• SEC’s Dodd-Frank Disclosure Rule Vacated by Federal Court in Washington, D.C.
  • July 11, 2013
  • Law Firm: Holland Hart LLP - Denver Office
  • Last week in Washington, D.C., U.S. District Court Judge John D. Bates vacated the Securities and Exchange Commission's ("SEC") Rule implementing Section 1504 of the Dodd Frank Wall Street Reform and Consumer Protection Act ("Dodd Frank"). Section 1504 requires oil, gas, and mining companies to report payments made to foreign governments in connection with the commercial development of oil, natural gas, or minerals. Judge Bates, in a detailed 30-page opinion, found that the SEC had acted arbitrarily and capriciously when it promulgated certain aspects of the "Disclosure of Payments by Resource Extraction Issuers" Rule implementing Section 1504. Though his ruling focused on two specific issues, Judge Bates vacated the entire rule and remanded the matter to the SEC for further action, thereby suspending implementation of the rule.

    The Bates Stamp of Disapproval: Understanding the Lawsuit and the Ruling

    Section 1504 of Dodd Frank directed the SEC to issue a rule requiring each "resource extraction issuer" or public oil, gas, or mining company to include in an annual report to the SEC information relating to any payment made to a foreign government or the U.S. government "for the purpose of the commercial development of oil, natural gas, or minerals." 15 U.S.C ยง 78m(q). In September 2012, the SEC adopted the disclosure rule by a 2-1 vote. The SEC rule required not only disclosure of payments to the SEC, but also mandated public disclosure, even when such reporting conflicted with or was prohibited by foreign law. The SEC found that the rule would cost U.S. public companies approximately $1 billion for initial compliance and would impose an ongoing cost of compliance of between $200 million and $400 million. These estimated costs do not include potential additional billions of dollars in costs to companies because of - among other things - business disruptions in connection with the Section 1504 disclosure requirements.

    The American Petroleum Institute (API), the Chamber of Commerce of the United States, and others challenged the rule, alleging, among other things, that the rule (and the statute) compelled speech in violation of the First Amendment of the Constitution, and that the SEC acted arbitrarily and capriciously in violation of the Administrative Procedure Act and the Securities Exchange Act of 1934. On July 2, Judge Bates granted summary judgment in favor of plaintiffs. Avoiding the constitutional question, the court ruled (1) that the SEC misread the Dodd Frank Act to mandate public disclosure of the required reports, and (2) that the SEC's decision to deny any exemption where the reporting obligation conflicted with foreign law in the host nation was arbitrary and capricious given the SEC's limited explanation of its decision and lack of "reasoned decisionmaking."

    On the public reporting issue, Judge Bates rejected entirely the SEC's reading of Dodd Frank and found that the Act does not require public filing of each company's reports. Judge Bates was unpersuaded by the SEC's contention that the language and intention of Dodd Frank compel public reporting. He observed that while Congress used the term "public" in other sections of Dodd Frank, it did not use the term "public" Section 1504. Further, Judge Bates reasoned, the term "report" does not always mean public reporting.

    With regard to conflicts between Dodd Frank disclosure requirements and foreign law, Judge Bates noted that the SEC itself had found warranted concerns that the Rule could add billions of dollars of costs to affected public companies. Yet the SEC failed to undertake any specific analysis of such costs and burdens, and failed to engage in sufficiently "reasoned decisionmaking" in refusing to create a reporting exemption. Accordingly, Judge Bates found that the SEC had "abdicated its statutory responsibility to investors," and that the SEC's "decision to deny any exemption was, given the limited explanation provided, arbitrary and capricious."

    Identifying the SEC's Reset Button: the Relationship Between Section 1504 and EITI

    In his opinion, Judge Bates suggested a path forward for the SEC to implement Section 1504 of the Dodd Frank Act. Judge Bates noted in his opinion that key oil, gas, and mining companies had acted to institute a voluntary international initiative - the Extractive Industries Transparency Initiative (EITI) - to disclose payments by extractive industry companies to governments. Under the EITI, governments combine with civil society and industry groups to set and carry out an established protocol for reporting payments, thereby achieving greater transparency while honoring foreign law and protecting established contracts and confidential commercial information.

    Judge Bates wrote that the SEC "noted throughout the Rule that it will burden competition and harm investors, but viewed itself as powerless to address that harm" because of its mistaken narrow interpretation of its discretion under Dodd Frank. With the benefit of the court's ruling, Judge Bates observed, the SEC "may well strike a different balance." More specifically, Judge Bates commented that in light of the SEC's stated intention to follow the EITI approach and that the Dodd Frank Act reporting requirement "deviates from the EITI less than the Commission assumed," the SEC "may materially alter the Rule in light of flexibility it did not know it had."