Section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act added Section 13(q) to the Securities Exchange Act of 1934 (the “Exchange Act”), requiring the Securities and Exchange Commission (“SEC”) to issue rules requiring resource extraction issuers to annually report payments made to a foreign government or the United States federal government for the purpose of the commercial development of oil, natural gas or minerals. The purpose of Section 1504 was to increase the transparency of payments to governmental entities by reporting companies engaged in the development of oil, natural gas or minerals.
On August 22, 2012, the SEC adopted new Exchange Act Rule 13q-1 and amended new Form SD, which had been adopted as part of the SEC’s “conflict minerals” rules, to implement the requirements of Section 13(q). Rule 13q-1 requires resource extraction issuers to make annual disclosures on new Form SD of payments made by the issuer, its subsidiaries, and entities under its control to a foreign government or the U.S. federal government for the purpose of the commercial development of oil, natural gas or minerals.
This article outlines the new rule, analyzes the rule’s application, and explains the disclosure requirements and compliance dates.
Application of Rule 13q-1
Rule 13q-1 only applies to “resource extraction issuers,” which are companies (i) required to file an annual report with the SEC on Form 10-K, Form 20-F or Form 40-F; and (ii) engaged in the commercial development of oil, natural gas, or minerals, regardless of the size of the company or the extent of its business operations constituting commercial development of oil, natural gas, or minerals. The rule does not provide any exemptions or exceptions. Moreover, no exemption exists for situations where foreign law may prohibit the required disclosure, instances when an issuer has a confidentiality provision in a relevant contract, or for commercially sensitive information.
Whether a reporting company is a resource extraction issuer depends on its specific facts and circumstances, particularly whether the company engages in the “commercial development of oil, natural gas, or minerals,” which is defined as the activities of exploration, extraction, processing, and export of oil, natural gas, or minerals, or the acquisition of a license for any such activity. This definition captures only activities directly related to the commercial development of oil, natural gas, or minerals. The rule does not cover ancillary or preparatory activities, the transportation of oil, natural gas, or minerals (other than for export), marketing activities, security support, or the manufacturing of a product used in the commercial development.
The SEC provided some guidance on the particular activities covered by the rule. For example, “extraction” includes the production of oil and natural gas and the extraction of minerals while “processing” includes field processing activities, such as the processing of gas to extract liquid hydrocarbons, the removal of impurities from natural gas after extraction and prior to its transport through the pipeline, the upgrading of bitumen and heavy oil, and the crushing and processing of raw ore prior the smelting phase. Processing, however, does not include refining or smelting. “Export” includes the export of oil, natural gas, or minerals from the host country, but not the removal of the resource from the place of extraction to the refinery, smelter, or first marketable location.
Nevertheless, further SEC guidance on the rule’s scope and application is warranted and hopefully forthcoming. SEC guidance or interpretations may provide clarification as to the extent certain issuers, such as oilfield service companies, and certain activities, such as fracturing, are covered by the new rule.
A resource extraction issuer must disclose payments made to a foreign government or to the U.S. federal government. A “foreign government” includes a foreign national or subnational government, a department, agency or instrumentality of a foreign government, or a company at least majority-owned by a foreign government. Payments to state and local governments in the United States, however, are not covered by the rule.
A “payment” means an amount paid that is:
(i) made to further the commercial development of oil, natural gas, or minerals; and
(ii) is “not de minimis,” which means any payment, whether a single payment or series of payments, that equals or exceeds $100,000 during the most recent fiscal year. In the case of any arrangement providing for periodic payments, a resource extraction issuer must consider the aggregate amount of related periodic payments in determining whether the payment threshold has been met.
Resource extraction issuers must disclose a broad array of “payments,” including:
(iii) fees (including license, rental, entry, and concession fees);
(iv) production entitlements;
(v) bonuses (including signature, discovery, and production bonuses);
(vi) dividends; and
(vii) payments for infrastructure improvements (but not social or community payments).
The covered issuer must disclose payments for taxes levied on corporate profits, corporate income, and production, but not payments for taxes levied on consumption, such as value added, personal income, or sales taxes. In addition, dividends paid to a government as a common or ordinary shareholder of the issuer would not need to be disclosed as long as the dividend is paid to the government under the same terms as other shareholders. The issuer will be required however to disclose any dividends paid to a government in lieu of production entitlements or royalties.
Moreover, resource extraction issuers must disclose payments of the types identified in the rules that are made in-kind. Accordingly, the covered issuer will need to determine the monetary value of in-kind payments based on cost, or if cost was not determinable, fair market value, and provide a brief description of how the monetary value was calculated.
A resource extraction issuer will be required to not only disclose payments it makes directly, but also payments made by any subsidiary or any entity under its control. The issuer will need to consider all relevant facts and circumstances when determining whether it has control of an entity. An issuer will be deemed to control any entity consolidated in the financial statements included in the issuer’s Exchange Act reports. An issuer may also be required to provide disclosure for entities in which it provides proportionately consolidated financial information.
A resource extraction issuer may not circumvent the rule by re-characterizing payments or activities that otherwise would fall within the scope of the rule. Accordingly, the SEC added an anti-evasion provision, requiring disclosure with respect to an activity or payment that is part of a plan or scheme to evade the required disclosure.
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