The U.S. Securities Exchange Commission recently proposed a new rule that will require issuers engaged in the commercial development of oil, natural gas, or minerals to disclose, in annual reports on Form 10-K, 20-F and 40-F, payments made to the U.S. federal government and foreign governments in furtherance of the development of oil, natural gas, or minerals. The proposed rule implements Section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Act" or "Dodd-Frank") (codified as Section 13(q) of the Securities Exchange Act of 1934, as amended). The SEC's release on the proposed rule can be found here. The proposing release requests comment on a significant number of definitional and interpretive questions relating to the proposed rule, providing industry participants the opportunity to help shape the final rules. The deadline for submitting comments on the proposed rule is January 31, 2011.

Scope of the Proposed Rule

The SEC's proposed rule largely duplicates the language of Section 1504 of the Act. The proposed rule requires any resource extraction issuer to disclose in its annual reports any  payments made to the U.S. federal government or any foreign government for the purpose of the commercial development of oil, natural gas, or minerals. 

The proposed rule requires, among other information, disclosure of the following:

  • the type and total amount of payments for each project;
  • the type and total amount of payments made to each government;
  • the total amount of payments, by category; and
  • the government that received the payments, and the country in which the government is located.

The proposed rule would adopt definitions of several key terms in substantially the form set forth in Section 1504 of the Act: 

  • The proposed rule applies to "resource extraction issuers," which is defined as "any issuer that is required to file an annual report with the SEC and that engages in the commercial development of oil, natural gas, or minerals."
  • The proposed rule defines "commercial development of oil, natural gas, or minerals" to include "exploration, extraction, processing, export and other significant actions relating to oil, natural gas, or minerals, or the acquisition of a license for any such activity."
  • The proposed rule defines "payment" as an amount paid that:
    • is made to further the development of oil, natural gas, or minerals;
    • is not de minimis; and
    • includes taxes, royalties, fees (including license fees), production entitlements and bonuses.

Chance to Shape the Rule

The proposed rule has the potential to impose significant record-keeping and reporting burdens on companies and to place companies operating internationally that are subject to the rule at a competitive disadvantage relative to those that are not. As noted above, the proposed rule is largely a duplication of Section 1504 of the Act, and the SEC made little effort to address the many interpretive questions and practical concerns raised by the language of the Act.  Instead, the proposing release identified ninety specific issues on which the SEC is seeking comment.  The resolution of these and other issues in the final rule may have a significant impact on companies engaged in a variety of aspects of the oil and gas and mining businesses. While the SEC has received thoughts regarding some of these issues from the American Petroleum Institute and others prior to the issuance of rule proposal, we urge industry participants to submit specific comments on the proposed rule to the SEC prior to the January 31, 2011 deadline.

The SEC recently completed a multi-year project in which it modernized its reserves disclosure rules applicable to oil and gas companies. This project involved extensive study and the receipt and consideration of numerous comments. The resulting rules are consistent and generally well understood and, for the most part, have been well accepted. It would certainly be more logical, less confusing to investors and less burdensome for companies for the SEC to harmonize the new rule with its existing rules to the greatest extent possible. 

For example, the terms "resource extraction issuer" and "commercial development of oil, natural gas, or minerals" could, at least with respect to oil and gas activities, be defined to be consistent with "oil and gas producing activities" as defined in Rule 4-10 of Regulation S-X. While Section 1504 of the Act and the new rule appear to be focused on the exploration and production function, the definition of "commercial development of oil, natural gas and minerals" refers to "processing" and to "other significant actions relating to oil, natural gas, or minerals . . ."  Incorporation of the well developed Regulation S-X definition would limit processing to field processing and avoid the implication that midstream, downstream and oilfield service activities are included in the required disclosures.

Additional areas in which the proposed rule should be clarified or harmonized with the existing rules include the following:

  • Local laws and the terms of agreements sometimes prohibit disclosure of commercial information about a country's oil and gas reserves and oil and gas producing activities.  The SEC recognized this fact when it included an exception to its reserves disclosure requirements applicable to those circumstances in promulgating Item 1202 of Regulation S-K. The proposed rule should be modified to contain a similar exception.
  • The proposed rules do not define the term "project." The definition of this term should be harmonized with the concept of "geographic area" or otherwise clearly defined in a way to avoid requiring companies to disclose massive amounts of granular information on a lease-by-lease or concession by concession basis. Doing otherwise will swamp investors with a flood of immaterial information that will burden companies and provide no discernable benefit to investors.
  • Further consideration should be given to the how the different types of payments should be required to be disclosed. As proposed, the rule requires project level disclosure for all payments, including those incurred at the entity level (e.g., taxes on corporate profits and corporate income). Project level disclosure of all costs will necessitate the development of systems to allocate entity level costs to particular projects. The new rule should seek to reduce this burden on companies.

The SEC has received a number of comment letters pointing out that, in implementing the requirements of Dodd-Frank, the SEC is statutorily required to consider, in addition to the protection of investors and the public interest, whether its rules will promote efficiency, competition and capital formation.  We hope members of the industry will take the time to contact the SEC with thoughtful comments as to how the purposes of Section 1504 of Dodd-Frank can be achieved without sacrificing efficiency, competition and capital formation.

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