Just last month the President promised to cut the red tape on oil and gas production, but clearly his message didn’t get through to the Securities and Exchange Commission (SEC). The SEC final rule on Section 1504 of the Dodd Frank Wall Street Reform Act of 2010 placed the most costly and burdensome reporting requirement squarely on the backs of America’s oil and natural gas companies.
The rule requires SEC-listed companies to report payments to foreign governments, subnational governments, and the Federal Government on a project-by-project basis. Throughout the comment process the American Petroleum Institute (API) and other business groups detailed the competitive disadvantage that could befall U.S. energy companies should the SEC require public disclosure of commercially sensitive payment information.
The SEC balked, refusing to include sensible exemptions for conflicts of law and needlessly requiring public disclosures by project, without even providing a definition of “project .”
Proponents of the final rule have argued that more transparency will help citizens hold their governments accountable for resource revenue and allow investors to assess risks associated with specific projects. Transparency and government accountability are worthy goals, but the idea that this rule protects investors is truly a red herring.
Federal securities laws have long been driven by the principle that investment decisions should be based on the disclosure of information necessary to understand the elements of real and unreal values behind a given security. In determining whether particular information is material – thereby necessitating disclosure – the general rule is there must be a substantial likelihood that a reasonable investor would have considered the information important in making their investment decisions.
As already required by existing SEC regulations, oil and natural gas companies disclose a wealth of information in their annual 10-K filings. A typical oil or gas producing company will report their reserves, production, proved undeveloped reserves, and detailed information pertaining to drilling and exploration. This detailed information is more than enough for a reasonable investor to assess the investment risks of a particular operating locale on a given security.
The SEC’s final rule on Section 1504 is a huge departure from traditional investor driven disclosures. The SEC failed to apply the materiality standard to disclosure – instead adopting a $100,000 threshold which is very low for listed oil and gas entities – and imposed an undefined requirement to disclose payments on a project-by-project basis forcing companies to collect and compile potentially millions of data points compounding the costs.
The SEC crafted a rule so overly broad, that even common carriers – pipelines, trucks, rail, barges, and aircraft – that transport oil gas and minerals will be required to disclose export-related payments to governments.
By the SEC’s own estimation the rule will cost U.S. listed companies a billion dollars in initial compliance cost, tens of billions of dollars in competitive harm, and ongoing compliance costs between $200 and $400 million annually. These estimates would make Section 1504 one of the most costly rules in history and it only applies to one industrial sector.
Just like other SEC registrants, oil and gas companies disclose the material risks associated with international operations, so if Section 1504 was truly about investors, why wouldn’t other industries be included? The answer is simple; Section 1504 is just another regulation and litigation vehicle – supported by groups like the Sierra Club, Oxfam America, Earthworks and Friends of Earth –aimed at undercutting affordable energy production.
This rule has nothing to do with investors and might actually harm investor interests by decreasing U.S. companies’ ability to compete with state owned companies from Russia, China, Venezuela and Iran. Indeed, some companies have even disclosed to investors in their annual 10-K that Section 1504 presents a governmental risk which undermines international competitiveness.
The oil and gas industry has long been a strong supporter of transparency and deeply involved in the Extractive Industries Transparency Initiative (EITI). EITI is a voluntary process that brings governments, companies and NGOs to the table and verifies payments from companies and the revenues governments received. Most importantly, state-owned companies – which control 78% of the world’s proved reserves, but are not covered by Section 1504 – operating in an EITI country must also disclose their payments leveling the playing field for all companies.
Section 1504 presents the classic problem of trying to fit a square peg into a round hole. Social and foreign policy is not compatible with the SEC’s mission to protect investors and promote competition.
The potential harm to investors and costs associated with Dodd Frank Section 1504 are real, the benefits in contrast – in the words of one SEC Commissioner – are “socio-political and aspirational in nature, worthy but indeterminate.”
Surya G. Gunasekara, Counsel, American Petroleum Institute co-authored this article.
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