ETR 129 The Impacts of Section 1504 of the Dodd-Frank Act
Jane Van Ryan
Posted March 22, 2011
In mid-April, the Securities and Exchange Commission (SEC) is expected to decide how to interpret a new law that is aimed at encouraging more transparency. The SEC's decision-making is critically important to publicly-traded oil companies. The ruling either could allow U.S.-listed oil companies to compete effectively against larger, nation-controlled oil companies for energy resources around the globe, or it could force U.S. companies to divulge information that could give a competitive advantage to companies such as the Chinese-controlled CNOOC.
In this podcast, Grant Aldonas of Split Rock International explains to API's Lisa Ceglia, how the law's good intentions could create real problems for U.S.-listed oil companies and their shareholders.
Use the audio player below to listen to information about the article and follow along with the show notes. I hope you find the podcast informative.
00:16 Several months ago, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act in response to the financial crisis that caused the worst recession in decades. Among other things, the law calls for U.S.-listed companies to divulge more information about their business dealings. Although the move toward greater transparency appears to be a positive development, Grant Aldonas of Split Rock International says that it could put U.S. companies at a significant disadvantage, particularly companies that compete internationally in the search for oil.
00:51 Grant, you've conducted a study outlining your concerns with the implementation of Section 1504 of the Dodd-Frank Act. First, could you briefly describe what Section 1504 says?
00:59 Mr. Aldonas: What the law requires is that U.S.-listed companies report all of the payments they make to governments, with respect to the commercial development of natural resources, like oil and gas, and do so as part of their annual reports. What's particularly striking about that is that the level of detail requiring the companies to adopt accounting procedures that are deeply inconsistent with the way they normally report information, as well as ultimately the disclosure. The point that the study really makes is that ultimately there's very little benefit, oddly enough, out of a broad reading of Section 1504, particularly relative to the cost that's going to be faced by U.S.-listed companies.
01:40 What's wrong with demanding that U.S.-listed oil and natural gas companies divulge more information about their international operations?
01:48 Mr. Aldonas: Well actually that's one of the ironies of this. All of the U.S.-listed companies were very involved in support of a multilateral effort including governments, the private sector, and nongovernmental organizations called the Extractive Industries Transparency Initiative (EITI). In supporting the EITI, the companies were perfectly willing to disclose what would have been helpful in terms of actually matching their payments with information that would be revealed by the governments that subscribe to the initiative. Unfortunately, what the law does is reach well beyond EITI, not only in terms of what it demands of the companies, in terms of reporting, but also what they would disclose. From a company's perspective, you're faced with is a situation that not only are you undermining the rules that U.S. negotiators agreed to, in a multilateral setting, but you're imposing a burden on the companies that ultimately doesn't yield more transparency, but puts them at a competitive disadvantage in the market place. It really is that classic cost-benefit thing. The cost is very high in terms of the cost it imposes on companies, but there's very little benefit in terms of the goal the legislation was designed to pursue.
03:01 Grant, many U.S.-listed oil companies are huge. Can't they compete successfully against large oil companies based in other countries?
03:09 Mr. Aldonas: There's a misperception particularly among a lot of the advocates in the transparency movement that the situation in the global energy market is somehow the same as it was in the 1970s: That it is dominated by the privately held companies (ExxonMobil, Conoco, Chevron, Texaco, etc.), but the reality is that it has changed fundamentally since the first era of embargo in the 1970s. Today if you look you would find that in the top 20 there's essentially one of those companies, all the rest are foreign state-owned energy companies. They now dominate the market.
03:55 How could the Dodd-Frank Act effect U.S. energy security?
03:58 Mr. Aldonas: First, it's a global market, so what you really want to be concerned about is whether or not you're limiting the possibility of U.S.-listed companies to compete effectively when they're bidding on a new process. It's not ultimately about price; it's whether they have access to the resource. You can imagine the reaction of the governments, even the governments that agreed to the EITI, to the idea that now these U.S. companies will be obliged to reveal much more than what U.S. negotiators and industry agreed to and what the foreign companies agreed to. One level of this is the possibility that they lose access; that they're no longer invited to bid, because there's no obligation on the part of these governments to actually invite ExxonMobil or Chevron or Conoco to bid if they feel uncomfortable with what these guys will have to reveal. The second thing is cost. Ultimately what you're requiring in this instance is the creation of a whole new kind of internal compliance program and a different set of accounting standards. No global company, not just in the energy sector, actually does their financial accounting along the lines of what a broad reading of Section 1504 would demand.
05:12 Since large U.S.-listed oil companies are owned by shareholders, many of whom have energy stocks in their pension funds and 401(k) plans, could they be hurt by Section 1504?
05:22 Mr. Aldonas: Absolutely. One of the interesting things about it is that the international companies all have to go to private markets for capital. If you make them less competitive in seeking capital, since this is a very capital intensive industry, you're going to find that they're going to be less capable of competing for the ultimate resource. They become less profitable at the end of the day. What that does from the point of view of the U.S. consumer and a U.S. investor, which is often times the same in terms of our 401(k) and our pension funds, is they no longer will have access to an investment opportunity which has paid off. That is because the international companies have the discipline of the market, unlike the state-owned energy giants who are obliged to be profitable. They base their costs on the bust, not on the boom. They manage themselves so they'll be profitable even in the bust cycle, which affects every natural resource industry. So they're always profitable, which is why everyone wants to buy their stock and their bonds. When you start to dent that, you really take the edge off of what they can deliver for the American investor.
06:20 Grant, this isn't the first time you have dealt with an international issue of this nature, correct?
06:24 Mr. Aldonas: I've been involved in the making of U.S. International Economic Policy for over 30 years, starting as a U.S. diplomat, then as a trade negotiator, later as the Chief International Trade Council on the Finance Committee and most recently as the Undersecretary of Commerce for International Trade. Equally, I've spent the bulk of my career in the private sector, in private practices as a lawyer as well as being chairman of the U.S. arm of Transparency International. I've been involved in the movement that actually encouraged transparency and that's what's made me such a strong advocate for a multilateral approach. What I've seen over those 30 years is that when the United States takes a unilateral step and imposes in effect a unilateral sanction, that only applies to U.S.-listed companies and what you find is that that never works.
07:11 In the past, U.S. listed companies have had to comply with laws that encourage transparency, like the Foreign Corrupt Practices Act (FCPA) and it seems they are still very competitive in the world marketplace. Could you talk a little bit about FCPA and how Section 1504 differs?
07:27 Mr. Aldonas: There's a tendency to suggest we should be able to impose obligations on U.S.-listed companies regardless because they remain profitable. The first question you should always ask yourself, and I know this was certainly true when I was working on the Hill, is that if I'm not going to get any return out of the legislation I am trying to pass, why would I impose an additional burden on any U.S.-listed company? That should be the starting point. Looking at Section 1504, the first question you should ask is what will it deliver? The reality is that it delivers something far short of what EITI would, because it doesn't bring the governments in as point of comparison. Ultimately, you really have to stop short of it and say regardless of how profitable these companies are, "Does it make sense to impose an additional burden if there's no return?" That is the case here with Section 1504. Assuming that they are profitable and assuming that you were getting some return out of it, you would still be obliged to say, "Are we imposing something that will necessarily make companies less competitive?" While I was Undersecretary of Commerce, I was responsible for reporting to Congress on the effect of the Foreign Corrupt Practices Act and the evidence in the record is absolutely clear. The number of export sales that we lost over a period of time because of inconsistencies between U.S. law, the Foreign Corrupt Practices Act, and the law applied by countries where many of our largest competitors were was stark. It was in the billions and billions of dollars. The idea that there's no consequence to this or there's no cost to this because a company remains competitive or because it remains profitable now really misses the point of what we've seen based on our experience with the Foreign Corrupt Practices Act.
09:14 The Securities and Exchange Commission (SEC) has to promulgate the rule that will be used to implement Section 1504, correct?
09:21 Mr. Aldonas: Absolutely, and actually it creates an opportunity. One thing that Section 1504 does is leaves the flexibility to the SEC to try to implement this law in a manner that's actually consistent with the multilateral rules that the U.S. government agreed to, that the U.S. industry agreed to, and that the nongovernmental organizations that have pressed for this legislation agreed to as well as a part of the EITI. In this instance, the SEC should use the discretion available to it to make sure that they're implementing the multilateral solution that works as opposed to opting for a set of unilateral sanctions.
09:56 Have you expressed your concerns to the SEC?
09:59 Mr. Aldonas: I did. I actually filed the analysis with the SEC for their consideration through the normal administrative process, and one thing I have to say both as a lawyer and certainly now in operating my own business, I admire the process SEC has created. It's always open, it's always very transparent. It's actually a model of the certain things that we should be doing. Kudos to the SEC for the process that's unfolding, because it will allow for a conversation that the passage of this legislation didn't allow. These are the sorts of issues that should have been raised in the consideration of the bill, fully debated and then we would have a piece of legislation that is actually consistent with the EITI and would more faithfully pursue the goal of transparency that a particular legislation that actually passed at the end of the day in Dodd-Frank when it was added to the bill.
10:50 In your view does Section 1504 really make oil and natural gas companies operations more transparent, or does it have the unintended consequences of encouraging less transparency?
11:01 Mr. Aldonas: That's an interesting question, Lisa, because it all depends on how the SEC chooses to implement the legislation. If, in fact, it uses the flexibility that is available to it, and implements the EITI faithfully as it was agreed to by the U.S. negotiators, the industry, and the NGOs, what you will see is that you will have embraced and reinforced a multilateral system that is going to have a cascading effect in terms of encouraging transparency. If, on the other hand, what you do is adopt a set of unilateral controls that fall only on the U.S.-listed companies, you do two very interesting things. One, you disable them in some respects. You'll have countries that will then be disinclined to have them bid for their natural resources. As a consequence you'll have less transparency. You'll see the market to the foreign state-owned energy companies that now dominate the global markets function in a way that will also decrease transparency, rather than increase transparency.
11:57 Grant, thank you for sharing your observations with us today and thank you for joining us on EnergyTomorrow Radio.