On 22 August 2012, the U.S. Securities and Exchange Commission (“SEC”) adopted implementing rules on two controversial provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) advocated by certain human rights groups. The two provisions, sections 1502 and 1504, are intended to curb corruption and promote transparency among companies involved in resource extraction as well as prevent violence in the Democratic Republic of Congo. For the past two years, the draft provisions have been highly criticised by industry as being unworkable, in the case of conflict minerals, and likely to put U.S. companies at a competitive disadvantage, in the case of the natural resource payment reporting requirements. Dodd-Frank was enacted to reform the US financial system with a view to preventing financial meltdowns of the scale in late 2008. However, the intended benefits of Sections 1502 and 1504 are “socio-political and aspirational in nature,” falling far outside the mandate of both Dodd-Frank and the SEC, inviting a judicial challenge when the full language of the rules is later released. 

Section 1502 of Dodd-Frank requires a detailed reverse supply chain analysis and yearly reporting on whether U.S. public companies use certain conflict minerals (including tantalum, tin, gold and tungsten) originating in the Democratic Republic of Congo or neighbouring countries, the history and complexities of which I discussed in a prior opinion. 

A similarly “exotic" provision of Dodd-Frank, section 1504, requires U.S. public companies that extract resources to disclose in an annual report how much they pay the U.S. and foreign governments for access to oil, natural gas and minerals. Its genesis dates back to 2010, when Congress Senators Cardin and Lugar submitted an amendment to Dodd-Frank based on the Energy Security through Transparency Act (S. 1700) of 2009, which requires all listed extractive companies to publish their payments in all the countries where they operate. It was added to Dodd-Frank during the conference process after regular debate.

Under the final rules, resource extraction issuers need to disclose payments that are: (i)  made to further the commercial development of oil, natural gas or minerals; (ii) “not de minimis”; (iii) within the types of payments specified in the rules. The rules define commercial development of oil, natural gas, or minerals to include exploration, extraction, processing, and export, or the acquisition of a license for any such activity. The rules define “not de minimis” to mean any payment (whether a single payment or a series of related payments) that equals or exceeds $100,000 during the most recent fiscal year. The types of payments related to commercial development activities that need to be disclosed include taxes, royalties, fees (including license fees), production entitlements, bonuses, dividends and infrastructure improvements.

One of the major concerns raised by industry is that the rules do not contain exemptions for reporting confidential or competitively sensitive information or exemptions for instances in which reporting the payments might violate foreign laws, forcing companies to choose between following U.S. law or the law set by host countries. Angola, Cameroon, China and Qatar are frequently cited as examples. However, Revenue Watch states that an evaluation of relevant legislation in over 100 countries found that not one prohibits the disclosures required by Dodd-Frank and that most statutes explicitly allow it. Similarly, recent research conducted by Revenue Watch and Columbia University Law School found that it is standard for industry contracts to allow for disclosures as mandated by securities regulators.

The U.S. Chamber of Commerce and American Petroleum Institute had been among groups vigorously resisting initial versions of the rules. John Felmy, the chief economist at the American Petroleum Institute, said that the rule is a “draconian approach to disclosure that will unnecessarily harm U.S. competitiveness and jobs.” Daniel M. Gallagher, the SEC Commissioner dissenting, agreed, stating that the rules would put U.S. companies at a disadvantage to foreign competitors who aren’t required to make such reports: “in Section 23 of the Exchange Act, Congress prohibited us from promulgating rules - such as the rule we promulgate today - that burden competition for a purpose not necessary or appropriate in furtherance of the purposes of the Exchange Act.” 

However, the merits of this argument are debatable given the increasing trend of voluntary disclosure and mandatory disclosure at a global level. The European Commission introduced a legislative proposal in October 2011 to require all EU-listed and large EU-based extractive and timber companies to publicly disclose their tax and revenue payments to governments worldwide. The proposals are made as amendments to the Transparency Obligations and Accounting Directives and mirror the reporting requirements included in section 1504. Further, the G8 recently endorsed mandatory reporting in the extractive industries as a complement to the Extractive Industries Transparency Initiative (EITI) in its G8 Declaration released at the conclusion of the G8 Summit in Deauville, France on May 27, 2011. The Hong Kong Stock Exchange (HKEX) and the Alternative Investment Market (AIM) of the London Stock Exchange (LSE) have recently adopted listing disclosure requirements for extractive companies that include disclosing payments to host governments. The International Monetary Fund (IMF) considers revenue payment and contract transparency in the extractive industries a best practice. 

The SEC undertook a detailed cost-benefit analysis of the reforms before voting on both rules after prior rules were successfully challenged in court based on allegations it did not adequately consider costs and benefits. The SEC estimated the total industry-wide cost to companies of implementing the conflict minerals rule would be around $3 billion to $4 billion. The annual cost could run between $206 million and $609 million, including expenses for due diligence and investigations to determine the origin of the materials. On the resource extraction rule, the SEC estimated initial compliance costs at close to $1 billion, and said ongoing compliance costs could run between $200 million and $400 million. Costs include building new internal systems to catch and process the information globally, and hiring compliance and legal employees. A divided SEC approved the rules for section 1502 in a 3-2 vote, with Commissioners Daniel Gallagher and Troy Paredes dissenting. It also approved the rules for section 1504 in a 2-1 vote, with Chairman Mary Schapiro and Commissioner Troy Paredes recusing themselves.

Commissioner Gallagher implicitly invited a judicial challenge to the provisions, stating “the SEC’s mission is more limited. We are charged with taking action to protect investors, and to 'promote efficiency, competition, and capital formation.' Unfortunately, I do not think the SEC has any realistic prospect of achieving the desired result, although I am fully convinced that we will impose significant costs on issuers — and thereby shareholders — in the process. As I said earlier, the SEC just isn’t the right tool for this type of social policy exercise, as we should know from past experience. As the Chairman stated when proposing the 'Conflict Minerals rulemaking nearly two years ago, 'expertise about these events does not reside within the Commission.”

While the causes are noble, these provisions have extended the SEC’s regulatory perimeter too far to regulate. The SEC is not the correct government agency to be tasked with furthering Congress’s foreign policy objectives and the cost-benefit analysis conducted by the SEC has been widely criticised as being inadequate. While groups critical of the rules said they would wait until after the full language of the rules is released to make a final decision as to whether to file a lawsuit, such a challenge could stall or even halt implementation, as happened following judicial challenges to the SEC’s rules mandating proxy access and independence standards for mutual fund board. Ironically, such a challenge is likely to be welcomed by the SEC with open arms. Commissioner Gallagher states it best:

I want to be very clear: I care deeply about improving the accountability of governments — even our own — to those they govern. I do not, however, think the SEC is the right tool for that job. We have no expertise in that area. Congressional mandates cannot alter that fact. Conclusory policy statements are not enough. We are bound by statute and encouraged by abundant judicial precedent to demonstrate an empirically sound foundation for the actions we take. And we have no reason to think the SEC will succeed in achieving complex social and foreign policy objectives as to which the policymaking entities that do have relevant expertise have, to date, largely failed.