On July 21, 2010, US President Barack Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act.1 Section 1504 of the act requires resource extraction issuers to disclose to the Securities and Exchange Commission (SEC) both legal and illegal payments to foreign governments for the commercial development of oil, natural gas, and minerals.2 This will have four main impacts on oil and gas companies:
• Although detailed rules need to be issued, at a minimum, the provision will require oil and gas companies to track extraction-related expenditures to governments on a company-wide basis and at a much more detailed level than previously required to be disclosed.
• Disclosure of this information can lead to Foreign Corrupt Practices Act (FCPA) exposure. The disclosed information can be compared to information provided by recipient governments subject to the Extractive Industries Transparency Initiative (EITI). Any discrepancies could raise FCPA red flags even if no bribery payments actually were made. And disclosing specific individual payments could lead to books and records violations if other payments are later found to have been made or the reported payments were mischaracterized.
• Although the FCPA contains no private right of action, because Section 1504 contains an affirmative duty to disclose government payment information to the SEC, a failure to do so could trigger shareholder lawsuits, including securities fraud causes of action under the Securities Exchange Act of 1934, leading to civil liability.
• The requirement for disclosures could run afoul of confidentiality provisions contained in relevant contracts.
Section 1504
Section 1504 arose as a complement to the EITI, a voluntary global initiative launched in 2002 to promote transparency in governments of countries that are rich in oil, natural gas, or minerals.3 Currently, 36 countries have implemented or committed to implementing the EITI (see box). Implementing countries generally require all extractive industry companies operating in their territories to publicly report their payments to governments for extractive resources. Under the EITI, government revenues from extraction industries and company payments for those resources are published in independently verified reports, and payments and revenues are then reconciled by an independent administrator whose opinion regarding any discrepancies also is published.
Section 1504 was drafted for policy reasons similar to those of the EITI. By disclosing the reported payments of extractive industry companies, Section 1504 seeks to reduce the likelihood that corrupt governments will take income from extractive industry revenues for their own personal gain. As Sen. Richard Lugar (R-Ind.) stated during the floor debates, "Too often, oil money intended for a nation's poor lines the pockets of the rich or is squandered on showcase projects instead of productive investments."4
Section 1504 requires disclosure of payments made by reporting companies to foreign governments or to the US federal government for oil, gas, and minerals. Unlike the EITI, however, Section 1504 does not require reconciliation of government payments disclosed by companies to the SEC and the revenues EITI countries report they have received from those companies.
Because Section 1504 applies to all companies engaged in the commercial development of oil, natural gas, and minerals that are required to file annual reports with the SEC, many companies that otherwise fall outside the EITI's voluntary reporting system—i.e., they do not operate in any of the countries implementing the EITI—would be subject to Section 1504. According to Sen. Benjamin Cardin (D-Md.), 90% of the major internationally operating oil companies, and eight out of the world's ten largest mining companies, would be required to file reports under Section 1504.5
Section 1504 requires "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."
Final rules implementing the provision must be issued by the SEC within 270 days following the date of the bill's enactment, in other words by Apr. 17, 2011. Affected companies will then have until the end of the fiscal year that ends not earlier than 1 year after the final rules were issued to submit an annual report containing the required information. There are two primary areas that will be affected by the rules: first, what payments and specific information about those payments must be reported and, second, what entities must report them. Section 1504 briefly addresses both of these issues.
Scope of payments
Section 1504 gives an idea of the types of information that companies will be required to report. First, and most importantly, Section 1504 requires the reporting of all payments made to any government—including the US government, any "department, agency, or instrumentality" of a government, or any company owned by a government—"for the purpose of the commercial development of oil, natural gas, or minerals."
Although it is unclear how broadly terms such as "instrumentality" will be construed, it is clear that companies need to identify extraction-related payments made to governments. This may pose a compliance problem because current accounting systems at individual companies may not track government payments as a separate category. Starting a tracking system that will allow easy identification and compilation of government payments across all accounts should be a top priority of oil and gas companies.
Second, the type of government payments to be reported is very broad and includes any payment the SEC determines is "part of the commonly recognized revenue stream for the commercial development of oil, natural gas, or minerals," although it excludes "de minimis payments." Until the rules define "de minimis," companies should plan to track and disclose all government payments. Tracking all government payments—even de minimis ones—is good practice in any case because the Department of Justice (DOJ) and the SEC have imposed FCPA liability on companies for improper payments that individually were "well under $100/payment."6 Moreover, the recently passed UK Bribery Law, which applies to companies doing business in the UK, does not provide an exception for de minimis payments.7
Third, the payments must be broken down by "each project" and "each government." Therefore, if there are multiple projects in one country or a project spans multiple countries, payment information will have to be broken down a number of different ways.
Finally, Section 1504 requires the payment information to be presented in an "interactive data format," which will allow the user of the data to identify the information by various categories and subcategories. As a result, it appears that each payment must contain a large amount of information. This information includes the currency used to make the payment, the type of payment made, the government entity that received the payment and the country that entity is located in, and the business segment of the resource extraction issuer that made the payment. The specific parameters of the information required and whether payments must be itemized (which appears to be how the law is drafted) or may be aggregated will be further defined in the rules.
Entities affected
Section 1504 also provides some measure of determining what issuers will be subject to the annual disclosure requirements. An issuer is subject to the reporting requirements under Section 1504 if the issuer is considered a resource extraction issuer based on two conditions. First, the extractive industry company must be required to file an annual report with the SEC. Because both foreign and domestic companies are required to file annual reports with the SEC to be listed on US stock exchanges, both foreign and domestic companies can fall within the definition of a resource extraction issuer. Second, the issuer must be engaged in the commercial development of oil, natural gas, or minerals. The "commercial development of oil, natural gas, or minerals" includes the "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."
It is clear that core oil, gas, and mining companies will be considered resource extraction issuers that must annually disclose under Section 1504 payments made to any government. It is unclear, however, how broadly the definition of "resource extraction issuer" will sweep—i.e., whether it will include all oil services companies or even extend to vendors that provide services peripherally related to the core extraction functions. Moreover, Section 1504 requires resource extraction issuers to report payments made by a subsidiary or an entity "under the control" of the resource extraction issuer. Thus, although unlikely given the language of Section 1504, it also is unclear whether Section 1504 would extend to a third-party vendor or contractor employed by an issuer.
Compliance issues
The first issue oil and gas companies will face is compliance with Section 1504's disclosure requirements. The rules promulgated may make a big difference in the scope of Section 1504. As noted earlier, areas that could be particularly affected by the rulemaking include the types of companies subject to the provision and the specific payment details to be included.
On July 27, 2010, the SEC announced that it was creating an open process for rulemaking whereby the public is able to comment even before the agency drafts and proposes rules in accordance with Section 1504. To facilitate public comment, the SEC has provided on its web site a series of e-mail links divided by topic.8 The SEC also announced that its staff will try to meet with any interested parties seeking a meeting. Only by actively participating in this unusual rulemaking process can oil and gas companies ensure they have a say in how Section 1504 is defined.
The rules likely will define the exact scope and level of detail of the information to be submitted under Section 1504. Many companies today, however, would be unable to provide such information without Herculean effort. Therefore, companies should start looking at their accounting systems and the information they currently require from their employees in order to prepare for complying with Section 1504.
Although final rules will not be issued for about 9 months, government payment data submitted to a company's accounting system for the fiscal year beginning after the rules have been issued must be included in the first annual report under Section 1504. If a company's fiscal year starts a day after the final rules are issued but its accounting system is not designed to capture the required information, the company may have to spend extensive resources to reconstruct the information that must be reported.
Thus it is better for companies to put specific tracking provisions in place now to ensure compliance as close to the start of the relevant fiscal year as possible. Companies should think about how to implement any necessary changes now, adjust their strategies when draft rules are proposed, and finalize implementation soon after the final rules are issued. In addition, if they do not already do so, companies should require bills, reimbursement forms, and accounting entries to include whether a payment was made to a government entity, what government entity received the payment, what country the government entity is in, the currency in which the payment was made, the business entity making the payment, what project the payment was made for, and the reason for the payment.
Avoiding FCPA liability
Disclosures under Section 1504 may also increase FCPA exposure for oil and gas companies. The FCPA consists of two sets of provisions: antibribery and accounting. The antibribery provisions prohibit payment of anything of value to a foreign official for purposes of securing business. The accounting provisions require companies to maintain certain recordkeeping standards and internal accounting controls to ensure payments are accurately recorded and irregularities indicating bribery can be detected.
The DOJ has responsibility for enforcing the criminal provisions of the FCPA and for civil enforcement of its antibribery provisions. The SEC is responsible for civil enforcement of the accounting and antibribery provisions with respect to issuers.
Section 1504 disclosures can lead to FCPA liability if the payments companies disclose to the SEC do not match up with disclosures by EITI countries of payments they have received from those companies. Although the SEC will not automatically reconcile reported payments with host-country revenues, the enforcement division of the SEC may look at audit reports published by countries participating in the EITI to compare revenues received by governments of those countries with the payments reported by companies under Section 1504.
Although any discrepancies may be a result of accounting conversions—e.g., the EITI requires country reporting on a cash basis while most companies report on an accrual basis—or other completely innocent reasons, such as differences in international accounting standards, such discrepancies can be red flags for agencies investigating bribery under the FCPA. In addition, if companies exclude payments or report payments in their Section 1504 disclosures that later turn out to be mischaracterized, the Section 1504 disclosures could be used to prove violations of the FCPA's accounting provisions.
Potential civil liability
Although the FCPA contains no private right of action, private litigants have brought shareholder suits, including securities fraud lawsuits based on SEC Rule 10b-5, when FCPA violations have been disclosed, some of which have resulted in large settlements. Under Rule 10b-5, private companies may be civilly liable for including material misstatements in or having material omissions from their annual reports if those statements or omissions are made in connection with the sale or purchase of securities, are made with scienter (knowledge of wrongness), and cause a loss to shareholders.
Oil and gas companies thus may be subject to a private securities fraud suit under Rule 10b-5 for a failure to fully and accurately report in their Section 1504 disclosures payments made that violate the FCPA. Although materiality is a requirement for a securities fraud suit, even if the payments themselves are not material, the costs of an investigation or the government fees that result from improper payments may be material.
Moreover, plaintiffs often bring lawsuits only after problems have been publicly reported. Thus Section 1504 may give plaintiffs' lawyers a hook on which to bring a civil case based on the nondisclosure or misrepresentation of payments that violate the FCPA.
Confidentiality issues
Companies subject to Section 1504 may find themselves in breach of contract if the information they disclose to the SEC is the subject of confidentiality provisions in licenses or agreements with providers of services or goods or with the country itself. A typical extraction-related confidentiality agreement may prevent oil and gas companies from disclosing to third parties any information concerning the terms of a particular arrangement a company has to purchase oil or gas from the host country. By disclosing payment streams to the SEC, oil and gas companies may find themselves in breach of such confidentiality provisions.
To avoid liability for breach of contract, prior to entering into contracts with confidentiality clauses, companies in the extractive industries should ensure that there is an exception allowing disclosure if required by law. For contracts that do not contain such an exception, prior to disclosing payment information under Section 1504, companies should ensure they have written permission to disclose confidential payment information otherwise covered by confidentiality clauses.
Ramifications of Section 1504 thus are sweeping. Implementation will require the close attention of international oil and gas companies and, perhaps, service providers. Section 1504 not only will require oil and gas companies to track government payments more closely, it also may open these companies up to additional liabilities. Oil and gas companies may find themselves facing increased scrutiny under the FCPA, additional shareholder lawsuits, including under SEC Rule 10b-5 for inaccurate or incomplete reporting, and legal liability for breach of confidentiality agreements.
References
1. Pub. L. No. 111-203, 124 Stat. 1376 (2010).
2. The text of Section 1504, which amends 15 U.S.C. § 78m by adding a section (q), is available at http://docs.house.gov/rules/finserv/111_hr4173_finsrvcr.pdf.
3. Senn, Mara V.J., Frankel, Rachel, "Firms can avoid EITI, FCPA pitfalls," OGJ, July 21, 2008, pp. 20-24.
4. 111 Cong. Rec. S3,815 (daily ed. May 17, 2010).
5. Reference 4 at S3,816.
6. "In the Matter of the Dow Chemical Company" (SEC Admin. Proceeding File No. 3-12567 Feb. 13, 2007), available at www.sec.gov/litigation/admin/2007/34-55281.pdf.
7. Bribery Act, 2010, c. 23 (U.K.).
8. Comments on Section 1504 can be submitted under the topic for "title XV-Miscellaneous Provisions" at www.sec.gov/spotlight/regreformcomments.shtml.
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