- SEC’s Dodd-Frank Disclosure Rule Vacated and Rejected by Federal Court in Washington, D.C.
- July 8, 2013
- Law Firm: Holland Hart LLP - Denver Office
This week in Washington, D.C., U.S. District Court Judge John D. Bates vacated the Securities and Exchange Commission's Rule implementing a provision of the Dodd-Frank Act requiring oil, gas, and mining companies to report publicly 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 to implement the reporting requirement imposed by the 2010 "Dodd-Frank Wall Street Reform and Consumer Protection Act." In so ruling, despite focusing on two specific provisions, Judge Bates vacated the entire Rule and remanded the matter to the SEC for any further action, thereby putting off implementation of the Rule. Nevertheless, given the overall policy trend in the United States and abroad toward increased transparency and reporting, particularly in the extractives sector, companies would be wise to continue efforts already underway toward compliance with the Rule.
The Bates Stamp of Disapproval: Understanding the Lawsuit and the Ruling
Section 1504 of the 2010 Dodd-Frank Act 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. Code § 78m(q). In September 2012, the SEC approved the “Disclosure of Payments by Resource Extraction Issuers” Rule by a split 2-1 vote and mandated annual public reporting by oil, gas, and mining companies of payments made to foreign governments for projects relating to the commercial development of oil, natural gas, or minerals even when such reporting was prohibited by or conflicted with foreign law obligations. By its own analysis, the SEC found that the Rule would cost U.S. public companies approximately $1 billion in their initial cost of compliance and would impose an ongoing cost of compliance of between $200 million and $400 million. In addition, the SEC found warranted industry’s concerns that foreign host country laws could add billions of dollars of costs to affected companies forced to comply with the SEC’s mandatory public reporting Rule.
The American Petroleum Institute (API), the Chamber of Commerce of the United States, and others brought a civil action against the Securities and Exchange Commission under the First Amendment to the U.S. Constitution and the Administrative Procedure Act to challenge the SEC’s Rule. The API and Chamber of Commerce alleged that the SEC in promulgating the Rule had acted arbitrarily and capriciously and violated the Administrative Procedure Act, the Securities Exchange Act of 1934, and the prohibition on compelled speech embodied in the First Amendment to the U.S. Constitution.
Without reaching the constitutional claim or several of the API’s and Chamber of Commerce’s other federal law claims, Judge Bates on July 2 granted summary judgment in favor of the API and the Chamber of Commerce, ruling (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 in which the oil development or mining occurred was arbitrary and capricious given the SEC’s limited explanation of its decision and lack of “reasoned decisionmaking.” After reviewing the relevant portion of the Dodd-Frank Act (Section 13(q)) and other provisions of the Exchange Act, Judge Bates rejected entirely the SEC’s reading of the Dodd-Frank Act and found that Congress in the Act had not required public filing of each company’s reports. In sum, because Congress did not use the term “public” in the applicable subsection (but had in others), and the definition of the term “report” does not always mean doing so in a public manner, Judge Bates dismissed the SEC’s arguments that the language and intention of the statute toward public reporting left it no other alternatives.
With regard to conflicts created by foreign law prohibiting disclosure of payment information, 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, Judge Bates found, failed to undertake any specific analysis of such costs and burdens or sufficiently “reasoned decisionmaking” in rejecting any exemption to the reporting obligation where the Rule conflicted with the established law of a foreign nation which prohibited the disclosure of payments to the foreign government. 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?
In his opinion, Judge Bates may have suggested a path forward for the SEC to implement this particular reporting requirement 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) -- among private industry and governments worldwide to make available information concerning 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, established contracts, and confidential commercial information.
In the concluding pages of his detailed opinion, Judge Bates suggested that EITI approach presented a path forward for the SEC to remedy the Rule. 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.” Now that the SEC has been informed that it does indeed have such authority, 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.”
The End of the Line for Public Reporting, or Just a Re-Routing? Notes for Extractives and Non-Extractives Companies
Although the ruling sends the SEC back to the drawing board, with a focus on two key issues, Section 1504 remains law. As such, in the broader policy context, all signs from the Obama Administration, the European Union, and others point firmly in the direction of a continued emphasis on increasing extractive industry reporting in as broad a manner as possible. In recent weeks, the G8 Communiqué1 and the OECD Global Forum on Responsible Business Conduct2 attended by governmental and business leaders from around the world, highlighted the need for transparency from extractives through public reporting. Over the last months, the State Department has prioritized outreach on Section 1504 and encouraged other governments to follow the model3 The European Union’s publication of updated extractive industry reporting guidelines, along a framework quite similar to 1504, on June 29 demonstrate that this message is being heard.4
Thus, while the next round of SEC rulemaking goes on, companies would be wise to view this as a more of a temporary halt along the trajectory and to continue preparing themselves for reporting requirements that hew fairly closely to the vacated rule. Perhaps, in the short term, there will be exemptions in the rule for certain elements of public reporting and data related to particular countries, but in the long term, those exemptions may fade in the wake of the practice of companies that decide to take these steps anyway (e.g., Rio Tinto’s public reporting on all tax payments worldwide). After all, the recently adopted revisions to the EITI standards included elements that, ten years ago, were deemed non-starters. With the United States and other developed countries now coming on board as EITI Implementing Countries (also considered an absurd concept ten years ago), these types of broad, public standards are likely to find their way back into the “expected” category down the line, meaning that preparation at the outset for the broader approach may save duplicative costs and unnecessary NGO or public scrutiny in the future.
For non-extractive companies, we highlight a few issues to take away from this ruling and overall discussion. First, again in the short-term, it is tempting to look at the connection between the failure of the SEC to include exemptions in 1504 reporting for projects in specific countries with legal prohibitions, and the unwillingness of the SEC to include a de minimis provision for minerals subject to section 1502. In sum, section 1502 requires a company (and mining companies are specifically excluded here) to determine whether gold, tin, tantalum, or tungsten are necessary, in any amount, to a product they manufacture, or contract to manufacture. If so, the company must work with its suppliers throughout the supply chain to make a reasonable country of origin inquiry, specifically to identify whether the minerals originated in the Democratic Republic of the Congo or any of its nine neighbors. If the company identifies any products containing minerals from these countries, or is unable to determine the country of origin, then it must report on the due diligence process undertaken to ensure that mineral purchases did not directly or indirectly benefit armed groups.
Second, the indicators are, increasingly, that revenue transparency reporting is moving beyond extractives. The recently instituted Burma Responsible Investing Reporting Guidelines apply to any U.S. person investing more than $500,000 in Burma5 and include a provision for public, annual reporting on, inter alia, payments to the Government of Burma (at national or sub-national levels) valued over $10,000. As companies in any sector consider new and emerging markets, with critical new business opportunities, consideration of the potential for where future reporting requirements may emerge is essential at the initial stages of investment.