CHAPTER 2 DISCLOSURE ISSUES FOR NATURAL RESOURCE COMPANIES

• Jurisdiction: United States

Strategic Risk Management for Natural Resources Companies
(May 2008)
CHAPTER 2
DISCLOSURE ISSUES FOR NATURAL RESOURCE COMPANIES
Paul Hilton
Hogan & Hartson L.L.P.
Denver, Colorado
Patricia Elias Doherty
Osorno Legal Consulting, Inc.
Lakewood, Colorado

Table of Contents

I. INTRODUCTION

II. A SECURITIES LAW PRIMER FOR THE NON-PRACTITIONER

A. Registration or Availability of Exemption

B. 1933 Act Liability

C. 1934 Act Liability

D. Materiality

E. Statements About Past or Current Events

F. Forward-Looking Statements

G. "Truth on the Market"

H. Threshold for Summary Judgment for Materiality

I. Officer Certifications of Periodic Reports

J. Are you a WKSI?

III. REGULATION FD

A. Regulation FD - What and Why?

B. The Requirements of Regulation FD

C. Enforcement Actions

D. Implications

E. Lessons Learned

IV. FORM 8-K - REQUIREMENTS AND PITFALLS

A. Form 8-K - The Basics

B. Form 8-K - A Few Traps for the Unwary

C. Form 8-K - Implications for Late Filing

V. DISCLOSURE OF ENVIRONMENTAL PROBLEMS

A. Item 101 of Regulation S-K - Description of Business

B. Item 103 of Regulation S-K - Legal Proceedings

C. SAB 92

D. Disclosure of Environmental Liabilities in Mergers & Acquisitions

VI. INSIDER TRADING AND 10B5-1 PLANS

A. The Safe Harbor

B. Warning: The SEC's Next Enforcement Initiative?

VII. MERGERS AND ACQUISITIONS

A. Issuer Acting in the Marketplace

B. When New Facts Make a Prior Statement Misleading

C. Summary and Guidance

VIII. OIL AND GAS RESERVES - SEC CONCEPT RELEASE

A. SEC Comment Release and Request for Comment

B. Modify Definition of "Proved" Reserves in Light of New Technologies

C. Disclose Probable Reserves Plus Proved Reserves

D. Report Oil & Gas Reserves Derived from Alternative Sources

E. Broaden the Definition of Proved Undeveloped Proved Reserves and Adopt a "Reasonable Certainty" Standard

F. Eliminate Year-End Pricing in Favor of a 12-month Average Price or Average Futures Price

G. Other Issues - Third Party Evaluations

IX. CORPORATE COUNSEL AS GATEKEEPERS: UP-THE-LADDER REPORTING AND ENFORCEMENT ACTIONS AGAINST INSIDE COUNSEL

A. The SEC's Attorney Conduct Rules

B. Enforcement Actions Against In-House Counsel: Lawyers as Gatekeepers (or Scapegoats?)

I. INTRODUCTION

Today's publicly-traded resource company is dealing with a seemingly infinite range of events that may require disclosure under the SEC's periodic reporting rules and is faced with an unforgiving landscape. The post-Enron political and social context has upped the ante for violations of the securities laws, providing an often hostile legislative, regulatory and judicial environment, as well adding numerous corporate governance requirements to the quiver of federal regulators and private plaintiffs. "Periodic reporting" under the Securities Exchange Act (the "1934 Act") has become more aptly described as "continuous reporting," and the headline crisis of the moment continues to shift from month to month--option grant timing, corporate governance, executive compensation--the list goes on.

We have attempted to summarize the areas of securities law which are of greatest concern to in-house counsel while concurrently providing a "primer" on the fundamentals of securities law for the non-securities law practitioner, in four parts:

• first, an overview of some of the core concepts of the securities laws - concepts that any lawyer or executive with responsibilities involving providing information that is material to a resource company's public reports will benefit from mastering;

• second, a description of several key disclosure topics under the securities laws - regulation FD ("Fair Disclosure"), 8-K reporting pitfalls, insider trading and reporting of related-party transactions;

• third, a specific discussion of the SEC's proposals relating to disclosure of Oil and Gas Reserves; and

• finally, a brief overview of SEC enforcement actions against in-house corporate counsel to illustrate situations where in-house counsel is expected to act as "gatekeeper" in the prevention of securities law violations.

II. A SECURITIES LAW PRIMER FOR THE NON-PRACTITIONER

A. Registration or Availability of Exemption

All securities must be registered. The premise of securities regulation in the United States is that the sale of any security, must be registered with the SEC (with all the elaborate

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disclosure requirements that entails), unless an exemption from registration is available. Public offerings are registered under the Securities Act of 1933 (the "1933 Act") on Form S-1 (for initial public offerings and companies with a market capitalization under $75 million), Form S-3 (for larger public companies offering securities for cash), Form S-8 (for equity incentive plans), and Form S-4 (for issuances of stock in exchange for stock, assets or other non-cash consideration).

Exemptions from Registration. Exemptions from registration are available for sales to Qualified Institutional Buyers (QIBs) and "Accredited Investors" (a specific term meaning investors with enough assets and experience to understand what they're buying), for sales within the safe harbor of Regulation D and the judicially-outlined private placement exemption and some sales to non-U.S. persons outside the U.S. under Regulation S.

Welcome to the Reporting Family. Once a company has over 300 stockholders or has completed an initial public offering, the company must register the publicly-traded class of securities and commence reporting under the 1934 Act. "Reporting" under the 1934 Act includes annual reports (on Form 10-K), quarterly reports (on Form 10-Q), reports on Form 8-K when any of an extensive list of events occurs, and reports of all stock grants to and purchases and sales by certain executive officers (often known as "Section 16" reporting). The company must also file proxy statements containing extensive disclosure of the matters to be voted on at any stockholder meeting. These "periodic" reports are entirely separate from the reports that any public company must file if it is offering securities to the public, registering securities held by stockholders for resale (Forms S-1, S-3 and S-8) or issuing securities for purposes of acquiring another company (Form S-4).

Listing the Securities. Of course, if in connection with a company's public offering it chooses to apply for listing on a stock exchange such as the New York Stock Exchange, the Nasdaq Global Market or the AMEX, the company must also comply with rules issued by the particular exchange on which it is listed--for example, rules relating to corporate governance (including the number of independent directors that must be on the company's board, the functioning of nominating, compensation and other committees of the board), shareholder approval of certain matters such as issuance of a large number of securities or establishment of a stock option plan, and other matters such as voting rights rules.¹

B. 1933 Act Liability

The 1933 Act was enacted to combat fraud in connection with an offering of securities by a company.

Section 11. Section 11 of the 1933 Act provides for civil liabilities if a registration statement (which contains the prospectus), at the time it is declared effective, "contains an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading."

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This is "strict liability," and the plaintiff need not show reliance on the misstated fact or causation of harm from the omission - the failure to make proper disclosure of a material fact entitles the plaintiff to get a full refund of the purchase price.

Anyone who acquired a security issued by the company if the registration statement contained or omitted such material facts is entitled to sue, among others:

• Every person who signed the registration statement (CEO, CFO and a majority of the board);

• Every director of the company at the time of the filing of the registration statement;

• Every "expert" named in the registration statement (such as reserve engineers or accountants);

• Any person or entity who controls one of these persons or entities; and

• Underwriters of the offering.

In addition, each person may be held liable for the full amount of the offering, subject to available indemnification and contribution rights. Directors and underwriters can limit their liability by establishing a "due diligence" defense, i.e., having counsel review all factual statements made in the registration statement and prospectus to establish the basis for a reasonable belief that all material facts are properly disclosed.

The SEC adopted major reforms relating to the offering of securities in 2005.² The SEC implemented the reforms to facilitate the securities offering process and increase the timeliness of disclosure of information to investors. Of significant importance, one provision provides that disclosure liability for public offerings attaches to the state of events and the adequacy of disclosure documents at the time of sale rather than at the earlier time of effectiveness of the registration statement. This is where Section 12(a) of the 1933 Act, which imposes liability on sellers for material misstatements and omissions in connection with the sale of a security, becomes important. Section 12(a) does not contain the strict liability of Section 11, but remains a potent weapon for plaintiffs.

C. 1934 Act Liability

The 1934 Act also sets a standard for liability for disclosure by a company or any person engaged in a securities transaction, officer, director or a stockholder under Rule 10b-5: if any person makes "any untrue statement of a material fact or omits to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading . . . in connection with the purchase or sale of any security."³

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