Earlier this month, on October 10, the U.S. Chamber of Commerce and three other industry groups filed suit against the Securities and Exchange Commission in federal court in Washington, D.C. The lawsuit seeks to overturn the recently-promulgated SEC rule implementing Section 1504 of the Dodd-Frank Act, which requires disclosure of payments to governments relating to oil, gas, and mining projects.
The New Rule
As discussed in previous posts, in late August 2012, the SEC adopted the “Disclosure of Payments by Resource Extraction Issuers” rule (the Rule), which applies to issuers that are engaged in the commercial development of oil, natural gas, or minerals, which includes exploration, extraction, processing (but not refining), and export from the host country. Section 1504 states that it is intended to support transparency regarding the payments made to governments in order to enhance accountability and good governance.
Under the new Rule, issuers must disclose all payments (or aggregation of related payments) of $100,000 or more to the U.S. federal and foreign governments for such activities. “Payments” are defined to include taxes, royalties, fees, production entitlements, bonuses, dividends, and expenditures for infrastructure improvements. Such reports must be made annually on Form SD and must include information including the amount paid, the recipient government, and the particular project to which the payment relates.
Issuers will be required to file their first report for the period beginning October 1, 2013 through the end of the company’s fiscal year, and annually thereafter. A number of multinational oil, gas, and mining companies already voluntarily report their payments to their host governments through the Extractive Industries Transparency Initiative, but the rule requires more detailed reporting for a larger number of countries.
When the SEC commissioners voted to adopt the Rule, two of the five commissioners, including the Chair, had to recuse themselves due to conflicts of interest. Of the remaining three commissioners, two voted to approve the Rule while the third issued a dissent claiming that the SEC had not adequately considered the cost or impact of the Rule, that the $100,000 threshold was too low, and that the Rule would put U.S. companies at a disadvantage to foreign competitors that are not required to make such reports.
On October 10, four industry groups filed suit in federal court in Washington, D.C. challenging the Rule. The lawsuit charges that the SEC violated the Administrative Procedure Act by adopting the Rule without taking into account significant public comments claiming that the Rule would have a negative impact on U.S. industry. The lawsuit also specifically charges that the SEC failed to conduct an adequate cost-benefit analysis as required by law.
The SEC noted in the public hearing on the Rule that the key benefits of the Rule — increased transparency and accountability of governments to their citizens — are challenging to quantify. The SEC estimated that the cost of compliance with the Rule would approach $1 billion initially, with follow-on costs in the $200 million to $400 million range.
Skeptics have charged that compliance costs will greatly exceed those estimates. The complaint quoted the dissenting commissioner, who criticized the SEC for failing to adequately tailor the Rule to avoid significant adverse effects on competition and stated that “[w]e are not at liberty to ignore selectively the longstanding congressional mandate to consider the impact our rulemaking is likely to have on competition.”
The lawsuit also alleges that the SEC improperly failed to provide for exemptions from the Rule when “necessary or appropriate,” as the SEC is empowered to do, and emphasizes the need for exemptions in certain circumstances, such as where foreign governments bar public disclosure of the subject payments.
Finally, the lawsuit claims the rule violates the reporting companies’ First Amendment rights by making them engage in speech against their will. If successful, the First Amendment challenge could invalidate not only the Rule itself, but also the corresponding provision of Dodd-Frank that directs implementation of the Rule.
The Road Ahead
The litigation is likely to grind on for some time. One question is whether the SEC will voluntarily stay the effective date of the Rule pending resolution of the litigation. While the SEC is not required to do so, it has taken that route in select prior instances. Alternatively, the plaintiffs may ask the court to impose a stay.
As to the ultimate outcome, the SEC might be vulnerable due to its cost-benefit analysis. In July 2011, a federal appeals court struck down the direct proxy access regulation, SEC Rule 14a-11, which would have given shareholders the right to have their director nominees included in management’s proxy materials, on grounds that the SEC failed adequately to assess economic impact and conduct a cost-benefit analysis.
The lawsuit has implications for the ability of the SEC to promulgate rules with costs and benefits that are not easily assessed. As a result, the litigation is likely to be closely watched by those interested in challenging the “conflict minerals” rule, issued by the SEC at the same as the conflict minerals rule. As previously discussed, on October 19, the U.S. Chamber of Commerce and the National Association of Manufacturers filed a petition of review with regard to the conflict minerals rule.
The lawsuit with regard to the extractive industry transparency rule has prompted a strong reaction from some stakeholder groups. The lawsuit drew strong criticism from the bipartisan lawmakers that sponsored Section 1504. Senators Ben Cardin (D-MD) and Richard Lugar (R-IN) called the lawsuit both “expected” and “frivolous.”
Non-governmental organizations that supported the law also protested the lawsuit. Global Witness, for example, stated, “the companies claim this law will create a competitive disadvantage, but their arguments don’t stack up.” Finally, Earthrights International and Oxfam America are considering legal action in support of the rule. Earlier this year, Earthrights and Oxfam filed a suit against the SEC seeking to compel the issuance of a final rule.