Thursday, April 11, 2013

Oral Argument in DC Circuit on Resource Extraction Provisions of Dodd-Frank Centers on SEC Cost-Benefit Analysis When Regulations Are Mandated

Oral argument in the DC Circuit involving the challenge to SEC regulations implementing the resource extraction provisions of the Dodd-Frank Act centered on the type of cost-benefit analysis needed to be done when Congress has mandated the SEC to adopt regulations. The oral argument, before Circuit Judges Tatel and Brown and Senior Circuit Judge Sentelle, occurred against the backdrop of an earlier DC Circuit opinion, Business Roundtable v. SEC. which held that the SEC was arbitrary and capricious in promulgating the proxy access rule and vacating the rule. American Petroleum Institute, et al. v. SEC, No. 12-1398, U.S. Court of Appeals for the District of Columbia.

Resource Extraction Provision. Section 1504 of the Dodd-Frank Act directs the SEC to adopt regulations requiring resource extraction issuers to include in their annual reports information on any payments made to foreign governments or to the federal government for the purpose of the commercial development of oil, natural gas or minerals. The SEC adopted regulations requiring a resource extraction company to disclose payments made to governments if it is required to file an annual report with the SEC and engages in the commercial development of oil, natural gas, or minerals. The company would be required to disclose payments made by a subsidiary or another entity it controls. A resource extraction company would need to make a factual determination as to whether it has control of an entity based on a consideration of all relevant facts and circumstances.

Cost-Benefit Analysis. On the cost-benefit issue, William Shirey, SEC Senior Litigation Counsel, said that at the end of the day Section 1504 is congressionally mandated rule-making. Congress spoke to the main issues, such as the publication of the information that comes in to the Commission that ultimately should be going out to the public in the same format, which forecloses the possibility of some kind of anonymized aggregation that neither the legislative history nor the statute speaks to.

The SEC senior counsel distinguished this case from the court’s proxy access decision in the Business Roundtable case, because this case involves a statutory provision that Congress has mandated in virtually an unprecedented fashion within the securities laws. Ultimately, the benefit is to provide payment transparency, he said, and also to provide information to investors. Senior Circuit Judge Sentelle noted that the payment transparency part of the SEC’s argument sounds ``kind of circular.’’ in that payment transparency is being compelled because it promotes payment transparency.

Given the congressional mandate, Judge Tatel asked what the role of the cost benefit analysis should be. While cost benefit is a nice formulation to use, replied SEC counsel, the Commission's obligation here is slightly more specific in that it has to consider the rule's impact on efficiency, competition, and capital formation. And as the court has instructed, that requires the Commission to consider as best it can what the economic implications of the rule are, and here the Commission did that, said counsel, ultimately deferring to Congress' determination about the benefits because the benefits were difficult to quantify or determine with any precision. But ultimately the Commission did use the cost analysis, he continued, and the competitive effects throughout the rule-making to tailor provisions, such as not expanding beyond the statute's contours the definition of commercial development, taking a very reasonable approach to the definition of de minmus, and not requiring an accounting or any kind of auditing of the disclosures. Thus, argued SEC senior counsel, the cost-benefit analysis did play a role in the discretionary components of this rulemaking.

Eugene Scalia of Gibson, Dunn & Crurcher, representing the petitioners, noted that, with respect to cost-benefit analysis, an agency assigned to protect shareholders has adopted a rule with a minimum of $14 billion cost on U.S. shareholders and to the competitive advantage of foreign countries. He argued that there were numerous ways beyond the small ministerial changes identified by the SEC counsel by which the Commission could have vastly reduced the costs, including, for example, grandfathering countries that currently prohibited these kinds of disclosures. For all of these reasons, the petitioners ask the court to vacate the rule.

Judge Tatel noted that, on the cost benefit analysis generally that the SEC states that the court’s opinion in the proxy access case was different because here there is a command by Congress to issue these regulations. In a sense, reasoned Judge Tatel, the SEC is arguing that Congress has already made the determination, at least on the benefit side of the analysis.

Rejecting the Commission’s contention, Mr. Scalia countered that any reasonably informed rulemaking where there's a statutory duty to do a cost-benefit analysis looks at where their costs fall and where the benefits fall.

On the publication issue, Mr. Shirey noted that there is issuer specific information that is coming in and projects that have to come in that have to be identified. The only use for that information is for it to be provided to the public. Thus, SEC counsel rejected the idea that somehow Congress left on the table the possibility of anonymized aggregation when the entire purpose of the statute is to provide transparency.

Judge Tatel asked what role the statutory language ``to the extent practical’’ plays. While the SEC counsel acknowledged that the statute requires compilation subject to a practicability determination and it may actually prove impracticable to do the compilation for some reason or another, he noted that Section 13(q) was added to the Exchange Act by Section 1504 and the Exchange Act is all about the public disclosure of corporate annual reports, current reports, and quarterly reports.

Statutory Language. Pressed by Judge Tatel on what in the statutory language makes Section 1504 unambiguous, Mr. Shirey said that in determining whether a statute is unambiguous you look at the structure and the design of the statute, and here you have a statutory provision that provides no use for the information that comes in other than providing that information to the public. There is no independent use that the Commission has identified to do with this information.

Section 13(q) stands on two legs, noted the SEC counsel, there is the project level disclosures, and the government level disclosures. The statute is designed to provide transparency on both ends, what resources are generating the funds, and where those funds are ultimately going to the government. Accepting petitioners' argument about an anonymized aggregation only gives the second piece of that, argued the SEC, because their whole view is that you can just anonymize the payments that are paid to the government. But if you just do that, contended the SEC, you lose that first critical piece of the transparency, the project level disclosures, and projects by definition cannot be aggregated. For example, argued the SEC senior counsel, you can't aggregate an Exxon/Mobil project with a Shell project that may sit, for example, on the other side of Turkmenistan. There is no meaningful way to determine what resource extraction activity the payments are coming from. There is no way to anonymize or aggregate that information to provide the transparency benefits.

Arguing for the petitioners, Mr. Scalia cited the SEC’s exemptive authority, which he described as a long-standing authority the Commission has to carve out what Congress has required. He noted that the Dodd-Frank Act prohibited use of the exemptive authority as to some things, but not as to Section 1504. Congress is not just presumed to have been aware, he noted, it was aware and left the authority open to the Commission.

Mr. Scalia observed that the reasons the Commission gave for not using the exemptive authority are the essence of arbitrary explanations. The Commission said an exemption would not be consistent with the language of the statute, and that it would not be consistent with the structure. He argued that exemptions by definition are exemptions that change what Congress provided.

He said that the SEC rejected a ``very sensible definition’’ of project proposed by the petitioner which, he said, was in and of itself a reason to vacate the regulation. The definition of project goes very directly to the competitive harm industry members fear, continued Mr. Scalia, which is that 90 percent of this market is dominated by state owned oil companies that will not be subjected to this requirement, and the more granular the information published the better the competitive advantage that they will receive.

With respect to requiring public disclosure, petitioner believes that there was room for discretion since the statute was ambiguous. Congress gave the SEC utmost flexibility to avoid burdening companies, emphasized Mr. Scalia, and the Commission declined to exercise that discretion.