with leases, licenses or concessions issued by a foreign government or the U.S. federal government, this determination should be straightforward. For other issues, the applicability of the new rules may be less obvious. For example, the new rules cover midstream activities, such as the processing of gas to remove liquid hydrocarbons, the removal of impurities from natural gas prior to its transport through a pipeline, and the upgrading of bitumen and heavy oil, through the earlier of the point at which oil, gas, or gas liquids (natural or synthetic) are either sold to an unrelated third party or delivered to a main pipeline, a common carrier, or a marine terminal. The new rules will also apply to issuers that crush and process raw ore prior to the smelting phase. Any issuer that is unsure whether it is a “resource extraction issuer” should consult its professional advisors for assistance in making that determination.
• Determine Whether Alternative Reporting is Available. As noted above, the EU Directives, Canada’s ESTMA and the USEITI have been recognized as “substantially similar” disclosure regimes for purposes of alternative reporting under the final rules. To the extent a Texas company has a dual listing in Canada or the EU or is otherwise subject to these alternative reporting regimes, its reporting obligations under the new rules may be limited.
• Assess Existing Systems and Processes. Texas companies should be examining their current financial accounting and reporting systems and processes to determine what changes, if any, will be required to track and report, on a project-by-project basis, the payments and other information required to be disclosed under the new rules. Issuers will need to ensure that their financial reporting systems isolate each of the types of payments required to be disclosed under the rules, including CSR payments, dividends and infrastructure improvement payments. To the extent significant modifications to the systems and processes are required, issuers should begin implementing those changes now, as they may be time-consuming.
• Review Confidentiality Provisions. Going forward, when entering into agreements with governmental entities, issuers should be mindful of the new rules and include appropriate carve-outs from the confidentiality provisions in such agreements to permit the disclosures required under the new rules. Issuers should also review their existing agreements that will require reporting under the new rules to see whether the new required disclosure is permissible under the applicable confidentiality provisions. To the extent such disclosure would constitute a breach under the terms of the agreement, issuers should seek to obtain an amendment to the agreement or a consent or waiver from the applicable counterparty.
• Consider Potential for Reputational or Competitive Harm. Issuers need to remember that regulators, competitors, activists and other groups will carefully scrutinize the information disclosed under the new rules. Each Texas company subject to the new rules should conduct an honest and thoughtful self-assessment of the potential disclosures, consider how the disclosures could be interpreted from the perspective of each of these third-party groups, and evaluate the likelihood of any reputational or competitive harm.
Ben Morgan is counsel in the Dallas office of Akin Gump. He focuses his practice on corporate and securities law.
Garrett DeVries is a partner in the Dallas office of Akin Gump. He represents clients in capital markets, securities, mergers and acquisitions, and equity derivatives transactions.
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