SEC’s Day of Reckoning on Transparency: Dodd-Frank Section 1504 on Disclosure of Natural Resource Revenues

On August 22, following a very lengthy delay, the Securities and Exchange Commission (SEC) is finally issuing the detailed implementing rules on natural resource transparency in Section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, adopted by Congress in July 2010. Specifically, Section 1504 stipulated that companies in extractive industries listed in U.S. exchanges would be required to report payments made to governments around the world.

This may sound clear enough, but as often is the case the devil will be in the details. Tomorrow those details will be in the hands of the SEC and will determine whether ‘effective transparency’ is attained or continues to remain elusive. Namely the SEC will determine whether the information that needs to be disclosed by companies is sufficiently detailed, relevant and accessible, enabling effective monitoring and analysis by civil society, investors and government reformists.

Given the content of the 2-year-old Dodd-Frank legislation, the SEC has no choice but to mandate disclosure. However, effective disclosure is by no means guaranteed as the SEC could issue weak rules, rendering disclosure ineffective. Thanks to Dodd-Frank legislation mandating transparency, the main danger is no longer wholesale ‘transparency evasion’ by many companies, but the more nuanced risk of enabling ‘transparency elusion’ (or ‘transparency avoidance’) by companies that wish to skirt detailed disclosure, thereby masking possible misdeeds.

In fact, in the aftermath of the financial crisis and in the increasingly sophisticated legal and business environment of the 21st century, outright and explicit opposition to some form of disclosure by corporations is seen as increasingly costly, particularly from a reputation standpoint. Thus, tactics have shifted to an extent – as they previously did in the tax compliance field, when some corporations ceased focusing exclusively on tax evasion opting instead for tax elusion (or tax avoidance, eluding or avoiding taxes rather than just evading them).

But more concretely, how could the SEC possibly undermine the disclosure mandated by the Dodd-Frank Act in Section 1504, and permit ‘transparency elusion’ by corporations?

There are several ways this could take place watering down of the rules could take place, effectively enabling disclosure elusion: first, by ruling weakly and in favor of corporations who wish to elude disclosure by minimizing the level of detail required by companies to disclose on payments made to foreign governments. In particular, this would happen if the SEC fails to mandate companies to report disaggregated payments for each concession, lease or contract, and instead gives them latitude to either define themselves what constitutes a ‘project’, or, possibly worse, to allow reporting only at the aggregate country level (even though the latter is unlikely, since Dodd-Frank specifies that project-level disclosure should take place).

Second, the SEC would side in favor of companies that wish to avoid effective transparency by granting them significant exemptions from reporting payments for medium-scale projects, ranging from $75,000 to $750,000 (there is already consensus that it is reasonable to exempt very small projects, such as those below $25,000).

Third, although unlikely, the SEC could grant companies exemptions in not having to report payments made to opaque (and often authoritarian) governments with domestic laws that may ban disclosure (even though there is no evidence that companies would be hurt by disclosing payments for those settings).

Finally, some oil companies represented by the American Petroleum Institute (API) and supported by Shell and others, have opted for an additional tactic to elude transparency: threatening to litigate against the SEC irrespective of how it rules tomorrow. The threat has been an overt effort to influence and weaken tomorrow’s rule-making by the SEC, while acting on that threat after tomorrow would aim to further delay the implementation of the actual disclosure rules and to subsequently weaken the transparency rules themselves.

If the SEC issues weak rules on some of the above mentioned critical aspects, companies may be able to effectively skirt disclosing financial information, which in turn would jeopardize accountability to shareholder investors and would impair analysis of tax compliance, of potential diversion of funds away from government treasuries, and of possible corruption or fraud. There also lies the positive flip side: if the SEC issues strong and effective transparency rules and leaves little room for disclosure avoidance, then accountability to investors would be enhanced and a potent deterrent would be in place regarding tax evasion and tax elusion, as well as regarding bribery and corruption among companies and public officials.

Growing evidence suggests that the benefits of transparency are sizeable for various dimensions, including incomes per capita and other social and political stability gains for the host country citizens, as well as gains for countries in terms of investments, macro-economic (fiscal) stability, financial sector development, and control of corruption.

For instance, our own data and research from around the world suggests that in the long run, with increased transparency, accountability and improved governance, citizens could see up to a 300 percent development dividend from improved governance – i.e. their incomes per capita could triple, while infant mortality could decline by two-thirds. Furthermore, some studies by other authors suggest a positive impact of transparency specifically in the natural resources sector.

But how costly to the corporate sector would disclosure be? It would be naïve to suggest that every corporation would gain (or have no costs) from full disclosure, at least in the short term. This has little to do with the actual administrative expenses of data collection for disclosure, because the incremental cost for new data collection over what data the companies already collect for tax and internal purposes would be small.

Instead, the real reason that disclosure may be costly to some companies in the short term relates to a different strand of our research: there are two types of companies, those that focus on efficiency and innovation and can thrive in a competitive level-playing field, and those that derive gains from rent-seeking (and outright bribery), monopolistic behavior or tax avoidance. The latter group would have an interest in maintaining an opaque status quo and stand to lose from a more equitable environment resulting from effective transparency, while the former group would stand to gain, since the playing field would be leveled across all companies, benefitting the entrepreneurial and competitive firms.

Therefore not surprisingly, the corporate sector remains divided regarding these transparency rules. Some mining companies have come out publicly in favor of transparency, as have prominent investors and former top executives, while some of the big oil companies are strongly opposed to it. In fact, some companies such as the giant Statoil in Norway and Newmont Mining already disclose payments voluntarily.

Thus, if one assesses the transparency benefits against the legitimate company costs (not counting the private costs to some companies due to corrupt behavior), the net payoff of transparency could be very large. This not only applies to overall societal gains, but incipient evidence also suggests that the corporate sector as a whole would benefit from a transparent level playing field (even as some opaque companies may lose out in the short term). It is also noteworthy that highly reputable pro-market, pro-business competition publications such as The Economist and the Financial Times have written prominent editorials supporting tough and detailed rule making to attain effective disclosure by companies in the natural resources industries.

But the expected large net benefits of transparency do not necessarily mean that SEC will automatically rule effectively tomorrow. It is fresh in our collective memories that in terms of its overall mandate on financial sector supervision and regulatory oversight, over the past decade the SEC failed to perform and was held partly responsible for contributing to the global financial crisis. The SEC was seen as, at best, being afflicted by poor leadership and as an ineffective bystander while the excesses of financial overleveraging and financial deregulation occurred. At worse, it was seen as having been subject to regulatory capture by the corporate sector, ultimately leading to regulatory failure (while becoming further tainted by the Madoff fraud scandal).

While some efforts to improve the SEC have taken place in recent years, the jury is still out regarding its current effectiveness in issuing and implementing regulations. Further, in the specific case of issuing rules mandating disclosure to companies in oil, gas and mining, the SEC may be overly influenced by the lobbying efforts and litigation threats by some big oil companies, fronted by the API, who oppose effective transparency.

On the other hand as the SEC aims to improve its performance and reputation, it could end up issuing effective transparency regulations in all the key dimensions, pleasantly surprising observers and transparency advocates. A good ruling would have important repercussions worldwide, including in the European Union, where preparation of similar regulations are being debated and the lead already taken by the U.S. on revenue transparency is being closely watched before they finalize their legislation.

Yet even if the SEC were to issue a strong set of rules, its role in promoting revenue transparency would not cease the day after tomorrow. How effectively the SEC fends off challenges by big oil companies, and then implements its rules in the future will matter significantly as well.

Even effective SEC implementation will not suffice in itself. Financial centers around the world would need to follow suit, governments need to continue making progress in making transparent revenue payments, working with the Extractives Industry Transparency Initiative (EITI) and similar such programs, and civil society evidence-based monitoring and advocacy efforts need to expand further, through the initiatives of the Publish What You Pay (PWYP) coalition and its member organizations.

Finally, as information from companies begin to flow more freely and transparently, analysts in NGOs, think-tanks and academia would be encouraged to exploit more fully the ‘power of data’, to further learn about improving governance in natural resources, deter corrupt behavior, and benefit citizens and honest corporations worldwide.