United States: New SEC Rule Aimed At Oil Companies

Lara Covington is a partner for Holland & Knight's Washington DC, office

Lisa Prager is a partner for Holland & Knight's New York office

Oil and gas companies are now required to report payments made to US or foreign governments under a new SEC rule that went into effect on Sept. 26, 2016. The reporting rule, called Rule 13q-1, requires detailed reports of payments made to governments for the commercial development of oil, natural gas, or minerals. The new rules were announced on the heels of similar initiatives adopted by the European Union (EU Accounting Directive and EU Transparency Directive), Canada (the Extractive Sector Transparency Measure Act), and the Extractive Industries Transparency Initiative.

As the rule takes effect, oil and gas companies may have to report more than just payments to US and foreign governments. Rule 13q-1 is part of the US policy to combat global corruption, promote accountability, and improve governance in resource-rich countries. It is also the result of a protracted rule-making that included challenges by the American Petroleum Institute (API), US Chamber of Commerce, and others as well as more than 150 unique comment letters and more than 149,000 form letters.

One of the chief concerns for many oil and gas companies was the public reporting of project-level data and the potential for competitive harm. Another issue that received decidedly less attention during the rulemaking is the impact of the anti-evasion provision and how it will require even further disclosures of certain payments traditionally within the ambit of the Foreign Corrupt Practices Act (FCPA), i.e., payments intended to benefit foreign government officials that are made pursuant to the commercial development of oil and gas.

REPORTING UNDER RULE 13Q-1

The new rules apply to oil and gas companies, but also more broadly to "resource extraction issuers," which includes all US and foreign companies engaged in the commercial development of oil, natural gas, or minerals that are required to file SEC Form 10-K annual reports. The requirements also cover the subsidiaries or affiliate entities included in a reporting company's consolidated financial filings. Subject companies must disclose information about the type and total amount of payments made for each project related to the commercial development of oil, natural gas, or minerals, and the type and total amount of payments made to each government, among other details.

Under Rule 13q-1, "commercial development" is defined as exploration, extraction, processing, and export, or the acquisition of a license for any such activity. "Project" means operational activities that are governed by a single contract, license, lease, concession or similar legal agreement that forms the basis for payment liabilities with a government.

A payment or series of related payments must amount to at least $100,000 during the same fiscal year to fall under Rule 13q-1. "Payment" includes taxes; royalties; fees, including licensing fees; production entitlements; bonuses; dividends; payments for infrastructure improvements; in-kind payments; and if required by law or contract, community and corporate social responsibility (CSR) payments.

Rule 13q-1 includes two targeted exemptions. The first provides transitional relief for companies that acquired an entity not previously subject to the final rules and allows them to delay reporting payment information for the acquired company until the first fiscal year following the acquisition. The second exemption provides a one-year delay in reporting for payments made in connection with exploratory activities, which was intended to address concerns from the API about the potential competitive harm that could be caused by disclosing payments to local governments in connection with "high-potential exploratory territory" and other commercially sensitive information. The rule also permits the SEC to provide relief from the requirements of the rules on a case-by-case basis; for example, where the required payment disclosure is prohibited under the host country's laws.

ANTICIPATED INDUSTRY EFFECTS OF RULE 13Q-1

Under the Rule 13q-1 reporting regime, oil and gas companies will likely see an increase in voluntary disclosures and investigations under the FCPA due to the rule's anti-evasion provision.

The FCPA prohibits corrupt payments to foreign officials and political parties for the purpose of obtaining or retaining business, securing an improper business advantage, or influencing or inducing an official act by the official or political party. But the FCPA does not impose a mandatory disclosure requirement on such payments unless they are deemed "material."

Rule 13q-1's anti-evasion provision captures payments that are related to the commercial development of oil, natural gas or minerals but are structured to avoid disclosure. This includes payments intended to benefit individual government officials. For example, payments for government expenses, providing jobs or tuition to persons related to government officials, and CSR payments to foundations or charities that are favored or controlled by government officials must all be disclosed if made to further the commercial development of oil, natural gas or minerals. In describing the anti-evasion provision, the SEC recognized that it captures such payments to individuals and referenced a case study that highlighted the role that resource extraction companies play in facilitating the suspect or corrupt practices of foreign officials seeking to divert resource extraction payments that belong to the government.

Because the rule requires oil and gas companies to disclose payments to individuals that are related to the commercial development of oil and gas, it will impact the way oil and gas companies respond to FCPA issues. Typically, when companies discover an FCPA issue, they conduct an analysis of several factors to determine whether to voluntarily disclose, and likelihood of disclosure is usually one of those factors. If the issue in question involves a payment to an individual related to the commercial development of oil or gas that will have to be disclosed under Rule 13q-1, the company will likely feel compelled to also disclose that payment to the DOJ and SEC.

In addition to increased voluntary disclosure under the FCPA, US enforcement authorities may use Rule 13q-1 disclosures as leads to investigate possible corruption. Rule 13q-1 is aimed at detecting and preventing corruption, and is thus a natural source of evidence for FCPA enforcement agencies. In fact, in issuing Rule 13q-1 and defending the decision to require project-level reporting, the SEC referenced its experience in implementing the FCPA and explained that disclosed data could help "citizens, civil society groups, and others to identify payment discrepancies that reflect potential corruption and other inappropriate financial discounts."

For Royal Dutch Shell, the first company to report under The Reports on Payments to Governments Regulations 2014 in the United Kingdom, a civil society group has already raised questions about the contents of its report. A review of the Royal Dutch Shell report by the organization Publish What You Pay revealed that the value of an in-kind production entitlement payment to the Nigerian government for the SPDC East project ($20.89 per barrel) was less than half of the average values for other Nigerian payments in kind ($51.59 per barrel). There are likely many legitimate explanations for this discrepancy, but for an eager investigator, it might be just enough to launch an inquiry into how the in-kind payment was valued and whether the official in charge of the SPDC East project was improperly influenced to accept a lower value.

Payments made through third parties, particularly CSR payments to foundations or charities, are also likely targets for US enforcement agencies. To the extent there is corruption involved with a project, the disclosure of these payments will provide investigators with information that could lead to the detection of such corruption.

OIL AND GAS COMPANIES SHOULD BEEF UP COMPLIANCE

Finally, Rule 13q-1 will likely lead to increased FCPA compliance. As the SEC noted in issuing the rule, reporting project-level data related to payments to governments "may also discourage companies from either entering into agreements that contain suspect payment provisions or following government officials' suspect payment instructions."

In preparing for compliance with Rule 13q-1, companies should begin a regular review of payments that may need to be reported under the rule's anti-evasion provision, including auditing projects involving payments to governments and reviewing any third-party relationships related to those projects. In addition, oil and gas companies should consider reexamining existing corruption compliance policies and procedures and investigating any other red flags raised in completing projects related to commercial oil and gas development.

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